05 March 2009

State-owned is not the main problem

The Treasurer should decline to approve the application by Chinalco to raise its stake in Rio Tinto from 9% to 18% through a $US19 billion purchase of Rio Tinto shares. For the application to be approved would be contrary to the national interest.

The principal reason for this is not, as often asserted in the media, the fact that Chinalco is a state owned enterprise (SOE), and might not therefore behave in accordance with normal commercial considerations. The most important reason is that Chinalco is a major player in its own right in the international minerals market, which is why it wishes to increase its stake in Rio Tinto, and likely to become more so. Either now or in the future, its commercial interests as a buyer and investor elsewhere might well diverge from the Australian national interest as a seller. We should examine carefully for its potential impact on the national interest every proposal for a major foreign purchaser of minerals to take a stake in the Australian minerals industry.

Viewed in today’s economic and financial context the Foreign Investment Guidelines are rather quaint in the distinction they seem to perceive between SOEs, sovereign wealth funds (SWF) and private companies. The reason for particular scrutiny of proposed investments by foreign governments or their agencies is stated in the Guidelines to be “the fact 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”.

The least problematic foreign investment of all would probably be portfolio investment by sovereign wealth funds like the Kuwait Investment Fund or its Norwegian counterpart – investors who do not seek to influence the management of the companies in which they invest, but who are simply interested in the dividends which will flow from their stake. To be fair, investments of that type, while required to be submitted for scrutiny, would quickly be approved.

Regarding the SOE issue, it is remarkable that, at a time when we are attempting to manage our way through a global financial crisis brought on by the “commercial” behaviour of private financial institutions in the United States and Europe, which behaviour has brought the world financial system to the brink of collapse, we are solemnly deliberating about the possibility of Chinalco behaving “not solely in accordance with normal commercial considerations”.

A distinct possibility, but state owned enterprises are not alone in this. And while some mineral commodities are sold on a very competitive basis – those like aluminium, zinc, copper and nickel which are sold through the “open cry” system on the London Metal Exchange, there are others, notably iron ore and coal, for which the trading processes do not begin to approach the perfect competition model of Economics 101.

Further, a company does not have to be state-owned to be respondent to the dictates of a government other than the Australian Government. All foreign-owned companies will be influenced to a greater or lesser degree by legislation and/or policy direction in their country of domicile.

As examples of private companies being governed by factors other than “normal commercial considerations”:

(1) To my first hand knowledge an American owned company declined to sell coal to Vietnam after Australian sanctions were lifted following the Vietnam War, because otherwise it would find itself in violation of the US Trading with the Enemy Act. Its national interest template was fashioned in Washington, not Canberra.

(2) The United States maintains extraterritorial application of its antitrust legislation. It asserts a right to pursue any anti-competitive activity that is deemed to have an effect on US commerce, irrespective of where the action took place. The 1970s Westinghouse case related to alleged price fixing of uranium by Australian, Canadian and French companies at a time when uranium could not be imported into the United States. Some very senior Australian mining executives had to avoid setting foot on US soil while that one was sorted out.

(3) In the late 1970s and early 1980s when the Fraser Government still had export controls on major mineral exports, the executives of several US-owned companies asserted that they could not comply with Australian Government policy or they would be in trouble in relation to the extraterritorial application of US antitrust law. The Australian Government was obliged to strengthen the regime to put its mandatory aspect beyond doubt. This imposed additional costs on other companies and on the Government itself.

(4) I wonder, in light of the US Patriot Act, whether any United States company managing or supporting communications equipment within Australia could guarantee at all times to comply with Australian privacy laws, as is often stipulated as a requirement in Government tender documents.

Another concern expressed in the Foreign Investment Guidelines is that an investment may impact on Australian Government revenue or other policies.

Transfer pricing by vertically integrated multinationals raises that issue and has undoubtedly impacted on Australian Government revenue. It is very difficult to police.

Also, it is not necessary to make an investment in order to impact on Australian Government revenue. In the 1970s and 1980s all iron ore for the Japanese steel industry was purchased on behalf of the nine Japanese steel companies by one company, Nippon Steel. Nippon steel purchased not only the Australian iron ore, but that obtained from Brazil and South Africa. The smaller importers of the day, Korea, China, India and Pakistan all awaited the Nippon Steel settlement and then settled for that price minus a discount of a few percent. This system meant that there was effectively only one game in town – three major producers, BHP, CRA (Rio Tinto) and CVRD (Vale), competing for the favours of that one buyer. There can be little doubt that there was a substantial effect on the revenue.

This situation was only rectified when the growth of the steel industries of China, Korea and India created a genuine competition for product and shifted market power in favour of the producers, thereby generating the rivers of tax revenue that were experienced before the global financial meltdown caused the minerals boom to run out of steam.

By all means let us examine the foreign investment proposals of sovereign wealth funds and state owned enterprises, but let us also give the Foreign Investment Guidelines an overhaul to line them up with the realities of the global minerals market. In particular, let us have a cold hard look at any proposal which would have a major player sitting on both sides of the negotiating table.

And how do we now treat those financial institutions, motor manufacturers and others that have been bailed out by and are utterly beholden to their governments? Do we treat them as State Owned Enterprises (they certainly meet the "links to foreign governments" test) or are they still treated as "private"?

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