Unserious defenders of NZ national interests

Our government finally made sufficient obeisance and secured a modest upgrade to its preferential trade agreement with the People’s Republic of China.  That included New Zealand agreeing (page 4) to take twice as many PRC-funded ideologically pre-screened Mandarin Language Assistants in our schools (rather than, say, properly funding language learning in schools ourselves).   The values-free cheerleaders for New Zealand deference and subservience to Beijing were all out praising the deal, and if the shameless National Party trade spokesman Todd McClay –  the one who last year was defending the PRC brutality in Xinjiang as being no more than a few vocational training schools and really none of anyone’s business –  was a bit carping and critical, he and his party were probably only critical that the current government does not (quite) do the full kowtow (they did actually sign that 22 country letter on Xinjiang, even if not one of them –  not an official, not a Minister, certainly not the Prime Minister –  will say a word about it).

Remarkably, for a pretty secretive government, sometimes one gets more coverage from the PRC government side than from our own.  The PRC Embassy here often has interesting statement or commentaries on its website.  There was such a commentary this week about the Prime Minister’s meeting with Li Keqiang in Thailand, including the prefential trade agreeement update, although for some mysterious reason I couldn’t see it on the PRC New Zealand embassy website but only on the PRC US embassy website.

Two lines caught my eye. There was this from the Chinese side

The Chinese side is committed to creating a market-oriented, and law-based international business environment, and hopes that the New Zealand side will create a level playing field in New Zealand for Chinese companies to invest and start business.

(One might scoff at the first half of that, but my interest was the second half)

and this describing the New Zealand government’s response

The New Zealand side is willing to provide a non-discriminative environment for companies from all countries investing and starting business in New Zealand.

Others noticed it to.  Here was the Executive Director of the China Council, the government/business propaganda arm of the New Zealand/PRC relationship

Pretty predictable (anything for the PRC, if only we – they – can get some more deals in the short term, is pretty much the China Council stance), but pretty unfortunate too.

The government is, or at least says it is, reviewing the Overseas Investment Act.  It was September last year when they issued terms of reference for the review.    There was a consultation document released in April this year, with a very short period for submissions, because –  according to the Cabinet paper released under the OIA – they wanted to ensure they had legislation passed this parliamentary term.  And yet here we are, now getting on for mid-November and nothing more has been heard.  They don’t seem to have even published the submissions yet.

National security was one of the dimensions covered (albeit superficially) in the consultation document.    Now ‘national security’ is one of those catch-alls that can be grossly abused –  see Trump’s grounds for steel tariffs on Canadian imports –  but the fact that it can be abused does not change the other, rather more important fact, that national security is an important issue, there are real threats (actual/potential), and one of the key roles of any government is to protect national security.    And, on the other hand, business interests have no particular concern for national security, especially if it gets in the way of their activities.

The worry here –  as the Prime Minister’s commitments are reported by the PRC –  is that neither does the government.    We seem to have governments more interested in enabling New Zealand businesses abroad, than in protecting the security, values, and integrity of New Zealand.

I generally have a pretty open approach to foreign investment.  It is often economically helpful and generally mutually beneficial.  Among firms and individuals from free and open societies, sharing similar values, and where companies are free to pursue their interests not those of their governments that is a pretty strong starting proposition.  Perhaps even more so when it involves investment from companies in countries near the frontiers of economic performance and productivity.  Personally, I’d favour removing pretty much all restrictions on such investment from abroad (perhaps preferably reciprocally, but the benefits to New Zealand mostly arise from opening up ourselves –  rather like removing all New Zealand tariffs (something successive governments refuse to do) would benefit New Zealand consumers).

I wrote about this briefly some months ago when I was lodging my own submission to the Overseas Invesment Act review, including how we should think about investment from the People’s Republic of China  and why treating all countries similarly simply does not make much sense (since neither the opportunities nor the risks are the same).  Here is what I wrote then

These days, New Zealand does not get much foreign direct investment –  and especially not much in the way of greenfields new developments.  I don’t think the screening etc regime is the main reason –  mostly, I suspect, we don’t have that much foreign investment because (a) there are few opportunities here, and (b) for the same sorts of reasons business investment generally has been weak for decades (high cost of capital, high real exchange rate, high taxes on business profits –  in that case, especially for foreign investors).  But I’d generally favour a more liberal environment, for almost all industries and for investors of almost all countries.

It is also worth recognising that most of any benefit (to productivity in New Zealand for example) from foreign investment will come from investment by firms based in rich and advanced countries.  Of course, there might be rare exceptions –  a firm based in Zambia, Laos or El Salvador –  but they will be exceptionally rare (the best ideas, technologies, management systems etc) will be in the rich countries –  part of why they got, and stay, rich.  So I’d favour a pretty-much open slather approach to foreign investment –  existing assets or new –  for investors based in rich countries (the OECD membership might be a decent starting point, and one could add in places like Singapore and Taiwan.

