The White Picket Fence: Australia's Open Investment Future

Showing posts with label Australia's Open Investment Future. Show all posts

Thursday, December 18, 2008

Is the Foreign Investment Review Board acting fairly?

Australia's foreign investment regime is once again the subject of controversy. In the past, high profile bids by Shell for Woodside (in 2001, blocked by then Treasurer Peter Costello) and by Xstrata for WMC Resources (in 2005, approved by Treasurer Costello with conditions) have attracted a great deal of controversy. This year, Treasurer Wayne Swan has been grappling with a surge of Chinese investment into the Australian resources sector. ⁽¹⁾ Meanwhile, a general protectionist drift in global Foreign Direct Investment (FDI) policy has emerged at the international level. ⁽²⁾

ASKING THE RIGHT QUESTION

We have been asked the question, "Is the FIRB (Australia's Foreign Investment Review Board) acting fairly?" One way to answer that question is to ask whether Australia is living up to its international commitments with regard to foreign investment. The Organisation for Economic Cooperation and Development (OECD), of which Australia is a member, has been at the forefront of efforts to develop international "rules of the game" for foreign investment and promote fair treatment of foreign investors. The OECD's general investment policy principles are established in the OECD's investment instruments, based on the OECD Code of Liberalisation of Capital Movements (1961) and the OECD Declaration on International Investment and Multinational Enterprises (1976, revised in 2000). ⁽³⁾ It is then possible to assess Australia's regime against those principles. However, we think framing the current policy debate in terms of "fairness" is problematic for at least two reasons.

First, from the point of view of the integrity of the investment regime, "fairness" is a strange test to set the FIRB. Fairness to whom? To shareholders and/or managers in the companies that are targets of foreign takeovers? To the foreign companies themselves? To Australian citizens? Or all of the above? What happens if being fair to one group of stakeholders means being "unfair" to another? A better alternative might be to evaluate the FIRB in terms of the stated objective of Australia's foreign investment framework: to protect the national interest.

Second, in practice the FIRB is only one component of Australia's investment framework. Indeed, the Board's functions are advisory only, with responsibility for the government's foreign investment policy overall -- as well as for making decisions on individual proposals -- resting with the Treasurer. ⁽⁴⁾ Ultimately, it is Wayne Swan who has to make the call as to whether a project will go ahead. ⁽⁵⁾

These two qualifications argue for a somewhat different question, along the lines of Can Australia's existing foreign investment regime ensure that Chinese investment in our resources sector is in the national interest?

The short answer to this question is, yes it can. The longer answer involves the consideration of several elements, including:

the nature Australia's foreign investment framework in general, and its treatment of government-controlled foreign investment in particular;
the degree of restrictiveness of Australia's investment framework;
the concept of the national interest;
the global context within which Australian investment policy has to operate;
and the specific context provided by the Australia-China bilateral relationship.

AUSTRALIA'S FOREIGN INVESTMENT FRAMEWORK

Foreign investment in Australia is regulated under the Foreign Acquisitions and Takeovers Act 1975 (the FATA) and by the Australian Government's Foreign Investment Policy (the Policy). ⁽⁶⁾ The Australian Government's approach is to encourage foreign investment consistent with community interests. The Policy acknowledges up front community concerns about foreign ownership of Australian assets. ⁽⁷⁾ So one important objective of the Policy is to balance community concern about foreign ownership of Australian assets against what the government recognises as the "strong economic benefits" that the economy receives from foreign investment.

The Policy provides the framework for Government scrutiny of proposed foreign investment while the FATA, together with the Foreign Acquisitions and Takeovers Regulations 1989, sets out which types of foreign investment proposal require notification to or prior approval by the Government, and provides monetary thresholds below which the relevant FATA provisions do not apply. ⁽⁸⁾ In addition to the reporting requirements under the FATA, the Policy also imposes additional restrictions on investments by foreign persons in sensitive sectors including banking, civil aviation and airports, shipping, telecommunications and the media.

The FIRB assists the Federal Treasurer exercise his responsibilities for making decisions relating to foreign investment and for administering the Policy. It examines proposals by foreign interests to undertake direct investment in Australia, and makes recommendations to the government on whether those proposals are suitable for approval under the Policy. ⁽⁹⁾ The FIRB is an administrative body with no statutory existence, and the FATA makes no reference to it. Instead, its role is confirmed by the Policy. ⁽¹⁰⁾

The requirement for prior approval for larger or more sensitive transactions is intended to allow the Treasurer to assess, on a case-by-case basis, foreign investment proposals against the criterion of the national interest. The FATA does not define the national interest, however, and the Policy merely states that the Government determines what is contrary to the national interest by "having regard to the widely held community concerns of Australians". The legislative intent therefore seems to have been to leave considerable discretion to the Government in defining the national interest.

DEALING WITH FOREIGN GOVERNMENT INVESTMENT

Particularly important in the context of the current debate over Chinese investment is the stance that the Policy takes towards investment by foreign governments. It requires prior notification in the case of all investments by foreign government, regardless of the size of the proposal -- implicitly recognising that this type of investment raises particular issues and community sensitivities.

Before 17 February 2008, the guidance offered by the Policy on this issue was quite brief, stating only that "All direct investments by foreign governments or their agencies irrespective of size are required to be notified for prior approval ... whether the investment is made directly or through a company that is owned 15% of more by a foreign government." ⁽¹¹⁾ On 17 February 2008, however, the Treasurer released a new set of guidelines for foreign government investment proposals -- against a backdrop of growing media attention on Chinese investment applications in the resources sector.

The new guidelines state that while proposed investments by foreign governments and their agencies would be assessed on the same basis as private sector proposals, the fact that these investors were owned or controlled by a foreign government raised "additional factors that must also be examined" given that "investors with links to foreign governments may not operate solely in accordance with normal commercial considerations and may instead pursue broader political or strategic objectives that must also be examined." ⁽¹²⁾ The Treasurer listed six issues that would be examined when considering proposed investments by foreign governments and their agencies. The Treasurer will look at the extent to which:

An investor's operations are independent from the relevant foreign government.
An investor is subject to and adheres to the law and observes common standards of business behaviour.
An investment may hinder competition or lead to undue concentration or control in the industry sectors concerned.
An investment may impact on Australian government revenue or other policies.
An investment may impact on Australia's national security.
An investment may impact on the operations and directions of an Australian business, as well as its contribution to the Australian economy and broader community.

In addition, some commentators have claimed to have detected a seventh criterion relating to proposed investments aimed at vertical integration. ⁽¹³⁾ In a speech given in July 2008, the Treasurer noted that "our predisposition is to more carefully consider proposals by consumers to control existing producing firms." ⁽¹⁴⁾

HOW RESTRICTIVE IS AUSTRALIA'S
FOREIGN INVESTMENT REGIME?

This foreign investment regime has been the subject of a fair degree of criticism, often relating to a perceived lack of transparency and the alleged vagueness of the "national interest" criterion. For example, the Financial Times newspaper, writing in reference to Xstrata's 2005 bid for WMC Resources, editorialised that "Other developed countries, including the US, screen inward investments. But few operate regimes that are more opaque, unaccountable or open to political and bureaucratic manipulation." ⁽¹⁵⁾ The same editorial went on to argue that the national interest test was a "criterion so vague as to justify almost anything" and concluded that Australia's system was a "protectionist relic". More recently, a report by consultants ITS Global argued that Australia's regulatory regime is imposing significant economic costs by delaying some foreign investment and prompting the withdrawal of other proposals. ⁽¹⁶⁾

Do these criticisms stack up?

One approach to answering this question is to look at the data provided by the FIRB itself. In 2006-07, 7,025 applications for foreign investment were considered under the Policy and the FATA. Of those, 200 were exempt or not subject to the FATA, 629 were withdrawn, and 6,157 were approved (Table 1). Just 39 were rejected. Of the foreign investment applications decided (proposals either approved or rejected), basically 100% were approved by value (Table 2). ⁽¹⁷⁾

Table 1: Foreign investment applications considered by the FIRB 2001/2 to 2006/7
By number of proposals

	2001-2	2002-3	2003-4	2004-5	2005-6	2006-7
Proposals considered	5,097	5,315	5,036	4,884	5,781	7,025
% of total	100	100	100	100	100	100
Approved unconditionally	1,041	1,105	995	1,127	1,386	1,520
% of total	20.4	20.8	19.8	23.1	24.0	21.6
Approved with conditions	3,405	3,562	3,452	3,233	3,800	4,637
% of total	66.8	67.0	68.5	66.2	65.7	66.0
Total Approved	4,446	4,667	4,447	4,360	5,186	6,157
% of total	87.2	87.8	88.3	89.3	89.7	87.6
Rejected	77	80	64	55	37	39
% of total	1.5	1.5	1.3	1.1	0.6	0.6
Withdrawn	402	365	319	287	373	629
% of total	7.9	6.9	6.3	5.9	6.5	9.0
Exempt	172	203	206	182	185	200
% of total	3.4	3.8	4.1	3.7	3.2	2.8

Source: Derived from Table 2.1 in Foreign Investment Review Board,
Annual Report 2006-07. (2008)

Table 2: Foreign investment applications decided, 2001/2 to 2006/7
By A$ billions

	2001-2	2002-3	2003-4	2004-5	2005-6	2006-7
Proposals decided	118.0	85.8	99.1	119.5	85.8	156.4
% of total	100	100	100	100	100	100
Approved unconditionally	70.2	53.5	58.9	60.4	72.5	140.3
% of total	59.5	62.4	59.4	50.5	84.5	89.7
Approved with conditions	47.7	32.2	40.1	59.1	13.3	16.1
% of total	40.4	37.5	40.5	49.5	15.5	10.3
Total Approved	117.9	85.7	99.0	119.5	85.8	156.4
% of total	99.9	99.9	99.9	100.0	100.0	100.0
Rejected	0.1	0.0	0.1	0.0	0.0	0.0
% of total	0.1	0.0	0.1	0.0	0.0	0.0

Source: Derived from Table 2.2 in Foreign Investment Review Board,
Annual Report 2006-07. (2008)

On the face of it, then, the FIRB data suggest that the investment review process is not particularly restrictive. However, the data do not really allow us to make this assessment, mainly because we do not know how much investment was not submitted for review that would otherwise have flowed into Australia if it had not been discouraged by the prevailing investment regime.

A slightly different approach is to look at measured outcomes in terms of Australia's receipt of inward FDI -- such as the country's ranking in global foreign investment inflows. On these measures, Australia does not stand out as an obvious outlier in the way that (say) Japan does. So, for example, ranking countries based on the stock of inward Foreign Direct Investment (FDI) as a share of GDP shows Australia placed around the middle of the pack (Figure 1). ⁽¹⁸⁾ However, comparisons of gross FDI inflows or of FDI as a share of GDP do not take into account other factors that might be expected to influence investment including resource endowments, trade barriers and geographical location along with the FDI regulatory environment and the general regulatory environment. For example, one alternative measure which is sometimes cited is UNCTAD's Inward FDI performance index, which ranks countries by the FDI they receive relative to their economic size. It is the ratio of a country's share in global FDI inflows to its share in global GDP. ⁽¹⁹⁾ Australia ranks a lowly 131 out of 141 in these rankings. But a glance at some of the countries ranked above Australia suggests that this may not be a particularly helpful measure of Australia's attractiveness as an investment destination: it seems unlikely that Canberra should be seeking to create the investment environment of a Moldova (#19) or a Congo (#33).

Figure 1: 2007 stock of inward FDI as % of GDP

Looking at outcomes tells us nothing about a potentially important counterfactual -- that is, how foreign investment into Australia might have performed given a different (more liberal) regulatory regime -- and hence by implication how the current regime may be altering Australia's relative attractiveness as an investment destination.

