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The Canadian-Australian Business Sector Productivity Gap: A Sectoral Analysis

I have a new report out with the Fraser Institute, co-authored with Milagros Palacios, The Canadian-Australian Business Sector Productivity Gap: A Sectoral Analysis.

posted on 25 July 2022 by skirchner in Economics

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The Canadian-Australian Business Sector Productivity Gap: A Sectoral Analysis

The Canadian-Australian Business Sector Productivity Gap: A Sectoral Analysis, with Milagros Palacios, Fraser Institute, 12 July 2022.

posted on 25 July 2022 by skirchner

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Today is my last day at the United States Studies Centre

Today is my last day at the United States Studies Centre. A big thank you to former CEO Simon Jackman for inviting me to work on the economic dimensions of the Aust-US relationship at such an extraordinary time. To find out what I am doing next, you will have to subscribe to my newsletter.

posted on 26 April 2022 by skirchner in Think Tanks

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Understanding the Prosperity Gap between Australia and Canada

Understanding the Prosperity Gap between Australia and Canada, Fraser Institute, 15 March 2022.

posted on 18 March 2022 by skirchner

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Sanctions are the least bad option against Putin’s aggression

I have an op-ed in the AFR on the effectiveness of sanctions, noting that they are often the least bad option when the alternative is escalating conflict.

The United States and other leading economies, including Australia, have instituted sweeping financial sanctions on Russian financial institutions and its central bank, adding to a raft of existing measures, some of which have been in place since the Russian annexation of Crimea in 2014.

The latest sanctions include limiting the access of selected Russian banks to the international payments system and freezing the foreign exchange reserves of the Central Bank of Russia (CBR) held offshore. The offshore assets of the Russian elite are also targeted.

The sanctions will make it difficult for Russia’s government and firms to transact internationally, deepening its diplomatic and economic isolation. However, there are carve-outs for Russia’s energy exports designed to maintain the flow of energy to Europe and the rest of the world. The Biden Administration did not want to add even higher global energy prices to existing domestic inflation pressures, leaving a major hole in the sanctions framework.

The effectiveness of the sanctions can be gauged in part by their effect on the Russian rouble and rouble-denominated asset markets. With its $US 630 billion in foreign exchange reserves largely immobilised, the CBR will have little option but to allow the currency to collapse, likely triggering defaults on foreign currency-denominated debt.

Russia’s international isolation in response to previous acts of aggression mean that its stocks and bonds have only a small weight in international bond and equity indices. Increased geopolitical risks will loom larger for global equity and debt markets than the direct effect of sanctions on Russian asset markets.

The Russian economy will also feel the impact of export controls on high tech goods, in particular, US use of its foreign direct product rule, which gives US law extra-territorial effect in relation to foreign-produced goods incorporating US content.

Previously road-tested against Chinese tech firms such as Huawei, these sanctions will severely constrain the ability of Russian industry to support the war effort. Taiwan, a major producer and exporter of semiconductors, has not surprisingly joined the embargo.

Financial sanctions against Russia will owe their effectiveness to the dominant role of the US dollar in the world economy and international payments system.

Most international trade and cross-border investment flows are either directly or indirectly US dollar-denominated.

The US controls and regulates the international clearing of US dollar transactions. This gives US financial sanctions enormous reach. Whether they are formally part of the sanctions regime or not, financial institutions cannot afford to risk losing access to the US-regulated dollar payments system by flouting sanctions.

Economic and financial sanctions have been a go-to policy instrument for US policymakers in recent years, having been employed against Iran, Venezuela, China and Russia. The use of economic coercion as an instrument of US foreign policy reflects both the size of the US economy but also the outsized role of the US financial system in the global economy.

There is little doubt that US-led economic sanctions against Russia will impose costs on the Russian state and economy. Regrettably, the biggest effect will be on the Russian population rather than the ruling elite.

It is unlikely that sanctions themselves will dissuade Putin from continuing his aggression against Ukraine. Additional economic sanctions were almost certainly a factor in Putin’s calculations of the costs and benefits war, even if he under-estimated their severity, just as he under-estimated Ukrainian resistance.

Other countries not part of the sanctions regime will continue to transact with Russia, mostly notably including China, although even China will be wary of the far-reaching implications of US dollar dominance.