For most of the poorer or smaller countries, I really don’t care much what the rules are.  Probabilistically, there is almost nothing at stake (at least in economic terms) in maintaining restrictions on Zambia, Laos, El Salvador (or 100 others) if that is what the political process demands.  But, equally, there isn’t much risk or downside to opening up to them either, especially if one is focused on the benefit of New Zealanders being (generally) able to sell to the highest bidder.

There are various odious regimes in the world.  Most them don’t matter much to New Zealand at all (thinking places like Equatorial Guinea).  But the PRC does and in my view we should –  while the regime remains as it is – be treating investment from there quite differently, for various reasons.    One is a straightforward economic one.  Almost any large PRC firm is either an SOE or has a significant element of state/Party control to it.  We spent years here trying to reduce the hand of the state in direct business operations in New Zealand.  State entities typically don’t run businesses well, don’t allocate investment efficiently, and so on.  There is no more likelihood (to put it mildly) that PRC state-controlled companies will do so than the New Zealand government ones will –  and at least the New Zealand government ones are ultimately answerable to New Zealanders.  Such investment is likely to be a net negative for New Zealand even if the price paid to the initial New Zealand vendor is higher than that vendor could have got from another –  private –  purchaser, whether from New Zealand or another country.

But the deeper reason is that the PRC is a big and powerful totalitarian state, that has repeatedly displayed aggressive intent, which has values antithetical to those of most New Zealanders.   Individual PRC buyers may well be perfectly decent well-intentioned people –  as plenty of 1930s Germans were too –  but a totalitarian state has, and repeatedly demonstrated, its leverage over its own people, by fair means and (too often) foul.  We would simply be ill-advised to allow PRC-associated interests to have significant investments in many sectors in New Zealand.  One could think of media or telecom companies, or tech firms.    The PRC banks operating here should be a matter of concern, especially if they get materially larger than they are now.   But the concern should range wider.  For example, the greater the control PRC interests have of elements of the dairy industry, the more difficult New Zealand might find it to be handle the sort of economic coercion the PRC has attempted to engage in re various countries in recent years.

And, of course, to circle back to my earlier point, it is not as if the PRC is one of the world’s advanced economies.  Productivity levels languish far behind even New Zealand’s modest levels, and everyone recognises the dependence the regime has had on industrial espionage.  Deep pockets aside –  with a mix of market and non-market motives –  how much genuine benefit to New Zealanders is there likely to be from PRC foreign investment over time?

It is possible that this sort of restrictive regime could come at some economic cost, in terms of lost productivity opportunities for New Zealand. My sense is that it would probably be quite a small cost, but we can’t be sure.  Perhaps more importantly, many precautions have a cost –  whether it be a national defence force, Police, anti-virus software, or a lock on your front door.  The PRC is a threat to New Zealand and countries like us, and we need to be willing to spend some resources (perhaps sacrifice some short-term opportunities) to establish some resilience to those threats.

But, of course, our elected “leaders” and business establishment figures have no interest in any of this.  For them, it seems, the character of the regime matters not a jot, it demonstrated track record at home, abroad, and in New Zealand matter not a jot.  There are deals to be done, donations to be collected, and  –  if there are any risks –  well that will be someone else’s problem another day.  And in the process they’ve allowed our political system to become corrupted, indifferent to the character of the regime, indifferent to the values of New Zealanders.  But their “friends in Beijing” are no doubt happy.

I didn’t post a link then to my short submission, but I will do so now.

Submission on. reform of Overseas Investment Act May 2019

Some excerpts.  First, the liberalising proposal

As a general proposition, I suggest that the government should look at a model which more clearly distinguishes between countries which, broadly share similar values, interests, legal systems and approaches to business and remove all (or almost all) restrictions on foreign investment originating from such countries. A starting point for such a list might be the OECD countries plus Singapore and Taiwan. If the beneficial owners of a potential investor are predominantly from these countries, it isn’t obvious that the net benefits from screening would outweigh the costs, including deterrence of investment, of such a regime. Much of world cross-border foreign investment originates from these countries (and the countries at or near productivity frontiers are included in this group), and to the extent that there are prospective economic gains from liberalising the regime, those gains are likely to arise in respect of these countries.

And on the other hand

And at the other end of the spectrum should be a small list of named countries from which we should simply not welcome foreign direct investment, and where the presumption should be against granting approval for any but the smallest and most innocuous of investments. Such a list might include countries subject to United Nations sanctions (notably North Korea), mostly for global good-citizen reasons, and membership of the list might change over time – Germany might have appeared in the late 1930s, the Soviet Union and its satellites during the Cold War – but the key country that should feature on any such list today would be the People’s Republic of China.

In other words, the issue is not specific countries for all time, but specific assessments of the character of regimes, their control over business, and the nature of any threat.

The consultation document makes every effort to be neutral as between countries. But that is a mistake. It is right to recognise that the source of potential threats can change over time, but unless the government is willing to openly confront the nature of specific potentially-threatening countries, it is difficult to build a regime that will serve well both the national security and economic interest imperatives, and provide a clear framework for potential investors (and potential vendors).

What of the PRC?

