Australia needs better foreign investment rules
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Australia needs better foreign investment rules

  Originally published in the Nikkei Report.

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Executive Summary

The Australian Treasurer has vetoed two bidders for the long-term lease of a half share in a major, state-owned electricity grid. The excluded bidders were a Chinese state-owned enterprise and a Hong Kong private company. He did this on the basis of security concerns, but gave no details. Australia is a country which relies on substantial foreign investment inflows to fund its long-standing current account deficit. What is going on here?

On his recent visit to China, Australian Prime Minister Malcolm Turnbull reiterated that Australia is "open for business." The Chinese know from experience that this does not mean that every foreign investment proposal is approved. The Australian authorities were ready to reject Chinalco's attempt to buy a larger share of Anglo-Australian mining giant Rio Tinto in 2009 (although the deal fell through, without government intervention, when market conditions changed). A recent bid for the vast Kidman cattle properties was rejected because part of the estate overlapped the government's Woomera Weapons Testing Range.

It is not as if Australia rejects only Chinese bids. Singapore's attempt to take over the Australian Securities Exchange was rejected in 2011. A decade earlier, Royal Dutch Shell's bid for Woodside Petroleum was blocked. Even close allies sometimes get knock-backs: an American company was denied Graincorp, a bulk grain handler, in 2013. Some areas are predesignated as off limits or subject to particular restrictions: foreigners might, perhaps, be able to take over one of the big four banks, but not more than one.

That said, both the potential bidders for the electricity grid already own similar assets in Australia. And it should be noted that seemingly sensitive assets have gone to foreigners in the past (including to the vetoed bidders). Singapore purchased the second-biggest telecommunications company, Optus, and China has a long-term lease of Darwin's port facilities. The electricity grid decision must have left the bidders flummoxed by the inconsistencies of Australian policy -- and doubtless angry. There are even mutterings about rising xenophobia.

Foreign investment is a sensitive issue everywhere. The new U.K. Prime Minister Theresa May has put a last-minute hold on plans for a new nuclear power station at Hinkley Point, in Somerset. One of her advisers expressed concerns about the security implications of Chinese funding. An exasperated Chinese ambassador vented his frustration in an article in the Financial Times.

Meanwhile Germany is having doubts about the planned Chinese purchase of the high-tech robot manufacturer Kuka. Critics warn that any resulting technology transfers could lead to Chinese dominance of the global market.

All this looks like universal "ad hocery," full of inconsistencies and changing views. The apparent muddle reflects just how difficult it is to develop clear principles and criteria for investment approvals. Security issues, for example, are hard to define, and the experts are always ready to think the worst of foreigners, especially if they are state-owned enterprises from countries which are not close allies.

To disallow Chinese-maintained equipment in vital areas of telecommunications might make sense, given Beijing's reputation for eaves-dropping. And yet Australia allowed Singapore to own one of the key telecoms companies, despite the country's reputation for official intrusiveness. Australia has already sold off quite a bit of its electricity grid to foreigners. If they can cause mischief, Australia is already vulnerable. Might the Hong Kong owners of the state of Victoria's Latrobe Valley power stations be pressured into turning off the lights at some dark moment in the future?

There are fanciful elements in some of these security-based arguments. The reality is that foreigners do not have to own the facility to hack in and disrupt computer controls. Australia would need different safeguards if this was the concern. The foreign-owned assets are physically in Australia, subject to Australian regulation and law. Surely Australia can protect its own interests in these circumstances? The bottom line is that owners of infrastructure would do more harm to themselves through disruption than they would do to the host country. If China wanted to blackmail Australia, a threat to reduce its imports would be far more effective.

A trickier issue

If security is a hard issue to articulate convincingly, there is a trickier issue still: Why might a country want to discriminate between different foreigners on the basis of "community concerns?" This has something to do with fear of domination by overly-powerful foreigners, especially those seen as somewhat suspicious and as not always having played by the global "rules of the game."

Former Australian Prime Minister Tony Abbott has voiced concerns about "ceding control" of the electricity grid. These concerns are universal -- that is, manifest in the U.K.'s Brexit vote and in the current U.S. election campaign. For Australia, an added dimension is about relative size. Even modest proposals from China will easily overwhelm a medium-sized country like Australia: from Canberra, Beijing is easily seen as the "elephant in the canoe."

No clear principles emerge from the current ad hoc approach. The national interest criterion is nebulous. It leaves the decision open to influence by those with the loudest voices and the narrowest views.

The Chinese and Australian economies have great synergies because of their differing comparative advantages. How effectively they work together will have a big bearing on future prosperity. Australia needs a more structured Foreign Investment Review Board process, not an ill-informed outcry every time a new proposal is made. If the concerns are well articulated and sensible, potential investors might feel unnecessarily excluded, but they are less likely to feel subject to random discrimination.

Of course the approval process should include serious analysis of security risks. But this needs realism and transparency. Secrets have to be kept, but general principles can be articulated publicly.

Instead of the negative process of looking for detrimental characteristics, the FIRB should ask foreigners to show why their proposal has significant positive benefit for Australia. Do the foreigners bring special expertise in technology or management? Are they ready to partner with Australians? Are they taking over an "Aussie icon?" Are they ready to pay a fair amount of tax in Australia, not arranging their affairs to have profits accrue in tax-avoidance centers such as Ireland or Singapore?

Equally significant is the question of whether the proposal opens up markets in the foreigners' home country. This should be particularly relevant for China, which needs supply-side security in basic commodities -- minerals, energy and food. How can they help us break into their huge market? If these benefits were to be articulated clearly, the costs of rejecting projects would be apparent. If the net benefits are not convincing, then maybe the proposal should be rejected, without needing other grounds.

In a world with "low for long" interest rates and increasing talk of secular stagnation, the profitable investment opportunities in a robust, market-based economy with strong rule-of-law and high security will be attractive for foreign investors. Setting the entry bar amid the absence of negative characteristics will mean that Australia may sell itself too cheaply, especially in its estimation of the general population. This public ground-swell requires the authorities to make a case that every project should bring substantial positive benefits for the nation.

Of course if this means that more projects are rejected because they cannot show strong positive benefits, that has implications for the balance of payments. Should Australia resurrect the old paranoia about external funding to justify accepting projects that have little or no benefit beyond supplying some foreign exchange? This should not be a concern. Australia has had a successful floating dollar since 1983: the exchange rate will handle any needed adjustment.

China is just at the start of its global integration: these dilemmas are not going to go away. As Australia sees more Chinese ownership of real estate, agricultural land, mines and infrastructure, managing the nationalist push-back among Australians will be a political challenge. If the investment criteria reflect community concerns accurately, some projects (from China, but other countries as well) will be rejected on essentially emotional grounds. We will have to get used to the sort of dressing-down the Chinese ambassador gave the British over Hinkley Point. They can complain, but the Chinese understand that foreign investment is a delicate issue: after all, their own restrictions are far more constraining than anything Australia might do.


Stephen Grenville is a nonresident fellow at the Lowy Institute for International Policy in Sydney and a former deputy governor of the Reserve Bank of Australia.

Areas of expertise: Regional economic integration; Australia's economic relations with East Asia; international financial flows and the global financial architecture; financial sector development in East Asia