Historically, economic sanctions have only a mixed track record of success in achieving foreign policy objectives, including inducing regime change.

The US economist Gary Hufbauer reviewed the use of economic sanctions dating back to 1914. He found that sanctions achieved their objectives only around one-third of the time and typically imposed only modest costs of around two percent of gross domestic product on target countries, although the costs imposed on Russia will likely exceed that historical average.

Sanctions can also be counter-productive, inducing even greater resilience and self-reliance on the part of the targeted country, as well as immiserating populations without harming elites.

Typically, economic sanctions are employed not because they are viewed as particularly effective in achieving immediate foreign policy objectives, but because they are less costly than alternative and less attractive policy options, most obviously, resort to armed conflict.

This is a particularly salient concern in relation to Russia’s invasion of Ukraine, where direct US and NATO involvement in the conflict would risk escalation with a nuclear-armed adversary. Putin has underscored that risk by putting Russian nuclear forces at a higher level of readiness.

Economic sanctions may be limited in their effectiveness, but are still among the best of a bad set of options in responding to Russian aggression.

Dr Stephen Kirchner is director of the International Economy Program at the United States Studies Centre, University of Sydney.

posted on 28 February 2022 by skirchner

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From “China Shock” to deglobalisation shock: China’s WTO accession and US economic engagement 20 years on

From “China Shock” to deglobalisation shock: China’s WTO accession and US economic engagement 20 years on, United States Studies Centre, University of Sydney, 24 January 2022.

posted on 24 January 2022 by skirchner

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From “China Shock” to deglobalisation shock: China’s WTO accession and US economic engagement 20 years on

I have a new report out with USSC, From “China Shock” to deglobalisation shock: China’s WTO accession and US economic engagement 20 years on.

Main points are as follows:

• China’s accession to the World Trade Organization (WTO) in 2001 was an important element of its growing integration into the world economy, as well as its domestic economic reform program dating back to 1978.

• In terms of access to US markets, accession only served to make permanent access China enjoyed since the 1980s.

• “China shock” literature highlights the number of US manufacturing jobs lost to import competition from China in previous decades.

• However, a broader assessment of the economic impact of the “China shock” suggests it has been a net positive for the US economy.

• US policymakers are increasingly critical of the role of the World Trade Organization and its failure to discipline China’s trade and industrial policies, but Australian policymakers see G7-led WTO reform as a key element to push back against China’s coercive economic diplomacy.

• President Trump’s trade war and sanctions against China led Chinese elites to equally question the extent of economic interdependence with the United States. President Xi Jinping revived the Maoist concept of “self-reliance,” explicitly citing the rise of foreign unilateralism and trade protectionism as a motivation.

• Far from calling out and disciplining China’s behaviour, President Trump’s trade policies, maintained by the Biden administration, have encouraged China to double-down on its state-led development model and strategic industry and trade policy, while potential multilateral solutions and processes have been neglected and under-utilised.

• The growth in discriminatory trade measures among G20 economies since the global financial crisis in 2008 demonstrates that the problems in the multilateral trading system are not specific to China.

• A key to restoring domestic political support for US leadership of the multilateral trading system is to reframe that leadership in terms of strategic competition with China around the rules and norms of the global economy.

• Effective US leadership of the multilateral trading system would not only promote US foreign policy objectives such as prosecuting its strategic competition with China but would also discipline US domestic economic policy in ways that better serve its economic interests. It also provides a rules-based framework to manage trade frictions arising from climate mitigation under the Paris Agreement and growth in the digital economy.

posted on 24 January 2022 by skirchner in Economics, Free Trade & Protectionism

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Op-eds - 2022

‘Sanctions are the least bad option against Putin’s aggression’, The Australian Financial Review, 28 February 2022.

‘Xi’s rightly wary of Fed tightening’, The Australian Financial Review, 19 January 2022.

posted on 19 January 2022 by skirchner

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Xi’s rightly wary of Fed tightening

I have an op-ed in the AFR explaining why Chinese President Xi Jinping will be eyeing a prospective Fed tightening warily and why the RBA will lag the Fed. Full text below the fold.

Chinese President Xi Jinping’s remarks to the World Economic Forum cautioning against a tightening in monetary policy on the part of major developed economies highlights the fragility of the Chinese economy. Xi is right to be particularly concerned about the potential for negative international spillovers from a prospective tightening in United States monetary policy.

