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Foreign investment by state owned entities

CHAIR (Senator Eggleston) —I declare open this hearing of the Senate Economics References Committee inquiry into foreign investment by state owned entities.

On 18 March 2009, the Senate referred the following matters to the Standing Committee on Economics for inquiry and report by 17 September 2009:

a) the international experience of sovereign wealth funds and state-owned companies, their role in acquisitions of significant shareholdings of corporations, and the impact and outcomes of such acquisitions on business growth and competition; and

b) the Australian experience of foreign investment by sovereign wealth funds and state-owned companies in the context of Australia’s foreign investment arrangements.

These are public hearings, although the committee may agree to a request to have evidence heard in camera or may determine that certain evidence should be heard in camera. I remind witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee, and such action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to a committee.

I welcome to these proceedings Ms Julie Novak from the Institute of Public Affairs. Would you like to make an opening statement?

Ms Novak —Certainly. Thank you very much for the opportunity to attend this evening. The central tenet of the IPA’s submission is that Australia stands to attract additional foreign investment if it eases its regulatory restrictions on such activity. This is a central policy issue, because the continuing economic uncertainties afflicting the world present challenges and opportunities for Australia as an investment destination going forward. Surveys by the United Nations suggest that global investors are becoming more cautious about their medium-term investment plans. Worryingly, Australia has lost some ground as an attractive FDI destination as perceived by major investors. How Australia reacts to these trends will be critical to attracting more capital onto our shores.

Despite the current challenges, we can position ourselves as a global safe haven for investment in troubled times if we understand that FDI is something to be welcomed, not repelled. In saying that, one should recognise that the global composition of FDI is changing, with managers of state owned enterprises and sovereign wealth fund vehicles looking to acquire assets overseas. As the committee well appreciates, there have been a number of high-profile investments—for example, in the Australian mining sector by Chinese state owned enterprises.

The IPA submits that these developments are, on balance, (a) economically useful and (b) politically benign. In relation to point (a), one cannot discount that SOE and SWF managers might pursue a non-commercial investment agenda. However, this is unlikely to be a regular occurrence, given that investments are subject to continuous market testing. If a non-commercial agenda affects the investment value, domestic project proponents may be less likely to entertain such FDI proposals from these investor classes in the future. So it provides really a check and balance.

Concerning point (b), the fact is that foreign governments have no additional economic power in a domestic economy does any other foreign investor does. Foreign investments are circumscribed by the laws of the host country. SOE and SWF investors must ascribe to our federal, state and local laws with respect to competition, labour and tax, among other things. If one accepts the case that most FDI projects by SOEs and SWFs are commercially motivated, there seems to be little point in blocking any proposed investment by these entities, subject to the observance of domestic laws and corporate governance standards. Yet Australia has been independently assessed by the OECD as having a relatively restrictive FDI policy regime, grounded on a concept of the national interest that is left undefined in the relevant legislation.

The screening procedures applying to major foreign investments by the Foreign Investment Review Board, the FIRB, are pivotal to Australia’s unenvied position on the FDI policy scale. In early 2008, the Commonwealth Treasurer added to the regulations by introducing six policy principles on investments by SOEs or SWFs, relating to operator independence, business standards, competition, revenue, security and economic impacts. The view expressed in the IPA submission is that this extra regulation contradicts assertions that our foreign investment regime is non-discriminatory towards all comers. The six criteria introduce an element of prejudgment into the FDI review process and may duplicate other policies that already exist, for example in the areas of competition policy and tax. Instead of being unafraid of SOEs and SWFs, Australia should continue to liberalise its foreign investment policies in order to attract new capital, which could be achieved even during these difficult economic times. I am pleased to take your questions.

CHAIR —Thank you. I might just ask you a few questions, and I am sure Senator Hurley will ask you some. Is there a difference between state owned enterprises and sovereign wealth funds and their behaviour as investment vehicles?

Ms Novak —The international literature, for example by the Peterson institute in the United States, does suggest that sovereign wealth funds—and I might say as an aside that Australia has its own effective sovereign wealth funds in terms of the Future Fund—tend to have a long-term investment horizon in terms of their behaviour. In terms of SOEs, it is quite clear that, due to their proximity to the state institutionally, they might be tempted to pursue a non-commercial agenda, but, as I alluded to in my opening remarks, there is continuous market testing in a globalised capital market. And, quite frankly, if you read some of the media reports—for example from some of the state owned enterprises which have expressed an interest to acquire assets in Australia—you will find that they are actually very keen to understand Western practices in terms of corporate governance standards. They are very keen to publicly express a long-term approach to investment. So there are some differences in terms of the institutional structure, and possibly behaviour, of these two separate vehicles. But, in terms of a long-term policy implication, I do not think there is much of a problem here.