The issues around the PRC are twofold. First, many of the larger potential foreign investors are state-owned enterprises (or state-controlled ones). We moved to reduce the role of state-owned companies in our economy, for good sound efficiency reasons, and we should establish a presumption in our foreign investment regime that foreign state-owned enterprises (especially ones that cannot operate at a genuine arms-length from government ownership/control) are unlikely to offer potential efficiency gains for the New Zealand economy. And second, because the People’s Republic of China is a regime (a) in which no one can operate fully at arms-length from the authorities (Party or state), (b) has a demonstrated record of not operating as a market economy, (c) shares almost none of the values of New Zealanders, and (d) represents a clear potential threat to the integrity and security of other countries, including in any future period of conflict. The fact that there may be many good, well-intentioned, investors from the PRC should simply not be relevant here, any more than the presence of decent well-intentioned Germans in the late 1930s should have left countries relaxed about German foreign investment at the time. The issue isn’t the individuals, but the authorities to which they are subject.

The risks around foreign investment from the PRC are not restricted to more-obviously sensitive assets (eg major media outlets or telecommunications systems) but apply more generally, partly because of the importance of PRC state-sponsored industrial espionage, but also because of the pervasive use by the PRC system of all sorts of potential sources of influence or connection. For example, vertically-integrated production and supply chains (including in the dairy industry, or the tourism sector would more difficult to withstand PRC attempts at economic coercion of the sort seen in various other countries in the last decade Investment from PRC sources represents a different and, generally, much more severe set of risks than that from Singapore, South Korea, Ireland or Canada.

More generally

The issue can be thought of in terms of a 2×2 matrix: there are benign countries large and small, and more troubling countries large and small. It is the larger and more troubling countries our restrictions should be focused on, and with regard not just to the current situation and immediate threats, but to maintaining resilience over, say, a 10 or 20 year horizon.

And to revert to the PRC

It is possible that such a near-complete ban on PRC-sourced foreign investment could come at some – likely modest – economic cost, the character of any such cost should not be seen as much different in kind to the price we pay for national defence and security systems. Without that expenditure, private consumption could be higher now – and potentially for decades to come – but we choose not to take that option because the recognise that there are risks and threats.

In this, as in other areas of public life, we shouldn’t be afraid to name the potentially hostile state and act accordingly, even as we would welcome such a state back into the fold when if the character of the regime changes. Germany and Japan were once our greatest threat, and are now close allies. They changed their regimes, systems, and strategic intent. When and if the government of China does, we should welcome foreign investment from there, commensurate with the values and practices of the new system. For now, however, we allow our system and society to be corroded from within to the extent we open our economy to significant PRC foreign investment, whatever the apparent short-term gains to individual vendors might be. It isn’t, by any means, the only (or perhaps even most important) set of PRC risks and threats but it is the one that is the subject of this consultation.

Businesses won’t care.  Governments should.  Ours appears not to.  The focus always –  be it on defence, the political system itself, or whatever (foreign investment, Confucius Institutes) – seems to be to minimise the issues, do as little as possible, try to pretend to the public there really isn’t an issue or potential threat at all.  That is pretty shameful and inexcusable.  That is our Prime Minister (and, of course, her chief rival has form suggesting that if anything he’d be worse on this score).

Talking of long-delayed inquiries, the Justice Committee’s inquiry into foreign interference –  the one the government didn’t want to open for public submissions at all –  has still not reported, and no reform legislation has been presented to Parliament either.   The big issues here are less about legislation than about will and mindset.  But again all the evidence points in the direction of big political parties preferring to minimise the issues to the very greatest extent possible.  Jian Yang, and the National and Labour Party “friends in Beijing” will be happy.

China and New Zealand

The Prime Minister, a large flock of New Zealand business people, and various media representatives are in China.  It is not a particularly attractive sight, perhaps one of many reminders of why bilateral or regional preferential trade agreements are such an unfortunate policy option (as leading trade experts, and entities like the Australia Productivity Commission often remind us).  Allow for some trade diversion risks, and the ever-more-entangled rules of origin, and such deals are often bad enough.  And then there is the matter of making repeated obeisance before the leaders of a tyrannical regime, begging for their favour; the crumbs off their table.   Perhaps worst of all, our elected leaders don’t even seem to find it distasteful.

New Zealand firms do a fair amount of trade with Chinese firms, and that trade has increased considerably in the last decade. Despite some breathless commentary, China was never our largest “trading partner”,  but New Zealand firms do more trade with the Chinese than with firms and individuals in any other country than Australia.  But then our trade is quite widely spread across many countries, and much of it is in products which are pretty homogeneous (it isn’t clear that it much matters whether New Zealand firms export dairy products to Venezuela, Saudi Arabia, or China: New Zealand producers sell somewhere whatever is produced, and what matters most is the global prices for dairy products).  There is a great deal of talk about the benefits (or risks) of being concentrated on whole milk powder (WMP), but the prices of the various different dairy products all seem to cycle together, and idiosyncratic patterns for individual products don’t seem to last for long.   (GDT only has a long run of data for these three, but over the last five years one can also see it in a chart from a wider range of dairy products).

dairy prices components

Here are our merchandise (goods) exports to China as a share of GDP.

exports to china % of GDP

Services exports data by country is only available annually.  Here are total New Zealand exports to China for the last four (June) years.

total exports to china

But how much difference has it all made?  The government has made much of trying to lift the export share of GDP, but here is a chart of that series.

total exports as % of GDP

Which has, as I’ve noted previously, been going nowhere for 25 years now.

