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Global macro & geopolitics from a small economy perspective

On small states & large states: China & NZ

Global Brief, Fall 2014
David Skilling

The liberal, rules-based international system is weakening, with a more fragmented system emerging in which larger countries can exert more influence. This will be particularly challenging for small countries, which are disproportionately reliant on international institutions and the rule of law to ensure open markets and a stable security environment.

A small country at the end of the world provides a useful perspective on these emerging issues. New Zealand has been relatively insulated from previous episodes of great power politics because of its physical isolation (“a strategic dagger pointed at the heart of Antarctica,” as a former New Zealand prime minister once put it). But as the centre of global economic and political gravity moves towards Asia, New Zealand is grappling with a new strategic context. New Zealand is adapting to this relatively well, but ongoing adaptation to this disruptive change will be required.

New Zealand – as with Australia – has long been seen as a Western outpost in Asia, is physically on the periphery of Asia, but is now aware that its economic and strategic future is increasingly tied to the region. Indeed, New Zealand has benefited substantially from the explosive economic rise of China; this relationship was one of the key factors that moderated the effect of the global financial crisis on New Zealand.

The share of New Zealand’s merchandise trade exports sent to China rose from four percent in 2001 to 22 percent in 2013. China is now New Zealand’s largest goods export market, and tourism, migration, and investment flows are also growing rapidly. The Chinese economic relationship is expected to continue to grow strongly. Prime Minister John Key recently committed to an official target for two-way trade with China to increase by another 50 percent to NZ$30 billion by 2020 from about NZ$20 billion today. This growth is supported by investments to increase New Zealand’s official representation in China, now New Zealand’s largest offshore physical presence. The September re-election of the government for a third term will see a continuation of this policy direction.

In addition to the substantial economic benefits that this relationship has generated, it creates a significant economic exposure. A Chinese economic slowdown would now have a significant effect on the New Zealand economy. New Zealand has previous experience with such economic exposures. One of the searing moments in New Zealand’s history was 1973 when the UK joined the European Community, ending preferential market access for New Zealand exports to Britain (which accounted for about half of New Zealand’s exports in the 1960s). This generated substantial economic costs.

Indeed, one general lesson from small states is that economic diversification is valuable: you do not want to have all of your eggs in one basket. Partly for this reason, New Zealand is actively involved in negotiating free-trade agreements with a broad range of partners (including the Trans-Pacific Partnership), and has developed strategies for building engagement with ASEAN and the Gulf Cooperation Council. But, even so, New Zealand still has significant – and growing – economic exposures to China.

In addition to the direct consequences of this economic concentration, there is a sense that this economic exposure may create a broader vulnerability in which China is able to exert economic pressure on New Zealand. For example, it may be able to use New Zealand’s economic reliance on China to encourage New Zealand to act in a particular way or to sanction New Zealand for particular behaviour. This may restrict New Zealand’s freedom of choice, or make certain choices more costly.

This vulnerability is due to a manifestly asymmetric power relationship. China clearly has more direct influence and hard power than New Zealand. And New Zealand’s economic reliance on Chinese demand is greater than China’s reliance on New Zealand (there are alternative suppliers of milk and other commodities to which China could shift).

New Zealand’s rapidly growing commercial relationship with China has been built on the basis of a strong bilateral political relationship, developed through sustained investment by successive governments over four decades. For example, New Zealand was the first country to recognize China as a ‘market economy’ for the purposes of WTO accession in 2004. This led to the world-first free-trade agreement (FTA) with China (and now FTAs with Hong Kong and Taiwan), as well as a recent agreement on Renminbi convertibility. New Zealand has been careful to position itself as relatively independent, and has not disagreed with China on major issues. Indeed, China refers to New Zealand as a model for the ‘bilateral relations between China and other developed countries’.

The flipside is that the ongoing health of the economic relationship is contingent on the state of the political relationship. And as the bilateral relationship becomes larger and more complex, New Zealand will inevitably be confronted by a series of challenging questions and choices with respect to China. It is likely that Wellington will do or say something that will put the country at odds with Beijing on an issue about which the latter cares about. This need not be the consequence of New Zealand’s political mismanagement as much as the realities of the interaction between large and small powers (as a Chinese official recently warned an ASEAN meeting: “we are large, you are small”). And China is becoming a much more assertive regional power with respect to its neighbours, such as Vietnam and the Philippines, not to mention Japan.

The differences in approach to China between New Zealand and Australia partly reflect these realities. Australia has adopted a more assertive stance on regional issue in Asia, has the US alliance as a central part of its foreign policy, and is deepening its relationship with Japan. But this is based on a more balanced economic power relationship between Australia and China: Australia has an even greater economic exposure to China, but has the great advantage of Chinese reliance on its supply of high quality iron ore.

To provide a sense of how China is prepared to act to advance its interests, it is useful to consider recent country experiences. In 2010, the Nobel Peace Prize was awarded to a Chinese dissident by the Norwegian Prize Committee. Exports of Norwegian salmon to China were subsequently restricted (for new veterinary reasons), resulting in significant losses in market share. The Norwegian government recently announced that they would not meet with the Dalai Lama, with a view to restoring the Chinese relationship.

In the UK, Prime Minister Cameron was refused a state visit to Beijing after he met with the Dalai Lama in 20102. The relationship is still relatively cool compared to that enjoyed by European competitors Germany and France. The UK’s quiet stance on recent protests in Hong Kong is seen to be at least partly based on a desire not to upset China. And in South East Asia, China uses its economic importance to influence the behaviour of the new ASEAN members – making it more difficult to reach unanimity in ASEAN on South China Sea issues.

To be sure, China is not the only large country that uses its economic power over smaller countries. New Zealand has memories of French behaviour in the 1980s after the Rainbow Warrior bombing; and New Zealand has not been at the front of the queue for an FTA with the US, in part because of its stance on the Iraq War and its anti-nuclear stance in the 1980s (which resulted in banning US naval vessels from New Zealand ports). Political power has always mattered, but it seems likely that economics and politics will be more tightly linked with respect to China than for other relationships.

The possible pinch points could be many things, from New Zealand’s stance on regional issues to policy on Chinese investment in New Zealand. But the ability for small countries to act fully independently is more difficult when large countries have significant economic power, and the multilateral system is not functioning well.

The intersection of international economics and politics – and the growing need to balance economic and political interests – will be a real challenge for many countries – not just New Zealand. In the region, countries like Australia and Singapore face many similar issues. History shows clearly that large countries tend to act like large countries. And so small countries in Asia – and elsewhere – will need to continue to be very thoughtful in order to survive and prosper in the shadow of large powers.