Sino-Australian wool trade in the WTO era: socio-economic and transaction cost factors as determinants of vertical coordination

The Sino-Australian wool trade relationship is the most significant in the international wool industry. China accounts for 65 per cent of Australia’s wool exports and Australian wool around 70 per cent of China’s imports. At the same time, it has also been one of the most contentious areas of Sino- Australian trade. There have been frequent disputes, protracted trade negotiations and numerous problems unsettling the smooth flow of product from Australian woolgrowers to Chinese wool textile mills. Despite a number of investigations and several bilateral and multilateral initiatives to improve trade protocols, in particular associated with China’s accession in the World Trade Organization (WTO) in 2001, many of these longstanding problems remain unresolved. A range of different methods are employed by China-located early-stage wool processors (ESWPs) to obtain their raw wool requirements. This research applies transaction cost analysis to examine the extent to which different raw material purchasing channels have changed (and are changing) over time. The research aims both to elucidate how China-located ESWPs govern the wool procurement transaction and to investigate the interaction of socio-economic (asset specificity, frequency, uncertainty) and transactional cost factors (information, negotiation and monitoring costs) influencing the decision-making of the ESWPs. This research is unique in that it has been conducted by a wool industry “insider” who speaks Mandarin and who has applied the Transaction Cost Analysis (TCA) from the perspective of the Chinese management of the ESWP firm in order to identify possible improvements. Transaction Cost Analysis seeks to analyse the “make or buy decision” or in this case the degrees of backwards vertical integration into the Australian wool marketing system by China’s ESWPs. The “make or buy” decision has become a theoretical reality since China’s WTO accession — an institutional change that allows more vertical coordination and the potential for improved fibre selection in Australia’s wool market. Understanding these structures can provide considerable insight into how the Australian wool supply chain (particularly fibre selection and soft attribute differentiation) can be improved to the benefit of stakeholders. This is especially important from the viewpoint of improving the quality of China’s intermediate wool processing — a vital stage where any mistakes in fibre selection cannot be undone and are expensive, often only “discovered” much later at garment or fabric delivery stage. Being a natural fibre destined for the high-end apparel market, quality with consistency is always a challenge for wool, “the fibre”, in the modern textile landscape. The research finds that although the conditions exist for vertical coordination, a hierarchy structure has v only been employed by foreign processors that had pre-existent raw material infrastructure in Australia. Most Australian wool imports still enter China through intermediaries without sufficient completeness of the contract, mainly owing to the uniquely “Chinese” method of price and quality risk management. Two large privately owned Chinese processors have vertically integrated for some of their raw material needs but also use intermediaries to avoid over dependency. The fact that China has still not completely fulfilled WTO entry requirements, specifically in regards to Tariff Rate Quota administration, also contributes to state intermediary participation and sovereign risk issues that periodically destabilise Australian wool markets. Institutional reforms have had little impact on wool quality, and significant improvements in terms of outcomes for both processors and woolgrowers would only be possible by further integration of Chinese processors into Australia’s wool marketing system