The 1936 Trade Diversion Policy – China, the United States and Australia: A Balancing Act in Retrospect

By Honae Cuffe*

Executive Summary

• For much of the twenty-first century so far, Australian foreign policy has been centred on a hedging of bets, orchestrating a careful balancing act between the US and China and the security and economic interests each embodies. The unfolding US-China economic conflict is the latest development bringing into sharp relief the inherent tension in Australia’s national interests.

• More than a recent phenomenon, Australia has long been balancing national, region-centred interests and great power interests. What is the likelihood of a positive outcome in this balancing act? The events of 1936 can perhaps shed some light.

• The 1936 Trade Diversion Policy saw Australia enter a trade war with its second-best trade partner, Japan. To understand why Australia would willingly risk an affluent trade relationship and, more critically, the carefully constructed diplomatic relationship, we must consider the imperial Australian-British relationship.

• The events of 1936 draw attention to the challenge of integrating Australia’s regional interests within the framework of a great power alliance. They serve as a warning to the government of today against a binary approach to foreign policy, suggesting the logic of a varied approach to economic and strategic relationships in our neighbourhood.

 

As a person living in a globalized and increasingly unstable world, I find US President Donald Trump’s recent decision to introduce a range of increased import tariffson steel and aluminium, and the tit-for-tat US and Chinese economic sanctions this has instigated, scary – even if the final range of tariff hikes is yet to emerge, following  a negotiation period.

As a researcher of Australian foreign policy history, specifically the tradition of trilateralism and the challenges of balancing global and regional national interests, these developments seem more than a little exciting. The possibility of a US-China trade war is the latest episode in a decade-plus long game of tug-of-war for power, principally in the Asia-Pacific region. Amidst all this is Australia, caught between its greatest security and trade partners, carefully orchestrating a balancing act between the two.

Although Foreign Affairs Minister Julie Bishop also appears to be cooling on the Trump administration—warding off US isolationism, condemning the nation’s increasing aversion to the rules-based order and, in a February 2018 speech given at the Menzies Centre for Australian Studies at Kings College London, throwing some doubt on the future of the US role in Asia-Pacific security when conceding that many of the US security commitments are ‘not formalised’—she continues to cite the US as Australia’s most important relationship in Asian-Pacific security. Simultaneously, Australia claims to be living in the ‘Asian Century’, encouraging the quiet diplomacy of cultural exchange with Asia. The New Colombo Plan, set to be ‘transformational [in] deepening Australia’s relationships in the region’, is the most obvious example, but there are also more tangible gains secured in bilateral and multilateral free trade agreements. While it is the ‘Asian Century’, China, for obvious reasons, ever dominates the discussion. In addition to economic opportunities, this has also included growing political and public concern surrounding Australia’s reliance on China and Chinese influence in Australia. Like the US, albeit with different intentions, the Australian government has responded by limiting Chinese property investments and banning foreign political donations; moves that have been condemned by some as a threat to Australia’s security and economic prosperity and pandering to US desires to curb Chinese influence.

Late in 2017, in the face of the shifting global and local power dynamics and the new challengesthis has created, the Department of Foreign Affairs and Trade released a Foreign Policy White Paper. While this was the department’s first comprehensive White Paper since 2003, it did not offer much in the way of an evolution of Australian foreign policy. The takeaway message was, as Rémy Davison notes, very clear: ‘in a high-stakes game of international poker, there is one certainty: you must hedge your bets’.

However, this hedging of bets is not a novel approach in the tradition of Australian foreign policy. For much of its history, Australia has faced the challenge of balancing its national interests between the opposing strategic outlooks of a regional and great power. What is the likelihood of a positive outcome in this balancing act? The 1936 Trade Diversion Policy can perhaps shed some light.

