Foreign Investment In Australia - Commission Research Paper

OverviewAbout this projectThe Commission’s 2016 inquiry into the Regulation of Australian Agriculture found that,despite the benefits of foreign investment to agriculture (and the economy), it attractsconsiderable negative public attention. To facilitate a more informed public debate aboutforeign investment, the Commission recommended that the Australian Government shouldrequest the Productivity Commission, in its annual Trade and Assistance Review, to reporton the trends, drivers and effects of foreign investment.In 2019, the Australian Government supported this recommendation. This report forms abroad initial examination of Australia’s foreign investment policies, with subsequent Tradeand Assistance Reviews building on this work through closer examination of recentdevelopments and more specific policy issues.Trends in foreign investmentAustralia is an attractive destination for foreign investmentAustralia has, since 1788, been a recipient of net foreign investment in most years.Foreigners invest in Australia because of our fast-growing and well-educated population,rich natural resource base, and stable cultural and legal environment.The Australian Bureau of Statistics (ABS) estimates that foreign-owned capital located inAustralia amounts to 3.5 trillion, while Australians own about 2.5 trillion of capitallocated overseas. These foreign investment figures include debt, derivatives and equityinvestment (figure 1).Foreign direct investment (FDI) is the portion of these holdings that is accompanied by adegree of foreign control, defined as an investor with at least a 10 per cent voting share overmajor company decisions. This is distinguished from portfolio investment, where the owneris a common creditor or shareholder that cannot make decisions, or directly influencedecisions taken by the business.OVERVIEW3

Figure 1The different kinds of foreign investmentBy Australian inward foreign investment stocks, at December 2018aDirect ( 1t)Portfolio ( 1.8t)Equity capital:Ownership, acquisitionsOther capital Equity securities:sharesDebt securities Financial derivativesOther investmentReserves-Other ( 0.7t)Reverse investmentTotal equity( 1.3t)Total debt( 2.3t)Total foreign investment ( 3.5t)a The sum of total equity and debt equals total foreign investment. Discrepancies due to rounding.Source: ABS, International Investment Position, Australia: Supplementary Statistics, 2018, cat. no. 5352.0 (table 2).Australia’s inward stock of FDI totalled 967.5 billion at December 2018, or 52 per cent ofgross domestic product (GDP), following strong net inflows since 2001 (figure 2). To putthese estimates in context, the value of physical assets in the Australian economy (excludinghousing) is estimated to be about 6 trillion, and aggregate household net wealth is about 10.5 trillion.4FOREIGN INVESTMENT IN AUSTRALIA

Figure 2Foreign direct investment in Australia has risen stronglyaInward and outward FDI stocks relative to GDPForeign investment in AustraliaNet FDIAustralian investment abroada The significant transactions in December 2004 and June 2005 were due to a large corporate grouprestructure, with the eventual transfer of its Australian subsidiaries moving offshore.Sources: ABS, International Investment Position, Australia: Supplementary Statistics, cat. no. 5352.0(various years) and Commission estimates.The growth in FDI into Australia contrasts with flatter global trends since the financial crisis(figure 3). Global statistics have also been affected by changes in US company taxes in 2018,which have encouraged repatriation of profits (a form of negative outward investment forthe United States).Australian investors also own and control a substantial amount of assets and enterprisesabroad, mostly in the financial and insurance services, mining and manufacturing industries.At the end of 2018, Australia’s outward FDI stocks had reached 696 billion, equivalent to38 per cent of GDP (figure 2 above).Overall, this means that Australia has been a net recipient of FDI, with the gap (net inwardFDI) equivalent to about 15 per cent of GDP in 2018. This is up from a low of 2 per cent in2001, with the increase driven by inward FDI growth, rather than any large decrease inoutward FDI.OVERVIEW5