CHAIR —You say in your submission that SOEs represent a reversal of privatisation. Do you want to comment on that, for the purposes of the record?

Ms Novak —Think about state owned enterprises in a potential investor country for Australia—for example, China. We have found that over the past 20 years the number of state owned enterprises that have been privatised in China has been quite substantial. Certainly China has pursued a deregulatory agenda going down that path. Obviously, in some of the key sectors of the Chinese economy there still remain state owned enterprises that are intimately linked to the government. From a broader perspective, SOEs and SWFs represent a new player in the international scene. We might suggest that it represents a reversal of privatisation. In terms of the inflow of investment into Australia by these vehicles, from an economic perspective they are pretty much synonymous with any private investor. No government entity in an overseas country has extraterritorial powers in Australia.

CHAIR —That is an important point, isn’t it? The vehicle is an investment vehicle; the foreign government really cannot control the laws or affect the outcomes.

Ms Novak —That is right. As Australia is a sovereign entity, it has its own priorities and policies for labour market standards, competition policy, taxation and the like. Any investor from overseas wishing to acquire Australian assets or a shareholding in a major Australian company has to adhere to Australian laws. There is no evidence that they are not.

CHAIR —You also say in section 4 of your submission:

Australian FDI policy has also come under greater scrutiny because of adverse political and community reactions to a growing number of investment applications from China. Concerns have been raised by the political elite and general community alike regarding the rising Chinese FDI in Australian mining.

But in a way we have been through all this before in the sixties, seventies and eighties with the Japanese. Would you like to make any comparisons between the Japanese and Chinese investment activities in Australia?

Ms Novak —Going back to the 1960s, perhaps in Japan there was a greater extent of government involvement in investment activities. For example, you had the Ministry of International Trade and Industry, MITI, which certainly had a key influence in Japanese industry and economic policy at the time. I think Japanese investment, on balance, has proven to be very favourable, for example, for Western Australian investment in the mining sector; there is no question about that. In the Japanese case there has been no doubt in my mind that there have been shared objectives between the foreign and the host interests in terms of maximising production for the net benefit of Australia. Obviously, as Australians we get a transfer of revenue through state tax royalties and the like. I think that the evidence we see so far with a number of Chinese entities acquiring mines in Western Australian is a continuation of an age-old trend that has occurred in Australia—that is, the fact that we have a deficiency of savings, we rely on global capital in order to develop our economic base and it is in everyone’ s mutual interest to do so.

CHAIR —The absence of sufficient Australian investment capital is an important point, too.

Ms Novak —Exactly. One of the telling stories of Australia’s economic development for over 200 years has been the very fact that there have been insufficient levels of savings, at least as a proportion of GDP. That has basically required us to run up a capital account surplus, which is the flipside of a current account deficit. In Australia’s early days we had investment in London, and now we are probably seeing some more investment from China but we still have to recognise that the US and UK still represent the main sources of foreign investment in Australia.

CHAIR —You mentioned MITI, which was the Japanese government agency that was involved with Japanese foreign investment in the sixties and seventies. I do not know whether MITI still exists. Could you tell us, if you can, about the relationship between MITI, the Japanese government and private investment houses?

Ms Novak —Certainly a lot of countries in the Western world and also in East Asia had, after the Second World War, broad policies of indicative planning of the overall economy where government investment agencies tried to steer the overall direction of economic development. I am not exactly sure to what extent there was a close, intimate, controlling relationship between MITI and investors into Australia, but I dare say it was a non-trivial relationship. I think MITI still does exist, albeit in a different form. Obviously there have been trends throughout the Western world and in East Asia over the past 20 years in favour of more light-handed regulation of industries on the basic acknowledgement that governments tend to be quite poor and ineffective in picking investment and economic development winners.

CHAIR —Could people have said, in the sixties, seventies and eighties, that MITI represented the heavy hand of the Japanese government in terms of, say, the Pilbara in Western Australia, the Australian iron ore industry? Would that kind of criticism have existed at that time?

Ms Novak —Certainly there are ingrained animosities held by certain sections of the community against foreign investment—basically an essential distrust of the foreigner, a lack of understanding of how foreign trade works to ensure the comparative advantages of countries are reconciled. The same concept does actually occur in terms of investment but there are, as we suggest in the submission, ingrained biases, ingrained sentiments and beliefs that, for example, selling off the mine or selling off the farm is damaging to Australia’s interests. We would certainly argue to the contrary, but the increasing interest with respect to foreign investment in recent years is a product in part of that ingrained aversion to and distrust of foreign investment.