 

 ‘A complete repudiation of all that had gone immediately before’

On 22 May 1936, the Australian government, under the leadership of Joseph Lyons, announced the Trade Diversion Policy (TDP). The TDP was touted as combating Australia’s foreign debt. Australia’s foreign debt was, in the main, the result of a longstanding adverse balance of trade with the US. This had been exacerbated by a mild economic boom in the early months of 1936 following increased export prices across the board. Rather than improving the nation’s economic position, imports escalated while exports grew only marginally. In addition, the wool yield for the year 1934/35 had been below average. In addition to an amendment of foreign import licensing systems, the TDP also introduced new prohibitive import duties for a large range of textiles. These targeted so-called ‘bad customers’; those nations benefiting from unfair trade advantages or whose imports from Australia were low in comparisonto their exports. This approach saw the US targeted. It was hoped that‘badcustomers’ would be forced to pursue a more favourable position in Australia’s market if they were threatened with exclusion. Contrary to this logic, however, was the targeting of Japan. Due largely to Japan’s need for raw materials and Australia’s capacity to produce them, Japan appeared to be a ‘good customer’. In fact, Japan was Australia’s second-best trade customer in terms of volume of trade, and at a very favourable ratio of 1:3. Only the UK, with the benefit of the imperial preference system, established at the 1932 Imperial Economic Conference in Ottawa, surpassed Japan. The imperial preference system was the British Empire’s response to the Great Depression. It was founded on the principal of greater imperial economic cooperation via discriminatory tariffs. Its aim was the restoration of Britain’s global economic position through promoting secure markets and protecting against competing markets by simply blocking them out. The dominions were granted preferential tariff rates in empire trade. In return, Britain was provided quotas of meat, wheat, dairy and fruit to be purchased from the dominions free of duties.

Prior to the TDP, Japan and Australia had been negotiating a Treaty of Friendship, Commerce and Navigation. However, these negotiations collapsed suddenly following Australia’s demand that Japan introduce a voluntary quota reducing the volume of textile goods exported to Australia. In the context of negotiating a trade treaty, and in view of Australia’s highly favourable balance of trade, Japan expected reciprocal trade to be encouraged. Not surprisingly, Japan refused to cooperate. With textiles targeted under the TDP, and this being Japan’s largest export, there was no doubt about whom Australia was targeting. Japan’s response was swift and harsh. On 25 June, the Japanese government announced an imperial ordinance that boycotted Australian goods. Almost all Australian exports were implicated, either through an absolute prohibition or under special import duty rates of fifty per cent. Australia responded with a new licensing system that extended to virtually all Japanese exports. The two nations were locked in a trade war.

The confused economic logic of the TDP is only compounded in light of the strategic environment of the Pacific in the 1930s. Much like today’s political situation in the Asia-Pacific, the region was in the throes of territorial disputes and a military power balance in flux; the UK having accepted naval parity in post-First World War disarmament negotiations, positioning Japan’s as the third largest navy in the worldand the dominant power in the Sea of Japan and the North Pacific. By 1936, the Japanese military had a stronghold on the government, effectively signalling the start of the nation’s rearmament process. Japan had invaded the Chinese province of Manchuria in 1931, going on to establish the puppet state of Manchukuo. It was condemned by the League of Nations for the invasion and subsequently left the organisation. In this geo-political climate, Australia did not wish to do anything that might antagonise Japan. In fact, trade offered a useful pathway to cultural and political diplomacy. This can be seen, for instance, in the 1935 appointment of a trade commissioner to Japan, whose role the Minister for External Affairs John Latham conceived as being a representative of Australian goodwill, spreading a ‘persistent and tactful …propaganda’.

 Much like those who have called into question the Turnbull government’s recent restrictions on Chinese investments, why would the Australia of 1936 willingly risk an affluent trade relationship and, more critically, the careful system of diplomatic ties it had established with Japan? To understand this, the significance of the British textile market, both in strategic and economic terms, must be considered.

Britain, Japan and the Global Textile Market

In the wake of a trade war, Australian Prime Minister Lyons offered a justification for TDP measures, in which he lay the entire blame on Japan and the textile exporters who had ‘continuously and drastically’ reduced the prices of their goods beyond reasonable competition. Interestingly, however, Australian and Japanese textile exports were not in serious competition. In fact, the cheap and readily available goods that Japan was able to offer were a boon for Australian buyers still recovering from the global depression. Two-thirds of Japanese imports to Australia did, however, compete with British textile imports.