Figure 3Australia bucks the global trendInflows of FDI relative to GDPaa The significant transactions in December 2004 and June 2005 were due to a large corporate grouprestructure, with the eventual transfer of its Australian subsidiaries moving offshore. ’Advanced economies’refer to the World Bank’s standard of classification.Source: UNCTAD (2020).More broadly, Australia’s equity position has also changed, recently switching to a positivenet equity position, due to portfolio investment by Australian superannuation funds seekinghigher returns abroad (figure 4). That is, Australians are increasingly net owners of foreignbusinesses, with net equity investment now standing at about 6 per cent of GDP( 250 billion).At the same time, Australia’s debt to the world is increasing, due to wholesale loans to thedomestic banking sector (which are largely used for residential mortgages in Australia).Together, these two trends show that foreign investment can provide benefits to Australiansboth as a source of additional capital for domestic investment, as well as an opportunity todiversify our savings.6FOREIGN INVESTMENT IN AUSTRALIA

Figure 4Australians now own more equity abroadNet foreign equity positionaForeign-owned equity in AustraliaNet equityAustralian-owned equity abroada Total Australian equity owned by foreigners less total foreign equity owned by Australians.Sources: ABS, International Investment Position, Australia: Supplementary Statistics, cat. no. 5352.0(various years) and Commission estimates.The costs and benefits of foreign investmentForeign investment into Australia means that more capital is deployed than would have beenpossible if funded solely through domestic savings. In effect, foreign capital lowers the costof capital for domestic investments, increasing the number of viable investments for bothbusinesses and households (such as through lower mortgage rates).The other way in which foreign direct investment benefits Australians is through ‘spillover’benefits that ultimately improve living standards. This is particularly the case with commercialdirect investment, which comes with greater engagement from multinationals, including useof their intellectual property, international logistics networks and management expertise. Thetechnology, innovation and technical know-how of these multinationals tends to leak into therest of the economy as a spillover effect, leading to improved productivity for local firmsthrough the direct transfer of advanced technology, enhanced competitive pressures ondomestic firms, and greater human capital development. Although these spillover benefits arehard to accurately quantify, decades of economic research suggest they are significant.OVERVIEW7

Foreign investment can be associated with negative spillovers too, where an investment hasadverse repercussions for the broader economy and community. Some negative effects arein fact the downside of otherwise positive outcomes for Australia (such as increasedcompetition), while other impacts relate to ongoing worries about whether foreign investorswill adhere to Australia’s social and environmental regulations.Foreign investment also stirs strong community reactions. While Australians are generallysupportive of globalisation and free trade, many members of the community expressreservations about Australia’s openness to foreign investment. In polls of communityattitudes, large majorities of respondents consistently state that foreign investment is a threatto Australian interests, and agree that there should be more restrictions on foreign ownership.As one commentator noted:Not many political issues stir the emotions in the way that foreign ownership does. It is a subjectthat provokes deep, visceral feelings of possession, solidarity and national identity.(Switzer 2008, p. 4)Australia’s foreign investment policyTo balance the economic benefits that foreign investment can bring against the risks, and tomaintain community confidence, the Australian Government regulates inward foreigninvestment through a range of mechanisms.The core of the Government’s policy is a broad foreign investment screening regime. All foreignacquisitions that exceed prescribed monetary thresholds (table 1) are subject to screening (inresponse to the COVID-19 pandemic, the Government has temporarily reduced all monetarythresholds to 0 — box 1). For investments over the threshold, the Treasurer considers whetherthere is evidence that they are contrary to Australia’s ‘national interest’, or if the Treasurer takesno action they are deemed approved after statutory time periods. If the Treasurer forms the viewthat the foreign investment is contrary to the national interest, they can: make an order to prohibit the investment going ahead allow the investment, but impose conditions order disposal of the investment if it has already gone ahead.The concept of national interest is not defined in law, but policy documents indicate that,when assessing the national interest, the Government normally takes into account: national security, based on assessments from our security agencies competition, particularly whether the acquisition may allow control of the supply of aproduct into the domestic market the tax and environmental impacts of investments the impact on the economy and community, including employees, creditors and otherstakeholders8FOREIGN INVESTMENT IN AUSTRALIA

