10 July 2011

Future submarine: informed debate needed.

An unhelpful and regrettably uninformed contribution to the debate about Australia’s future submarine capability, and indeed about the current Collins Class submarines, was made last week by a senior official who ought to know better, and upon whom we ought to be able to rely for public utterances underpinned by careful research and analysis.

In Australia’s mining boom: what’s the problem?, an address to The Melbourne Institute and The Australian Economic and Social Outlook Conference, 30 June 2011, Productivity Commission Chairman Gary Banks had this to say, in a section of his address which canvassed areas which might contribute to fiscal consolidation:

But no doubt there is more low-hanging fruit waiting to be picked. For example, the case for Australia spending $36 billion or so on another dozen homemade submarines, when imported alternatives could be purchased for a fraction of the cost (and risk) has never been adequately explained publicly — notwithstanding the generally acknowledged failure of the Collins Class precedent. The whole area of defence procurement seems ripe for a thorough independent review.

While I would agree with Mr Banks about the need to review defence procurement, his comments about the availability from an overseas supplier of an acceptable future submarine are remarkably ill-informed.  He appears to believe that a submarine is a commodity, like sand or cement – as long as the article travels under the label “submarine” it will do the job.

In fact a submarine is one of the most complex pieces of military equipment in existence, the design of which involves wicked trade-offs between range, capability and stealth. Because of these trade-offs, submarines are carefully designed for the particular roles they are to perform, with equally careful regard to the geographical environment in which they are to serve.

To put it in a nutshell, European submarines are typically built for short patrols in deep cold water.  Australia needs long range submarines, to operate in warm shallow water.  All other navies which operate long-range submarines operate nuclear fleets, so if we want a long range fleet it is going to have to be purpose designed.

As long ago as 2008 a group of some of the nation’s leading experts on submarine design and operation advised the Government that there is no military off the shelf option which will provide the capabilities which Australia requires, and that this will of necessity be a developmental project. The nearest design which meets Australia’s capability requirements is the Collins Class submarine, and accordingly this represents the lowest risk starting point for the development of a new design for the mid-21st century. 

In addition, there is good reason to believe that the United States will refuse to release certain critical technologies for incorporation into a European designed and/or built submarine, for fear of technology leakage.

This advice of these experts informed the Government’s thinking about the requirements for Australia’s future submarine capability and was reflected in the 2009 Defence White Paper. The case which was made and accepted had nothing to do with “skilled job creation or technological spillovers” as suggested by Mr Banks in his presentation – it was purely and simply a clear case of there being no off the shelf option that goes even close to meeting the need.

As for his claim about “the generally acknowledged failure of the Collins Class precedent”, I know of no-one in the submarine world who thinks that the Collins Class was a failure. The Defence Materiel Organisation has never provided enough budget to maintain them properly, but that is another story.

And just for the record, there was no significant cost over-run with the Collins project, notwithstanding the Howard Government’s beat-up to the contrary, which as far as I can discern was intended to demonstrate that the then Leader of the Opposition, Kym Beazley, had made a foolish decision when, as Defence Minister in the Hawke Government, he had opted to have the submarines built in Australia. Of the $1.7 billion allocated to “fix” the submarines following the 1998 McIntosh-Prescott Report, only $143 was for areas where the submarines failed to meet the requirements of a contract well in excess of $5 billion (in other words, to fix the submarines); $300 million was for changed operational requirements and $727 for technological obsolescence (i.e., technological developments which had taken place during the build).

These remarks by Mr Banks were a reprise of a comment he made in his keynote address to the Annual Forecasting Conference of Australian Business Economists in December 2010 (see here), at which he referred to “submarines costing multiples of equivalent imported models”.  The key word there is “equivalent” – the best advice available to the Government that Mr Banks serves is that there is no equivalent imported model. Who told Mr Banks that there was?

Comments by senior commentators like Mr Banks matter.  His recent remarks were enthusiastically quoted by Australian Financial Review Economics Editor Allan Mitchell in an opinion piece on Wednesday 6 July, and by columnist Brian Toohey in a piece posted on Inside Story on 7 July (see Luxury vessels here). And so the notion that building the submarines is an unnecessary indulgence receives further confirmation in the public mind.