One of an extremely small number of studies to attempt this kind of analysis finds that efforts by Australia to reduce its prevailing restrictions on FDI down to the levels prevailing in the United Kingdom would lead to a significant increase in the stock of inward FDI. ⁽²⁰⁾ Another attempt to carry out this kind of assessment was conducted with reference to the easing of investment restrictions produced by the AUSFTA. Modelling by the Centre for International Economics, commissioned by the Government, suggested that by raising the notification threshold for US investors in Australia, AUSFTA would not only reduce transactions costs for US investors, but could also contribute to a reduction in the equity risk premium. This in turn was estimated to produce substantial economic gains for Australia, implying that the existing restrictions might impose significant economic costs in terms of foregone economic welfare. ⁽²¹⁾ The approach taken by the CIE is controversial, however, and other analysts have argued strongly that treating the change to the FIRB screening process as producing a change in the risk premium is inappropriate; instead, any estimated gains should be restricted to the (far more modest) consequences of the associated decline in transactions costs. ⁽²²⁾

In the absence of any clear results on the cost of existing restrictions, general surveys of overall investment attractiveness or investment climate tend to show Australia stacking up reasonably well in international terms. So, for example, the 2007 A T Kearney FDI Confidence Index -- which surveys executives from companies that together account for about 75% of global FDI flows -- ranks Australia in a fairly creditable eleventh place, albeit down from eighth place in 2005 (Figure 2). ⁽²³⁾ A more recent survey by UNCTAD looking at the FDI intentions of the world's leading transnational corporations ranks Australia as the ninth most attractive destination in the world for FDI. ⁽²⁴⁾ Similarly, Australia scores quite well on the Heritage Foundation's "Investment Freedom" index, receiving a score of 80 out of a maximum possible score of 100 (Figure 3). ⁽²⁵⁾ Such measures suggest room for improvement, but no drastic failings.

Figure 2: A T Kearney 2007 FDI Confidence Index

Figure 3: Heritage Investment Freedom Sub-index

In contrast, a much more negative picture comes from the OECD's FDI regulatory restrictiveness index. This covers 9 sectors (although not the resource sector) and 11 sub-sectors and seeks explicitly to measure deviations from "national treatment" -- that is, discrimination against foreign investment. ⁽²⁶⁾ According to the OECD, Australia's investment regime is one of the most restrictive of any OECD members, and is also restrictive compared to that prevailing in a number of non-members as well: out of the 43 countries ranked by the OECD's index, Australia is categorised as the sixth most restrictive (Figure 4). ⁽²⁷⁾

Figure 4: OECD FDI restrictiveness index

DEFENDING AND DEFINING THE "NATIONAL INTEREST"

We noted above that one criticism levelled at Australia's investment regime is the reliance on a "vague" national interest test. The ITS Global report cited above, for example, stresses that neither the FATA nor the FIRB provides any guidance as to how the national interest is to be defined. It argues that this means that "the only substantive constraint on the Government's handling of foreign investment issues is the requirements for democratic accountability, as expressed through the Australian Parliament. This makes all foreign investment issues inherently political ... foreign investment policy will tend to reflect the views of the median voter, regardless of how much the median voter knows about foreign investment or the economic trade-offs that are involved in restricting it." The result, the report argues, is a high level of political uncertainty that discourages foreign investors.

We have already addressed the issue as to whether Australia's foreign investment framework is discouraging capital inflows. We would also differ with the contention that the only constraint facing the government is the Australian Parliament. Australia runs large current account deficits which require external financing, and has done so for nearly all of its history. This means that no Australian government can afford to pursue policies that will scare off foreign investors en masse. While acknowledging community concerns the Policy makes clear in its first line that its aim is to encourage foreign investment. ⁽²⁸⁾

More fundamentally, however, this assessment is mistaken in the assumption that a change to the national interest criterion would somehow remove politics from the equation when it comes to foreign investment. Despite the clear economic benefits of openness to investment flows, foreign investment is a sensitive domestic issue. The Lowy Institute Poll 2008 (conducted in July) found that 90 per cent of Australians either "strongly agree" or "agree" that that the government has a responsibility to ensure major Australian companies are kept in majority Australian control (Figure 5). ⁽²⁹⁾ There was also overwhelming agreement (85 per cent) that investment by companies controlled by foreign governments should be more strictly regulated than investment by foreign private investors.

Figure 5

Source: Hanson, Australia and the World: Public Opinion and Foreign Policy.
The Lowy Institute Poll 2008. (2008)

Several important implications flow from this.

The first is that no government, no matter how supportive of foreign investment, is going to give up its discretion to review potentially sensitive foreign investment proposals. This is a simple political reality, and applies particularly to applications by government-controlled entities such as state-owned enterprises or Sovereign Wealth Funds (SWFs): "While SWFs are not new, as they grow in size and importance it seems inevitable that their activities will be subject to increasing scrutiny by the governments and citizens of the countries in which they invest." ⁽³⁰⁾

Nor is this reality confined to Australia. According to Devlin and Brummitt, the German government is reportedly considering legislating to block state-controlled foreign investments; the European Commission is inquiring into whether state-controlled investment funds from Russia, China and the Middle East threaten Europe's single market; and the United States has revised legislation governing its Committee on Foreign Investment in the United States. ⁽³¹⁾ This follows the high profile Dubai Ports World and CNOOC/Unocal cases. In that sense the Australian public mood seems to be part of a broader upsurge in investment protectionism, to be discussed below.

Second, rather than dismissing parliamentary accountability as a constraint on foreign investment we would argue that it is legitimate and appropriate for the elected government of the day to be charged with defining the national interest. There should be as much transparency and accountability as possible built into the process. But we would argue that the level of public scrutiny of proposals currently before the FIRB is considerable and that in a rapidly changing international investment environment trying to tie the Treasurer's hands by seeking to codify the national interest would be difficult to achieve and potentially counterproductive. Charging unelected officials with this responsibility certainly does not seem an improvement.

Third, given these political realities supporters of an open investment framework should recognise that sustaining public tolerance for the system overall -- a system which approves the overwhelming majority of applications -- requires that Government is able to reassure the public that a rigorous process of scrutiny is in place. While this entails an overhead, that may be the price that has to be paid to maintain the credibility and integrity of a relatively open investment regime that is essential for meeting Australia's enduring need for foreign capital.

THE NATIONAL INTEREST AND NATIONAL SECURITY

One important component of the national interest is national security.

The international investment framework recognises that protecting national security is a legitimate concern for and responsibility of national governments. Article 3 of the OECD Code of Liberalisation of Capital Movements provides that: ⁽³²⁾

The provisions of this code shall not prevent a Member from taking action which it considers necessary for:
the maintenance of public order or the protection of public health, morals and safety;
the protection of its essential security interests;
the fulfilment of its obligations relating to international security.

This principle is reflected in Australia's national investment framework. The Guidelines for Foreign Investment Proposals recognise that:

5. An investment may impact on Australia's national security.
The Government would consider the extent to which investments might affect Australia's ability to protect its strategic and security interests. ⁽³³⁾

Critics of investment controls argue that the national security exception is a back-door protectionist device, and there is some evidence for that. Strikingly, nearly all of the restrictions to international foreign investment regimes imposed in recent years have been justified in terms of national security. ⁽³⁴⁾ So how serious is the threat posed to national security by foreign investment -- particularly investment by entities controlled by foreign governments?

The answer depends somewhat on the nature of the threat.

Some investments pose a direct and fairly obvious threat to national security. These include attempts to acquire Australian companies in which reside technologies, capabilities, knowledge or other information that are important to our national security.

A good example is the 2001 acquisition by Singapore Telecom (SingTel), a telecommunications company partly owned by the Singapore government, of Optus (then majority owned by Cable & Wireless). In that case the deal proceeded, but only after a significant delay in the FIRB review process while the companies involved worked to address concerns about the potential for the sale to compromise sensitive defence communications. The Treasurer approved the deal subject to conditions designed to protect Australia's security interests and supported by Australian security agencies, including an agreement between SingTel and Defence on access, performance and security matters. ⁽³⁵⁾

While China's investment interest in Australia currently focuses on the resources sector, publicly available information about the scale of Beijing's overseas intelligence-gathering activities suggests that any move by a Chinese government-controlled entity to acquire an interest in Australian sectors such as defence or telecommunications which are sensitive in national security terms should receive very close government scrutiny indeed. ⁽³⁶⁾

The OECD's investment instruments recognise that investments by government-owned entities can raise concerns as to whether their objectives are commercial or driven by political, defence or foreign policy considerations. ⁽³⁷⁾ This risk is also reflected in Australia's guidelines, which recognise that "investors with links to foreign governments may not operate solely in accordance with normal commercial considerations and may instead pursue broader political or strategic objectives that could be contrary to Australia's national interest." ⁽³⁸⁾

Some grounds exist for concern about foreign governments using sovereign investment to pursue these non-commercial goals. In a recent statement to the relevant US Congressional subcommittee, Congressmen Manzullo and Marchant stated that "some SWFs and their governments have challenged US national security interests ... In particular, the Russian Government's inappropriate use of corporate and capital resources to pursue its international strategic and political objectives ... should be very alarming." ⁽³⁹⁾ Less alarming but still of concern -- and closer to home for Australia -- are reports that the purchase of Costa Rican government bonds by China's State Administration of Foreign Exchange (Safe) was in return for Costa Rica severing ties with Taiwan and establishing relations with Beijing. ⁽⁴⁰⁾ This has been cited as evidence of Beijing's willingness to use financial tools for foreign policy ends.

At least theoretically, government-controlled foreign investors could seek to influence the policies and capabilities of recipient countries by taking direct ownership of strategic sectors or critical infrastructure for the purpose of sabotaging it -- or using the threat for coercive purposes. They could also seek to exert leverage over government policy through the threat of investment withdrawal or, more subtly, by coopting domestic interests: subtle forms of pressure are more likely than overt threats because of growing economic interdependence. ⁽⁴¹⁾ Moreover, sovereign investment does have negative consequences for the international system, including feeding growing protectionist sentiment, undermining international financial cooperation and reinforcing authoritarian governments. ⁽⁴²⁾

It is ultimately impossible to reach clear-cut decisions about the motivations for investment decisions by government-owned entities. As Edwin Truman has pointed out, SWFs "are governmental entities, and governments are political." ⁽⁴³⁾ Daniel Drezner agrees: "SWFs are, by definition, extensions of the state. They are therefore viewed as maximising their country's long-term strategic interests rather than as profit-maximising actors." ⁽⁴⁴⁾ It follows that sometimes decisions on whether to oppose such proposals will also be political decisions. And what applies for SWFs will also apply to other forms of government-controlled investment

On balance, we are inclined not to exaggerate either the national security implications of investment in Australia by foreign government-owned entities or the potential for national security concerns to be abused as a means to block legitimate investment proposals, for several reasons:

we have not been able to find any example of a significant investment proposal that has been rejected by Australia on national security grounds (in the SingTel case the application was approved subject to certain conditions); ⁽⁴⁵⁾
the proportion of SWF foreign investment targeting strategic sectors globally seems relatively insignificant. A June 2008 study by the Monitor Group found that "The vast majority of SWF investment has avoided sectors in which foreign government ownership may seem threatening to national security in the recipient country". ⁽⁴⁶⁾ They found that investments in transportation, defence, aerospace and high technology comprised less than one per cent of all purchases;
even where SWFs have made investment decisions based on criteria other than profit maximisation, there seems to be little evidence that any of these attempts to exercise leverage had any policy effects. This is consistent with the international relations consensus that threats of economic exit work only under a limited set of circumstances and theory suggesting that, as a result of economic interdependence, SWFs lack the capability to coerce the OECD economies. ⁽⁴⁷⁾

Finally, it should be noted that foreign investment can also have significant benefits for national security for the target country as well as the source nation, not least because a commitment to international openness may work as an important contributor to regional or even international stabilisation -- with the European Union experience as arguably one of the most successful examples of this process. ⁽⁴⁸⁾

THE CHANGING GLOBAL ENVIRONMENT

The recent controversy regarding Australia's foreign investment policy regime has to be understood against the backdrop of several developments at the global level.