the character of the investor, including whether they operate on a transparent commercialbasis and are subject to transparent regulation and supervision in their home country.Treasury provides secretariat services to the Foreign Investment Review Board (FIRB),which in turn advises the Treasurer on foreign investment decisions. The Treasurer alsodelegates non-controversial decisions that are consistent with the policy framework to juniorministers and senior Treasury and Australian Taxation Office (ATO) staff. Since 2015, theATO has been responsible for administering residential real estate assessments.Box 1Recent changes to foreign investment policyOn 29 March 2020, the Treasurer announced that the Government would be screening all foreigninvestment into Australia for the duration of the COVID-19 crisis. To allow time to screenapplications, FIRB will extend the timeframes for screening from 30 days up to 6 months, but willprioritise investments that ‘protect and support Australian businesses and jobs’.The Treasurer said that these measures were necessary to ‘safeguard the national interest asthe coronavirus outbreak puts intense pressure on the Australian economy and Australianbusinesses’ (Frydenberg 2020a).In June 2020, the Australian Government announced major reforms to Australia’s foreigninvestment policy. These reforms would be permanent replacements for the temporary COVID-19measures. The reforms included: introducing a new national security test for foreign investment that raises national securityconcerns and falls beneath the screening threshold for the national interest test requiring mandatory notification of proposed foreign investment in a ‘sensitive national securitybusiness’ (to be defined in regulation after consultation, but anticipated to include criticalinfrastructure, businesses involved in the manufacture or supply of defence ornational-security related goods, businesses that own, store, collect or maintain sensitive datarelating to national security or defence, and others) creating a new ‘call in’ power to allow the Government to review an investment not otherwiserequired to be screened or notified, and a ‘last resort’ review power to reassess approvedinvestments where subsequent national security risks emergeThe Government also announced stronger penalties, compliance and enforcement powers, theintention to develop a new register of foreign ownership and a review of application fees. TheGovernment said that it intended the reforms to commence 1 January 2021.OVERVIEW9

Table 1Foreign investment screening thresholdsThreshold — partner countriessubject to higher thresholda millionResidential real estate or vacant landThreshold —other countries million00Developed commercial real estate1 192275Business acquisitions in non-sensitive sectors1 192275275275Business acquisitions in sensitive sectorsbAgricultural land1 192c15dAgribusinesses1 19258Foreign government investors: all direct investments,new business proposals and interests in land00Business acquisitions in sensitive national securitysectorse00a Currently applies to investors (other than in agricultural land) from Canada, Chile, China, Japan, Mexico,New Zealand, Singapore, South Korea, the United States and Vietnam, and any country for which theComprehensive and Progressive Agreement for Trans-Pacific Partnership subsequently comes into force.b Sensitive sectors are media, telecommunications, transport, defence and military-related industries,encryption and securities technologies and communication systems, and the extraction of uranium orplutonium or the operation of nuclear facilities. c For Chile, New Zealand and the United States. d ForThailand 50 million. e Subject to legislative amendment.Source: FIRB (2020a).In June 2020, the Australian Government announced that it would be creating a new‘national security’ test for investments that raise national security concerns and which fallbelow existing monetary thresholds.In 2017-18, the number of applications was 11 855, with 11 145 approvals at a total valueof 163 billion. Residential real estate makes up the majority of approvals — accounting forabout 90 per cent of the number of approvals in 2017-18 — but only about 7.5 per cent oftheir value. The number of applications in 2017-18 was sharply lower than the peak of over43 000 in 2015-16 (figure 5).10FOREIGN INVESTMENT IN AUSTRALIA