There is a debate to be had about Australia’s future submarine, an important debate – so let’s hope that it can be a better informed debate than it seems to be at the moment.

Note: The information cited above about the budget allocations for completion of the Collins Class project was drawn from Peter Yule and Derek Woolner, The Collins Class Submarine Story: Steel, Spies and Spin, Cambridge University Press, 2008, p. 324.  

03 July 2011

Foreign investment and food security

The question of whether or not the purchase of Australian farmland by foreign governments or foreign government agencies or enterprises, or indeed by any foreigners at all, will have an impact on Australian food security continues to bubble along in the nation’s political discourse.  Associated with these concerns are claims that the purchase of Australian assets by foreign government owned agencies or companies involves a loss of Australian sovereignty.

The two hot items currently giving momentum to this debate are the purchase of farmland in Western Victoria by a Qatar Government-backed entity, and the purchase of 43 farms outside Gunnedah by the Chinese Government-controlled Shenhua Watermark Coal Corporation, whose interest in these farms is clearly the coal that lies under them.

One of the latest contributions to the debate is an opinion piece by CIS Research Fellow and Senior Lecturer in Economics at UTS Business School Stephen Kirchner, in The Weekend Financial Review, 2-3 July 2011.

Kirchner sees no problem in foreign investment in our farm sector – he says it will enhance our food security – and he sees only base motives in those who wish to “meddle” in commercial transactions and thereby prevent Australian farmers from getting the highest sale price they can for their farms:

What unites politicians on this issue is not so much xenophobia but their conviction they have the right to meddle in commercial transactions they don’t like.

Xenophon’s proposed national interest test is more prescriptive than the existing national interest test under the Foreign Acquisitions and Takeovers Act, which is deliberately open-ended.

Ironically, this would open the door to administrative and judicial review of the Treasurer’s unbounded discretion to reject foreign acquisitions that fall within the terms of the act.

This may not bother Xenophon, but it certainly bothers other politicians and Treasury, who want to preserve their ability to meddle without scrutiny by the courts.

The FIRB is just a fig-leaf of bureaucratic respectability for political decisions to interfere in commercial transactions and deny the resident owners of Australian equity the right to realise its full value by selling to the highest bidder.

There is some silly ideological stuff here: Kirchner appears to believe that nothing should be permitted to get in the way of a “commercial transaction” – being “commercial” puts it off limits, apparently – and his imputation of base motives to anyone who believes otherwise almost obscures the key policy point he makes in his article:

In the unlikely event of a serious international conflict or crisis, foreign-owned assets in Australia can be nationalised or exports of food restricted.

There are some important issues to be considered in relation to large scale foreign investment in Australia, but as Kirchner’s comment immediately above indicates, they have little do with either food security or sovereignty.

To deal with the latter point first, investment in Australia by sovereign entities or sovereign-owned or –controlled entities involves no compromise to Australian sovereignty. This is because, while the entity might exercise the powers of the sovereign in its own country, it can only be present in Australia as an Australian natural or corporate person, its actions within the Australian jurisdiction entirely subject to Australian law.  Foreign entities farming in Australia, for example, are subject to the same rules about land clearing, control of noxious weeds, plant and animal health, use of agricultural chemicals etc. as everyone else, and to tax laws including those relating to transfer pricing.

Similarly, any entity, sovereign or not, wishing to convert farmland for purposes of mining will be subject to the approval of the responsible State and Commonwealth authorities. There is a debate to be had about whether or not 43 farms outside Gunnedah should be made over for coal mining, but that debate has nothing to do with the fact of the 43 farms now being owned by a Chinese Government-owned company.

Unlike Mr Kirchner I do not believe that nothing should be permitted to get in the way of a commercial transaction and I think that from time to time particular transactions raise important matters of national interest for consideration by the Government of the day.

