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More on Rio, BHP-Billiton & Chinalco’s rejected love

I had thought my comments for Australia’s national interests being best served by rejecting the Rio-Chinalco deal were self-evident.  My general argument was that Australia should not give up its monopoly power in the resource sector by transferring resource assets to Chinese firms with monopsony power over the purchase of Australian raw materials.  These arguments were set out more fully here.

But obviously not – others have very different views.  The ANU’s Peter Drysdale provides an alternative viewpoint on the East Asia forum.

According to Peter the main issue is politics not economics – the Chinese will retaliate for the rejection of the Chinalco bid and we have damaged Chinese ‘generosity’ towards Australia’s many ‘failings’ as a nation, a fact that will impede future relations to the detriment of both countries.

In a private communication Peter rejects my claim that – apart from transport issues – there is any significant monopoly power in these markets and argues that my viewpoint is inconsistent with “Applied International Resource Economics” 101.  

I remain however unrepentant in my view that Australia should have a clear ‘national interest’ argument for approving foreign investment proposals and that in this case there was no sensible case for allowing the Chinalco move to proceed. Whether Kevin Rudd skilfully delayed approval until the Chinalco move failed or whether, as Rio stated, it simply changed its mind given a change in market conditions we will not know for 30 years until Cabinet papers are distributed.   But the shift was advantageous to Australia.

In response to Peter’s claims I argue as follows.

On the issue of providing evidence for monopoly power. The massive BHP profits for a start ($13.7b in 2007), the annual negotiations over iron ore and coal prices (contract iron ore prices rocketed 85% in 2008/09) and the enormous market share China takes from Australia suggest this is not a price-taking industry where prices are driven to the marginal cost of extraction.  There will be additional transport economies in the Pilbara resulting from the merged operations but essentially a Rio-BHP unit in the north-west will have enhanced market power which is the reason their share prices both rose so strongly after the announcement.  They rose when they saw the Chinalco deal was not going through.

 

Immediately too after the announcement – and again in today’s SMH – the Chinese side started moaning about the ‘monopoly power’ of the merged BHP-Rio entity. They saw the monopoly issue clearly and I am surprised that Peter does not. The huge set up costs in terms of providing transport and port infrastructure as well as the massive concentration of iron ore resources in Australia’s north west make it most unlikely these industries are contestable.

 

Why would Australia transfer ownership of key resources to a foreign monopsonist purchaser of these resources?  This is the possible reason Rudd went slow on the Chinalco bid and rightly so.

 

Having lived in Asia for a decade I constantly experienced attempts by local civil servants and politicians to put Australians ‘on the back foot’ by drawing attention to discriminatory immigration policies and alleged xenophobia.  This is pure hypocrisy and should not be taken seriously, and to our national disadvantage, in disputes over foreign investment approvals or trade.   The argument is a negotiating tactic by Asian governments that does not reflect reality unless it is misguidedly taken seriously.

 

China will be disappointed in the failure of the Chinalco deal but this has nothing to do with a failed ‘love affair’ with Australians. The Chinese sought to demolish Rio’s price-setting power in iron ore and coal markets and to thereby deflate any market power BHP-Billiton might have.  China is acting in its self-interest and should do so. So was Australia which was not being xenophobic or anti-Chinese at all.  It was simply acting in its national self-interest.

 

On the issue of long-term retaliation by the Chinese against Australia because Australian firms seek to exploit monopoly power in resource markets – it needs to be understood that possible Chinese retaliation is a commercial reality that will need to be internalised by Rio-BHP.  The most likely retaliation is that China will seek alternative suppliers. Then Rio-BHP may need to levy ‘entry forestalling’ prices if it is to best capitalise on its market position.  

7 comments to More on Rio, BHP-Billiton & Chinalco’s rejected love

  • derrida derider

    Once again I agree 100% with you Harry. Stopping the deal was a no-brainer.

    What you say about allegations of Australian “racism” being used as a pretext in commercial and political negotiations is true, and is indeed hypocrisy. The obvious response is to call them on it by pointing out their own racist and xenophobic practices, which are often far far worse than any Australian ones. Publicly offending them would hurt us in the short run (and entrench their view of us as rude) but it would soon put a stop to this game.

    It doesn’t mean that Australian racism is not a genuine problem for Australians though.

  • Uncle Milton

    “The most likely retaliation is that China will seek alternative suppliers.”

    There is only one to speak of, the Brazilian company Vale. (Or the Chinese could go to Twiggy Forrest, except he’s tiny, and Australian too.) But as any elementary Cournot Nash model of oligopoly will tell you, when Rio and BHP act in concert, that will put up the price that everyone charges, including Vale.

    The problem for the Chinese can be summed up in three bullet points.

    1. They want to make a lot of steel.

    2. To make steel, you need iron ore.

    3. Most of the world’s iron ore is to be found in Western Australia.

  • hc

    I think that the Cournot-Nash story is right – the prospects of small and new producers (as well as Vale) are improved. I am sure too there will be a scramble for smaller producers both by Rio-BHP and Vale and, of course, by China. China already has a 17% stake in Twiggy.

    I read recently that the combined annual iron ore out of BHP and Rio is 270 million tons annually. Amazing!

  • People are talking about the monopoly issue and the Cournot Nash model just like they can be applied anywhere without a need to be modified. It is laughable for such a naivety. Don’t you think it might be more appropriate to use a strategic model of strategic gaming by monopoly and monoposony (not sure the spelling is correct)? There is a need for a little bit more advanced economics, perhaps. Let’s be realistic about it.

    China is much bigger than Australia. It is unlikely that Australia will benefit from strategic gaming with China. So it may be in Australia’s interest not to play that game and build trust with the Chinese to benefit both.

    Just think one side can move and the other side, the bigger one doesn’t is misleading to not only other people, but self-cheating as well. Let’s be mature, alright?

  • hc

    Lincoln, I don’t know what you are talking about.

    ‘It is laughable for such a naivety.’ Demonstrate don’t just make an abusive claim.

    It is spelt ‘monopsony’.

  • hc, some quick points to discuss with you. First how do you define national interest clearly so that whoever is reviewing foreign investments can apply it consistently across the board? Second, is your argument of monopoly power by Australia correct or informed as it should be? Both Rio and BHP say they would market their share of iron ore production separately that seems to contradict your argument. Third, Are either Rio or BHP wholly owned by Australians, so Australia has the monopoly power? If they are not, why an increase in Chinalco’s share in Rio would reduce any monopoly power that Australia has?

    In terms of models, why is the Cournot-Nash story right in this case? Isn’t that model assumes perfect competition on the demand side? if that is the case, is that consistent with your argument of monopsony power demand?

  • This is by far the greatest post I’ve identified on this subject, thanks for making my day.