China’s economy expanded 1.6% in the fourth quarter last year and 4% over the year, the slowest growth pace in 18 months. This was a little better than expected, but only served to fuel long-standing suspicions that the official growth data have been smoothed.

Economists at the Federal Reserve Bank of San Francisco have developed a China Cyclical Activity Tracker (China CAT) as a cross-check on the official GDP figures using indices of economic activity such as electricity, rail shipments and industrial production that are less amenable to official window-dressing than China’s national accounts.

For the third quarter of last year, the China CAT points to annualised growth of minus 5%, well below the still barely positive official growth figure. This would be only the second time the Chinese economy has seen a contraction since 2008.

China’s economy was facing significant cyclical and structural headwinds even before it had to confront the implications of the new omicron variant of COVID-19. Chinese policymakers have been trying to engineer a controlled deleveraging of the economy, including deflating its deeply troubled property sector.

The economy is also show signs of strain as a result of the Chinese Communist Party’s prioritisation of political control over economic growth and reform.

While Xi Jinping talked-up his ‘common prosperity’ agenda to the World Economic Forum, the reality of that agenda is not an ‘open, competitive and orderly market system,’ as he suggested, but arbitrary and capricious attacks by the authorities on domestic industries, firms and entrepreneurs.

With the economic pie growing more slowly, the party-state is increasingly focused on redistribution.

China is attempting to maintain a zero-COVID approach against the highly transmissible omicron variant that has quickly over-run other formerly low-COVID jurisdictions around the world, disrupting domestic supply chains and economic activity.

Against this backdrop, it should not be surprising that the People’s Bank of China started cutting policy rates last month. This week, it lowered its one-year loan rate by 10 basis points to 2.85% and its rate on seven-day reverse repurchase agreements to 2.1%.

The problem for China is that its ability to ease monetary policy is constrained by its managed exchange rate regime. Like many other emerging market economies that manage their exchange rates with reference to the US dollar, China is vulnerable to a tightening in US monetary policy.

The US Federal Open Market Committee meets next week and will deliberate on the need for a near-term tightening in monetary policy in response to a strong labour market and some of the highest inflation rates in 40 years.

Having successfully stabilised the US economy with aggressive monetary policy actions during the pandemic, the Fed has growing freedom of action to respond to inflationary pressures.

The problem for China and other emerging market economies is that the Federal Reserve’s mandate is domestically focused. Xi Jinping’s concerns, while not misplaced, are unlikely to sway policymakers abroad. China will have to rely on its own policy settings to support its troubled economy.

The prospective tightening in Fed policy also underscores Australia’s outlier status in terms of global tightening efforts.

The Reserve Bank was slow to expand its balance sheet relative to the Fed and other central banks during 2020. The Australian dollar outperformed its G10 peers through much of 2020 as a result.

Ultimately, the RBA expanded its balance sheet by a similar amount as the Fed on a relative basis, but the expansion was delivered much later.

Just as Australia lagged the world in easing monetary policy, it now lags in prospects for a tightening, which helps explain recent weakness in the Australian dollar.

The December quarter trimmed mean inflation measure released on 25 January is likely to come in at 0.8%, taking the annual rate to just shy of the mid-point of the target range at 2.4%. This will provide the RBA with sufficient justification to wind-up its bond purchase program after its February meeting.

But with the RBA facing a review after the next election, Governor Lowe will be wary of raising the cash rate too quickly.

Having positioned Australia poorly before the onset of the pandemic and lagged the rest of the world in its pandemic response, the RBA cannot afford further hawkish policy errors that might add to the criticisms from an independent expert review.

Dr Stephen Kirchner is program director, International Economy, at the United States Studies Centre, University of Sydney.

posted on 19 January 2022 by skirchner in Financial Markets, Monetary Policy

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Australia has become a net exporter of human and financial capital

I have an op-ed in the AFR noting that Australia has become a net exporter of human and financial capital. I argue that reversing these net outflows should be a priority for post-pandemic recovery. Full text below the fold. Note AFR is responsible for ‘savings’ instead of ‘saving’!

For almost all of its history, Australia was a net importer of both people and capital. The reasons are straightforward enough. Australia offered a better life for migrants and attractive investment opportunities for foreign capital.

