P U T T I N G  S O M E  B A L A N C E  I N T O  T H E  F O R E I G N  D I R E C T  I N V E S T M E N T  D E B A T E 

By Cameron Bagrie, independent economist and former ANZ chief economist http://www.bagrieeconomics.co.nz/

The Upshot

 

  • New Zealand is a nation of poor savers.  We don’t save enough to fund our investment needs. 

  • Foreign direct investment is critical if real productive investment needs are to be met, and direct investment is more beneficial than borrowing more via the banks to invest in housing. 

  • China is a small player when it comes to investment in New Zealand but our largest trading partner.  That’s an odd mismatch. 

  • For New Zealand to prosper we need to lift export performance.  New Zealand doesn’t have a great track record investing offshore. 

  • Using foreign direct investment wisely could be a key factor in helping New Zealand lift economic performance and access international markets.

 

A basic economic identity is that investment equals savings. You can’t invest unless you have the savings pool to fund it. 

 

New Zealand does not generate sufficient domestic savings to fund our investment needs. We’ve used offshore savings.  This has been reflected in New Zealand running current account deficits, which in turn has meant increases in foreign investment in New Zealand via either debt or equity. New Zealand has not delivered a current account surplus since 1973.

 

The household savings rate is minus three cents.  For every dollar, New Zealand households earn they spend $1.03. Little wonder we are reliant on offshore capital to fund our investment needs.  We live for today as opposed to being prepared to invest for tomorrow, although other issues such as low wages and high living costs (especially housing) are major factors too.

 

New Zealand has a huge investment pipeline. We have a shortage of houses and it’s getting worse. The accommodation sector is full more and more times of the year. Commercial vacancy rates are low.  We have severe roading and transport issues. The Government is bemoaning massive underinvestment in housing, education and health.  Local governments are under pressure to invest more in critical infrastructure.

 

Unless we see a miraculous uplift in savings across New Zealand, offshore investment and capital will be essential if those investment needs are to be met.

 

There is little on the policy agenda that suggests savings performance is going to lift sharply.  

 

Investment Gap

 

We have seen an improvement in national savings over the past decade. The likes of Kiwisaver and Super Fund have helped.  Households are a little warier taking on debt, regulators are more watchful, and banks are being more prudent. 

 

The current account deficit has narrowed as national savings have improved.  However, the pool of savings remains insufficient to fund New Zealand’s investment needs. At present, there is a “gap” of $6 billion that is plugged by either borrowing more overseas or foreign firms buying New Zealand assets or making portfolio (non-controlling) investment in New Zealand assets.

 

New Zealand didn’t really worry about borrowing extensively offshore (largely for housing) prior to the global financial crisis.  However, by being exposed to offshore capital (debt) and with debt markets stressed (costing more), New Zealand was hit harder than other nations during the crisis.

 

Regulators, rating agencies and banks themselves now pay a lot more attention to the funding gap and offshore funding.  This is the gap between domestic deposits and borrowing. A large gap means you have to borrow offshore.  As the housing market has slowed and banks have tightened credit criteria, the funding gap has closed up.  But it has meant less credit (debt) to fund investment. 

 

It also means the natural “filler” to fund our savings shortfall is becoming equity as opposed to debt.  

 

Foreign investment in New Zealand comprises direct investment (buying a controlling interest in an asset), portfolio investment and debt. Most foreign investment in New Zealand has been debt, a reflection of the nation’s fixation with housing. We’ve been borrowing to invest in unproductive assets as opposed to productive ones. It would be far more beneficial for the nation if the investment received from offshore was directed into productive assets, and particularly the export sector.

 

New Zealand is a substantial holder of offshore assets and investments. New Zealand’s investment offshore totals $252 billion, of which $35 billion is direct investment and $138 billion portfolio investment (think shares and debt instruments). In a globalised world, investment flows and decisions become truly international.

 

New Zealand international liabilities total $407 billion, of which $118 billion is direct investment. Portfolio investment is $194 billion, of which the majority is debt. That’s largely issued via the banking sector to fund New Zealand’s love affair with housing.