Britain had recovered slowly from the economic haemorrhaging experienced during the First World War and Great Depression. In part, this experience was the result of industrial mismanagement and in part an inability to compete with rising markets. Conversely, Japan’s markets expanded, and in 1932, it had replaced Britain as Australia’s chief textile supplier. An even more critical loss came the following year when Japan became the largest cotton market in the world.

British textile producers, who held considerable influence in domestic politics, blamed the competitive Japanese textile industry and pressured the government to limit its trade advantage. Britain turned to protectionism, accusing Japanese producers of extensive cost-cutting and dumping. The British Tariff Board recommended that the British Empire form a united front, applying anti-dumping duties against a range of Japanese textiles to protect Britain’s own market. Australia refused to comply on the grounds that Japanese textile exports, dumped or otherwise, did not directly compete with its exports. This decision by Australia did not honour the spirit of imperial economic unity and protectionism it had apparently endorsed when signing the 1932 Ottawa Agreement. 

The papers of the 1934 Australian Eastern Mission—Australia’s first diplomatic mission outside of Britain and its empire, led by Latham to the countries of East and Southeast Asia—suggest that there were both economic and security factors at play in the decision not to enforce anti-dumping duties against Japan. During the Mission’s stay in Japan, Australia was privately thanked for its decision not to implement anti-dumping duties. Arthur Moore, a visiting officer from the Department of Trade and Customs, responded that Australia’s decision ‘shared very clearly its regard for maintaining friendly relations with Japan, and also was, in itself, concrete evidence of the value placed on Japanese trading relations with our Country’. This statement speaks to the role of trade in fostering stronger Australian-Japanese ties with the aim of maintaining regional security. For the meantime, Australia’s geopolitical considerations outweighed Britain’s economic wellbeing.

 British Pressure Intensifies

Australia’s poor record of commitment to the Ottawa Agreement and imperial economic unity did not go unnoticed by the UK. The Secretary of State for Dominions Affairs described Australia’s attitude as ‘a source of difficulty to the commercial relations between the two countries’, which had ‘give[n] rise to much dissatisfaction on the part of trade organisations in the United Kingdom’. Despite this, Lyons touted his government’s unwavering commitment to imperial trade during the 1935 Commonwealth Prime Minister’s Conference: ‘No foreign interest should be allowed to frustrate the high purpose of Ottawa’. Even as Lyons publicly supported the image of imperial unity, his government was seeking to expand commercial relations with Japan. Negotiations for an Australian-Japanese Treaty of Friendship, Commerce and Navigation had begun in late 1934, following the successful Australian Eastern Mission. The following year, Australia appointed its first trade commissioner in Tokyo. It was these developments that led the Lyons’ government to request the narrowing of some preferential margins, describing them as ‘obstacles which … appear insurmountable’ in negotiating trade treaties—and it was Australia’s past unsatisfactory adoption of the Ottawa principles that led the British government to firmly reject such changes.

By 1936, the tension between Australia’s regional and imperial economic and strategic interests finally came to a head. In March, a special envoy from the Manchester Chamber of Commerce visited Australia; a visit that became known as the ‘Manchester Mission’. The stated aim was to increase Australian textile purchases from Britain. The principal obstacle to achieving this goal was identified as foreign textiles, described in a Sydney Morning Herald article as having ‘invaded’ the Australian market. The Manchester Mission delegates framed Australia’s recent increased textile trade with Japan as a clash of interests, with a necessary decision between the two. Japan’s purchases positioned the nation as Australia’s second-best trade partner, however, these purchases were limited mostly to wool and wheat. Britain, on the other hand, made more varied purchases. The message was clear: Britain could not be expected to continue its preference for Australian goods without reciprocal treatment. This was particularly pertinent with the UK seeking to negotiate frozen beef purchases from Argentina. As a major beef exporter and member of the British Empire, the Australian government considered itself the more suitable market. To act in favour of British textile interests, it was hoped, would lead to an improved position for Australian beef.

