Bruce McKern: Fear of foreign investors misplaced

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The collapse of the proposed investment in Rio Tinto by Chinese Government-owned company Chinalco relieves the Australian Government of having to make a politically difficult decision.

But it is a pity that this investment did not have the opportunity to run the full gamut of the regulatory approval process and provide a much-needed demonstration of how Chinese investment in Australia will be treated in future.

Chinalco's proposal to raise its ownership in Rio Tinto eventually to 18.5 per cent had the attraction of providing much-needed cash to Rio Tinto. But as the market for natural resources began to improve and Rio Tinto's share price soared, the prospect of a fresh share issue looked more appealing.

Rejecting the Chinalco offer in favour of a rights issue may have been the right decision for Rio Tinto's shareholders, but it has put off to a future time decisions about how Australia will treat investment by foreign government-controlled entities.

The issue is not going to go away, because China, like Japan 40 years ago, has a voracious appetite for raw materials and will continue to be obsessed about securing reliable supplies. To reduce its dependence on the vagaries of the spot markets, it wants to secure supplies through ownership, as it has done in South America and Africa.

The furore about China's investment in Australia neglects the fact that so far it has been minuscule - $3 billion as of 2008 in all sectors, or less than 1 per cent of the total (3.2 per cent if Hong Kong is included).

So what are the arguments against foreign investment? One is that the outward flow of profit is a loss to Australia. But profits occur only if a business is doing well - employing people, paying taxes and helping the balance of trade. And profit outflows to foreigners cannot occur if the capital has not been invested in the country in the first place.

A second argument is that decisions about an Australian business may be made in another country. But this is not often likely to be negative for Australia.

Most of the decisions that a foreign owner makes will have the same outcome as decisions a domestic owner would make. For example, in a recession, might a foreign owner choose to close down an Australian operation? Possibly, if the Australian operation were less economic than other operations in the company's multinational network. But an Australian-owned operation would probably have the same fate forced upon it by more efficient competitors.

A foreign-owned business can remain in operation in difficult times if it is efficient.

What of the argument that it may be a problem for a resources company to have a major customer own part of its equity? Well, it is true that a substantial shareholder will have access to production and cost information, which arguably might give it advantages as a customer.

However, in many industries customers have a remarkably good understanding of the cost structure of their suppliers, so that ownership does not confer a significant advantage. And some fraction of whatever a customer gains by way of a better price will be lost in the lower profitability of its equity.

While this issue was a concern when Japanese customers first invested in Australian mining companies, there is no evidence that they were able to exercise unreasonable pricing power over their purchases. What they did gain was certainty over supply, which locked them in as long-term customers.

National control is a reasonable concern if a particular commodity is not available on competitive world markets, or if there are threats of interruption to world trade. But this is not the case for Australia's commodities. Australia has vast reserves of most of the commodities it exports and ample for our domestic needs.

There are three other scenarios in which the actions of a foreign government-owned investor might be at odds with the interests of the Australian economy. These need to be addressed in any agreement to allow substantial foreign government ownership.

First, like most governments, a foreign government might not be as good a manager as a private sector owner. Second, a foreign government might close down a local operation in preference to closing an operation at home.

And third, a foreign owner, whether government or private sector, might attempt to ship the output out of the country at an unreasonably low price, benefiting its consumers. However, all of these issues are matters which can be addressed in the approval process (and the transfer pricing issue is subject to control by the taxation authorities).

Foreign investment in Australian natural resources has been overwhelmingly beneficial, and there is no compelling reason why foreign investment from China, even when Government-owned, should be rejected.

The important issue is what conditions should be attached to approval.

Attracting more Chinese investment to Australia would strengthen China's dependence on Australia and deepen economic ties. It would give Australia a stronger argument for China to open up to Australian investment, which at present is only $3.8 billion.

A clear policy towards investment from China would provide a great opportunity for insisting on reciprocity for Australian investment in China.

* Professor Bruce McKern is at the United States Studies Centre, University of Sydney, and a visiting fellow at Stanford University's Hoover Institution.