Senator HURLEY —In your submission you say that Australia has an already restrictive regime and you quote the OECD index scores, which I think we also heard from Treasury last night. The potential restrictions you list, which the indicators take into account, are equity restrictions, screening restrictions and operational restrictions. I am interested in whether you think Australia is any more restrictive in any of those particular areas and in whether you think any one of those areas in particular could be handled more lightly.

Ms Novak —Could you clarify, Senator. You mean more restrictive in recent times?

Senator HURLEY —No, more restrictive than the other countries that finish up ahead of us in that index.

Ms Novak —I do not think there is too much doubt that Australia’s regulatory regime is more restrictive than those of other countries, particularly those of continental Europe. One has to recognise that, for example, in continental Europe they have a free trade and investment zone, so, yes, that is a caveat. I think that the OECD investment restrictiveness index is reasonably credible. They have developed this index for a period of 10 years. Interestingly enough, it happens to be a by-product of Australian work in the late 1990s on investment in the services industry.

Regarding whether a reduction in investment regulatory restrictions will lead to a reduction in Australia’s high-end index score, I would answer in the affirmative, as we suggest in the submission. For example, if Australia relaxed some of its regulatory restrictions—and I am happy to talk about that further if you wish—particularly with respect to the screening regulations that we have, then it should be able to scale itself back towards the middle of the pack in terms of its position among OECD scores. I draw your attention to figure 2 in the submission. I think this is the chief contributor to Australia’s high-end score against the OECD index.

Senator HURLEY —The screening is interesting. Do you think that is a result of policy requirements, or do you think it is due to the ACCC who, I think, do that kind of screening job? Are they perhaps a bit too rigorous in their application of it?

Ms Novak —In terms of this index, it does not take into account actual enforcement. Basically, this is a statutory restrictiveness index. The Commonwealth Treasurer, I understand, has basically said that these index scores should be caveated in the sense that our enforcement is quite generous. We allow a lot of major foreign investments, including by Chinese SOEs, to come in, but the fact remains that Australia’s foreign investment policy regime is in place. It is obviously circumscribed by the Foreign Acquisitions and Takeovers Act 1975. Any future or current government can use those regulations to the full extent if they wish. So therein lies, I think, the sovereign risk and the regulatory risk that is posed by Australia’s foreign investment regime. There have been some cases where, for example, Chinese SOEs have expressed concerns about what they see as quite uncertain and confusing FDI regulations. There has been some anecdotal evidence of some withdrawals of investments as well. So certainly, from the IPA’s perspective, we would argue for a relaxation of those regulatory restrictions if Australia is to attract more capital in the long run.

Senator HURLEY —Then let us go to those guidelines that were, in fact, introduced in response to a number of concerns early last year. You said, I think, that those policy-guiding principles were not necessary. Were some of them implicit in the law and guidelines previously anyway?

Ms Novak —It is very hard to say. The Commonwealth Treasurer probably insists that it is so, but the fact of the matter is that they were not codified in the past and they are codified now. So, effectively, it does represent new regulation.

Senator HURLEY —I wonder if some of these give comfort to people that SOEs or similar entities are not a threat and give form to the existing policies—things like ‘an investment that may impact on Australia’s national security’ or ‘an investment that may impact on Australian government revenue or other policies.’ In some senses, they are fairly practical and commonsense applications.

Ms Novak —What this basically implies is that much of the guidelines are in fact duplicative, because we happen to have already in effect laws with respect to competition, laws with respect to tax and so on. Even if it does give comfort or discomfort to prospective investors, the fact is that we have these things sorted out already.

Senator HURLEY —To move to sovereign wealth funds and SOEs, I think we clearly need more FDI in Australia to advance our industry, but have you seen a pattern in investments by SWFs or SOEs in which they tend to go to safer types of investments? Is there any other pattern in the kinds of investments recently?

Ms Novak —No, I have not really detected any such pattern that you might ascribe—really the investment decisions of investors tend to be quite heterogeneous. For example, there have been some much-cited cases in the US where some sovereign wealth funds invested in US banks last year. We have had cases in Australia where these sorts of entities have expressed an interest to invest in the mining sector. There is really a rich diversity of investment destinations where funding could effectively be parked. At the end of the day, that is a decision for the individual SOE, SWF and of course the affected firm involved—whether it might accept acquisition of its assets.

Senator HURLEY —Where I am going with this is that you tend to need funding particularly in those areas for which it is a bit harder to attract funds and which tend to be more venture capital related. They are things where you might need a bit of extra capital to grow something that might be seen as a little bit risky or as something new. It is in those areas that we particularly want to see FDI come in and bolster. It might be a small or medium business that has a good idea.

Ms Novak —That might be so from the position of an external observer, but we would not really want to see governments try to pick investment winners on the basis that the investment funds might flow to sectors that might be seen as desirable from the perspective of the external observer or the policymaker. At the end of the day, it is really an individual’s decision. Investment funds flow through a whole variety of complex and less complex activities. It is a heterogeneous, globalised world out there and it is very hard to prejudge where the most desirable destinations are.