Of course, New Zealand firms import a lot from China as well.  Here is the merchandise trade balance between New Zealand and China since 1981.

merch trade balance with china

But once services trade is included, for the last three years New Zealand has run a goods and services surplus with China.

It was a little surprising to hear the Prime Minister in pursuit of investment from China

“But we in New Zealand will take that view from a Government perspective, that we’re a fast-growing economy, we want to to develop great international relationship and we also want to have a higher standard of living. We fundamentally don’t have enough private-sector capital of our own to fund that growth.”

Set aside the “fast-growing” economy claim for now – I guess the total economy has been growing quite a bit by OECD standards, even as per capita growth has been pretty dismal –  but what really struck me was the observation that “we fundamentally don’t have enough private-sector capital of our own to fund that growth”.  If the Prime Minister simply means that we run current account deficits (in which total domestic investment exceeds total national savings) that is, of course, true.    But it is not as if we have any trouble financing that current account deficit on world markets –  apart from any other indicators, that is evident in the persistently high level of the exchange rate.  Countries that have trouble financing themselves tend to have persistently weak real exchange rates.  We don’t.

To be clear, I have no particular problem with foreign direct investment, and in general I think we should have fewer restrictions on it.   China is a slightly different issue, but mostly because all major businesses are ultimately state-controlled. I’m not suggesting any specific restrictions on Chinese FDI (except perhaps where national security considerations warrant it) but we need to remember just how badly distorted and underperforming China’s economy is.  It isn’t exactly one of the success stories of market capitalism, unlike say Taiwan.  New Zealand hasn’t done well in recent decades, but for all its fast growth (much real, some probably illusory), China’s overall levels of productivity are still astonishingly poor.

gdp phw nz china taiwan

The better of China’s firms may be very good at managing the twisted eddys of Chinese politics.  That is very different from thriving in a proper market economy, where the rule of law prevails, and connections to the powerful don’t (or are not meant to) matter much.  If FDI from China happens, so be it and some it may add wider value, but it isn’t the most obvious place to be pursuing FDI from (if politicians should be doing such marketing at all).  The real gains from FDI aren’t dollars of foreign capital but rather the ideas, technologies etc that really successful global firms can bring with them, with spillovers into the New Zealand business sector and the wider New Zealand economy.

And all this is without devoting space to our apparent studied indifference on the South China Sea issue (“we aren’t taking sides, we just want a resolution”, as if there is no difference between tyrannies and democracies –  Philippines and Japan for example), or talk of extradition treaties with China.  If people can be shown to have lied on their immigration applications, no doubt we should revoke their approval to be here, but are we seriously comparing the so-called “justice” system of China to that of countries like our own?   For all the talk of “fugitives” in New Zealand, we need to remember that much of the so-called anti-corruption programme of the last few years has been about purging those who got offside with the winners in the latest Party realignments.  Some of those now abroad might well be “bad guys”, but it isn’t clear that any people who matter in China’s government are, in any sense, “good guys”.

Finally, in all our enthusiasm for trade with emerging China, I amused myself yesterday by downloading the 1939 New Zealand Official Yearbook to see what trade we were doing with Germany and Japan in the 1930s.  Not much with Germany, but I’m imagining there must have been some breathless enthusiasm, at least in some circles, about our rising trade with large and emerging Japan, by then our third largest export market.

japan exports

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TPP

A few earlier posts touched on some issues around TPP.

I remain pretty uneasy about the likelihood of overall net benefits emerging from this deal for New Zealanders.

And since this is one of those polarising issues – at least in New Zealand – I should restate (in a perhaps over-simplified way) my priors:

  • The ability to trade freely in goods and services is generally good and beneficial
  • Unilateral removal of New Zealand’s own trade restrictions has generally benefited New Zealanders.
  • We should have gone further and removed our remaining tariffs and either abolished, or sharply constrained, our anti-dumping regime.
  • A liberal foreign investment regime is generally good and beneficial.
  • New Zealand’s foreign investment regime is less liberal than it could and should be.   (There may, however, be important exceptions to the general case for a liberal regime.  Had the Soviet Union sought to buy up a large contiguous chunk of Northland I’d have had no hesitation in supporting a ban.  And non-resident purchases of houses, especially houses that sit empty, on a large scale might also be an exception,  but only given the absurdities of our domestic planning and land use restrictions.)
  • Intellectual property protections appear to have generally gone beyond what is appropriate to foster a climate of innovation.  Copyright is the most obvious example.
  • Strong government institutions, and particularly those which protect and ensure the rule of law, are important to any successful and prosperous society.
  • A key element of the rule of law is equal treatment of the powerful and the weak.
  • The freedom for domestic Parliaments to adopt even daft and dangerous policies is an integral part of the sort of system of government that we inherited from Britain and have made our own.