A further, implied motive in the decision to adopt the TDP was that of military security. As a small power, militarily reliant on Britain and situated in an increasingly politically unstable region, Australia’s trade question could not be separated from security, or the longstanding fear of Asian invasion. Indeed, when announcing the TDP, Henry Gullett, who was responsible for trade treaty negotiations, noted that British strength ‘depends upon its … diverse secondary industries’ and ability to sell from these industries. Lyons believed that improved reciprocal Australian-British trade would surely increase immigration from the UK, making a ‘useful and timely … contribution to Empire defence’; he told the British Prime Minister Stanley Baldwin as much. In summary, Australia was keenly aware of the tie between economic policy and defence. There was little choice beyond action that protected British interests, for a strong empire necessitated strong imperial markets.

 

The Aftermath of the TDP

Japan’s targeting under the TDP was a short-lived policy. As early as 18 June – even before Japan had introduced its own prohibitive tariff rates – Australia was contemplating bilateral negotiations for a settlement; in August, duties on cotton and silk exports were amended “as a gesture of amiability”, and by December, a final agreement had been reached. The settlement removed Japan’s 50 per cent tariff increase and boycott, while Australian duties on artificial silk and cotton piece goods were lowered. Australia also secured a voluntary restriction on Japanese textile exports. Japan, seeking to equalise its trade with Australia, reduced wool purchases. Both of these new quotas fell significantly short when compared to the previous year’s purchases. However, the settlement achieved the aim of a textile quota system that had, in the main, prompted the breakdown of trade treaty negotiations. This quote did not seek to exclude entirely Japanese textiles, simply restore preference for British textiles. In this, Australia’s goal in the TDP had been to demonstrate its generous support for Britain, while securing a trade treaty with Japan that would safeguard a profitable trade relationship, albeit at a lower volume. This was not the outcome.  The year 1937/38 saw Australia’s first ever trade deficit with Japan – the latter falling far below its agreed wool quota – and trade between the two nations would not return to pre-TDP levels for fifteen years.

Britain also played a role in Australia’s economic health post-TDP. The message of the Manchester Mission and Australian-British government correspondence had been one of reciprocity and the implied agreement that British and imperial markets would fill the void left by Japan following the TDP. This enthusiasm soon dissipated as the British refused to publicly support the policy. The Australian Minister for Commerce pleaded with the British government to ‘say something that would support [Australia] in their gesture to assist the United Kingdom trade’. Britain acknowledged the benefits it accrued under the TDP, yet maintained that the policy had been pursued without any prior consultation and ‘could not be regarded as being agreed between the two governments’. Correspondence now available through National Archives of Australia shows that this was not the case, with Australia ensuring that Britain was kept informed of the development and objectives of the policy. Just four days before the announcement of the policy, Lyons wrote to his British counterpart that the Australian government ‘would not have felt justified in imposing restrictions had it not been for your repeated requests and our urgent need for a larger share in United Kingdom market’. Retrospectively, this position suggests that although Australia’s actions and expectations were underpinned by imperial interests, Britain would not necessarily reciprocate.

The diverging expectations of the imperial alliance extended to Australian-British beef negotiations following the introduction of the Trade Diversion Policy. The Minister for Commerce, Earle Page, visited London in June 1936 to discuss Australian primary exports. In a phone call with Lyons, Page remarked that ‘what has been offered to Australia was useless’. Although Page was eventually able to secure the concession of a five per cent increase in Britain’s purchases of Australian meat over the following three years, this was a small and hard-fought recompense for the loss of the Japanese market. While the total value of Australian trade with Britain did increase in the financial years following the TDP, it was only by 2.38 per cent, and this remained relatively unchanged until the outbreak of the Second World War.