Senator HURLEY —I am not suggesting that government should direct funds; I am wondering if there is evidence that funds flow across a number of areas, including into those newly developing areas.

Ms Novak —As I mentioned a couple of moments ago, I think there is at least anecdotal evidence that the intentions of these bodies tend to be quite diverse and quite flexible in terms of the objectives that they are trying to bring to bear.

Senator HURLEY —A final topic: until fairly recently, the star in the FDI firmament was Ireland, which grew rapidly on the back of FDI. I think it was Senator Joyce who commented last night that a lot of those OECD countries that were above us are now in financial strife. Do you see any relationship to that? How do you see that playing out now?

Ms Novak —The case of Ireland is actually very interesting. In a previous life, I worked in the federal department of industry and I tendered a submission to a House of Representatives inquiry about investment attraction. What I found in this submission was that the sources of growth for Ireland were not so much the high-profile FDI which, as it so happened, tended to flow out of the Irish economy about three or four years after it was attracted by government funds. It was really due to major endemic catch-up type sources of growth such as increasing labour market participation, especially by women, and higher birth rate—basically, the so-called ‘three Ps’ that the Treasury often talk about in terms of long-term sources of growth. In the Irish case those seemed to be the more direct and influential drivers of growth rather than basically frittering money away to high-profile firms who just relocated out again when convenient to them.

Senator Hurley —The last part of that question was if you see any connection between the difficulties those economies are in now and the fact that they have a regulatory regime. Do you see any connection at all?

Ms Novak —Certainly, when I look at the OECD index I do not see Ireland in the top 5 or exceeding Australia at all, so I do not really see that as a major connection. Apart from FDI, there are other forces at work that determine the growth prospects of economies.

Senator HURLEY —To go a bit further on that, we are talking mostly about major industrial economies. Would any of those economies that have advanced without a significant amount of foreign investment?

Ms Novak —China is a great example of a catch-up economy where, for example, they have net savings in their economy—so much so, in fact, that they are effectively lending money out to net borrowing countries like Australia. Foreign investment, as important as it is in key sectors of the economy and, arguably, as important as it is for small, open economies like Australia, is not necessarily a story that is repeated for each and every economy across the world.

Senator PRATT —Rarely does the human rights record of a state owned entity or sovereign wealth fund come into play when considering approval for investment—notwithstanding that numerous activist groups and community groups often raise these kinds of issues. I wonder whether you have looked at these issues in your consideration.

Ms Novak —No, not at those broader issues that you allude to. This submission essentially focuses on the economic aspects of foreign investment. To make a general point, freer economies tend to respect human civil rights anyhow. I think one of the long-term benefits for those countries that have SOEs that tend to invest abroad is that they learn about, for example, Western standards of corporate governance, business standards and so on and so forth. So it is a long-run, evolutionary learning exercise for them. I think, on balance, it is certainly very beneficial to have open capital markets, not only for economic reasons but for extra-economic reasons as well.

CHAIR —We have had quite a lot of Chinese investment in Australia for quite a long time. It is interesting that there was so much controversy about the Chinalco proposal when in fact, if you go back to 1987, there was a joint venture in the Channar mine between Rio Tinto and Sinosteel. Has that mine come to the end of its life?

Ms Novak —I am not sure actually. If you wish, I am happy to find out for you. But you are quite right; Australia has had a long-run relationship with China, from an investment perspective, starting in the late eighties. There is some Chinese investment—for example, in Victoria in the aluminium sector. So it is broad and it is quite pervasive. It is interesting that, if you look at some of the investment statistics from the Foreign Investment Review Board, you will find that obviously there had been some net inflow of foreign capital from China, but certainly, over the past couple of years, there has been an increase in interest. This comes with the ebbs and flows, I think, of the global economies. Certainly China’s economic prospects have improved in trend terms over the past 20 years. They do need resources, so I think here is an opportunity for mutual advantage between the two countries.

CHAIR —Yes. That is true. I do recall, however, when Channar was set up, it was done with great flamboyance and I think the Chinese Vice Premier came to Western Australia, the investment was very much welcomed and, I presume, Sinosteel was a state owned enterprise.

Ms Novak —Yes. That is right. That is my understanding.

CHAIR —The other question I would like to ask you about state owned enterprises is with regard to the Browse Basin gas fields off the Kimberley coast and Imprex. I have been told that that may be in some way a state owned enterprise of the Japanese government. Is that the case or not?

Ms Novak —I am not aware of that case. No.

—Thank you very much appearing, Ms Novak.

Ms Novak —Thank you very much for the opportunity.

[8.08 pm]