So I’m pre-disposed to favour trade and investment liberalisation.  In general, the more the better.

But even the academic literature tells us that free-trade agreements among groups of countries are not the same, and don’t offer the same welfare gains, as more generalised free trade. The Australian Productivity Commission reminded us of that again just last month. Australia’s own FTA with the United States has generally been regarded as having secured few (perhaps even negative) benefits for Australians.

And it is already apparent that intellectual property protections are set to be extended in any TPP agreement.  That is a win for the owners of those properties – few of whom will be in New Zealand – but where is the evidence of a general welfare gains for New Zealand citizens, or indeed, those of other countries?   (And this is so, even acknowledging Eric Crampton’s in-principle point about free-riding and pharmaceuticals).

And why do we want to further entrench investor-state dispute settlement provisions (ISDS), that provide greater rights to foreign investors than domestic investors have? We should, primarily, be making New Zealand law in the interests of New Zealanders, and I have not seen a single serous argument for how that end is served by providing better remedies to foreign investors than to our own. Disputes about government policy should be fought out in domestic political arenas, and disputes on law should be fought in the domestic courts. For better or worse, we ended “foreign” jurisdictions (the Privy Council) in domestic law a decade or so ago.    I’m not suggesting that foreign investors are any better or worse than domestic businesses – but we shouldn’t treat them differently. As I noted in an earlier post, previous great eras of foreign investment flourished without the need for such additional protections.

And while perhaps it is true that key points in any negotiations go down to the wire, shouldn’t we be uneasy that at this very late stage, such indications as there are suggest that the prospects of trade liberalisation gains that matter to New Zealand don’t look good? Dairy gets a great deal of attention in our media, but I wonder just how important any progress on liberalising it is in any other capitals? There seem to be more countries who care about resisting liberalisation, or for whom it just doesn’t matter, than who really care much about securing more dairy liberalisation.   That doesn’t sound like a recipe that leaves our negotiators much leverage.

And no doubt there is considerable truth in the proposition that negotiations need to take place in private.  No doubt, equally, if there was a will there would have been a way to be more open than the TPP process has been. After all, we used to think domestic government deliberations should be protected from public scrutiny as well. Now we subject them to extensive consultative processes, and the scrutiny of, for example, freedom of information acts.

Negotiations in private are a delegation of responsibility, by New Zealanders to responsible ministers. And trust is an important dimension of any delegation. Perhaps trust might be a little higher if New Zealand had a Trade Minister who, however competent, comes out with statements like this

“This is a moving game, and we need adults to do this – not breathless children to run off at the mouth when the deal is not actually finished.”

I guess he is old enough to have been a public servant before the Official Information Act.  But after a decade in Parliament those sorts of attitudes really aren’t good enough –  perhaps the only saving grace is that he is indiscrete enough to say what perhaps others only think.

I’ve expressed concern previously about the momentum that takes hold in these sorts of processes.  These negotiations have been going on for years.  New Zealand ministers and officials have prided themselves on having a key administrative role in them.  So how willing is the government, really, to walk away, on a hard-headed (rather than wishful) assessment of whether any deal actually benefits New Zealanders.  And will other hard-headed governments think New Zealand will really be ready to walk?  On its own.

Our Trade Minister is rumoured to be about to head off to Washington as our next ambassador, and the Prime Minister appears to enjoy his good relationships with, and easy access to, people like the Barack Obama.  Basic agency theory suggests we shouldn’t just assume that their interests (or any other past or future ministers) are sufficiently aligned with those of the principals –  New Zealand citizens and voters.  To walk away might mean putting ourselves “outside the club”, whatever that specifically means.  At a time when the government appears to be revelling in its position on the UN Security Council (and I still struggle to take seriously the idea of New Zealand as a key player, whether in the cause of Middle East peace, or the Security Council veto), there might be more reasons than usual to question how willing the government will be to step away if only a bad economic deal is finally on the table.

Perhaps the issue won’t arise.  Perhaps Malcolm Bailey’s comments this morning that the current dairy offers (whatever they are) should be “unthinkable” for New Zealand are just part of some orchestrated positioning exercise, with a bit of MFAT choreography, to try to prod slightly better offers out of our trading partners. But, at the moment, what we read and hear in the media doesn’t sound promising.  It doesn’t sound enough for even those instinctively inclined to support liberalisation to think that we New Zealanders would be better off it we signed up.    Bad deals have been done in past –  the Australian-US FTA –  and we can’t just assume away the possibility.

Of course, if a deal is signed it will still have to be ratified by Parliament (and through domestic processes in other countries).   No doubt the government will have a rough ride through that process –  no matter what deal is signed –  but equally I’d have thought that the support of ACT and United Future shouldn’t be hard to secure, and that there is little serious threat to its ability to secure ratification.