 

Foreign investors and firms expect a return on their investment in New Zealand. Much is often made of the dividends and income stream that is sent offshore.  This is dominated by the finance sector (mostly the banks) which accounts for 61% of the outgoings. Industries such as agriculture account for 3%. Food and beverage manufacturing is 4%. This reflects the fact that most of the investment into New Zealand has been debt in nature via the banking sector and ended up in housing assets as opposed to real productive assets.  That debt carries an interest cost and banks also pay a dividend. Agriculture-related investment by offshore firms in New Zealand is just under $8 billion.

 

The largest investor in New Zealand?

 

A perception that China is a huge investor and buying up chunk-loads of New Zealand assets is not backed up by the data.

 

Australia is the largest investor in New Zealand, accounting for 30% of all foreign investment. This is followed by the UK at a bit under 20% and the United States at 10%.

 

China is 2% (ranking number 5), and even if we include Hong Kong as an investment surrogate, the combined total of both is only 5%. Most investment by China has been in the portfolio and other category as opposed to direct investment.  China’s direct investment in New Zealand is a paltry $1.1 billion (March 2017 figures). Australia’s is more than $50 billion.

 

As countries become aligned on the trade front it is natural for connectivity to increase in terms of investment and people flows. We can see this through the trade and investment figures with Australia. New Zealand is aligned to Australia through both the flow of trade in goods, people (migration), tourism (Australia accounts for 40% of our tourists) and capital investment.  Australia accounts for just under 20% of exports (goods) but has a greater share of investment flows.

 

Connectivity with China

 

We can see rising connectivity with China beyond trade in goods. China is now New Zealand’s second largest in-bound tourist market. There were 438,000 visitors in the year to March 2018. This not only showcases New Zealand but show-cases New Zealand’s brand and products which can be exported. Education is another sector the two countries are strongly aligned.

 

China accounts for more than 20% of New Zealand’s exports and just under 20% of imports but is small when it comes to capital and investment flows. It would be unusual for trade connectivity not to manifest in greater investment flow over time. In fact, if investment flows between China and New Zealand do not increase over time then it is likely the trade relationship will not be as strong as it is at present. 

 

Our own backyard

 

Some of the negative attention foreign investors receive often overlooks the wealth destruction we’ve seen from New Zealand entities. We only need to turn our minds back to the finance company debacle.  This has a large negative impact on society and savings/investment portfolios. They were all New Zealand owned and controlled. Of late we’ve seen some high profile New Zealand companies destroy material amounts of wealth.

 

Export performance

 

For New Zealand to prosper we need to lift export performance. Exports have remained stubbornly around 30% of GDP despite aspirations to lift performance.

 

In the dairy industry - a major export earner - we have pending environmental taxes (water, nitrogen, carbon – it’s the combination that will hurt) and shifts in freshwater regulations. We are at “peak cow”. Some will have to de-stock to meet environmental requirements, which will lower returns. No more exploration permits will be issued. The mining sector faces environmental challenges. The combination is not a huge share of GDP but it’s still a material one at around 5% of GDP.  If those sectors are flatlining, or more likely, set to go in reverse, we are going to need more growth from the rest of the economy.

 

New Zealand desperately needs to unlock other areas of export growth and opportunity to fill this void and lift export performance at the same time.  Sectors such as tourism have received a lot of attention, but the reality is that they are low wage sectors.

 

If the “cap” is in for agriculture – and it is – then attention is going to need to turn to the manufacturing sector as a replacement source of growth.

 

It is not clear how or whether the manufacturing sector can step up, but it will need to.

 

Foreign-owned land

 

The Overseas Investment Office have approved approximately 2,480 in total (nearly 2000 for freehold land, the rest leased) in land transactions since 2001.

 

This has involved a gross land area of 2.186m hectares, some of which is direct foreign ownership and some of which is a New Zealand firm in conjunction with an international one. 

 

Such large chunks of land sales have contributed to rising anti-foreign investor sentiment. While we can debate the merits or otherwise in this, perhaps an alternate way to think about the issue is how we can get offshore investor involvement, but without the physical or extensive land ownership given political sensitivities?  This is where manufacturing could play a role. 

