A New Era for Australia-Japan Economic Ties

Only a few years ago close watchers of the Australia-Japan relationship were lamenting its lack of élan, its similarity to a stale, if comfortable, marriage. You could hardly think that now. In the past five years $36 billion in foreign direct investment has been made in Australia by Japanese companies. The longevity of the relationship has been revised, to reveal a much higher value than previously thought. While investment from China has been grabbing the headlines, Japanese investment has been much larger but uncontroversial. To put it into perspective, in the 3 years 2008-2010 direct investment from China was about $9 billion, whilst from Japan it was almost $13 billion. The total stock of Japanese direct investment in Australia at the end of 2010 was $49.4 billion, the third largest after the US and UK. The Chinese total stood at $12.8 billion, most of it resources.

The key characteristic of Japanese investment has been the diversity of economic sectors into which it flowed. This pattern fits well with the notion of ‘new complementarity’, which Andrew Cornell and I first applied to the Australia-Japan relationship in 2008.

One of the key lessons of the latest phase of globalisation is that the risk of ventures in any new markets is lessened by greater adjacency. That is, the more connections the new venture has with existing successful ventures, the better the chances of success. Adjacency may be literal, in terms of geography, but more fundamentally it is about opportunities alongside and complementing businesses and relationships already in existence. All markets and particularly Asian markets depend to a greater degree on well developed human capital networks. The 50 years of formal Japan-Australia ties means these networks are into third and even fourth generations, including well established business, cultural and social networks. Rather than seeing a staid relationship, it means recognising incremental and highly opportunistic value that is relatively easily exploited.

Both Australian and Japanese firms have competitive assets and capabilities in various parts of the same value chains and can find complementarities throughout, not just opposing ends of the spectrum. The accumulation of economic activities, in whichever sector, produce competition but it also produces numerous opportunities. Australian and Japanese companies have complementary competitive advantages in many diverse sectors, which provide opportunities for joint ventures, supply of goods and services and M&A.

Soft power, popular culture, robotics, pharmaceuticals and biotechnology, advanced services – these are some of the myriad new fields previously not considered part of a Japan-Australia relationship but growing in response to developments in each economy and shared issues such as the demographics of ageing.

Australia will become an even more attractive destination for Japanese direct investment, not just in raw materials and energy, but also in food and beverages, financial services, pharmaceuticals, renewable energy and life sciences. Similarly, Japan will attract Australian capital and capabilities in wealth management and other services. The structure of Japan’s private sector is heavily pronounced towards services. In 2010 manufacturing was 22% of GDP while services was more than 75%. There are two points to be made here: it is in services that many of the new business opportunities will arise; and an increasing level of Japanese manufacturing is produced outside Japan, especially in Asia, which has enormous networks of fragmented production and trade of intermediate goods.

Recent examples of these trends abound. From Japan: Kirin, Suntory, Asahi Breweries, Dai Ichi Life, Sekisui House, Sojitz and MUFG (Lynas), MUFG (AMP Capital), ITOCHU (desalination plant), Mitsubishi (iron ore, water utility), Mitsui (wind farm), JFE Engineering (water recycling), Kansai Electric and Sumitomo (power stations), Nippon Steel Engineering, Chiyoda

From Australia: Niseko (skiing, real estate), Toll Holdings (logistics), Challenger Financial (real estate), Qantas Jetstar, ANZ, NAB, AMP Capital (funds management), Blake Dawson (legal services).

Japan’s northern island, Hokkaido, is now the fastest growing skiing destination for Australians. Australian investment in the Niseko fields have accelerated the trend by considerably expanding Hanazono, establishing, developing and running operations, including Niseko International Ski School, Demo Ski Hire and Fusion retail. Australian accents are firmly entrenched on the slopes.

I also hope that more Australians will travel to Japan to enjoy the many delights on offer, from the highest culinary levels, to the historic and natural attractions (temples, mountains, rivers, bamboo forests, autumn leaves). Perhaps the Jetstar venture will create opportunities for Australians to travel easily within Japan and outside the usual places.

Australia’s most Asia-focused bank, ANZ Banking Group, had already identified Japan as a vital investment location. Not for branches and lending but for the other side of the bank’s balance sheet, the liquidity required to finance lending.

Japanese companies are increasingly looking at Australia when looking abroad for biotechnology partners and services. Australians are developing a reputation for quality, reliability and innovation. An example is the opportunity in pharmaceuticals where Australian product and technical expertise is increasingly coming to the attention of the Japanese market. In March 2009, the biotech group Biota Holdings struck a deal with Daiichi Sankyo.

Japan and Australia share a similar concern for environmental issues. Environmental issues create particular opportunities in advanced know-how and technologies in site remediation (soil and groundwater); waste disposal/management (hazardous waste incineration/destruction, industrial waste and product recycling); environmental management systems and global standards compliance

Ventures in other Asian countries are a key part of future Australia-Japan commercial relations, referring to the “integrated production chain” at the heart of modern Asian economic success. Just as Japanese commercial firms, most recently in food and agribusiness, have recognised Australia as a production/manufacturing base for products like noodles and beverages for third markets, so is this opportunity available more broadly.

In the past couple of years there have substantial joint missions of Australian and Japanese companies exploring the huge potential of collaboration in infrastructure projects and PPPs in India and Indonesia, as well as in Australia and Japan.
Building on the past, future business opportunities will be shaped by three major factors:

• the tectonic shift of relative economic power to the Asian region;
• corollary: regional economic integration intensifies as regional production and services are interlocked.
• opportunities for investment in Australia, based on the rise of Asia and on the future growth in Australia’s population and income;
• demographic forces in Japan, which lead to the need to invest offshore for growth and to the surplus of savings which provide finance.