But if an agreement is signed, it is going to be important that there is serious scrutiny of it before Parliament is asked to ratify it.  There will lots of vocal commentators, and no doubt some of them will make useful and reasoned points that contribute to the debate.  But we need more than that, on what will be quite a detailed agreement.  We need a serious independent assessment of economic implications of whatever ministers have signed.  Perhaps the Productivity Commission could be invited to oversee that analysis. As it happens, the Commissioners include a former Secretary to the Treasury, and a former Director-General of Agriculture.  I doubt that the Productivity Commission currently has the in-house expertise at present to do the detailed work itself, but with the ability to (for example) contract modelling expertise the PC should be able to make a useful assessment, better informing any pre-ratification debate.

Trade agreements, TPP, and the Australian Productivity Commission

I’m on a tight deadline today and wasn’t going to write anything here, but a reader pointed me in the direction of the Australian Productivity Commission’s newly-published Trade and Assistance Review 2013-14, which devotes an entire chapter to “Issues and concerns with preferential trade agreements” (pages 61-86 here).

As the Sydney Morning Herald summarised it:

The Productivity Commission has launched a scathing attack on Australia’s latest series of free trade agreements, saying they grant legal rights to foreign investors not available to Australians, expose the government to potentially large unfunded liabilities and add extra costs on businesses attempting to comply with them.

Allowing for the relative restraint of bureaucratic language on the one hand, and newspaper style on the other, “scathing attack” doesn’t seem like an unfair description.  Perhaps as importantly, the report raises serious questions about TPP, (although the APC has not seen the documents being negotiated).

As regards rules of origin (whether for goods or services) the APC makes their points about cost and complexity by simply relentlessly listing the different rules of origin in the various Australian FTAs for the item “Bed linen, table linen, toilet linen and kitchen linen”.  They report estimates that “the cost associated with origin requirements could be as high as 25 per cent of the value of goods trade with ASEAN”.  By contrast, unilateral abolition of domestic tariffs, or comprehensive multilateral agreements avoids these costs.  The APC makes quite a lot of the point that time, and political capital, spent negotiating FTAs may be, in part, at the expense of unilateral liberalisation of international trade and domestic competition-enhancing reforms.

The APC report also devotes considerable space to investor-state dispute settlement (ISDS) provisions.  They seem very sceptical of the case for these provisions (and note that 40 per cent of those launched last year were taken against developed countries – presumably countries with robust domestic legal systems).  As they note, signing up to ISDS provisions involves new, unfunded, contingent liabilities for governments while, in their view, there is no sign that the ISDS provisions Australia has already signed have done anything to increase either inward or outward Australian foreign investment.  They also note that the Chief Justice of the High Court of Australia has publicly expressed concern about the risk that ISDS provisions could undermine the authority of domestic courts.

Finally, the APC notes the difficulty of assessing the potential impacts of trade agreements.  They argue that this makes a ‘compelling case for the negotiated text of an agreement to be comprehensively analysed before signing”.  At least in Australia, actual analysis and evaluation appears to have fallen far short of this standard.

Trade agreements aren’t going to be a much of a theme on this blog, but I found it interesting that as orthodox and pro-market body as the APC felt it appropriate to reiterate its scepticism on FTAs in this way.    Here are the key points from the APC document.

apc

For New Zealand, there still seem to be some important questions to be answered around TPP, and before it reaches a point where a government majority simply votes a signed agreement through the House.   There is no sign yet of material dairy trade liberalisation, intellectual property protections are likely to make us worse off (and perhaps also the ordinary citizens of other countries, even those who host large intellectual property owners), while further ISDS provisions, for which there is no identified market failure, seem set to strengthen the hand of foreign investors relative to domestic ones, undermining the primacy of our own Parliament and courts, for no obvious gain.   I am also uneasy about the provisions that get inserted in these agreements to limit the ability of countries to respond to economic and financial crises.  I was involved in work on these while I was at the Reserve Bank, and again it is not obvious what the problems are with existing multilateral provisions (IMF and WTO).

I remain uneasy that New Zealand might end up signing an agreement primarily because of the momentum in the process, and the desire of our own elites not to self-exclude from “the club”, rather than because there are demonstrable gains to the national welfare of New Zealanders.  If so, it would be cause for concern.  I wonder what sort of robust economic evaluation is envisaged here before MPs are asked to vote on any agreement?

ISDS provisions

In his column in the latest New Yorker James Surowecki looks at Investor-State Dispute Settlement (ISDS) provisions that feature in many bilateral and multilateral trade and investment agreements.  These provisions allow individual investors in some circumstances to seek redress against domestic governments not just in domestic courts, but before an international arbitration tribunal (most commonly the ICSID, which is based at the World Bank).

As Surowecki notes, “these provisions have been opposed by an unusual coalition of progressives and conservatives”.