 Arguably more critical than the economic strain caused by the TDP, this episode created fissures in Australian-Japanese diplomatic relations, and in turn, shifted Australia’s strategic standing in the Asia-Pacific region. Gullett himself had held reservations about the political implications of trade diversion. The British High Commissioner in Australia, Geoffrey Whiskard, when recounting a conversation with Gullett, described him as ‘definitely apprehensive that these proposals would lead eventually to trouble between Japan and Australia, and he expounded at some length his views as to the indefensibility of Australia against Japanese attack’. The outbreak of the Second Sino-Japanese War in July 1937 only served to heighten these fears in Australian political circles. Jack Shepherd, a contemporary political commentator, drew an interesting link between the TDP and the Second Sino-Japanese War. The TDP served to exclude Japan from a key market, causing great economic desperation and depriving the nation of its means of survival. This, he argued, hastened Japan’s career of regional conquest and aggressive pursuit of raw materials. Japan’s need for raw resources to service its immense population was indeed a motivating factor in its policy of aggressive expansion, however, the role of trade diversion in this expansion is hard to substantiate definitively. It can be reasonably argued that Japan came to resent Australia and its policy that attempted to build an exclusive imperial economic bloc. This united economic front may very well have contributed to a Japan’s sense of being denied the markets it so badly needed.

Conclusion

China’s current economic positionis not one that will likely result in aggression in response to the exclusionary trade measures adopted by both Australia and the United States. However, the parallels between 1936 and current events draw attention to the longstanding challenge of integrating Australia’s regional interests within a great power alliance framework.It serves as a warning to the government of today against a binary view of foreign policy, encouraging a more varied approachtomultilateraleconomic, diplomatic and strategic initiatives in our neighbourhood.

 

Honae Cuffe is a PhD candidate in history at the University of Newcastle. Her doctoral research seeks to isolate a new tradition in Australia’s approach to foreign policy. It gives a particular focus to how the nation has integrated its national interests within the outlooks of ‘great and powerful friends’ and regional powers. Contact Honae at: honae.cuffe@newcastle.edu.au. Twitter: @HonaeHCuffe.

 

 

Selected Further Readings

Many of the primary sources made reference to in this article are freely available to view through a National Archives of Australia record search. The most pertinent to this topic include the files:

CP290/1, 10; A425, 1939/2673; A981, Far 5 Part 16; A981, Far 5 Part 17; A981, Trad 68 Part 2; A1667, 430/B/52A; NAA: A2910, 41.

Cumpston,I.M. ‘TheAustralian-JapaneseDisputeoftheNineteen-Thirties.’TheAustralian Quarterly 29, no. 2 (1957): 45-55.

Department of Foreign Affairs and Trade, ‘Opportunity, Security, Strength: The 2017 Foreign Policy White Paper.’ http://dfat.gov.au/news/news/Pages/opportunity-security-strength-the-2017-foreign-policy-white-paper.aspx. Last accessed 16/04/2018. 

David Goldsworthy, Editor. Facing North: A Century of Australian Engagement with Asia. Canberra: Department of Foreign Affairs and Trade, 2001.

Clive Hamilton. ‘Why do we keep turning a blind eye to Chinese political interference?’ The Conversation, 4 April 2018. https://theconversation.com/why-do-we-keep-turning-a-blind-eye-to-chinese-political-interference-94299. Last accessed 16/04/2018.

O’Brien, J.B. ‘Empire v. National Interests in Australian-British Relations during the 1930s.’ Historical Studies 22, no. 89 (1987): 569-86.

Shepherd, Jack. ‘Empire Versus Far East in Australia’s Economy.’ Far Eastern Survey8, no. 7 (1939): 75-81. 

Shepherd, Jack, Australia’s Interests and Policies in the Far East. New York: International Secretariat, Institution of Pacific Relations, 1939.

Sissons, D.C.S. ‘Manchester v Japan: The Imperial Background of the Australian Trade Diversion Dispute with Japan, 1936.’ Australian Outlook30, no. 3 (1976): 480–502.

Tate, M. and F. Foy. ‘More Light on the Abrogation of the Anglo-Japanese Alliance.’ Political Science Quarterly 74, no. 4 (1959): 532-54.

Tsokhas, K. ‘The Wool Industry and the 1936 Trade Diversion dispute between Australia and Japan.’ Australian Historical Studies 23, no. 93 (1989): 442-61.

White, Hugh. ‘Without America: Australia in the New Asia’, Quarterly Essay 68, (2017): 1-81.