But in the last few years, these people and capital flows have seen a dramatic reversal. While the pandemic is heavily implicated in these outcomes, public policy is not doing enough to restore the inflow of human and financial capital.

For the year-ended in June, net overseas migration (NOM) was minus 88,800 people. Net overseas migration has now been negative for five quarters. In the June quarter alone, over 47,000 people emigrated from Australia.

The population grew by just 0.2% over the year to June. There was an outright decline in Australia’s population in the September quarter last year.

The government upgraded the outlook for net overseas migration in its Mid-Year Economic and Fiscal Outlook relative to the May Budget on the assumption of a gradual relaxation of border controls from the end of this year.

But the outlook for net overseas migration remains subdued. A net outflow of 41,000 people is still expected for this financial year. NOM is positive in 2022-23, but does not approach pre-pandemic levels until 2024-25.

On this basis, the population is expected to grow by only 0.3% this financial year, 1.2% in 2022-23 and 1.4% by the end of the forward estimates.
Australia will be 1.5 million people short in 2030-31 relative to what was expected at the time of the pre-pandemic budget update at the end of 2019.

Australia’s border controls were key to controlling the pandemic in 2020. Closed borders were very forgiving of policy mistakes behind the border, at least until the middle of this year.

The federal government, in cooperation with the states, could have scaled-up managed isolation and quarantine capacity, even if still short of that needed to sustain pre-pandemic levels of international arrivals. Instead, international arrivals were heavily rationed.

The government should consider catch-up increases in net overseas migration to offset the losses due to the pandemic border closures. This could include uncapping permanent migration numbers, similar to the temporary migration program.

As well as net outflows of human capital, Australia has also seen massive outflows of financial capital.

In the year-ended September, Australia exported a net $74 billion in capital, the flip-side of a current account surplus running at a massive 4.4% of GDP. The current account has been in surplus since the June quarter 2019, averaging 2.6% of GDP.

While the contribution of iron ore exports to the current account surplus is well understood, the underlying cause of the surplus is an excess of domestic saving over investment.

Australia is now sending more capital abroad than the rest of the world is investing in Australia. In gross terms, Australia invested a massive $172 billion in foreign stocks and bonds and a further $9.2 billion in direct investment abroad in the year-ended in September.

There is nothing wrong with Australians investing abroad. But it is a problem to the extent that it reflects a lack of investment opportunities at home.
Much of this capital outflow is directed to the United States, one of the few countries with capital markets large enough to accommodate the rest of the world’s excess saving. But US investment in Australia has been declining over the last three years. Australia has underperformed peer economies in attracting US investment.

Border closures have weighed on foreign investment in Australia by making due diligence on cross-border acquisitions more difficult.

While Australian policymakers use to fret about persistent current account deficits, those deficits for the most part reflected strong investment outcomes. Persistent current account surpluses due to excess saving and a lack of investment are arguably more problematic.

The current account surplus should narrow as the economy recovers from the pandemic. The government’s mid-year budget update expects the current account to be back in deficit next financial year. But it is worth recalling Australia was running current account surpluses in the three quarters before the onset of the pandemic in March last year.

To the extent that the legislated increase in the Superannuation Guarantee compulsory contribution rate to 12% increases national saving, it will make
Australia’s excess saving problem worse. Domestic capital markets are awash with conscripted saving, which is increasingly finding a home offshore.
Public policy needs to focus on increasing investment rather than saving. Raising saving will not by itself lift domestic investment performance.

Increasing net overseas migration would help raise investment demand. Greater inflows of human and financial capital should be viewed as complementary and a key element of post-pandemic recovery.

Dr Stephen Kirchner is program director, International Economy, at the United States Studies Centre, University of Sydney.

posted on 22 December 2021 by skirchner in Financial Markets, Free Trade & Protectionism, Population & Migration

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The Reserve Bank of Australia’s pandemic response and the New Keynesian trap

The latest issue of Agenda includes a symposium on Economic Policy during Covid. Includes a contribution from me on ‘The Reserve Bank of Australia’s pandemic response and the New Keynesian trap.’ Note text was finalised mid-year. A lot of water under the bridge since then.

posted on 10 December 2021 by skirchner in Economics, Monetary Policy

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China’s WTO Accession and US Economic Engagement 20 Years On

I have an article in Australian Outlook marking the 20th anniversary of China’s accession to the WTO and recent debates about US economic engagement with China.

posted on 09 December 2021 by skirchner in Free Trade & Protectionism

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Omicron is the least of the problems for global trade

I have an op-ed in the AFR noting that logistics are the least of the problems facing the WTO’s MC12 when the world’s two largest economies no longer seek greater integration.