Nor do I share his view that Treasury officials are motivated in this matter by a desire to meddle. In the days when I was directly involved in advising on foreign investment in mining (1970s-80s, as a senior officer of the Department of Trade and Resources) I was far more often concerned by the desire of Treasury officials not to meddle in transactions that I saw as raising serious national interest questions.  This was particularly the case when John Howard was Treasurer; to my recollection John Howard never saw a foreign investment proposal he didn’t like, and most of the relevant Treasury officials were of a similar view.

As I wrote back in March 2009 about the proposal for Chinalco to increase its stake in Rio Tinto (see State-owned is not the main problem):

The principal reason [why the application should be declined] 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.

Issues raised by proposed investments which establish foreigners in a position on both sides of the commercial negotiating table are:

-  Transfer pricing issues

-  Access through taking a minority stake to commercially sensitive price information – very important in relation to monopsony buying practices of the Japanese steel industry before market conditions put market power in the hands of the producers rather than the consumers.

-  Issues to do with foreign government coordination of purchasing by enterprises within their jurisdiction, public or private.  Two examples will suffice:

(1)    In the late 1970s when the contracts were being negotiated, the sum of the amounts that the nine Japanese power utilities wished to take from the Northwest Shelf LNG project was vastly in excess of the amounts that the project would produce. Having secured from the NW Shelf consortium a rather unwise undertaking that they would not sell any of the gas to other than Japanese customers, the Ministry of International Trade and Industry then proceeded to allocate amounts determined by it to the individual power companies, so that suddenly Japanese demand was equal to Australian supply, and there was no price auction. I will leave it to the reader to judge what impact this may have had on the project’s revenue stream.

(2)    In 1986, when China ceased buying all its wool through a single government agency (Chinatex, represented at the Australian wool auctions by the formidable Mme Zhu Youlan) and four separate agencies began to compete with each other in the market, there was a major spike in the Australian wool price – a fact which Mme Zhu in conversation with me attributed to the inter-agency competition.  Clearly the reduced coordination in China was good for Australian woolgrowers.

-  The willingness of foreign executives to abide by Australian Government policy (very difficult in my experience with US companies which for entirely understandable reasons put US laws such as the Trading with the Enemy Act and the extraterritorial reach  of US antitrust law ahead of Australian law).

The above examples should be sufficient to indicate that large-scale foreign investment does indeed raise national interest questions which it is proper for governments to consider.  To those who find it troublesome that the national interest is nowhere defined in legislation, and believe that it ought to be, my response would be that determination of the national interest is properly a matter for the elected government of the day, in the circumstances at the time, and the capacity of a present or future government to determine the national interest should not be constrained by an attempt to define it in advance in legislation at a particular moment in time.  There was a time when State Governments felt that it was in the public interest to legislate that no Asian person can own an interest in a mining lease or a boat, and sooner or later such legislation can become, well, downright embarrassing. As a 1963 article in Time magazine noted (see here):

Whim Creek. The White Australia policy is often carried to absurd, esoteric extremes. Recently, five Japanese technicians employed by a Japanese-controlled mining concern—at, of all places, Whim Creek in Western Australia—were convicted of violating an obscure 1904 law specifying that "no Asiatic or African alien shall be employed in any capacity whatever in or about any mine claim." As a result, Western Australia's state legislature last week repealed the law, but virtually negated its action by adopting an amendment specifying that Asians must still get government permits to work in the mines.

As for those governments who believe that they are increasing their resource or food security by investing in production in Australia, my advice would be that the investment achieves very little by way of security over and above that which can be obtained simply by signing a commercial contract with an Australian-based supplier.

On the one hand, contracts are enforceable at law, and there is every reason for the buyer to expect them to be performed if at all feasible. On the other hand, the Australian Government has clear power under the Constitution to prevent or control exports, and nothing written into a commercial contract will prevent an Australian Government from exercising that power if it saw it as being in the national interest to do so.  In the unlikely event that Australia ever faced food shortages, it is hard to imagine an Australian standing idly by and permitting food supplies needed in the home market to be exported.

There can be all sorts of valid reasons for foreign governments and their controlled entities to invest in Australia, but security of supply is not really one of them.

There can be all sorts of reasons for Australian Governments to decline to approve proposed investments by foreign government entities, but loss of sovereignty is not one of them.