He finds a high level of acceptance of the benefits of globalisation.  Australians, he concludes, recognise that foreign investment leads to job growth and wealth creation.  But he also finds some unease about foreign investment and of a high level of control by foreign investors.  He reports unease about Chinese investment in the minerals sector, though an understanding that growth in China has significant benefits for Australia.

Clearly this is a matter that generates strong views and Australians have genuine concerns about the matter. The weight of opposition complicates the government’s response to the Chinalco deal.   But there is some work to do here since to deny the deal will be costly for Australia.

What are some of the factors driving this opinion?

Senator Barnaby Joyce’s website offers some insights, including his TV advertisements on the matter.

Looking at these concerns in turn is instructive.

Generally, the problem here is a matter of aligning targets and instruments.

We are selling sovereign assets

One concern is that foreign investors are being allowed to buy an asset that belongs to all Australians, that is, resources in the ground.

Dead right – resources belong to all Australians and that is why when they are taken from the ground, the mining companies pay for them.  The revenue is collected in a variety of ways including by royalties.

The foreign investors are buying shares in mining companies which have been given the rights to exploit particular resources but those companies still pay for their use.

If there is a problem with this arrangement, then that suggests we have not designed the arrangements for access to natural resources efficiently.  And indeed there may be more efficient arrangements available than royalties, including forms of resource rent tax. But it’s our responsibility to get that right, not the foreign investors’ responsibility.

The buyer is a customer

Consumer investment in these sorts of project is usual. Recall the investment by Japanese companies. China, Peter Drysdale and I argued, appears to be more interested in taking minority stakes and doing so in a transparent way than was the case with investment from Japan.

What is the value of the customer equity? These are large projects also providing specific forms of the mineral – some adjustment is required to use the raw material in the processing stage and the consumer values full information on those characteristics. Some investment by the consumer signals their commitment to the project and this is a valuable commitment in order for the project operators to raise finance. It also lowers the extent of other funding that has to be raised. To put additional restrictions on customers making this sort of investment makes Australia less attractive as a place to invest.

Actually, in the case of the iron ore, Chinalco is not expected to be a customer. Its direct interests are in Rio’s other projects.

The foreign investor will use its influence to lower iron ore prices

The context to this discussion is, as I have argued elsewhere, that the market for iron ore is competitive.

Attempts to raise the price would lead to undercutting by other suppliers which would restore prices to their original level.

The other more topical concern is that Chinalco would use its influence to lower prices of iron ore, so as to benefit the Chinese steelmakers.  This requires, as the ACCC explained, a ‘China Inc’ view of the world.

Such a joint view of profit is not to be expected! I’d expect there will be many different interests at play in the consortium of Chinese organisations.

Any attempt to lower the world price, so as to benefit consumers such as Chinese steelmakers, would lead to drops in output by other suppliers which would then cause world prices to rise again, or else Rio would have to bring on project after project to keep the price down.  The price drop could not be sustained.  The ACCC makes this argument in its review of the Chinalco-Rio connection.

The foreign investor is actually a foreign government

Other governments, it is argued, should not be allowed to invest in Australian resources.

We review all big investments by foreigners. Should there be some extra consideration of big investments by other governments? Peter Drysdale and I reviewed some of the arguments why there might be a case for additional attention to a foreign investment by a government, beyond any considerations that are already captured by Australia’s national interest test in the FIRB process.

These included the underpricing issue just discussed.

Another was a concern that

FDI investments involving state ownership and dominant shareholding and control might be used to pursue political or strategic goals inconsistent with the efficient development and marketing of national resources.

We argued that

…all firms that invest abroad, private as well as public, are ultimately subject to the laws and policies of the countries in which they are incorporated (at home and in the countries in which their subsidiaries operate) and questions of extra-territoriality do arise in the operation of firms internationally and have to be covered by state-to-state dealings.