First, one consequence of the ongoing redistribution of economic power away from both the developed world and from the Atlantic economies is that the developed world is now having to become used to the idea of being a recipient of foreign investment from emerging markets in addition to its traditional role of a being a source of investment into those same countries. ⁽⁴⁹⁾

Second, many emerging markets give the state a relatively large role in their economies. As a result, a large share of the new emerging market outward investment is being funnelled through state-owned enterprises, state-owned banks and SWFs. This has posed a dilemma for developed world policymakers. The latter have told their voters that the private sector, not government, should take the lead in managing most businesses. At the same, time they have stressed the importance of openness to foreign investment. When confronted by government-controlled foreign investment, one of these propositions has to give. The question is, which one? ⁽⁵⁰⁾

This is intensified by a suspicion that government-controlled foreign investors might operate on non-commercial grounds. While defenders of open investment regimes tend to stress that there is no evidence to show malign behaviour by sovereign investors, nevertheless there is evidence that state-controlled investors have motives beyond the commercial, as discussed above.

Third, many developed country governments now face electorates which are increasingly sceptical regarding the benefits of further international economic liberalisation. ⁽⁵¹⁾

Finally, the world economy had until relatively recently been experiencing a dramatic resource boom. The resulting surge in commodity prices served to fuel resource insecurity in consuming countries and resource nationalism in producing countries, simultaneously making the resource sector both an increasingly attractive and an increasingly sensitive target for foreign investment.

One consequence of these developments has been an upsurge in "investment protectionism", as scepticism regarding the benefits of FDI has seen a succession of developed economies tighten their foreign investment laws and declare high-profile assets off-limits to foreign investors. ⁽⁵²⁾

The intensification of the international financial crisis following the bankruptcy of Lehman Brothers on 15 September 2008 has altered this global environment for foreign investment in at least four important ways.

First, the deepening financial crisis has produced a sharp fall in asset prices and a rise in risk aversion across the world. In the short term, this looks set to reduce the availability of foreign capital. Projections for FDI next year are now being slashed. The OECD thinks that global FDI inflows will be down 13% by the end of 2008, and continue to fall into 2009. ⁽⁵³⁾ More competition for scarce foreign investment could encourage governments to be more mindful of discouraging foreign investors through regulatory changes. At the same time, however, lower asset prices might encourage bargain hunters which may trigger fears about so-called "fire sale FDI".

Second, the downturn in global economic and financial conditions has brought an abrupt end to the resources boom. As a result, resource scarcity/nationalism issues may fade somewhat in importance.

Third, the outlook for growth across the world economy has deteriorated markedly and there is some danger that tougher economic times will intensify existing protectionist pressures.

Finally, the crisis has seen a dramatic expansion in the role of the state in developed country financial systems. Given these changes, developed country claims regarding their desire to limit the role of government in their economies will now ring somewhat hollow.

THE AUSTRALIA-CHINA BILATERAL RELATIONSHIP

While shifting global conditions have certainly played a role in influencing the foreign investment climate within Australia, however, the current policy challenge is located very precisely in the context of the bilateral Australia-China relationship, and in particular in the surge of Chinese investment into the Australian resource sector, and in Canberra's response to that surge.

To some extent, the rise in Chinese interest in investing in Australia should come as no great surprise. ⁽⁵⁴⁾ Until recently, the bilateral economic relationship has been a very lopsided one. Trade ties have been deep, and getting deeper: in 2007/8, two-way trade in goods and services reached A$63.7 billion, accounting for 13% of total Australian trade and making China our largest trading partner. In marked contrast, investment links have been very modest. The total stock of Chinese foreign investment in Australia at the end of 2007 was a mere $6.2 billion, or less than half of one percent of the value of total foreign investment.

That large gap between the scale of the trading and investment relationships has now started to close. Moreover, it has been showing signs of doing so very quickly. Over the past two financial years, Australia has approved some A$10 billion in proposed Chinese investment, and earlier this year forecasts for 2007-08 suggested a figure for proposed investment in excess of A$30 billion. ⁽⁵⁵⁾ In this sense the China relationship is following the pattern of Australia's highly successful economic relationship with Japan, dating back to the 1970s, which saw major Japanese investment follow trade in the resources sector. Not surprisingly, such a dramatic increase has caught the attention of policymakers, as have high profile deals such as Chinalco's US$14 billion dawn raid on Rio Tinto.

One important complication with regard to Chinese investment arises from the nature of the Chinese economic model. Since Australia's Foreign Investment Policy requires that every investment proposal from a government-controlled entity undergo inspection by the FIRB, and as a great many Chinese businesses have government-ownership stakes, a large share of Chinese investment in Australia inevitably falls into the review process.

A further important complication is (geo-) political. Traditionally Australia's most important trading partners have also been our key security partner (the UK and then the US) -- or at least an ally of our key security partner (Japan), all of them democracies. Now for the first time our largest trading partner is authoritarian, a quasi-mercantilist, and a strategic competitor of our major ally.

Public opinion seems to be alert to these emerging complexities. The Lowy Institute Poll 2008 showed that 62 per cent of Australians agree that China's growth has been good for Australia but also revealed growing unease about the strategic consequences of China's rise: 60 per cent agreed that China's aim is to dominate Asia and 52 per cent agreed that Australia should join with other countries to limit China's influence.

China was the most opposed in a list of potential sources of foreign governmentcontrolled investment (Figure 6). ⁽⁵⁶⁾

Figure 6

Source: Hanson, Australia and the World: Public Opinion and Foreign Policy.
The Lowy Institute Poll 2008. (2008)

SHOULD WE WORRY SPECIFICALLY
ABOUT THE RESOURCE SECTOR?

Importantly, the current policy challenge relates not just to Chinese investment, but more specifically to Chinese investment in the resources sector. A particular issue that arises here relates to presence of resource rent -- that is, the supernormal or excess profit that is earned in the exploration, development and extraction of mineral deposits. Resource rents can be a product of the quality differential between mining projects: Australia is a low cost iron ore producer, for example, and so at a world price that is set by the (higher cost) marginal producer earns a rent that cannot be competed away. ⁽⁵⁷⁾

In the case of the iron ore market -- which has a market structure that looks something like a cartel with a fringe of smaller players, whereby a small number of large players set the price taking into account the impact this will have on the fringe producers -- it should be possible for the major producers to restrict output in the face of strong, inelastic demand to extract an additional scarcity rent. ⁽⁵⁸⁾ Crucially, using market power to restrict output and drive up scarcity rents may be in the national interest of the producing country, since this might allow it to take advantage of the Hotelling condition. ⁽⁵⁹⁾

It follows that allowing a foreign investor from a consuming country like China to make an investment that will compromise the use of that market power may not be in Australia's national interest, since China and Australia may well have divergent interests when deciding on pricing and on how the economic and scarcity rent is to be shared. If the investor is government-controlled, these conflicting national interests are arguably even more likely to come to the fore: with its rapidly growing demand for resources, China, for example, might prefer that output expand at a more rapid rate (and lower price) than may be in Australia's national interest. ⁽⁶⁰⁾

DON'T PANIC

There is no need to panic about Chinese foreign investment into Australia and the consequences for the national interest, however. In particular, there is no need to tighten Australia's existing foreign investment framework.

At present, the majority of foreign investment into Australia is -- quite rightly -- not treated by the existing policy framework as threatening our national interest in any way, whether by virtue of its size or the particular sector into which it is headed. For the same reasons, this will remain the case even as the flow of Chinese investment increases. In other circumstances where there are particular concerns -- related to competition or government revenues -- there are other domestic policy tools (competition policy, taxation policy) that can be brought to bear without turning to additional restrictions on foreign investment.

That will still leave some sectors and investments that will trigger sensitivities, regardless of whether the foreign investor is government or privately controlled. Here, the existing policy framework already provides the Treasurer with plenty of scope to intervene. Indeed, since the veto of Shell's attempted takeover of Woodside in 2001 a common criticism has been that that there is too much discretion available, not too little.

There will also be a small number of cases where Canberra will decide that while a private sector investor is acceptable, a government-controlled one isn't. We suggested above that one example of this situation could arise in the case of a foreign government-controlled investor taking a significant stake in a resource company that can exercise market power. The Government is already thinking along these lines: according to the Treasurer, "as the proposed participation by a consumer of the resource increases to the point of control over pricing and production, and especially where the resource in question is already developed and forms a major part of the total resource, or where the market disciplines applying to public companies are absent, I will look more carefully at whether the proposal is in the national interest." ⁽⁶¹⁾ Again, the current framework, even prior to the announcement of the six principles on 17 February 2008, already provides adequately for such circumstances in the form of the national interest test, allowing the Treasurer to either set appropriate conditions to mitigate specific concerns, or to exercise an outright veto.

Overall then, fears that the current foreign investment framework is inadequate to deal with the challenges posed by Chinese investment are unfounded. At the same time, however, concerns about the adverse consequences of the existing foreign investment regime should not be exaggerated. Granted, the additional elaboration provided by the Treasurer's enunciation of six guidelines for foreign investment was probably unnecessary, in that the existing national interest test was already quite adequate. ⁽⁶²⁾ But some of the concerns now being expressed about the political nature of the process either look overdone or ignore political realities.

This is not to say that we think there is no room for improvement. The FIRB process in particular is often criticised for a lack of transparency, and it is possible that some improvements could be made here. That said, it appears that one major constraint is the requirement of the companies themselves to secure commercially confidential information. Moreover, when the Treasurer did move to increase the transparency of the process by announcing his six principles, this was instead seen in some quarters as adding additional restrictions to the investment process.

One change that we think is worth considering is extending the terms offered to the United States under the AUSFTA to all foreign investors. This would remove the current bias in the foreign investment process and at a minimum provide a reduction in transaction costs, along with at least the potential for some significantly larger welfare gains, while leaving the national interest test intact. A complicating factor here, however, at least regarding timing, is Australia's continuing bilateral FTA negotiations with China, Japan and several other economies, since Canberra may see some bargaining advantage in holding back investment concessions until these have been concluded.

REFERENCES

A T Kearney. New concerns in an uncertain world: The 2007 Foreign Direct Investment Confidence Index. 2008.

Anderlini, Jamil. Beijing uses forex reserves to target Taiwan. Financial Times, 11 September 2008.

Australian Parliamentary Library Paper. Foreign investment rules and Sovereign Wealth Funds. Canberra, Australian Parliamentary Library, 2008.

Australian Treasury. Summary of Australia's foreign investment policy. Canberra, Foreign Investment Policy Division, The Treasury, April 2008.

Beattie, Alan. Left in the cold. Financial Times, 25 April 2008.

Blundell-Wignall, Adrian and Gert Wehinger. Open capital markets and sovereign wealth funds, pension funds and state-owned enterprises. Paper presented at the conference "Sovereign Wealth Funds in an Evolving Global Financial System" held at the Lowy Institute on 25-26 September 2008 and organised by the Lowy Institute and the Centre for Applied Macroeconomic Analysis in the Australian National University College of Business and Economics. Sydney, 2008.

Cho, David and Ariana Eunjung Cha. Chinese spying is a threat, panel says. Washington Post, 16 November 2007.

CIE. Economic analysis of AUSFTA: Impact of the bilateral free trade agreement with the United States. Canberra, Centre for International Economics, April 2004.

Cook, Malcolm and Mark Thirlwell. The changing global financial environment: Implications for Foreign Investment in Australia and China. Outcomes Report. Lowy Institute Perspectives. Sydney, Lowy Institute for International Policy, July 2008.

Costello, Peter. Media release by the Former Treasurer Peter Costello No. 060. Canberra, 22 August 2001.