The core economic relationship remains firmly founded on Japan’s lack of energy and raw materials and Australia’s abundance of same and reliability of supply. The three major factors mentioned above will add considerably to this core relationship. Built on the foundation of the core relationship, the most important contribution to the marginal increase in wealth will come from Japanese direct investment into Australian industries.
Three recent publications provide some insights into the long term trends and consequences for demand, supply and investment. For both Australia and Japan these trends have enormous implications.

ANZ Insight Issue 1 August 2011: Earth, Fire, Wind and Water: Economic Opportunities and the Australian Commodities Cycle, “Since 2000, the nature of global economic growth has been turned upside down. Until then, global growth was primarily driven by the developed world with about two thirds of growth coming from the developed world, and one third from the developing world. Between 2000 and 2010, this pattern was turned on its head. In the five years to 2010, almost three quarters of global growth came from the developing world.”

Asian Development Bank (Aug 2011): Asia 2050: Realizing the Asian Century, “Asia is in the middle of a historic transformation. If it continues to follow its recent trajectory, by 2050 its per capita income could rise sixfold in purchasing power parity (PPP) terms to reach Europe’s levels today. It would make some 3 billion additional Asians affluent by current standards. By nearly doubling its share of global gross domestic product (GDP) to 52 percent by 2050, Asia would regain the dominant economic position it held some 300 years ago, before the industrial revolution. With a per capita GDP of $40,800 (PPP), Asia in 2050 would have incomes similar to Europe’s today. It would have no poor countries (those with average per capita GDP of less than $1,000), compared with eight today.”

HSBC Global Research (Jan 2011): The World in 2050, “World output will treble, as growth accelerates on the back of the emerging economies. On average, annual world growth is projected to be accelerate towards 3% compared with growth of just over 2% in the 2000s. Emerging-world growth will contribute twice as much as the developed world to global growth over this period. By 2050, the emerging world will have increased five-fold and will be larger than the developed world. 19 of the top 30 economies by GDP will be countries that we currently describe as ‘emerging’. China and India will be the largest and third-largest economies in the world, respectively. Substantial progress up the global league table will be made by a host of other emerging economies – most notably, Mexico, Turkey, Indonesia, Egypt, Malaysia, Thailand, Colombia and Venezuela.”

A large number of low-income populations are experiencing increasing levels of income and are demanding more natural resources: minerals, energy, food. It is in Asia that the greatest such shift is occurring, between Australia and Japan. This is a long process of decades, not a cyclical “boom”.

“The direct export opportunity is unparalleled in Australian history. If Australia expands capacity rapidly enough, commodity export revenues1 could reach $480 billion in real terms by 2030, even with significant price and margin reductions across key sectors. Direct and support sector employment could double with at least 750,000 jobs created, and likely many more. Investment related employment in particular is likely to grow faster than current estimates indicate.” (ANZ Insights)

In parallel with the demand for natural resources, there will be a huge increase in opportunities for the services and manufacturing sectors that connect with mining. The connected industries should not be underestimated. To give an indication of the scale and diversity of these connected sectors, they include:

Engineering consultancy services; heavy industry; non-building construction; plant hire and leasing; explosive manufacturing; machinery and equipment wholesaling; surveying services; port operators; rail freight transport; road freight transport; shearing, cropping and other services to agriculture; fertilizer manufacturing; pesticide manufacturing; scientific research; contract mining; information technology; consulting & process engineering; logistic suppliers; labour hire; electrical contractors; electrical utilities; drillers; testing services; remote housing; mining software; recycling/waste management; financial services; project development business.

“Unprecedented investments are required. Around $1.8 trillion in commodity related investment is required over the next 20 years equal to almost 50% of today’s total Australian capital stock across all industries. This investment is enormous by any measure, and represents a large increase compared to historical investment. Commodity related investment levels were around $30 billion per annum prior to 2006, and gradually climbed to more than $60 billion in 2010. In our Base Case, investment climbs to more than $100 billion, before stabilising at around $80 billion in 2015 (representing more than 5% of GDP).” (ANZ Insights)

Japanese capital will be one of the key sources of investment. This happening already but will only accelerate in the future as the demand for capital expands to unprecedented levels.

Demand for minerals and energy is primarily driven by two processes: urbanization and industrialization. Demand growth accelerates as countries move from around US$2,000-3,000 per capita up to US$10,000-15,000. Typically the movement of large numbers of the population from rural areas to cities creates huge demand for housing, roads, rail, water, electricity and heating. Urbanisation in both China and India has been proceeding at extraordinary rates, about 15-20 million in China and about 10 million in India. There will be literally hundreds of cities with populations of more than 1 million people.

As income levels increase, total calorie consumption increases. Whereas average daily kilocalorie consumption in the least developed countries is 2,150 per capita, in developing countries it is around 2,800 and in advanced countries it is around 3,500. Just as important, the nature of those calories changes dramatically. Lower income country diets are focused on cereals, which are typically the least resource intensive foods (that is, they require less land and water per calorie). However, higher income country diets are more focused on fruit and vegetables, sugars, meat, dairy and other animal products such as eggs. Much of this is about a shift in diet from carbohydrates to protein. These foods are far more water and land intensive per calorie.

The economic growth of China and India, will result in rising income levels and industrial expansion. In turn this will increase the demand for imported soft commodities (wheat, soybeans, feed grains) due to the additional demand for water resources, which are limited in both countries. Expansion of agricultural exports from Australia would be expected, which would in turn require investment.

By Manuel Panagiotopoulos of the Australian & Japanese Economic Intelligence