We also noted that these issues do not arise at all for any foreign investment in which there is minority participation without control, by either a government-owned or privately owned firm. The former cases are extreme and unusual. The latter cases are, we said, by far the most common in which Chinese state-owned investments are involved in the Australian resource sector.

We also argued that state owned enterprises are increasingly subject to market disciplines. These come from a variety of sources, including partial listings of these companies and pressure from their bankers. We extracted material from an interesting interview reported by McKinsey with a Director of such companies who talked about trends in corporate governance.

The bigger issue is that you might not want to have a government owned firms as your partner, because it is less efficient than a private partner. Peter Drysdale and I noted empirical evidence which suggests that state-owned foreign investors have performed well. Nor did we find ‘any evidence of the use of state power or privileged information in their business abroad. The goals of these ventures appear to be simply to operate successfully within the confines of market.’ We presented case studies that demonstrated the consistency of investment strategy with commercial motivation by Chinese investors.

The buyer will have a degree of control which is too high

This concern has been raised in some of the press commentary on the project, including by Robert Gottliebsen. Chinalco’s series of rights are neatly laid out in the ACCC determination and Gottliebsen’s concern was that ‘the series of rights that are proposed for Chinalco…give it much greater power over the Rio Tinto operation than its share of profits would warrant’.

These are important considerations and the FIRB is expected to look closely at these aspects.  There is a very long agreement document which sets out the detail but also there are protocols for the management of these relationships in joint venture set-ups. In the end, this is a matter for the other shareholders who have to vote to support this deal.

The shareholders will also have to decide whether the price that Chinalco is offering is high enough. Other bidders are also possible, including BHP, which may test that value. Whether there are better options for refinancing Rio is also a matter for the shareholders. If they think so, they will have to convince other financiers to find the funds.

China would not let us buy a mine in China

If China would not let us buy a mine there, the argument goes, we should not let them buy one here. Whether China would or would not let an Australian investor mine in China is open to question but beside the point. Insistence on this kind of reciprocity is costly for Australia. China’s policy is it own concern. Our national interest is to get value for our resources, which means opening access to them to bids from a competitive process.

It has also been observed that recently China stopped Coca Cola buying a local juice company.

That decision was presented as the result of the application by China of competition policy, something which Australia has been encouraging, and on the face of it the market shares involved suggested the merger was worth scrutiny. But even if other considerations, such as protecting national brands, intruded then that is a matter for domestic policy in China. Australia’s concern is to maximise the value of our national resources.

China’s domestic policies are not those we support, for instance, on political processes or human rights

This is also true, and these are genuine interests of the Australian community, but they are matters best dealt with directly as they are now, for example, in state to state arrangements.

Using restrictions on commercial transactions to pursue these sorts of goals represents the application of a very blunt and ineffective instrument that is more than likely to have perverse consequences. Other forms of commercial relationship such as student flows it can be argued support long run social change in China. That argument goes for economic development more generally.

Foreign investors will have access to areas which pose security risks

This concern was apparent in the initial decision on the proposal to purchase of Oz Minerals by China Minmetals. Oz’s Prominent Hill mine is on defence land in the Woomera area and it had to be excluded from the offer.  It is not clear though why this is not an issue for anyone accessing the area, and why if security is of that significance any projects were allowed to proceed there. To introduce this consideration for some investors retrospectively introduces a degree of discrimination as well as a greater level of uncertainty in the foreign investment regime in Australia.

Bottom line

As genuinely held as these concerns may be, the bottom line is that banning this particular commercial transaction would be an expensive way of achieving the various targets that the critics have in mind. Some of these targets have merit and significance – they are certainly worth talking about – but the deciding argument is that there much are better ways of achieving them.

It makes no sense to add a layer of discrimination against China in our approach to welcoming foreign investment in the resource sector or other sectors of the economy. It is not in our long run interests.

It’s an Australian responsibility to get the right instrument aligned with each target while at the same time extracting the best value we can from developing our natural resources.