 

What does the research and key organisations say on foreign investment?

 

The 2017 OECD report on New Zealand noted that “Foreign direct investment boosts recipient countries’ productivity by providing capital to fund capital formation, opening up access to global supply chains and markets and promoting local competition. These benefits are particularly important for small countries such as New Zealand that lack a large domestic market.”

 

The OECD considers New Zealand’s screening of foreign direct investment to be poorly targeted.  There are delays, significant compliance costs and ministerial discretion creates uncertainty.  The OECD recommends relaxing screening.  However, they also recommend a public register of foreign direct investment to ease community concerns and “emphasising that the NZ government retains sovereign control over activities taking place on NZ land, irrespective of ownership.”   These are pragmatic steps that help a small open country such as New Zealand benefit from foreign direct investment, but without sacrificing sovereignty.

 

Research by the New Zealand Treasury points to the positive benefits that foreign direct investment brings to New Zealand. 

 

 

ANZ’s recent Agri-focus publication (December 2017) cites numerous benefits foreign investment brings beyond the provision of capital.  These include:

 

  • Better productivity – research shows that firms with foreign investment outperform domestic firms.

  • Exit opportunity for entrepreneurs – foreign direct investment provides an exit opportunity for entrepreneurs who may not have the resources or the desire to continue to grow their business beyond a certain point.

  • Greater access to technology, or customised products or services.

  • Upstream demand for their products via an expanded distribution network.

  • More consumer choice – foreign-owned businesses can provide competition, spurring innovation and providing consumers with more choice at lower prices (boosting welfare). These competition effects are likely to be important in small markets such as New Zealand, particularly in the non-tradable sectors.

  • Integration and connections with a global supply network.

 

Success in Overseas Markets

 

New Zealand companies have a notorious track record of failure when they head overseas. Think Air NZ and Ansett. Telecoms jaunt into Australia.  Fonterra into China. PGW into South America. Michael Hill Jeweller. The Warehouse.  

 

Cracking overseas markets is tough. New Zealand is not going to get wealthy selling goods and services to ourselves. We need to access offshore markets, and particularly markets such as China, which is set to be the largest economy in the world. This requires greater understanding of offshore markets, both the opportunities and challenges. This is where foreign direct investment, and the broader benefits of such investment is important.

 

Benefits of international firms investing in New Zealand for exports

 

International firms who invest in New Zealand with a view to exporting should have deeper export market knowledge than New Zealand firms trying to get a foothold. Often they will be exporting back into their home or local market. This can lessen the risk profile for locally-based exporters as they try to expand into new and offshore markets.

 

Put simply, foreign direct investment is a way of allocating capital to businesses with the best growth prospects, anywhere in the world.

 

Investors naturally seek to achieve a good return without too much risk, which is what we term the profit motive. This profit motive doesn't care about religion, politics or race. It’s like Switzerland; neutral on all sides!  It reduces the effects of politics, cronyism, nepotism and bribery. 

 

Receiving foreign direct investment, and having firms continually attracted to a country such as New Zealand is a vote of confidence in our political and legal institutions, and business practices. New Zealand should be proud of that.  It would be a real problem and issue if firms were not attracted to New Zealand given our savings shortfall.  We need the investors.

 

New Zealand ranked top in the World Bank Doing Business 2018 report for ease of doing business.  This was the second year in a row New Zealand ranked first. Little wonder firms want to invest!

 

New Zealand may have a liberal investment regime but there are strict tests buyers of land must go through. That’s sensible and prudent. 

 

They must demonstrate financial commitment, business experience and expertise relevant to the investment.  They need to be of good character and meet visa/permit criteria related to the Immigration Act.  That means no criminal record.  The investment needs to benefit New Zealand. There is an onus on creating and retaining New Zealand jobs. Investment is supposed to introduce new technology or business skills, increase export revenue, improve productivity, increase primary products’ value-add and protect or enhance environmental/amenity values of the investment.

 

One wonders how many transactions between New Zealand firms would pass those tests!

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