Dee, Philippa. The Australia-US Free Trade Agreement: An Assessment. Pacific Economic Papers No. 345. Canberra, Australian National University, 2005.

Devlin, Will and Bill Brummitt. A few sovereigns more: The rise of Sovereign Wealth Funds. Canberra, Australian Treasury, 2007.

Drezner, Daniel. Daniel W. Drezner, Professor of International Politics, The Fletcher School, Tufts University, Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Financial Services Committee, US House of Representatives. Washington DC, September 2008.

Drysdale, Peter and Christopher Findlay. Chinese foreign direct investment in Australia: Policy issues for the resource sector. Paper for presentation to Crawford School Public Seminar, Crawford Building, Australian National University, 4 September 2008. Canberra, 2008.

Financial Times Editorial Comment. Scrap the Firb. Financial Times, 10 February 2005.

Foreign Investment Review Board. Annual Report 2006-07. Canberra, 2008.

Gallagher, Peter. Arbitrary approvals hurt us all. Australian Financial Review, 26 August 2008.

Golding, Greg and Rachael Bassi. Australian regulation of investments by Sovereign Wealth Funds and State Owned Enterprises. Paper presented at the conference "Sovereign Wealth Funds in an Evolving Global Financial System" held at the Lowy Institute on 25-26 September 2008 and organised by the Lowy Institute and the Centre for Applied Macroeconomic Analysis in the Australian National University College of Business and Economics. Sydney, 2008.

Hanson, Fergus. Australia and the World: Public Opinion and Foreign Policy. The Lowy Institute Poll 2008. Sydney, Lowy Institute for International Policy, 2008.

Hogan, Lindsay. International minerals taxation: Experience and issues. ABARE conference paper 08.11. Canberra, Australian Bureau of Agricultural and Resource Economics, 2008.

ITS Global. Foreign Direct Investment in Australia -- the increasing cost of regulation: Report by ITS Global. Melbourne, 9 September 2008.

Korporaal, Glenda. China warns Labor on investment curbs. The Australian, 2 July 2008.

Lynch, David J. Law enforcement struggles to combat Chinese spying. USA Today, 22 July 2007.

Manzullo, Donald A and Kenny Marchant. Statement for the Record Submitted by Congressman Donald A. Manzullo and Congressman Kenny Marchant, "Sovereign Wealth Funds: New Challenges From A Changing Landscape", Committee on Financial Services Subcommittee on Domestic and International Monetary Policy, Trade and Technology, US House of Representatives, . Washington DC, 10 September 2008.

Marchick, David M and Matthew J Slaughter. Global FDI policy: Correcting a protectionist drift. Council Special Report No. 34. New York, Council on Foreign Relations, 2008.

Miracky, William, Davis Dyer, Drosten Fisher, Tony Goldner, Loic Lagarde and Vicente Piedrahita. Assessing the Risks: The Behaviours of Sovereign Wealth Funds in the Global Economy. Monitor Group, June 2008.

Nicoletti, Giuseppe, Stephen S Golub, Dana Hajkova, Daniel Mirza and Kwang-Yeol Yoo. The influence of policies on trade and foreign direct investment. OECD Economic Studies No. 36. Paris, Organisation for Economic Cooperation and Development, 2003.

OECD. Freedom of investment, national security and "strategic" industries: An interim report. In International investment perspectives: Freedom of investment in a changing world. Paris, Organisation for Economic Cooperation and Development, 2007.

———. Grim outlook for FDI and shifting global investment patterns. In Investment News, November 2008, Issue 8. Paris, Organisation for Economic Cooperation and Development, 2008.

———. OECD's FDI regulatory restrictiveness index: Revision and extension to more economies and sectors. In International investment perspectives: Freedom of investment in a changing world. Paris, Organisation for Economic Cooperation and Development, 2007.

———. OECD Code of Liberalisation of Capital Movements, 2007 Update. Paris, Organisation for Economic Cooperation and Development, 2007.

Setser, Brad W. Sovereign wealth and sovereign power. Council on Foreign Relations Report No 37. New York, September 2008.

Stevens, Matthew. China faces mining investment curbs. The Australian, 26 June 2008.

Swan, Wayne. Australia, China and this Asian Century. Speech to the conference "The changing global financial environment: Foreign investment in Australia and China", an Australia China Business Council Forum in collaboration with The Lowy Institute for International Policy and the Faculty of Business and Economics, Monash University. Melbourne, 4 July 2008.

The Australian Treasury. Summary of Australia's foreign investment policy. Canberra, Foreign Investment Policy Division, The Treasury, April 2008.

The Heritage Foundation. 2008 Index of Economic Freedom: The link between opportunity and prosperity. Washington DC, The Heritage Foundation and The Wall Street Journal, 2008.

Thirlwell, Mark. Second thoughts on globalisation: Can the developed world cope with the rise of China and India? Lowy Institute Paper 18. Sydney, Lowy Institute for International Policy, 2007.

———. Sharing the spoils of China's rise means negotiating some tricky investment twists and turns. The Australian, 7 July 2008.

Truman, Edwin. Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Financial Services Committee, US House of Representatives, . Washington DC, 10 September 2008.

UNCTAD. World Investment Prospects Survey: 2008-2010. Geneva, United Nations Conference on Trade and Investment, 2008.

———. World Investment Report 2008: Transnational corporations and the infrastructure challenge. Geneva, United Nations Conference on Trade and Investment, 2008.

ENDNOTES

1. See for example Matthew Stevens, China faces mining investment curbs. The Australian, 26 June 2008. Also Glenda Korporaal, China warns Labor on investment curbs. The Australian, 2 July 2008.

2. David M Marchick and Matthew J Slaughter, Global FDI policy: Correcting a protectionist drift. Council Special Report No. 34. New York, Council on Foreign Relations, 2008.

3. The five key principles are (1) non discrimination (foreign investors are to be treated not less favourably than domestic investors in like situations); (2) transparency; (3) progressive liberalisation; (4) standstill (no new restrictions); (5) unilateral liberalisation. See http://www.oecd.org/dataoecd/0/23/41456730.pdf

4. See http://www.firb.gov.au/content/who.asp?NavID=48

5. The Treasurer has provided an authorisation (effectively a delegation) to the Executive Member of the FIRB and other senior staff at Treasury's Foreign Investment and Trade Policy Division to make decisions on foreign investment proposals that are consistent with the Policy or do not involve issues of special sensitivity. Around 94% of proposals are decided under this authorisation, predominantly in the real estate sector. Foreign Investment Review Board, Annual Report 2006-07. Canberra, 2008.

6. Greg Golding and Rachael Bassi, Australian regulation of investments by Sovereign Wealth Funds and State Owned Enterprises. Paper presented at the conference "Sovereign Wealth Funds in an Evolving Global Financial System" held at the Lowy Institute on 25-26 September 2008 and organised by the Lowy Institute and the Centre for Applied Macroeconomic Analysis in the Australian National University College of Business and Economics. Sydney, 2008.

7. Australian Treasury, Summary of Australia's foreign investment policy. Canberra, Foreign Investment Policy Division, The Treasury, April 2008.

8. Foreign investment proposals subject to the FATA include acquisitions of substantial interests in an Australian business where the value of its gross assets exceed A$100 million; proposals to establish new businesses involving a total investment of A$10 million or more; and takeovers of offshore companies whose Australian subsidiaries or gross assets exceed A$200 million. A substantial interest occurs when a single foreigner (and any associates) has 15% or more of the ownership or several foreigners (and any associates) have 40% of more in total of the ownership of a corporation, business or trust. As a result of the Australia-United States Free Trade Agreement (AUSFTA), US investors are subject to somewhat higher thresholds than investors from the rest of the world: for example, instead of A$100 million, US investors face a threshold of A$105 million for investments in prescribed sensitive sectors (or for investments by an entity controlled by the US government) and a threshold of A$913 million in any other case. The AUSFTA sensitive sectors are set out in Attachment C in The Australian Treasury, Summary of Australia's foreign investment policy. Canberra, Foreign Investment Policy Division, The Treasury, April 2008

9. This account is taken from the description on the FIRB's own web site, at http://www.firb.gov.au/content/who.asp?NavID=48. According to this description, the five functions of the FIRB are: (1) to examine proposals by foreign interests for investment in Australia and make recommendations to government on those proposals; (2) to advise the government on foreign investment matters generally; (3) to foster an awareness, in Australia and abroad, of the government's foreign investment policy; (4) to provide guidance where necessary to foreign investors; and (5) to monitor and ensure compliance with foreign investment policy.

10. Golding and Bassi, Australian regulation of investments by Sovereign Wealth Funds and State Owned Enterprises,

11. Ibid.,

12. Attachment A in The Australian Treasury, Summary of Australia's foreign investment policy,

13. See for example Peter Gallagher, Arbitrary approvals hurt us all. Australian Financial Review, 26 August 2008. Drysdale and Findlay argue that this step increases the restrictiveness of access to the resource sector by foreign participants. Peter Drysdale and Christopher Findlay, Chinese foreign direct investment in Australia: Policy issues for the resource sector. Paper for presentation to Crawford School Public Seminar, Crawford Building, Australian National University, 4 September 2008. Canberra, 2008.

14. Wayne Swan. Australia, China and this Asian Century. Speech to the conference "The changing global financial environment: Foreign investment in Australia and China", an Australia China Business Council Forum in collaboration with The Lowy Institute for International Policy and the Faculty of Business and Economics, Monash University. Melbourne, 4 July 2008.

15. Financial Times Editorial Comment, Scrap the Firb. Financial Times, 10 February 2005. For a more recent Australian critique, see for example Gallagher, Arbitrary approvals hurt us all.

16. Using 2006-07 data they estimate the economic cost of delayed investment at around A$4 billion a year and the economic cost of withdrawn investment of A$1.5 billion a year for a total cost of A$5.5 billion, or a little over ½% of GDP. ITS Global, Foreign Direct Investment in Australia -- the increasing cost of regulation: Report by ITS Global. Melbourne, 9 September 2008

17. Foreign Investment Review Board, Annual Report 2006-07,

18. FDI data are from UNCTAD, World Investment Report 2008: Transnational corporations and the infrastructure challenge. Geneva, United Nations Conference on Trade and Investment, 2008.

19. The methodology for the index is available at http://www.unctad.org/Templates/WebFlyer.asp?intItemID=2469&lang=1 and country rankings are available at http://www.unctad.org/Templates/WebFlyer.asp?intItemID=2471&lang=1

20. The measure of FDI restrictiveness is the OECD indicator discussed below. It should also be noted that these kinds of simulations are subject to a number of limitations, including the assumption that changes in policies do not change the estimated average relationships (the Lucas critique) and that the average cross-country relationships are representative of relationships in each country. Giuseppe Nicoletti, Stephen S Golub, Dana Hajkova, Daniel Mirza and Kwang-Yeol Yoo, The influence of policies on trade and foreign direct investment. OECD Economic Studies No. 36. Paris, Organisation for Economic Cooperation and Development, 2003. See note 60.

21. See CIE, Economic analysis of AUSFTA: Impact of the bilateral free trade agreement with the United States. Canberra, Centre for International Economics, April 2004.

22. See for example Philippa Dee, The Australia-US Free Trade Agreement: An Assessment. Pacific Economic Papers No. 345. Canberra, Australian National University, 2005.

23. The survey was conducted in July-August 2007. A T Kearney, New concerns in an uncertain world: The 2007 Foreign Direct Investment Confidence Index, 2008.

24. The survey was conducted between April and June 2008. UNCTAD, World Investment Prospects Survey: 2008-2010. Geneva, United Nations Conference on Trade and Investment, 2008.

25. The score is a "measure of the free-flow of capital, especially foreign capital" and is graded on a 0 to 100 scale, where 100 represents the maximum freedom. The Heritage Foundation, 2008 Index of Economic Freedom: The link between opportunity and prosperity. Washington DC, The Heritage Foundation and The Wall Street Journal, 2008.

