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What's really wrong with Chinese investment?

20 Aug 2012

While debate about Chinese investment in Australia is on the boil, we still don't know what will be cooked up.

Tony Abbott has said that investment by Chinese state owned enterprises will "rarely be in Australia's interest". Bob Carr has labelled Abbott's position "dangerously dumb".

Chairman of the Foreign Investment Review Board, Brian Wilson, has weighed in saying that "Australian businesses, however they are owned, should be run on a purely commercial basis and not as an extension of the policy, political or economic agenda of a foreign government". Wilson's position doesn't rule out Chinese SOE investment, but it does give wide latitude to deny it.

The US is by far Australia's leading foreign investor with well over half a trillion dollars in assets here. But Chinese SOEs are rising fast, and often with FIRB approval. As a new University of Sydney-KPMG study shows, China has invested nearly $50 billion in Australia over the past five years with almost all of it in two very sensitive sectors, mining and energy.

China has largely managed down these sensitivities through small passive investments in Australian companies. The stand out exception was the $20 billion 2009 Chinalco bid for 18% of Rio Tinto that sank in a sea of acrimony. FIRB didn't apply its "national interest" test to kill the bid, but instead sat on its hands until the Rio board rejected the Chinalco offer.

The same script played out in America in 2005 when the Committee on Foreign Investment in the United States watched the Chinese National Offshore Oil Company's offer for Unocal fall apart before it had to rule.

Now China is back on the front foot, this time in Canada. Ottawa might like to follow the pattern of these high profile FIRB and CFIUS non-decisions. But it is unlikely to be so lucky because the case before it concerns a CNOOC takeover bid for struggling Canadian oil and gas company, Nexen, which its board has approved for $15 billion, all cash and at a 60% premium over market value.

Nexen would be the largest ever Chinese foreign takeover. But according to the Investment Canada Act, the Canadian government must first decide if the takeover would be a "net benefit" to the country, even broader than FIRB's national interest mandate.

If and when Ottawa acts, it will be a case of damned if you do and damned if you don't.

Approving the Nexen takeover would provoke heated accusations of selling the nation's crown jewels to a communist country with malign intent. Rejecting the CNOOC bid would send a loud and clear "your investment is not welcome" message to China.

Nexen is likely to be only the first of many similarly tough cases facing western governments as Chinese foreign investment fast becomes a defining feature of the global economy.

China is home to two of the world's five largest sovereign wealth funds and four of its biggest ten banks. The post-2005 30%-and-counting appreciation of the renminbi against the major global currencies is generating irresistible incentives for China to export less and invest more abroad.

These ineluctable forces mean it is only a matter of time before Australia faces its own CNOOC-Nexen. How then should the FIRB and the Treasurer react?

FIRB's national interest guidelines are quite general, and there are good reasons for this. But the contours of the whisper campaign against Chinese investment are much clearer. 

But when this campaign is put under the analytic microscope, flaws appear in the three core elements of the anti-China case.

The first charge is that Chinese SOEs unfairly benefit from the fact that China's state-run financial system lends them money on the cheap.

This is no doubt true, and China is often taken to task by the World Trade Organisation for similar complaints about its exports. But there is no WTO-equivalent to govern foreign investment, and many countries manipulate the cost of capital to help their own industries.

American and European firms have been given fat post-GFC paydays. But no one in Australia is complaining about the piles of money the US government poured into General Motors, because it helps keep Holden here.

Moreover, state involvement in if not ownership of companies is back in vogue, not only in China, and government support is always part and parcel.

For heavy government involvement, think so many failing European banks or the "government sponsored enterprises", Fannie Mae and Freddie Mac, that control the bulk of American mortgages.

Formal state owned enterprises of global consequence include Saudi Aramco, probably the world's biggest energy company, India's biggest bank, the State Bank of India, and the largest company in Latin America, Brazilian energy giant Petrobras.

While Chinese SOEs are a big story, they are far from alone when it comes to tight government-corporate ties.

The second concern about Chinese investment is a lack of reciprocity. China wants to invest freely in Australia, but restrictions on foreign investors in China are legion.

Surely Australia should use approval of Chinese investment here as a bargaining chip to open up the Chinese market for Australian firms wanting to operate there?