Figure 5FIRB application numbers spiked then dipped, butaggregates are driven by real estate investment300CommercialinvestmentsValue of applications ( b)Number of applications45,00030,000Residentialreal ments250200Residential realestate1501005002005-062011-122017-18Source: FIRB annual reports (various years).The decline in the number of applications may have occurred for several reasons. Investorsmay have avoided making multiple speculative applications for potential residences sincethe introduction of application fees, foreign investment into Australian real estate may havebeen discouraged by the stamp duty and land tax surcharges introduced in recent years, orinvestment from China may have been restricted by a tightening of Chinese regulation onoutward investment.Australia also applies specific foreign ownership restrictions in some sectors. Many of theseequity restrictions prohibit majority ownership by foreign investors collectively and in somesectors there are ownership limits for individual foreign investors. The legislated ownershiprestrictions operating in Australia are: aggregate foreign ownership in an Australian airline (including Qantas) is limited to49 per cent (with any one foreign holding capped at 35 per cent) the Airports Act 1996 limits foreign ownership of some airports to 49 per cent, with a5 per cent airline ownership limit; and cross-ownership limits (where a foreign investorowns more than 15 per cent of Sydney airport) between Sydney airport and eitherMelbourne, Brisbane or Perth airports the Shipping Registration Act 1981 requires a ship to be majority Australian-owned if itis to be registered in Australia aggregate foreign ownership of Telstra is limited to 35 per cent and individual foreigninvestors are only allowed to own up to 5 per cent.Finally, regarding Australian real estate, foreign non-residents can only invest in residentialproperty if that investment (directly) adds to the housing stock — that is, establishedOVERVIEW11

dwellings cannot be purchased.1 Temporary residents can only buy an established dwellingif it is used as their residence and sold when they leave Australia.The effect of restrictions on foreign direct investmentAustralia’s foreign investment policy is likely to have a material effect on the volume offoreign investment, although statistics can be difficult to interpret.Foreign investment is rarely blocked outright — between 2015 and 2018 only10 applications out of 108 990 were rejected (table 2). However, the low rejection rate maybe partly explained by the screening regime discouraging some investors from applying atthe outset, due to the costs and uncertainty created by the process. The size of this effect isnot directly observable, although it can be modelled (discussed below).Similarly, withdrawal may pre-empt a likely rejection, deflating the rejection rate. Onaverage, about 5 per cent of applications are withdrawn prior to a decision, although it isdifficult to know whether an application is withdrawn due to likely rejection or for othercommercial reasons (such as more than one applicant pursuing the same asset, or a changein the commercial viability of a project).Table 2Applications and rejection and withdrawal ratesRejection rate (%of applications)RejectionsWithdrawal rate (%of 92554.764208 8291985–19901.903326.011 04917 4491991–19961.794707.501 97026 2791997–20021.875247.782 22028 5372003–20080.572096.812 12931 2742009–20140.06622.933 055104 2472015–20170.01103.902 73370 058Financialyearsaa Financial years beginning in the years indicated.Source: FIRB annual reports (various years).Comparing Australia’s policies to regimes elsewhere, the Organisation for EconomicCooperation and Development’s (OECD’s) index of FDI restrictiveness places Australiawell above the OECD average, though still lower than Canada and New Zealand (figure 6).However, the index also shows that Australia’s regime is not overly restrictive in absoluteterms (a score of 0.149, compared with a maximum of 1.0). The OECD also notes a declinein Australia’s restrictiveness since 1997 (when the score was 0.2), in line with a broad trendacross the OECD.1 The possibility that foreign investors add to the housing stock indirectly (e.g. if a vendor of an establisheddwelling uses the funds to invest in a new dwelling) is not considered by Government policy.12FOREIGN INVESTMENT IN AUSTRALIA

There are some limitations with the OECD index. For instance, it uses a subjectiveassessment to weight the strength of statutory restrictions, it does not include screening thatis strictly for national security purposes, and it does not measure how statutory restrictionsare enforced.Figure 6Australia is generally open to FDI, but is less open than otherOECD countriesaOECD FDI restrictiveness index, 2018Australia’s screening restrictionsOECD averagea The restrictiveness index is between 0 (least restrictive) and 1 (most restrictive), aggregated across sectorsSo

located overseas. These foreign investment figures include debt, derivatives and equity investment (figure 1). Foreign direct investment (FDI) is the portion of these holdings that is accompanied by a degree of foreign control, defined as an investor with at least a 10 per cent voting share over major company decisions.