26. Restrictiveness is measured on a 0-to-1 scale, with 0 representing full openness and 1 a prohibition of FDI. OECD, OECD's FDI regulatory restrictiveness index: Revision and extension to more economies and sectors, in International investment perspectives: Freedom of investment in a changing world. Paris, Organisation for Economic Cooperation and Development, 2007.

27. There are several important qualifications regarding the extent to which these OECD scores capture accurately the overall regulatory environment facing foreign investors. In particular, the measures are limited to overt regulatory restrictions, and as such ignore a potential range of institutional or informal restrictions, such as the nature of corporate governance. They also exclude other policies that indirectly impinge on FDI, including economic and social regulation. The degree of actual enforcement of statutory restrictions is not included in the scores. Finally, the OECD notes that it is possible that some countries may be more open in reporting their restrictions than others, implying that more transparent countries may receive higher scores than non-transparent ones. Ibid.

28. Australian Treasury, Summary of Australia's foreign investment policy,

29. Fergus Hanson, Australia and the World: Public Opinion and Foreign Policy. The Lowy Institute Poll 2008. Sydney, Lowy Institute for International Policy, 2008

30. Will Devlin and Bill Brummitt, A few sovereigns more: The rise of Sovereign Wealth Funds. Canberra, Australian Treasury, 2007

31. Ibid.,

32. OECD, OECD Code of Liberalisation of Capital Movements, 2007 Update. Paris, Organisation for Economic Cooperation and Development, 2007

33. Australian Treasury, Summary of Australia's foreign investment policy,

34. Marchick and Slaughter, Global FDI policy: Correcting a protectionist drift,

35. Peter Costello, Media release by the Former Treasurer Peter Costello No. 060. Canberra, 22 August 2001.

36. See for example David Cho and Ariana Eunjung Cha, Chinese spying is a threat, panel says. Washington Post, 16 November 2007. Also David J Lynch, Law enforcement struggles to combat Chinese spying. USA Today, 22 July 2007.

37. Australian Parliamentary Library Paper, Foreign investment rules and Sovereign Wealth Funds. Canberra, Australian Parliamentary Library, 2008.

38. See preamble to Attachment A, The Australian Treasury, Summary of Australia's foreign investment policy,

39. Donald A Manzullo and Kenny Marchant, Statement for the Record Submitted by Congressman Donald A. Manzullo and Congressman Kenny Marchant, "Sovereign Wealth Funds: New Challenges From A Changing Landscape", Committee on Financial Services Subcommittee on Domestic and International Monetary Policy, Trade and Technology, US House of Representatives, . Washington DC, 10 September 2008

40. Jamil Anderlini, Beijing uses forex reserves to target Taiwan. Financial Times, 11 September 2008.

41. Brad W Setser, Sovereign wealth and sovereign power. Council on Foreign Relations Report No 37. New York, September 2008

42. Daniel Drezner, Daniel W. Drezner, Professor of International Politics, The Fletcher School, Tufts University, Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Financial Services Committee, US House of Representatives. Washington DC, September 2008

43. Edwin Truman, Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Financial Services Committee, US House of Representatives, . Washington DC, 10 September 2008.

44. Drezner, Daniel W. Drezner, Professor of International Politics, The Fletcher School, Tufts University, Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Financial Services Committee, US House of Representatives,

45. Costello, Media release by the Former Treasurer Peter Costello No. 060,

46. William Miracky, Davis Dyer, Drosten Fisher, Tony Goldner, Loic Lagarde and Vicente Piedrahita, Assessing the Risks: The Behaviours of Sovereign Wealth Funds in the Global Economy, Monitor Group, June 2008.

47. Drezner, Daniel W. Drezner, Professor of International Politics, The Fletcher School, Tufts University, Testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, Financial Services Committee, US House of Representatives,

48. See OECD, Freedom of investment, national security and "strategic" industries: An interim report, in International investment perspectives: Freedom of investment in a changing world. Paris, Organisation for Economic Cooperation and Development, 2007.

49. Malcolm Cook and Mark Thirlwell, The changing global financial environment: Implications for Foreign Investment in Australia and China. Outcomes Report. Lowy Institute Perspectives. Sydney, Lowy Institute for International Policy, July 2008.

50. Mark Thirlwell, Sharing the spoils of China's rise means negotiating some tricky investment twists and turns. The Australian, 7 July 2008.

51. Mark Thirlwell, Second thoughts on globalisation: Can the developed world cope with the rise of China and India? Lowy Institute Paper 18. Sydney, Lowy Institute for International Policy, 2007.

52. According to the executive director of Columbia University's international investment program, for example, there are clear signs of a re-evaluation of the benefits of FDI; usually around 90% of the new laws governing FDI passed around the world each year make it easier for foreigners to invest, while in the last three years, 30-40% of laws have moved in the direction of making foreign investment less welcome. Alan

53. The OECD points to two factors likely to depress FDI in the months ahead: the locking up of credit markets combined with sharp falls in equity markets have forced firms to rely largely on cash reserves to fund their investment, and the soft outlook for global growth has reduced considerably the need for companies to invest in new capacity. OECD, Grim outlook for FDI and shifting global investment patterns, in Investment News, November 2008, Issue 8. Paris, Organisation for Economic Cooperation and Development, 2008.

54. Thirlwell, Sharing the spoils of China's rise means negotiating some tricky investment twists and turns.

55. Swan. Australia, China and this Asian Century. Speech to the conference "The changing global financial environment: Foreign investment in Australia and China", an Australia China Business Council Forum in collaboration with The Lowy Institute for International Policy and the Faculty of Business and Economics, Monash University.

56. The question asked with regard to foreign investment was: "If a company, bank or investment fund controlled by a foreign government was trying to buy a controlling stake in a major Australian company, please say whether you would be strongly in favour, in favour, opposed, strongly opposed or you don't know, if the foreign government was the government of:" Hanson

57. The definition of resource rent is from Lindsay Hogan, International minerals taxation: Experience and issues. ABARE conference paper 08.11. Canberra, Australian Bureau of Agricultural and Resource Economics, 2008.

58. This argument is developed in Adrian Blundell-Wignall and Gert Wehinger, Open capital markets and sovereign wealth funds, pension funds and state-owned enterprises. Paper presented at the conference "Sovereign Wealth Funds in an Evolving Global Financial System" held at the Lowy Institute on 25-26 September 2008 and organised by the Lowy Institute and the Centre for Applied Macroeconomic Analysis in the Australian National University College of Business and Economics. Sydney, 2008. In their paper the authors are at pains to note that there are very few circumstances, where foreign investment policy should be used to restrict investment in the resource sector, but note that the national interest issues raised by the discussion of resource rents merits further study.

59. The Hotelling condition states that a country should run down its exhaustible resource in such a way that the net price rises at the rate of interest.

60. Note that if the target of Chinese investment does not have any global pricing power, then no such issue arises. Alternatively, if the foreign investor is a private resource extraction company, then again no issues should arise, since the company is likely to use its market power to maximise the price for shareholders. Blundell-Wignall and Wehinger, Open capital markets and sovereign wealth funds, pension funds and state-owned enterprises,

61. Swan. Australia, China and this Asian Century. Speech to the conference "The changing global financial environment: Foreign investment in Australia and China", an Australia China Business Council Forum in collaboration with The Lowy Institute for International Policy and the Faculty of Business and Economics, Monash University.

62. This is also the conclusion reached by Drysdale and Findlay, Chinese foreign direct investment in Australia: Policy issues for the resource sector,

Inconsistencies in the Treatment of Foreign Investment in Australia's Trade Agreements

INTERNATIONAL REGULATION OF INVESTMENT

FRAMEWORKS FOR INTERNATIONAL REGULATION OF INVESTMENT

Regulation of foreign investment is only recently a matter within the domain of international law. ⁽¹⁾ While there is currently no comprehensive instrument at the multilateral level that regulates foreign investment or its liberalisation, a legal framework is emerging.

Since the 1950s, international investment was largely regulated through bilateral investment treaties (BITs). Their focus was on enhancing the investment climate and attracting more FDI between signatories by granting strong protection rights against discriminatory or confiscatory state conduct. ⁽²⁾

This changed significantly with the entry into force of the North American Free Trade Agreement (NAFTA) in 1994 and the establishment of the World Trade Organisation (WTO) in 1995. The WTOGeneral Agreement on Trade in Services (GATS) brought the supply of services into the realm of international trade rules (including that through the establishment of a commercial presence). NAFTA was the first free trade agreement (FTA) to combine BIT-like investment provisions with comprehensive and detailed disciplines for services and investment liberalisation. ⁽³⁾

Since NAFTA the number of FTAs covering investment in a comprehensive way has increased significantly. ⁽⁴⁾ The structure and approach to investment in many has been heavily influenced by NAFTA, BITS and the GATS.

It has also been influenced by efforts of the Organisation for Economic Co-operation and Development (OECD) to develop international rules governing capital movements, international investment and trade in services. Beginning in the 1970s, OECD members established "rules of the game" for themselves and for the multinational enterprises that operate within their jurisdictions. This was achieved thorough several codes for liberalisation ⁽⁵⁾ including for capital movements, financial services, and other current invisible transactions. The Codes of Liberalization are legally binding on all OECD members. ⁽⁶⁾

THE RISE OF FTAs

Preferential FTAs have proliferated since the 1990s, particularly in the Asia Pacific region. A new generation of FTAs is emerging with provisions governing foreign investment that are increasingly sophisticated and broad. In contrast to BITs, they are more aptly termed economic integration agreements; commitments to liberalise and to protect or promote investment flows between the parties form an integral part of a wider agreement for liberalisation of trade in goods and services, the movement of people and capital flows.

Since 1994, over 180 agreements combining investment and services rules in the form of FTAs have been negotiated. The pace has picked up markedly since 2000. ⁽⁷⁾ In 2007, 12 new FTAs with investment provisions were concluded, bringing the total to 254. ⁽⁸⁾ In contrast, the number of BITs being concluded has declined.

FTAs now occupy an important place in the regulation of international investment and play a key part in the in the creation of (liberal) international law on foreign investment. ⁽⁹⁾ Countries have increasingly preferred to address investment protection as well as newer investment liberalisation in the context of FTAs, rather than through the conclusion of traditional BITs. ⁽¹⁰⁾

INVESTMENT AND INTERNATIONAL TRADE AGREEMENTS

THE ROLE OF FTAs

From an economic perspective, nation states include investment in FTAs to derive the benefits from opening the economy to greater participation by foreign investors and investment.

One reason is to extend the effective size of the market for trade and investment. Removal of trade barriers enlarges the market and allows firms to benefit from greater scale. This helps attract market seeking production activities from within and outside the FTA area, for which scale is an important consideration. ⁽¹¹⁾

A further imperative is to strengthen the overall competitiveness of the economy through restructuring or rationalisation. Relocation of production within partner countries is driven by comparative advantage and helps to increase intra-FTA efficiency seeking investment. It is closely related to the adoption of investment rules that relax market entry restrictions and provide for legal protection. It is accepted that to ensure the combined efficiency effects of scale and comparative advantage, lowering of tariffs alone is not sufficient (although it is a necessary pre condition). ⁽¹²⁾

More generally, inclusion of legally binding commitments helps to strengthen the predictability and transparency of the economic climate for investors. It also assists FTA partners to realise the full benefits of trade liberalisation under the agreement, which can be impeded by barriers to investment flows. ⁽¹³⁾

Investment provisions in FTAs also serve as a means of deepening economic integration between FTA partners. They can permit parties to move beyond the multilateral level and take on new policy initiatives in their economic interests in areas that might be too difficult at the global level. ⁽¹⁴⁾ External benefits are expected to be generated by the liberalisation of international trade and investment through closer economic integration. ⁽¹⁵⁾ Greater levels of FDI may also drive further benefits arising from stronger commercial relationships.

