Written by Dr Ken Henry, Non-Executive Director – FASSA, BCom, PhD, DB h.c, for Corporate Finance Insights – February 2014

 Australia’s role in securing the food, water and supply chains of Asia will be dependent on our ability to embrace change and innovation, says Dr. Ken Henry.

There are some key parallels between the issues my colleagues and I were grappling with when I was leading the development of the former government’s White Paper on Australia in the Asian Century and those The Economist team, headed by Laurel West, Asia Director Industry & Management Research, encountered when writing the recent NAB sponsored White Paper – Improving Food Quality in Asia. As we consider those common issues, we need to start by stepping back and putting them into a broader context.

Outlook – population and consumption

Over the last 50 years, the world’s population has grown about 120 per cent. At the same time the world’s production of food grew by about 180 per cent. So food production has outstripped population growth by some margin. Today Asia consumes more than 50 per cent of the world’s total food production.

Globally 1 billion people suffer from chronic hunger – 600 million of them live in the Asia Pacific region. A further 1 billion people in the world live on less than US$2 per day in income – those people too should be regarded as being food insecure.

Paradoxically, at the same time we have an alarmingly accelerating incidence of obesity – so we should not only be thinking about food quantity but also about food quality.

By 2050 the world’s population will grow by about one-third, which means there will be about 9.5 billion people living on the planet. Global food demand will increase by 70 per cent over that time period: inAsia, food demand will double and in non-Asian countries food demand will go up by about 40 per cent.

As consumer numbers rise, they are also becoming wealthier – in terms of incomes and real wealth. Today there are about 500 million people throughout Asia, including South Asia, who are regarded as middle class. By 2030, that number is expected to be 3.2 billion people.

There are some products – meat, milk and eggs, vegetable oil and sugar – that are subject to increasing demand at a more than proportionate rate with income. In Australia today average meat consumption is between 100 and 110kg/person.

In South Asia it’s 5.5kg/person. But by 2050 it will probably be 18kg/person. In East Asia more meat is consumed already – 40kg/person increasing to 75kg/person/year.

Water and food security in focus

On the supply side there are some obvious challenges. Firstly fish stocks have been severely depleted around the world, including Asia. Secondly the supply of arable land is shrinking due to continuing urbanisation and population growth.

Between now and 2050, Asia’s population will grow by more than 1 billion people – 400 million of those will be in India. In China the rate of population growth is already quite slow. Even so, China’s population will grow by another 60 million people out into the 2030s before it starts to decline.

The spectacular growth in global food production in the last 50 years was made possible by more intensive irrigation. Today 80 per cent of Asia’s fresh water is devoted to irrigation agriculture. And there are significant water quality problems already being encountered, particularly in China and India.

Sixty per cent of China’s ground water is regarded as ‘bad’ or ‘worse than bad’. Fifty per cent of the water in the Hai River basin and in the Yellow River is considered unusable for any purpose including agriculture. China creates desert at the rate of 2,500sqkm/year.

Although a major increase in food production has occurred with the introduction of new crop varieties, fertilisers and irrigation, crop yield growth has stagnated recently. In addition, agricultural input costs have been increasing strongly and trade policies throughout the region remain poor.

There are some big issues at stake here. Regional security is a key concern. Food security, water security and energy security are front of mind for the Chinese political leadership. That means that China has an intense interest in both the sources of water, food and energy and in the quality of their supply chains.

It’s worth asking whether China can satisfy its legitimate aspirations for security in food, energy and water without disturbing the peace and stability of the region. Those security considerations are among the factors that are driving interest in vertical integration in all three areas but especially in food and energy.

Opportunities for the future

Yet one should not be pessimistic in all of this. There are opportunities – in particular for Australia. We probably grow enough today to feed 40 to 60 million people. It’s possible that Australia could double or even triple food production – and I’ve heard higher estimates than that.

But even if we were to triple our food production, we would be feeding only a very small proportion of the world’s population – and only a very small proportion of the Asian population. We couldn’t even aspire to feed more than one-twentieth of Asia’s middle class, no matter what we were to do with our agricultural production.

But with Asian food demand doubling over the next 40 years as predicted, and with a premium being placed on high quality, safety and reliability, there is an extraordinary opportunity for premium Australian produce.

The Asian century White Paper points to the following factors that should assist Australia in carving out a future as a safe, reliable and high quality food supplier in the Asian century:

•  Proximity to Asian markets;
• A relatively open foreign investment system;
• Expertise in environmental management and environmental sustainability;
• Robust bio-security systems;
• A record of innovation;
• A reputation for high-quality safe product;
• A skilled workforce;
• A strong financial system; and
• Demonstrated expertise in logistics and supply chain management.