Advocates argue that ISDS provisions help to encourage foreign investment.  For some of the opponents, that would almost be enough of an argument itself.  For them, foreign investment itself is threatening.   But plenty of people who are generally keen on pretty open foreign investment are also somewhat wary.  I reckon that regulatory obstacles, and screening regimes, in respect of foreign investment  in New Zealand should be materially reduced, but partly because I think foreign investment should be treated as similarly to domestic investment as possible, I’m not sure why we should be providing separate remedies, and separate quasi-judicial fora, for disputes taken by foreign investors.  If we do need greater protection for investors, and for citizens, against arbitrary actions of governments lets have that debate domestically, amend our domestic laws accordingly, and provide equal protection to all.

The first such ISDS provision apparently dates back only to a Germany-Pakistan agreement in 1959.  And, of course, a great deal of foreign investment happened before then – in fact, the whole first great age of globalisation, prior to World War One,  Huge amounts of debt and equity finance went abroad from Europe (the UK in particular) into colonies of settlement in particular.  That included countries with pretty good legal institutions from the start (such as New Zealand) as well as places like the new, and often shaky, states of central and south America.  And it wasn’t just colonies of settlement  –  destinations included Turkey, Persia and China.

Last week I was reading a fascinating older book about just these sorts of issues.  Finance, Trade, and Politics: British Foreign Policy 1815-1914 by D C M Platt, who went on to become a pretty eminent economic historian, looks in detail at how the British government dealt with the interests abroad of British lenders and investors (be they debt holders or concessionionaires or….).  The short answer is that, unless there were really pressing political considerations involved, or the initial obligations themselves arose out of an inter-governmental agreement, the British government took the stance, and held to it pretty firmly, that difficulties with foreign governments were mattered to be dealt with by the investors themselves in the courts, tribunals, and political processes of the country concerned.

The government, and Foreign Office officials, were constantly lobbied to provide additional support to British investors, and the pretty consistent response was “no”.  Governments were typically sympathetic, but they took the view that investors dealing in foreign countries needed to look after themselves.  This, recall, was the government of the strongest power at the time, the government of the country that was, by far, the largest source of foreign debt and equity finance.  And it was a great age of financial globalisation.  And not an ISDS in sight.  If the approach wasn’t followed perfectly, it still looks to me like a pretty good model, that worked pretty well.  Surowecki suggests that “in the old days, aggrieved American investors would call in the Navy to protect their interests”.  If so, it certainly wasn’t how the British did things.

A common argument from defenders of ISDS provisions is that very few claims are lodged, and in very few cases do ruling go against national governments.  But Surowecki notes that ‘nearly 100 have been filed in the past two years, as against some five hundred in the previous quarter century before that”, presumably partly a reflection of that fact that such provisions are becoming more common, but also (perhaps) of a greater degree of activism. He reports that investor-protection is an increasingly prominent part of US law-school curricula.

The other argument is that inclusion of ISDS provisions helps encourage foreign investment.  But the evidence I’ve read suggests, unsurprisingly, that this is true only for recipient countries that have had poor quality domestic legal systems.  For them, the offer of ISDS provisions is a credibility-enhancing device, designed to provide potential investors greater reason for confidence in the security of their investment.  The evidence also suggests that there are few or no gains in foreign investment flows between pairs of countries (eg US and UK) that already have perfectly good domestic legal systems.

From a New Zealand perspective, one argument might be “we have a good legal system, so there might be no gain, but there is no probable cost either”.  I’m not entirely convinced.  After all, Philip Morris is pursuing an ISDS case against Australia over plain-packaging of cigarettes, a remedy that would presumably not be open to them under Australian domestic law.  I’m not expressing (and don’t have) a strong view on that, as yet unresolved, case, but it seems to me that advocates of such ISDS provisions need to make a stronger case for why different remedies should be opened up to foreign investors, and why the domestic courts and domestic political process –  on which the rest of us must rely –  are not sufficient.  There may be such a case, but I’ve not yet seen it.

The unease should be heightened when we recognise the limitations of the ISDS process.  There are a couple of useful backgrounders on ISDS issues by Gary Clive Hufbauer on the Peterson Institute website (eg here).  Hufbauer is a supporter of ISDS provisions, but he draws attention to both the lack of appeal provisions in ISDS tribunals, and the lack of transparency (“ICSID does not require parties to post their briefs and arbitration decisions on the web so that the public knows the arguments and the rationale for any award”.   Appeal provisions are pretty fundamental to our system of justice.

Perhaps the argument for New Zealand signing up to such provisions, whether in TPP or other agreements, is that it helps New Zealand firms investing abroad.  But at a pragmatic level, the countries we are negotiating TPP with now almost all have pretty good domestic legal systems.  And why does the New Zealand government think it is part of its role to negotiate provisions to allow New Zealand investors more rights in respect of investment in overseas countries than those countries provide to their own domestic investors?   The hands-off approach was good enough for Palmerston, Gladstone, and generations of their contemporaries.