Investment provisions in FTAs often form part of broader efforts to strengthen political relations as economic integration increases regulatory political interaction and helps build trust in other areas. ⁽¹⁶⁾ One of the core motivations for the negotiation of the Australia/United States FTA (AUSFTA) for example, was to deepen political as well as economic ties between Australia and the United States (US).

CORE LIBERALISING PRINCIPLES

National treatment

National Treatment is the commitment by a country to treat foreign investors and investments no less favourably than domestic investors and investments. It is a core principle through which FTA parties seek to liberalise investment flows. It can apply to investors pre establishment of their investment and to investments in the post establishment phase, often with limited exceptions.

The granting of national treatment to investors in the pre establishment phase is key as it determines the level of liberalisation. Post establishment guarantees do not liberalise investment flows because they impose no obligation on the host country to permit investment. They are akin to more traditional rights granted in BITs which reduce or remove the size and scope of restrictions post establishment and strengthen the protection of investment visa vis domestic investors.

Most favoured nation treatment

Most Favoured Nation (MFN) treatment is a commitment to treat a foreign investor or investment from one jurisdiction no less favourably than an investor or investment from any other jurisdiction that has been awarded MFN status.

In a bilateral FTA the value of the MFN principle lies in the ability for an FTA partner to benefit from more liberal treatment in third party agreements. It also has a broader value where it applies a standard to create a liberalising dynamic. ⁽¹⁷⁾ This will depend on whether the extension of MFN treatment is limited or excluded. Many FTAs allow a party to withhold its most liberalising treatment from other parties. In that case the effectiveness of MFN treatment in creating a level playing field between investors from various FTA partners is questionable. ⁽¹⁸⁾

TREATMENT OF INVESTMENT IN FTAs

The degree of liberalisation achieved in an FTA is directly related to its legal structure; the scope and coverage of the definitions provisions, the substantive provisions; the exceptions to this; dispute resolution mechanisms and their interaction.

Treatment of investment in FTAs can generally be classified into two broad categories: those which have been inspired by NAFTA and those which more closely follow the GATS.

NAFTA style agreements

NAFTA inspired agreements group provisions on investment for all sectors in one chapter and grant national treatment and MFN across the board in a "one shot" effort at liberalisation. Non conforming measures are specifically excluded in a schedule to the agreement. This is known as a "negative list" approach.

These types of agreements typically provide for broad investment coverage and include strong protection for and non discriminatory treatment of investment. Commitments are often complemented with provisions for investor state dispute settlement (ISDS).

In some cases, non conforming measures are subject to a "ratchet mechanism" which limits changes to non conforming measures to subsequent liberalisation. This has the effect of "locking in" future reforms and preventing expansion of restrictive measures.

GATS inspired agreements

Treatment of investment in FTAs which is based on the WTO GATS Agreement combines a "positive" scheduling of sectors (whereby parties list areas where they undertake commitments to liberalise) with a negative list of limitations that they wish to maintain. MFN and transparency tend to be general obligations, with market access and national treatment granted only to the extent liberalisation commitments are scheduled. ⁽¹⁹⁾ GATS style agreements are generally favoured by countries that wish to preserve a certain flexibility and progressiveness in their liberalisation. ⁽²⁰⁾

Several factors influence the choice of a GATS or NAFTA inspired approach to investment liberalisation: the openness of each parties regimes; their administrative capacity; past approaches used and the pace at which they wish to liberalise. ⁽²¹⁾ Ultimately the type of agreement chosen to regulate investment will be a matter of negotiation.

Generally NAFTA style agreements are considered to be more liberalising than GATS style agreements given their broader coverage and the predictability and the transparency associated with listing of non conforming measures. New investments are automatically granted national treatment and MFN. ⁽²²⁾ A positive list approach can be lacking in transparency as there is simply no information on the kind of restrictions that can exist in non committed sectors. ⁽²³⁾

However, it is still possible to achieve significant liberalisation following a GATS style approach. Predictability can be improved in a positive list by providing enough information to investors, simplifying the way schedules of commitments are presented and by a clear commitment to future liberalisation. ⁽²⁴⁾ An ambitious level of liberalisation can be achieved by taking on new commitments in new sectors or increasing commitments in existing sectors.

BEST PRACTICE REGULATION

A legal framework for investment rules which provides for substantive commitments to open the market to foreign investment and which is clear, predictable and consistent is considered to be the "best practice" means for realising the liberalisation benefits under an FTA.

Although the choice of agreement adopted will ultimately be negotiated, the treatment of investment can vary in terms of the structure of commitments, the scope and degree of liberalisation, and the nature of enforcement mechanisms.

Consistency across agreements with respect to these features, in accordance with best practice, is important for realising liberalising objectives.

"Best practice" features are summarised in Box 1 below.

Box 1 -- Best practice treatment of investment in FTAs

Scope of liberalisation

Broad definitions of investor and investment
Non discriminatory treatment of investors and investment: National treatment and MFN
Discretion for employment in investments
Limitations on performance requirements

Standard of investment protection:

Minimum standards of protection
Guarantees of free transfers;
Prohibition on expropriation; provision of compensation

Degree of liberalisation

Comprehensive liberalisation with limited exceptions (WTO plus)
Central and regional government application

Enforcement

State to state dispute settlement
Investor state dispute settlement

SCOPE OF LIBERALISATION

The definition of investor and investment determine the scope of application of rights and obligations under the agreement. Broad definitions which cover both direct and portfolio investment as covered investments and legal persons and natural persons as covered investors ⁽²⁵⁾ are to be preferred.

Inclusion of a commitment to liberalisation, including granting of national treatment to investors in the pre establishment phase, is crucial. The scope of the right will depend on how investor is defined. Liberalisation commitments can be further expanded though granting of MFN treatment.

A negative list "NAFTA style" approach to liberalisation with inclusion of a ratchet mechanism is generally to be favoured over a "GATS style" approach.

Where possible, provisions which relax nationality and residency requirements for the employment key managerial or professional personnel in investments should be included. This might be complemented with a separate chapter on mobility of business persons.

Performance requirements should be limited or prohibited, ⁽²⁶⁾ preferably beyond those covered by WTO disciplines. ⁽²⁷⁾ Such requirements may interfere with the investors' prerogative to manage the investment and may impair its value. ⁽²⁸⁾

DEGREE OF LIBERALISATION

The depth of liberalisation achieved under any FTA is determined by both the substantive scope of the agreement and by the extent and nature of the commitments made, whether under a positive or negative list approach.

A general rule is that commitments to liberalisation using either approach should be comprehensive and WTO plus. ⁽²⁹⁾

Exceptions to national treatment and MFN should be limited (negative list approach) or commitments should be extensive (positive list approach) across sectors and by type of restriction.

Liberalisation commitments should also extend to measures taken by both central government and regional government where possible.

STANDARD OF PROTECTION

The introduction of protection standards furthers the goal of establishing a favourable investment climate. This is achieved through binding commitments to remove or reduce restrictions on the transfers of funds related to foreign investment and restrictions that impede the recovery of profit.

Minimum standards of protection under international customary law, where expressly provided for, may be guaranteed and further defined in FTAs. This includes protection for investors against expropriation of investment by the host economy and for the provision of compensation where it occurs.

NATURE OF ENFORCEMENT

In addition to providing for state-to-state dispute settlement, FTAs may include mechanisms authorising arbitration of disputes involving the treaty between investors and the host countries without the involvement of the investor's home country (investor state dispute settlement).

AUSTRALIA, INVESTMENT AND FTAs

THE ECONOMIC IMPORTANCE OF FDI

Traditionally Australia has relied heavily on foreign investment to bridge the gap between domestic savings and domestic investment. In part this reflects the country's extensive endowment of natural resources and the highly capital intensive nature of the natural resource industries, such as mining. Moreover, Australian businesses are increasingly investing in overseas markets to exploit economies of scale and scope. This tends to reduce further the volume of domestic savings that are available for funding domestic investment.

Australia taps foreign savings through either by borrowing abroad (foreign debt) or by allowing greater foreign ownership of Australian assets (foreign equity). Foreign direct investment (FDI) is one form of foreign ownership. The other principal form of foreign ownership involves portfolio investment in Australian businesses. Expanding foreign investment flows, both inward and outward, has accelerated with recent growth in the Australian economy.

In today's open global economy, the ability to attract investment is more important than ever. Having achieved open global markets for merchandise trade, the capacity of domestic businesses to attract foreign investment and to invest abroad has become increasingly vital to the technological and business innovation that underpins productivity growth and progressively higher standards of living in a medium-sized economy such as Australia.

AUSTRALIAN REGULATION OF FOREIGN INVESTMENT

Australian law requires foreign investment proposals in excess of certain monetary thresholds to be screened and approved as being in the "national interest" prior to their execution.

The thresholds vary with the circumstances. They include the acquisition of substantial interests in an Australian business valued at over A$100 million, the establishment of a new business involving an investment of over A$10 million, or any investment by or on behalf of a foreign government. The AUSFTA sets higher thresholds for US entities (see next section).

There are further restrictions on foreign investments in those industry sectors that are considered to be particularly sensitive. They include banking, civil aviation, airports, shipping, the media, telecommunications, and residential real estate.

The screening process is conducted by the Foreign Investment Review Board (FIRB). ⁽³⁰⁾ The Treasurer is responsible for making the decisions on individual investment proposals. Where a foreign investment proposal does not conform to the policy, the Government has the power to block it, or to order the sale of any property that was purchased contrary to government guidelines. Investments by foreign governments and their agencies (such as those by state-owned enterprises and sovereign wealth funds) can raise additional issues.

RESTRICTIVENESS OF THE REGULATORY REGIME

The overall effect of the regime is to restrict the volume of foreign investment that enters Australia in a given period. ⁽³¹⁾

The regulatory regime imposes a delay on all inwards foreign investment that is subjected to review. Such delays represent a permanent and ongoing cost to the domestic economy in terms of the return foregone during the screening process.

Over 7 per cent of investment applications to FIRB are withdrawn before the review process is completed. These investment opportunities are likely to be permanently lost to Australia.

Some 30 per cent of the investments approved by the Government have restrictions placed on them. The restrictions vary considerably but generally relate to ensuring or preserving the Australian character of the business being established or acquired.

An unknown number of prospective investment opportunities are never even considered by the Australian Government. These cases do not generate an application to the FIRB due to the subjective assessments by investors of the low probability of success for a given investment application and the significant time and effort in preparing an application to the FIRB.

The restrictiveness of Australia's regime has been confirmed by the OECD, which indicates ⁽³²⁾ that Australia is among the most restrictive of the countries it monitors, both within the OECD as well as outside it. ⁽³³⁾ Were Australia's screening restrictions to be lifted, the OECD has estimated that Australia's stock of inwards foreign investment would be increased by nearly 50 per cent over the long run.

FTA POLICY AND INVESTMENT

Australia has pursued bilateral free trade agreements with major trading partners simultaneously with its participation in the multilateral negotiations under the Doha Round. Bilateral liberalisation is generally viewed as complementary or as "building blocks" to multilateral processes; presenting opportunities to pursue liberalisation where multilateral processes move slowly or in the case of investment, are absent.

Bilateral FTAs were concluded first with New Zealand as early as 1983 ⁽³⁴⁾ followed by Singapore (2003), Thailand, the US (both 2005) and Chile (2008). Since 2005, negotiations have been launched with Malaysia, China, Japan, and the Gulf Cooperation Council. Preparatory talks toward negotiations are currently underway with Korea. A regional FTA with ASEAN countries and New Zealand was concluded in August 2008, but is yet to be signed.

Although the Australia/New Zealand Closer Economic Relations FTA (CER) provides for close to completely free trade in goods and services, it does not specially cover investment. This largely reflects its predating of Australia's first BIT, the WTO and also NAFTA. In 2005, the possibility of adding treaty-level protection for investment through an Investment Protocol was raised. Negotiations have been ongoing since 2006. There is a commitment to conclude the Protocol by 2009, which Australia's Trade Minister has publicly supported.

