Free trade game just got tougher

Charismatic Chinese politician Bo Xilai famously resorted to Olympic imagery - proclaiming New Zealand the "gold medal winner" - to explain why China decided to negotiate a trade deal with a tiny nation of just 4.4 million.

On October 1, 2008, the ground-breaking China-New Zealand free trade agreement came into force, giving greater access to the 1.3 billion-strong Chinese market and reducing tariffs on many of our prime agricultural exports to zero over a lengthy phase-in period.

Five years on, Bo has been stripped of his political rights and is serving a life sentence in Beijing's Qinchen prison after being convicted on charges of bribery, embezzlement and abuse of power in an extraordinary saga which scandalised China, and exposed the deep division in the senior echelons of the ruling Communist Party, which were sparked by his own cynical attempts to capitalise on latent Maoism.

It's worth recalling upfront that when Bo - at the time China's high-flying Commerce Minister - came down to New Zealand for those first tentative steps in the free trade gavotte, he said it was former Prime Minister Helen Clark's decision to award China "market economy status" that clinched the State Council's decision to allow this country to jump to the top of its free trade queue.

"Put it this way," he told me in an exclusive interview for the Herald, "by offering us a very small favour you have got in turn a huge market.

"Of course all the participants due to their excellency need to be admired. But only the first three will be offered medals. And in the opinion of the Chinese people this time, New Zealand proved to be a gold-medal winner. Congratulations."

The free trade deal has lost none of its gold medal lustre.

New Zealand's dairy exports to China have soared. So much so that we are now known as the "Saudi Arabia of milk".

The dairy industry has been the major winner from the FTA, which resulted in tariffs coming down more quickly than they did for major international competitors. But Fonterra's profits have also been underpinned by the huge Chinese demand for foreign milk powder which emerged after the 2008 melamine contamination scandal destroyed parents' trust in products made by their own dairy companies.

Local infant formula manufacturers have since sprung up by the dozen to cash in on the New Zealand brand. China's own dairy companies are rapidly expanding their footprint here, with the biggest, Yili, building a $214 million state-of-the-art infant formula plant on the South Canterbury plains; while Yashili's $220 million Pokeno plant is expected to sport a strong "green" sustainable image.

Shanghai Pengxin is gearing up to celebrate the first anniversary of its controversial acquisition of the Crafar farms. And Synlait's joint venture with Shanghai's Bright Dairy continues to flourish.

New Zealand meat exporters - after a lengthy period of trying to make headway in an environment marred by barely disguised Chinese bureaucratic protectionist tactics while they were urged by NZ officials not to "go public" - are finally making strides.

Within China, manufacturers such as Fletcher Building, with its rapidly expanding laminate business, are leveraging the premium end of the market as Chinese consumers' love affair with high-end brands goes from strength to strength. The key tourism business is flourishing to the point where Chinese property companies are now seeking to build superior hotels here to cater to affluent Asian tourists.

It is not widely acknowledged, but the FTA also conferred on New Zealand a special status in China via its investment chapter. This smoothed the way for Chinese manufacturers to buy assets here, such as Haier with Fisher & Paykel Appliances. The provision was also aggressively cited by Chinese officials when they believed New Zealand was unfairly impeding Pengxin's farm acquisition.

But the brute reality is that there is now a new hardball era in China, which this country's politicians, bureaucrats and businesspeople are still learning to navigate. Chinese regulators are Free trade game is just getting tougher

zeroing in on alleged corporate price-fixing by foreign companies in industries ranging from dairy, to pharmaceuticals, to the multinational automotive sector.

Fonterra is among a group of dairy companies swept up in the crackdown and it has already been fined. The NZ dairy company said its fine was one of the lowest in the range and that it co-operated with the pricing review by the powerful National Development and Reform Commission (NDRC).

"We believe the investigation leaves us with a much clearer understanding of expectations around implementing pricing policies, which is useful as we progress our future business plans," was how Fonterra China boss Kelvin Wickham put it.

The Wall Street Journal had a different take, bluntly reporting that several dairy firms were spared punishment because they "carried out active self-rectification".

This tough new environment calls for a much more sophisticated approach than New Zealand has previously deployed. This is no better illustrated than by the respective approaches taken during the recent food scare, sparked by Fonterra's decision to issue a multi-country product recall after tests revealed a batch of whey protein was potentially contaminated with botulism-causing bacteria.

The Chinese Embassy's commercial counsellor Zhang Fan told TV3's The Nation that Chinese consumers were questioning why Fonterra kept making mistakes, an oblique reference to Fonterra's shareholding in Sanlu - a company which was deeply embroiled in the melamine disaster - and the February controversy over the discovery of the nitrogen inhibiting chemical DCD in some milk powder exports.

Said Zhang: "They are asking: 'Why is always something wrong with Fonterra?' As they say in Chinese: 'Mistakes should not be repeated again and again'.

Fonterra was caught unprepared for a major food recall. Cabinet ministers added to the confusion by saying China had slammed its dairy trade doors shut to New Zealand, when officials had just stopped potentially affected product.

As for Zhang, his shrill tone surprised New Zealand officials, suggesting they may have rather naively relied on the many celebrated "firsts" in the relationship - including the FTA - and falling back on the "special friendship" to see the country through the inevitable stoushes in significant trading relationships.

It is not that simple. Cabinet ministers now know that New Zealand is frankly under-cooked to deal with the growth of trade and investment since the FTA came into force. Official representation is being stepped up.

Fonterra will come under added pressure as the Chinese Government's orchestration of the consolidation of its dairy industry into just a few state-supported national champions gathers pace. Before the recent food scare, Fonterra's executives believed their company would play a significant role in the consolidation. That might still happen. But right now Chinese officials want the New Zealand dairy sector to concentrate on tidying up its own patch first. There are also questions over whether New Zealand should follow suit and consolidate its own infant formula manufacturing sector into just a few trusted players, as China is doing.

This poses a challenge to New Zealand's own cherished free market ideals and is causing murmurings among smaller infant formula exporters that it would be unfair to wipe them off the table when it was Fonterra, not them, who caused the damage to the New Zealand brand.

The situation will play out and a great deal of work is under way in China to recover New Zealand's market position.

The free trade agreement has ensured greater market access for our firms. But China is still China.

Rakon has had to trim its ambitions; Zespri's Chinese subsidiary was fined after a Shanghai court upheld smuggling charges against the Kiwifruit exporter's Chinese subsidiary and one of its employees; and some under-funded Kiwi companies continue to find it tough going.

This year former Chinese Vice-Commerce Minister Wei Jianguo suggested to the inaugural China New Zealand Partnership forum in Beijing that New Zealand should treat the FTA effectively as a living document and look for new areas of co-operation.

There was a sense from leading Chinese present that this country should not rest on its laurels as the first Western nation to cement a free trade agreement with China and take more note of the fact that the preferential access New Zealand now enjoys will be lost when China notches up deals with other nations.

Australian PM Tony Abbott has made finalising his country's FTA a priority for his new Government.

Senior Chinese business players have applauded Prime Minister John Key's suggestion that New Zealand and Chinese commercial interests - particularly in the food sector - should combine forces in third countries.

The FTA has given New Zealand a valuable springboard into China. But the days of amateurville are well over. The Olympic race track is getting crowded. New Zealand will have to lift its game if it wants to stay the gold medal winner.

Herald columnist Fran O'Sullivan is Co-Chairman of the annual China Business Summit; sits on the advisory board of the NZ China Council and moderated the Beyond the FTA session at the inaugural China New Zealand Partnership Forum in Beijing this year.