ISDS provisions are probably not the most important aspect of TPP, or other similar agreements.  But there doesn’t seem to be much else on offer.  Countries like New Zealand seem fairly certain to be losers from extended intellectual property protections, and the comments from John Key and Tim Groser still don’t suggest any prospect of great movement on dairy protectionism.  And if the strongest argument for TPP really is something like strengthening the US relative to China (a goal which I have no particular problem with),the longer-term success of any such strategy depends on perceptions of legitimacy.  Given the unease many people seem to feel about ISDS provisions, which can look (whether or not they are) like something that is “designed to put corporate interests above public ones”, and the limited evidence of any real economic gains from such provisions, it isn’t obvious why ISDS provisions serve the interests of ordinary citizens or governments, in democratic countries with robust legal and political systems. In the words of a contributor at Forbes, (not, probably, high on Jane Kelsey’s regular reading list) ISDS provisions seem disconcertingly like a “subsidy to business that comes at the expense of domestic investment and the rule of law”

“Larry Summers on TPP makes perfect sense”?

Tyler Cowen wrote last night “Larry Summers on TPP makes perfect sense.  I haven’t seen anything on the anti- side coming close to this level of analysis, and in a short column at that.”

I’ve been a bit ambivalent about TPP, so thought that I’d better read the Summers piece.  My problem was that I came away more skeptical than I went in.

My own priors are pretty clear.  Free trade is good –  as a matter of liberty and as a means to greater prosperity.  I’m sure one can find exceptions, but the rule is a pretty good one to live, and make policy, by.

But then Summers tells us that:

First, the era of agreements that achieve freer trade in the classic sense is essentially over. The world’s remaining tariff and quota barriers are small and, where present, less reflections of the triumph of protectionist interests and more a result of deep cultural values such as the Japanese attachment to rice farming. What we call trade agreements are in fact agreements on the protection of investments and the achievement of regulatory harmonization and establishment of standards in areas such as intellectual property. There may well be substantial gains to be had from such agreements, but this needs to be considered on the merits area by area. A reflexive presumption in favor of free trade should not be used to justify further agreements. Concerns that trade agreements may be a means to circumvent traditional procedures for taking up issues ranging from immigration to financial regulation must be taken seriously.

But if free trade is good, the same case can’t be made for “regulatory harmonisation”.  We just don’t know enough about what regulation is sensible, and worthwhile, and we live in democracies where the case for regulation in specific areas should be fought out through domestic political processes.    A diversity of regulatory approaches is often the way we learn.     And protections for intellectual property are typically far too high anyway –  in other words, agreements on such matters risk being (or are by design) generally anti-competitive, anti-market, measures.

In fact, the strongest argument for TPP I could find in the article was one grounded in domestic US politics ( recalling that Summers had been a senior official in both the current and previous Democratic administrations).

The repudiation of the TPP would neuter the U.S. presidency for the next 19 months. It would reinforce global concerns that the vicissitudes of domestic politics are increasingly rendering the United States a less reliable ally.

Really?    We all know that second-term US Presidents, especially those whose Vice-President is not heir presumptive, quite quickly become lame ducks.  Is this presidency really any different?  And where is the pressing demand for TPP?  No doubt there are elites in each of the negotiating countries with a great deal at stake, but where is the popular demand for this agreement?  As Summers puts it, it doesn’t seem to be a free trade agreement anyway.  Which population centre will think worse of the US if negotiations stall?    No doubt some US business groups will be aggrieved, but that is domestic politics, not international relations.  Failure of TPP would be embarrassing for Barack Obama, but that seems less like a national interest issue than a partisan one?

I’ve long been a bit puzzled by what was supposed to be in any deal that would make it economically worthwhile for New Zealand (as distinct from being “inside the club”).  I recall the IMF doing some modelling a decade or more ago on the US-Australia FTA, which had concluded that that agreement had been modestly welfare-diminishing for Australia –  as if a desire for a deal, any deal, and perhaps the momentum that any  process takes on over time had overridden a hard-headed assessment of the economic interests of Australia.   If there were genuine large-scale liberalisation of the global dairy trade, then we might reasonably think New Zealand would be better off from a deal.  But has that ever seemed very likely?  And if only small (or no) trade gains are on offer, how should we weigh that against the losses from strengthened intellectual  property protections?

And how should be think about the incentives on our key political participants?  Having pursued an agreement for so long, what sort of threshold would have to be crossed before they would be willing to walk away from negotiations?  It is not clear that the personal and national interests are necessarily tightly aligned.  Perhaps the US Congress will  vote in ways that mean they never have to make that decision.

To repeat, I’m a free trader.  I think New Zealand should have removed its remaining tariffs, and wound back its anti-dumping regime, long ago.  I’m in favour of a materially more liberal approach to foreign investment.  And I generally favour less regulation rather than more.  But all these are causes that should be fought out openly, and in the domestic political process.    So, I hope there is a better case for TPP than that put forward by Larry Summers, who actually seems somewhat ambivalent if it weren’t for the impact on Obama’s political position, but so far I haven’t found it.

And that before I saw Keith Woodford’s recent column on interest.co.nz.  Woodford knows a great deal about the global dairy industry, and he makes what seem like pretty persuasive arguments that there might not be much in it for New Zealand even if the US and Canada were to move towards an unsubsidised and less heavily regulated dairy industry.