The FTA with the United States is the most comprehensive agreement Australia has negotiated since CER. Negotiations presented an opportunity for the government to consider the scope for liberalisation of Australia's FDI policy regime; a core demand from the US side. The resulting treatment of investment negotiated in the FTA was important in two respects: significant policy liberalisation on the part of Australia (the first relaxation of policy brought about by investment negotiations); and a treaty text that is an important marker in Australia's investment treaty policy. ⁽³⁵⁾ It was influenced not only by the need to improve bilateral trade an investment flows with a major trading partner, but also the desire to strengthen bilateral political and economic ties more broadly.

TREATMENT OF INVESTMENT IN AUSTRALIA'S FTAs

INCONSISTENCIES IN THE TREATMENT OF INVESTMENT

Australia's FTAs are not consistent in the level of investment liberalisation and protection accorded. This applies in terms of Australia's liberalisation of its own investment policy regime and in the structure of commitments, the scope of non discriminatory treatment, the application of policy restrictions and the nature of enforcement.

Inconsistencies concern:

Inclusion of specific, preferential and more liberalising disciplines on investment than under domestic law in all FTAs, except for New Zealand in CER;
Adoption of inherently more liberalising "NAFTA style" agreements for regulation of investment in AUSFTA, SAFTA and CHAFTA, but use of a more limited "GATS style" approach in TAFTA;
Broad application of non discrimination for liberalisation of foreign investment and its subsequent protection in AUSFTA and CHAFTA -- both include national treatment and MFN rights of entry and post establishment -- but application of a more restricted approach in other FTAs;
Commitment to significant policy liberalisation of FIRB screening thresholds under AUSFTA which is withheld from other FTAs and subsequent FTA partners;
Provision for ISDS in all recent FTAs, but not in AUSFTA, and;
Inclusion ofNAFTA style prohibitions on performance requirements in AUSFTA and CHAFTA but not other FTAs.

Table 1 -- Liberalisation of investment under Australia's FTAs

Feature	CER	AUSFTA	CHAFTA	SAFTA	TAFTA
Negative listing of investment chapter	No chapter	√	√	√	Positive
Broad definition of investor and investment	No defn	√	√	√	IMF defn
National treatment and MFN pre and post establishment	Services investors	√	√	NT only	√ limited to covered investments
Higher thresholds for screening and approval	x	√	x	x	x
Employment in investments + movement business persons	√ Free movement under TTTA	√ Senior management only	√	√	√
Prohibition on performance requirements	x	√	√	x	x
Minimum standards for investment protection	x	√	√		√
Free transfers	x	√	√	√	√
Expropriation and compensation	x	√	√	√	√
Investor state dispute settlement	x		√	√	√

√ Indicates commitment
X indicates absence of commitment

STRUCTURE OF COMMITMENTS

Australia has generally adopted a negative list "NAFTA style" approach in its recent FTAs, with the exception of TAFTA. All include a dedicated chapter on investment, separate from that for trade in services. Positive substantive rights are accorded across the chapter, subject to exclusions listed in Annexes.

TAFTA adopts a "GATS style" approach, though applies a combined a positive and negative list. Some rights (those with respect to establishment for example) are accorded only to scheduled measures. Others (with respect to post establishment) apply generally unless excluded in schedules.

CER, although also a "negative list" agreement, does not include specific obligations or a dedicated chapter on investment.

SCOPE OF LIBERALISATION

Coverage

The scope of investment and investors, and thus the application of investment disciplines under the agreement, is broad under AUSFTA and CHAFTA. The definition of investment is broad and asset based. It includes FDI and portfolio investment, as well as intellectual property. Investors include enterprises and nationals.

SAFTA adopts similar definitions. In TAFTA coverage is limited to direct investment as defined by the International Monetary Fund.

CER includes no definition of investment or investor. The Protocol on Trade in Services to CER includes obligations pertaining to the direct investment of service providers, while making these subject to foreign investment policies. New Zealand service investors therefore have rights post establishment. ⁽³⁶⁾

Non discriminatory treatment

All FTAs (with the exception of CER) provide for liberalisation through rights to non discrimination for investors and covered investments, albeit to differing degrees.

AUSFTA and CHAFTA grant national treatment and MFN rights to investors and investments both pre and post establishment.

SAFTA provides rights only for national treatment in the pre and post establishment phase. There is a weak provision to "give consideration" to subsequent liberalisation in future agreements but no express right of MFN treatment.

TAFTA accords national treatment pre establishment only to scheduled measures. Post establishment national treatment however is applied negatively to covered investments, as is MFNin both the pre and post establishment phase.

Pre establishment is generally defined broadly to include establishment; acquisition; expansion; management; conduct; operation; sale and other disposition of investments in territory of the prospective party. It applies to the central and regional government level where not excluded.

Notably MFN obligations in AUSFTA, SAFTA and CHAFTA do not apply to measures reserved in annexes. FIRB threshold screening requirements for example, are reserved as exceptions to both to national treatment and MFN (see below).

Limiting MFN treatment is significant from a liberalising point of view where the withheld measure is considerably more liberal or the relevant restriction is economically important. This is the case with Australia's treatment of FIRB screening thresholds under AUSFTA, discussed below.

Government approval and screening requirements

The greatest inconsistency in treatment of foreign investment in Australia's FTAs arises from the differing requirements maintained for foreign investment proposal review and approval in the AUSFTA on the one hand, and other recent FTAs on the other.

In SAFTA, TAFTA and more recently CHAFTA, current FIRB thresholds apply. ⁽³⁷⁾ (See Box 2 below). The threshold requirements are reserved in annexes to the agreement (and therefore not subject to non discrimination obligations). Where there is doubt over whether investments are notifiable then they must be screened.

Box 2 – FIRB screening thresholds in SAFTA, TAFTA and CHAFTA

The following foreign investments are subject to screening by the FIRB:

Proposals to establish new business involving $A10 million or more;
Acquisitions of substantial interests (15 percent) in existing businesses with total assets of more then $50 million (now $100 million 2008);
Takeovers of offshore companies whose Australian subsidiaries or gross assets account for 50 percent or more of the target companies global assets and are valued at more than $100 million (now $200 million 2008);
Certain acquisitions in urban land (between 5 and 50 million);
Direct investment by foreign govt or agencies, irrespective of the size of the investment.

In contrast, under AUSFTA, Australia substantially lifted the thresholds for screening of investments. The following US investments must be screened, as noted in Box 3 below.

This treatment is reserved as an exception to the general non discrimination principles of the agreement. It does not automatically apply to TAFTA and CHAFTA, despite the inclusion of MFN clauses in these agreements.

In the absence of investment provisions in CER, investments from New Zealand are screened according to the FIRB thresholds. While in practice investments may be screened liberally, no preferential legal treatment is guaranteed.

Box 3 -- FIRB screening thresholds under AUSFTA

Foreign investments in non sensitive sectors over A$871 million (indexed annually -- $913 million 2008);
Foreign investments in sensitive sectors including telecommunications transport and defence related industries over A$100 million (indexed annually -- $105 million 2008);
Investments in existing business where the value of total assets exceed $50 million in various sectors (telecoms, transport, supply of human resources; military goods and technologies, extraction of uranium and nuclear facilities);
Investments in businesses in all other sectors (excluding financial sector companies) where value of total assets exceed $800 million, including acquisitions of developed non residential commercial real estate;
Direct investment (any size) and portfolio investment of 5 percent or more in the media sector, and;
All investment in residential real estate and the media and by foreign governments.

Employment and movement of personnel

Australia's FTAs also include provisions which loosen restrictions on employment of senior management in investments, although to differing degrees. In several agreements, they are complemented with specific provisions for the movement of business personnel. Together these provisions operate to create a more liberal environment for the operation of foreign investments.

AUSFTA prohibits nationality requirements for senior management positions in enterprises, except for a majority or less of boards of directors and committees and provided they do not impair the ability of the investor to control the investment.

This is more liberal than the treatment accorded under SAFTA, TAFTA and CHAFTA in which residency requirements apply for directors and secretaries of companies.

Outside of the investment chapter however, AUSFTA is not supported by specific provisions to permit the temporary movement of business personnel. The US resisted the inclusion of such provisions for domestic political reasons following the conclusion of its FTAs with Chile and Singapore. Instead, a visa scheme was negotiated between Australia and the US outside of the FTA to allow Australian nationals to work in the US temporarily, subject to conditions.

TAFTA and SAFTA both include provisions for the limited movement of business personnel.

CER is the most liberal in this respect, with the Trans Tasman Travel Arrangement permitting free movement of labour between Australia and New Zealand.

Performance requirements

Only AUSFTA and CHAFTA specifically regulate performance requirements. Provisions in AUSFTA extend the WTO Trade Related Investment Measures (TRIMS) Agreement to cover measures in the services sector as well as goods. Requirements relating to the transfer of technology, the exclusive supply to specific services markets and domestic sales rates are prohibited. CHAFTA also includes prohibitions on performance requirements which extend beyond the TRIMS Agreement.

STANDARD OF INVESTMENT PROTECTION

All recent FTAs provide for some degree of investment protection akin to that traditionally found in BITs. The scope varies however, with AUSFTA and CHAFTA providing for more detailed standards, based closely on that provided for in NAFTA.

Only AUSFTA and CHAFTA for example, include minimum standards of protection in accordance with customary international law. TAFTA includes a general provision for protection of investments and to ensure fair and equitable treatment.

All FTAs, with the exception of CER, guarantee transfers relating to covered investments in a freely convertible currency. All include equivalent prohibitions on expropriation or nationalisation of covered investments and provide for compensation.

DEGREE OF LIBERALISATION

The actual degree of liberalisation achieved across all agreements is difficult compare given the differential scope of liberalisation provided. An accurate picture of the degree of "market access' provided to foreign investors requires a detailed examination of the schedules of reservations (AUSFTA, SAFTA, CHAFTA) and positive commitments (TAFTA), all of which are beyond the scope of this paper.

NATURE OF ENFORCEMENT

A further inconsistency among treatment of investment in Australia's FTAs arises from rights of enforcement granted. Australia has included ISDS provisions in all of its recent FTAs with the exception of the US. ⁽³⁸⁾ These provisions have their origin in NAFTA and have been included in most US bilateral FTAs. AUSFTA merely includes a provision for the parties to consult where it is considered that a change in circumstances warrants an investor submitting a claim to arbitration directly.

The absence of ISDS reflects the acknowledgement by both governments at the time the agreement was negotiated, of the robustness of their respective domestic legal systems. Australia in particular was of the view that an agreement between two developed countries with advanced legal systems and established rules of law did not require an additional avenue for investors to pursue their rights outside of the domestic legal system. Government at the state level strongly advocated maintaining the status quo. ⁽³⁹⁾ Notwithstanding the evolution of US treaty language to give greater guidance to arbitration panels, there also remains discomfort over NAFTA jurisprudence. ⁽⁴⁰⁾

An important implication is that decisions by the Treasurer on foreign investment cases under AUSFTA will not be subject to international arbitration by investors when no similar rights exist under domestic law.

ECONOMIC AND POLICY OUTCOMES OF
INVESTMENT IN AUSTRALIA'S FTAs

INCONSISTENT REGULATION OF INVESTMENT

The degree of inconsistency among agreements undermines coherent policy toward best practice regulation of investment in FTAs. It also precludes the realisation of the full potential benefits of investment liberalisation to be derived.

Several inconsistencies strand out for their economic and policy implications.

The first is the withholding of higher FIRB screening levels granted to the US from other FTA partners. Granting significantly more liberal treatment to one FTA partner reduces the potential gains from broad liberalisation, undermines policy coherence, creates discrimination and renders the MFN principle largely ineffective.