Not so fast. The reciprocity play runs directly counter to the core free market principle that countries should open their economies unilaterally because this will increase efficiency and competition at home, irrespective of what other countries do.

This was at the heart of the Hawke-Keating reforms that are today championed by their staffer Craig Emerson, now the Trade and Competitiveness Minister.

It would be a massive step for the Liberals to depart in office from 25 years of Australian pro-market orthodoxy, despite Tony Abbott's recently stated position.

The final reason many are sceptical about Chinese investment is the most important, and it was clearly laid out by the FIRB chairman.

China's SOEs, even though many are traded on the stock market, are de facto instruments of Chinese state power. And, it is no small matter that China is still run by the communist party.

But what could a Chinese SOE owning assets in Australia really do to hurt us?

Resource security is no doubt a major motivator for Chinese direct investment in Australia, seeking to ensure that lots of our natural resources head China's way, with predictable supply and at low prices.

This Chinese investment in our minerals, energy and agricultural bounty is often also in Australia's national interests, and not only because of the cash involved.

Perhaps the best example is one that didn't create much political blowback. Sinopec's 25% stake in the Origin Energy-led liquefied natural gas mega project in the Gladstone basin is based on a guarantee that 3.3 million tonnes of LNG will go to China every year until 2035.

The big plus from the Sinopec deal was the confidence it gave US energy giant Conoco to put many billions of dollars and its world leading technology into the project. The comparatively tiny Australian market for gas was close to irrelevant.

It is hard to see how Sinopec could use its Origin tie in to hurt Australia, even if it wanted to???and there is no evidence to date that it is. Certainly gas that is destined for export couldn't hurt the domestic market.

Sinopec wants the LNG to come on line as quickly as possible and for as much gas as possible to be produced as efficiently as possible. Origin and Conoco have precisely the same objectives.

LNG prices are increasingly set on the world market. Sinopec will be able to influence this market as both a major buyer and a financial player in projects like Gladstone. But it is hard to see how it could control the price, even if this was Beijing's bidding. 

Would things be different if the today unthinkable happened, and Sinopec bought Origin, or CNOOC took over Woodside, or any Chinese state controlled entity acquired any major Australian natural resource company?

The facile answer is that Chinese control would change everything. But why precisely?

The commercial imperatives for the now Chinese controlled company would remain the same???harness lots of Australian raw materials for sale in China and the rest of emerging Asia at world market prices.

If the Australian government was concerned about a Chinese owned company making excessive profits on its exploitation of our raw materials, it could simply increase the taxes levied along the lines of the recent MRRT on the big miners.

A Chinese owned company would definitely want to take what it learned in Australia and use it to build a world beating firm in China. This is a central goal of Chinese policy. But the same is true for all multinational companies around the world.

Of course the ultimate national security worry concerns Asia Pacific geopolitics and the prospect of armed conflict.

If war, god forbid, broke out between China and the US over Taiwan, Tibet or the South China Sea, and Australia lined up with its US ally, could China use its Australian assets to punish us? It is hard to see how since China would still want our resources.

If China wanted to pressure Australia to distance itself from the US more generally, it could certainly threaten not to buy Australian raw materials. But this threat would be weakened, not strengthened, if China owned some of these resources.

China could direct its SOEs owning our assets to stop working them. But China would be cutting off its nose to spite its face.

The bottom line has been known since at least Immanuel Kant. Economic ties between countries reduce the risk of armed conflict because their interests are too intertwined. The story is typically told with respect to trade. But it also holds for foreign investment. 

Put it all together, and the common fears about Chinese investment in Australia seem overwrought it not unfounded.

Chinese investment is bound long to remain an anxiety-producing issue in Australia. But it is worth remembering this was also the case with Japanese investment forty years ago.

Back then, economic hard heads prevailed and Australia benefitted from Japanese investment. This despite the facts that Japan was about as "state capitalist" as a democracy could be, it was an effective one party (LDP) state, and its fundamental interest in Australia was resource security.

Japan, of course, was part of the US alliance system with Australia. China clearly is not. And there will always be defence, security and intelligence reasons to deny some foreign investment in Australia. But this doesn't mean throwing a blanket over Chinese investment here.

Instead, it is time to start thinking about Chinese investment more in light of Australia's positive experiences with foreign investment and less using alarmist innuendo about nefarious Chinese plans for global domination.