These factors give Australia an impressive brand, but there are some things we need to do and need to do better. The first is to develop better links between scientists and businesses both here in Australia and across the region; these linkages are going to be needed to underpin the development of best practice in food production and value adding in food.

We also need a better understanding of work places and of cultures in the region. If Australian businesses are going to do well in the region, Australian business people need to become much more Asia capable. We need businesses that are capable of securing partnerships in the region and as part of regional and global value chains.

Competition and the cost base

A key question is around how Australian businesses can hope to compete given a high local cost-base, relative to the region. When commodity prices took off in late 2003, it was the biggest external demand shock the Australian economy had ever experienced.

Something had to give in order to re-equilibrate aggregate demand and aggregate supply. And the thing that gave was the relative price between Australia and it’s trading partners. That relative price is captured in two things – the nominal exchange rate (the average of Australia’s exchange rate with all of its trading partners) and the relative cost of production. You can think of the latter as relative nominal unit labour costs.

From the end of 2003 through to when the global financial crisis (GFC) hit, both the nominal exchange rate and nominal unit labour costs accelerated. Since the GFC, things have been a little different. The AUD is still pretty high: the nominal trade weighted exchange rate is still elevated relative to its average of the 1990s. But Australia’s costs of production, while still growing, have not been growing at the pace of our trading partners. That effect is starting to wear off. Nevertheless, Australia has become a much more expensive place for doing business.

Ingredients for the future

There is a role for Australian businesses in securing niches in global supply chains and indeed in regional supply chains closer to home, through partnerships that are built on trust, mutual respect, and focussed on quality, reliability and safe product.

The Asian agricultural and food production sectors produce mass product at low cost. That is not our future. Our future is in high quality product. But we’re only going to secure that future if we have a good understanding of Asian culture, of the way business is done in the region, and if we have businesses that are capable of securing partnerships in regional and global value chains.

Trade liberalisation in the region is also required – and that’s why every Australian government that I’ve been associated with has banged the drum about the need for further trade liberalisation and especially in the Asia Pacific region. It’s good to see that the new government has emphasised that it is determined to secure further regional trade liberalisation.

Greater knowledge and more sophisticated regulation in Australia that supports sustainable agricultural development in this country are also critical ingredients. We have our own ecosystem and water sustainability challenges but we have demonstrated the capacity to introduce innovative regulatory regimes for enhancing environmental sustainability of agricultural practices. Even so, more work needs to be done.

Massive infrastructure investment is required in Australia if we’re going to secure our future in the Asian century, and that includes our future in agri and food businesses throughout Australia.

Not all of Australia’s future agricultural product is going to come from the north, but there is certainly an infrastructure deficit in the north of Australia, particularly road and rail infrastructure that connect places in an east-west direction rather than a north-south direction. This country has a strong infrastructure backbone, but it’s lacking ribs.

We also need to do whatever we can to further develop an Australian national brand. And that brand is going to be a clean, safe, secure brand. That’s the area in which we’re going to be able to secure a future.

Attending to all of the factors that affect two-way investment flows should be a key priority going forward. By that, I mean Australian investments in the region. But I’m also talking about regional investment – whether it be Chinese, Japanese, Indian or Korean – investments in Australia. Finally, we need to ensure that Australian business ventures can access capital in the right form, at the right price, for the right tenor. National Australia Bank has declared a strong interest in ensuring that Australian businesses are able to access capital appropriately.

Since the Australia in the Asian Century White Paper was released, we’ve had a change of government. While it’s too early to speculate about the implementation in light of that change, we should be very optimistic.

This government has indicated already that it has a deep commitment to ensuring that Australia has a much more intensive and extensive focus on infrastructure. It has also indicated that it’s going to conduct a broad review of the Australian financial system, which will provide an opportunity for the development of some of these issues, particularly access to capital. And the government has also indicated that it’s going to undertake a review of the Australian taxation system.

There is enormous opportunity for change that will benefit agricultural food production in Australia and improve the prospect of Australian food producers making the most of the Asian century.

This article was first published in Corporate Finance Insights – February 2014.  For more Corporate Finance insights download the full report.

More from NAB:

India Monetary Policy Review – April 2014

Commodity Update: Minerals and Energy – March 2014

China: Special Update – 19 March 2014