The indefinite postponement of the World Trade Organization’s (WTO) 12th Ministerial Conference in Geneva due to a new COVID variant represents yet another setback for the multilateral trading system. Logistics aside, the WTO faces fundamental questions about its future. In particular, it is far from clear whether the world’s two largest economies, the United States and China, are committed to greater global economic integration.

The delay to MC12 comes ahead of the 20th anniversary of China’s accession to the WTO on 11 December. WTO membership was an important element of China’s integration into the world economy, as well as its domestic economic reform program.

But 20 years on, China’s role in the world economy is now seen as increasingly problematic. The 8th review of China’s trade policy by the WTO in October 2021 saw 50 delegations, including Australia’s, line-up to criticise China’s state-led development model, adherence to WTO rules, as well as its use of coercive economic statecraft. 

WTO accession in 2001 only served to make permanent access China already enjoyed to US markets since the 1980s, but removed the substantial implicit trade barrier represented by uncertainty around whether the US Congress would renew China’s most favoured nation status each year. More importantly, WTO accession saw China lower its trade barriers to the rest of the world, including the United States.

The ‘China shock’ literature has highlighted the number of US manufacturing jobs lost to import competition from China in recent decades. However, a broader assessment of the economic impact of that shock shows that it has been a net positive for the US economy. Had the US resisted China’s integration into the global economy, greater import-competition would have almost certainly arisen from other developing economies. The China shock was not really specific to China, but part of a much broader globalisation shock to manufacturing that benefited the US and world economy.

Greater US economic engagement with China was never expected to lead to top-down political liberalisation on the part of the Chinese Communist Party (CCP), but it was expected to lead to bottom-up changes in Chinese society that would present long-run challenges to CCP rule. Increased political and economic repression under Xi Jinping, including recent leftist ‘rectification’ campaigns against successful Chinese firms and industries, are symptomatic of increased regime insecurity and counter-intuitively vindicate the view that China’s integration into the world economy would challenge the regime.

President Trump’s trade war and sanctions against China have also led the CCP to question the extent of economic interdependence with the United States. President Trump’s ‘American First’ policies and President Biden’s ‘foreign policy for the middle class’ are mirrored in China by Xi’s advocacy of a concept of national security that embraces economic self-sufficiency, aspires to global technological leadership, engages in economic statecraft and seeks to diversify away from economic engagement with the US.

Far from calling out and discipling China’s behaviour, President Trump’s trade policies, largely maintained by the Biden Administration, have encouraged China to double-down on its state-led development model.

Many of the complaints about China’s trade and other practices are actionable in terms of WTO rules, but these rules and dispute settlement mechanisms have been underutilised by the US and other countries.  There has been a collective failure to hold China’s feet to the fire on its WTO accession commitments, which went beyond those of other members. To the extent that there are gaps in existing WTO rules and processes, these gaps are not specific to China. While China is the bigger offender in terms of subsidies and other discriminatory trade measures, the US, EU and other G20 economies have also undermined the multilateral trading system with similar measures of their own.

Far from of being a champion of globalisation, the US has increasingly disengaged from the world economy over the last twenty years, beginning with the failure of the WTO ministerial conference in Seattle in 1999 and culminating most dramatically in its failure to join the Trans-Pacific Partnership in 2017.

The 1999 Seattle conference failed in part because its US hosts failed to book the convention centre for long enough to enable an extension of talks. The meeting had to give way to a convention of optometrists.

Meeting logistics are now the least of the WTO’s problems when the world’s two largest economies no longer have greater economic integration as a common goal.

