Social distancing restrictions imposed in response to the COVID-19 Crisis (the “CVC”) caused Australia’s worst recession since the 1930s—an experience shared by economies worldwide. With the relaxation of these restrictions and an effective vaccine on the way, Australia is now seeing an economic rebound. However, even if economic activity recovers quickly to pre-pandemic levels, the underlying economic fundamentals—most notably private investment, productivity and wage growth—are destined to remain weak.
Before the CVC the Australian economy was growing at slower rate than prior to the 2008-09 GFC.
The economy’s growth rate had fallen below the 30-year average of just over 3 per cent due to a sizeable fall in investment. Real wage growth has also been sluggish because private investment acts as conduit for productivity growth by embodying the latest technology. Therefore, a return to long-run growth rates and employment levels requires a return to long-run investment levels. This is where bolstering foreign investment could play a major role.
From capital importer to capital exporter
For most of its history Australia has been a capital importer: that is, total investment has exceeded domestic savings due to supplementary investment from abroad. But this is no longer the case. The turnaround in Australia’s current account from deficit to surplus in 2019 signified this.
Yet this turnaround was not the welcome economic development many commentators interpreted it to be, as it reflected total domestic investment falling short of domestic saving for the first time in decades.
As a reaction to the CVC, support has grown for a revitalisation of Australian manufacturing using cutting edge technology to add value to the agricultural and mining products Australia specialises in. Foreign investment could facilitate this as it has done in the past, the once-flourishing motor vehicle industry being the most obvious example.
There are two main impediments to higher foreign investment in Australia. One, the company tax rate for large companies, many branches of multinational companies, is too high at 30 per cent. Two, national security has become a major criterion for evaluating foreign investment proposals submitted to the Foreign Investment Review Board (FIRB).
Internationally uncompetitive company tax
On tax rates, the United States and the United Kingdom, traditionally Australia’s two main sources of foreign direct investment, have rates of 21 per cent and 19 per cent respectively. Following the 2018 Trump company tax cuts Australia became a net equity investor abroad as reflected in the recent current account surpluses.
Even cutting company tax for large companies from 30 to the 25 per cent rate applicable to small companies would leave Australia’s company tax rate significantly above the worldwide average.
The company tax rate in Hong Kong and Singapore (the world’s most competitive country according to the World Economic Forum’s competitiveness measure) is 17 per cent, 12.5 per cent in Ireland, and 18 per cent in Switzerland. China and Ireland, two miracle economies that surged in the 1990s, prospered due to tax concessions that encouraged direct foreign investment.
National security concerns
The other major factor that will slow foreign investment in Australia going forward is national security concerns. Over recent years national security has been central to FIRB assessment and has been the rationale for blocking at least ten major Chinese proposals.
Motivated by these concerns, foreign investment policy administered by the FIRB tightened on January 1, accompanied by substantially increased application fees and provision for the Federal Treasurer to recall acquisitions years after they have been approved.
The risk is that a stricter foreign investment approval process will act to discourage investment from countries unintentionally caught up in the process. In the wake of the China dispute there is scope for more investment from other advanced and emerging economies although national security review now makes it harder for foreign interests from anywhere to invest in Australia. The security pendulum may well have swung too far.
We need more not less foreign investment
Increased foreign investment and international trade with other Asia Pacific nations would significantly contribute to lasting economic recovery and reduce unemployment.
Historically, by freeing the nation from the constraint of limited domestic saving, foreign investment has served Australia well by raising national income and the standard of living.
Economic theory tells us that the economy-wide gains that stem from greater foreign investment parallel gains that result from liberalising international goods and services trade. Yet foreign investment is considerably lower than it could be, given Australia’s location in the most dynamic region in the world.
The economy has traditionally relied on inbound foreign investment to fuel economic growth, but from 2019 net capital outflow was recorded for the first time since the early 1970s. To foster more foreign investment the federal government needs to address two major barriers to foreign investment. First, the company tax rate has to be more internationally competitive, and second, care needs to be taken that new procedures put in place to guard national security are not ignoring the economic costs of deterring security-safe investment.
Professor Tony Makin is an Economist and member of the Griffith Asia Institute.