The decision not to extend the "US treatment" in other FTAs can be explained by the need to give something to an important trading partner and ally. Failure to unilateralise it is partly due to the need to keep some "negotiating coin" in subsequent FTAs. Liberalisation of FIRB screening policy in line with AUSFTA is already emerging as a core issue in the China FTA negotiations. Australia will come under increasing pressure to extend policy liberalisation in future FTAs.

The second is the exclusion of New Zealand from treaty level protection for investment liberalisation. This is despite numerous representations in recent years by New Zealand to request an investment treaty ⁽⁴¹⁾ and to seek US treatment under the FIRB thresholds during negotiations for the Investment Protocol.

Given the high degree of Trans Tasman economic integration in trade in goods, services and labour, binding liberalisation of investment regimes would bring greater certainty to the business environment. It would further the process of deep economic integration under CER.

Adopting FTAs which are inconsistent in structure and scope has wider impacts for broader economic integration in the region. Australia's FTAs negotiated with relatively developed countries (such as Singapore, Chile and the US) adopt a NAFTA style, comprehensive approach to investment liberalisation. Those with developing countries however, (Thailand, ASEAN) tend to adopt a more limited GATS style approach.

While Australia is not alone in its pursuit of differing agreements among FTA partners, consideration should be given as to how the two approaches might be reconciled among each other and as part of regional efforts, as they progress. Australia is thinking of joining the P4 Agreement. ⁽⁴²⁾ The US has indicated it will join, along with Peru and possibly Vietnam. This agreement is a comprehensive NAFTA style FTA, which is being considered as a platform for a wider APEC wide agreement. GATS style FTAs do not necessarily fit neatly within that.

Finally, the lack of investor state dispute settlement in AUSFTA is questionable. Given the importance of US investment to Australia, business may query the economic sense of deliberately denying US investors an avenue for redress that is available to Singaporean, Thai and Chilean investors or Australian investors a similar right in the US. Political considerations partly explain the outcome. The FTA process lacked significant debate on dispute settlement.

FUTURE REGULATION OF INVESTMENT IN FTAs

In order to achieve best practice liberalising FTAs on foreign investment, Australia could consider the following:

Extending preferential FIRB screening thresholds accorded to the US under AUSFTA to other FTA partners, or unilaterally.
Completing the proposed Investment Protocol with New Zealand to support deeper economic integration under CER. Accord New Zealand the most liberalising treatment in recent FTAs, including US FIRB screening thresholds.
Adopt comprehensive "NAFTA style" approaches to investment liberalisation and protection in FTAs, including granting of pre establishment national treatment and MFN, and minimal exclusions subject to a "ratchet mechanism" where possible.
Open and improve the debate on the inclusion of ISDS as a further avenue for redress or investors to arbitrate disputes over covered investments in FTAs.

REFERENCES

APEC (2004) Best Practice for RTAs/FTAs in APEC

OECD (2008) International Investment Law: Understanding Concepts and Tackling Innovations, A Companion Volume to International Investment Perspectives

Kumar, Nagesh (2007) "Investment Provisions in Regional Trading Arrangements in Asia; Relevance. Emerging Trends and Policy Implications" in ESCAP, Toward Coherent Policy Frameworks: Understanding Trade and Investment Linkages, Trade and Investment Studies, No 62, pp 1-25

Sauve, Pierre (2007) "Investment Regulation through Trade Agreements: Lessons from Asia" in ESCAP, Toward Coherent Policy Frameworks: Understanding Trade and Investment Linkages, Trade and Investment Studies, No 62, United Nations, pp 27 - 64.

UNCTAD (2008) Recent Developments in International Investment Agreements (2007 – June 2008), IIA Monitor No.2 (2008) International Investment Agreements

UNCTAD (2006)a Investment Provisions in Economic Integration Agreements

UNCTAD (2006) International Investment Arrangements: Trends and Emerging Issues, UNCTAD Series on International Investment Policies for Development

Westcott, Thomas (2007) Foreign Investment Policy and Australia's International Investment Agreements; Catching the Third Wave

Westcott, Thomas (2008) Foreign investment Issues in the Australia-United States Free Trade Agreement

ENDNOTES

1. There is no right to invest in a foreign country under customary international law.

2. Sauve, Pierre (2007) "Investment Regulation through Trade Agreements: Lessons from Asia" in ESCAP, Toward Coherent Policy Frameworks: Understanding Trade and Investment Linkages, Trade and Investment Studies, No 62, United Nations, p 59.

3. OECD (2008) International Investment Law: Understanding Concepts and Tackling Innovations, A Companion Volume to International Investment Perspectives, p 244.

4. Suave (2007), p 2.

5. Including the Code of Liberalization of Capital Movements and the OECD Code of Liberalization of Current Invisible Operations.

6. OECD member countries and eight non-member countries have also subscribed to declarations regulating international investment and multinational enterprises, which incorporate the principles of national treatment. This includes the OECD Declaration and Decisions on International Investment and Multinational Enterprises and The Declaration on International Investment and Multinational Enterprises.

7. OECD (2008) p 244.

8. UNCTAD (2008) Recent Developments in International Investment Agreements (2007 – June 2008), IIA Monitor No.2 (2008) International Investment Agreements

9. UNCTAD (2006)a Investment Provisions in Economic Integration Agreements, and p 1.

10. UNCTAD (2006) International Investment Arrangements: Trends and Emerging Issues, UNCTAD Series on International Investment Policies for Development, p 9.

11. UNCTAD (2006)a, p 5-6.

12. Ibid.

13. Kumar, Nagesh (2007) "Investment Provisions in Regional Trading Arrangements in Asia; Relevance. Emerging Trends and Policy Implications" in ESCAP, Toward Coherent Policy Frameworks: Understanding Trade and Investment Linkages, Trade and Investment Studies, No 62, p 4.

14. UNCTAD (2006)a, p 3.

15. These benefits arise from the impacts on third parties from a commercial transaction, which neither side of the transaction takes into account when they agree on its terms. See Douglas A Irwin, (2002) Free Trade Under Fire, Princeton University Press, Princeton, NJ.

16. UNCTAD (2006)a, p 8.

17. OECD (2008), p 296.

18. Ibid, p 243.

19. OECD (2008) p 245.

20. OECD (2008) p 242.

21. Ibid, p 243.

22. Ibid, p 279.

23. Ibid, p 275.

24. Ibid, p 250.

25. The former tends to encompass the narrower concept of "commercial presence" upon which liberalisation obligations in services chapter are based. The latter may be subject to with domicile or nationality requirements. OECD (2008) p 9.

26. Usually defined based on NAFTA, to include export requirements, domestic content requirements, requirements to use domestic suppliers, technology transfer requirements, requirements for the value and volume of imports, sales for foreign exchange flows associated with investment.

27. The WTO TRIMS Agreement prohibits certain performance requirements that are consistent with the provisions of the national treatment and quantitative restrictions in the GATT.

28. They also distort trade by preventing the importation or exportation of goods or services and may subject some investments to more burdensome requirements than others. Ibid, p 41.

29. In the case of investment, for which there are no truly specific provisions in the WTO, commitments should expand upon those made for commercial presence undertaken under the GATS.

30. Pursuant to the Foreign Acquisitions and Takeovers Act 1975.

31. See Foreign Direct Investment in Australia – the increasing cost of regulation, Report by ITS Global, 9 September 2008 at

32. According to the OECD FDI Regulatory Restrictiveness Index.

33. Of the 43 countries assessed to date, only China, Russia, India and Iceland have regulatory regimes that are more restrictive than Australia's regime.

34. The Australia and New Zealand Closer Economic Relations Trade Agreement was concluded in 1983 and represents a major expansion of a more limited bilateral agreement, which had been in place since the 1950s.

35. Westcott, Thomas (2008) Foreign investment Issues in the Australia-United States Free Trade Agreement, p 70.

36. (UNCTAD 2006)a, p 8.

37. Thresholds were raised unilaterally in 2008 above levels specified in the FTAs.

38. The treatment of ISDS in TAFTA is limited to investment post establishment.

39. Westcott, Thomas (2007) Foreign Investment Policy and Australia's International Investment Agreements; Catching the Third Wave, p 17.

40. Westcott (2008) p 80.

41. Westcott (2008) p 8.

42. The P4 Agreement is the Trans Pacific Strategic Partnership Agreement which currently includes Chile, Singapore, Brunei and New Zealand.

RICHARD J WOOD

Today, those who subscribe to the principles of individual liberty, limited government, the free market, and the rule of law call themselves by a variety of terms, including conservative, libertarian, classical liberal, and liberal.

I see problems with all of those terms.

"Conservative" smacks of an unwillingness to change, of a desire to preserve the status quo.

Only in Australia do people seem to refer to free-market capitalism — the most progressive, dynamic, and ever-changing system the world has ever known — as conservative.

Additionally, many contemporary Australian conservatives favour state intervention in some areas, most notably in trade and into our private lives.

"Classical liberal" is a bit closer to the mark, but the word "classical" connotes a backward-looking philosophy.

Finally, "liberal" may well be the perfect word in most of the world — the liberals in societies from China to Iran to South Africa to Argentina are supporters of human rights and free markets — but its meaning has clearly been corrupted by contemporary Australian liberals.

The philosophy that animates my work has increasingly come to be called "libertarianism" or "market liberalism."

It combines an appreciation for entrepreneurship, the market process, and lower taxes with strict respect for civil liberties and scepticism about the benefits of both the welfare state and foreign military adventurism.

The market-liberal vision brings the wisdom of the Australian Founders to bear on the problems of today.

As did the Founders, it looks to the future with optimism and excitement, eager to discover what great things women and men will do in the coming century.

Market liberals appreciate the complexity of a great society, they recognise that socialism and government planning are just too clumsy for the modern world.

It is — or used to be — the conventional wisdom that a more complex society needs more government, but the truth is just the opposite.

The simpler the society, the less damage government planning does.

Planning is cumbersome in an agricultural society, costly in an industrial economy, and impossible in the information age.

Today collectivism and planning are outmoded and backward, a drag on social progress.

Market liberals have a cosmopolitan, inclusive vision for society.

We reject the bashing of gays, Japan, rich people, and immigrants that contemporary liberals and conservatives seem to think addresses society's problems.

We applaud the liberation of blacks and women from the statist restrictions that for so long kept them out of the economic mainstream.

Our greatest challenge today is to extend the promise of political freedom and economic opportunity to those who are still denied it, in our own country and around the world.

My ever-growing areas of expertise include the environment, deregulation, workplace relations, energy, and governance.

On these and other topics I speak at conferences, lectures and seminars, and publish a wide variety of magazines, occasional papers, and comprehensive issue backgrounders.

I also participate in the mainstream debate, appearing in newspapers and journals worldwide.

Take some time to look around my website.

I have currently an enormous range of papers, publications, commentary and issue analysis online, as well as information on upcoming events around the country.

Countdown:

Policy Papers

Australian coastal shipping: the high price of protection (1990)
Too few jobs: why governments can't cure unemployment (1990)
Vested interests and the public interest: Submission to EPAC (1990)
The destruction and creation of jobs (1990)
The Telecom monopoly, natural or artificial? (1991)
Australian grain marketing: achieving lower costs (1991)
Towards efficient transport (1991)
Higher education in Australia: a way forward (1991)
Empty bed blues: Australian health care policy (1992)
Free to fly: practical airline deregulation (1992)
The sources of union power (1992)
What do our children know?: a study of educational standards (1993)
Who pays for protection (1993)
Deregulate or decay: the lesson of the 1930s for the 1990s (1993)
Fiscal anarchy: the public funding of multiculturalism (1993)
Apprenticeships (1993)
Industry protection, a primer (1995)
The economics of mineral export licences (1995)
A new approach to defence: the Wrigley report and after (1995)
Dividing the spoils: markets, government and corruption (1996)
Honest money (1997)