Dr Stephen Kirchner is program director, International Economy, at the United States Studies Centre, University of Sydney.

posted on 30 November 2021 by skirchner in Free Trade & Protectionism

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A Geoeconomic Alliance: The Potential and Limits of Economic Statecraft

A Geoeconomic Alliance: The Potential and Limits of Economic Statecraft, United States Studies Centre, University of Sydney, 29 September 2021.

posted on 30 September 2021 by skirchner

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A Geoeconomic Alliance: The Potential and Limits of Economic Statecraft

I have a new report out with the United States Studies Centre, A Geoeconomic Alliance: The Potential and Limits of Economic Statecraft. The report examines the history and application of economic statecraft and its relevance to the Australia-US alliance and US-China strategic competition. An important theme that emerges from the report is the limits to economic statecraft in pursuing geopolitical objectives. In particular, China’s economic statecraft has prompted defensive reactions in target countries, including strengthening cooperation with the United States.

There is a short version in Australian Outlook.

posted on 30 September 2021 by skirchner in Economics, Foreign Affairs & Defence, Foreign Investment, Free Trade & Protectionism

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Countering China’s trade coercion should be alliance agenda

I have an op-ed in the AFR arguing that China’s economic statecraft, including its attempted coercion of Australia, has mostly been unsuccessful in promoting its geopolitical objectives and may prompt a collective allied response.

posted on 21 September 2021 by skirchner in Economics, Foreign Affairs & Defence, Free Trade & Protectionism

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US investors cool on Australia

I have an op-ed in The Mandarin summarising my latest report on the Australia-US bilateral investment relationship. Text below the fold.

There is an even longer version in Australian Outlook.

The United States has traditionally been Australia’s most important investment partner. The bilateral investment relationship was valued at just under $1.8 trillion in 2020. However, even before the pandemic, there were emerging signs of weakness in that relationship. US investment in Australia significantly underperformed in 2020, continuing a three-year trend.

More competitive US tax settings due to former President Trump’s tax reforms have been an important factor in this underperformance. The Biden administration will again revamp the US corporate tax system, with the G20 also agreeing to re-write global tax rules. In this context, Australia will need to pay careful attention to the competitiveness of its own tax and other policy settings to maintain the interest of US and global investors.

For the OECD area, foreign direct investment (FDI) inflows fell 51% in 2020. Australia’s experience was in line with this performance, with a 48% decline in inbound FDI. However, US investment in Australia fell by even more, with an outflow of $12 billion, the first such outflow since 2005. The US share of the stock of FDI in Australia has declined for two straight years, while the US share of total foreign investment in Australia has been declining for three years.
Data from the US Bureau of Economic Analysis shows that since the passage of President Trump’s Tax Cuts and Jobs Act in 2017, Australia has underperformed peer economies and regions in attracting US FDI. Canada, Europe, the UK, New Zealand and the Asia-Pacific region ex-Australia all outperformed Australia in attracting US investment.

A number of factors explain the weakness in US investment in 2020 in particular. The pandemic saw significant repatriation flows, as global investors, including those in the US, sold foreign assets to raise cash. The main outflow of US investment in Australia in 2020 was holdings of Australian debt securities and unwinding derivatives hedging those positions.

Australia has also seen a dramatic change in its external finances. Increased saving and weak domestic investment have resulted in record current account surpluses. In flow terms, Australia has become a net lender rather than a borrower internationally, reducing the overall need for foreign capital inflow.
Australian investment in the US continues to grow, in particular portfolio investment, with domestic capital markets increasingly saturated with superannuation saving. The increase in the Superannuation Guarantee from 1 July will only make this excess saving problem worse.

Australia’s increased regulation of FDI and application fees for foreign investors have also weighed. Treasurer Josh Frydenberg lowered the monetary screening thresholds to zero during 2020 to guard against the opportunistic acquisition of distressed Australian firm by foreign interests. But the foreign buying spree never eventuated. China’s overseas investment fell to a 13-year low in 2020, having now declined every year since 2016.

While unofficially targeted at China, Australia’s increased scrutiny of FDI weighs more heavily on the US due to its non-discriminatory application and because the US is traditionally the larger investor. Australia saw more FDI from China in 2019 and 2020 than from the US, even as the Chinese authorities limited outbound capital flows.

More competitive US corporate tax settings since 2017 were always expected to weigh on US investment in Australia, with Australia having one of the least competitive corporate tax rates in the OECD and one of the highest tax burdens on capital.

The Biden plan will tax US corporates more heavily, which will improve Australia’s attractiveness to foreign investors on a relative basis. However, it will also weigh on US corporate investment at home and abroad, so the implications for US investment in Australia are ambiguous.

In the context of international negotiations, the US and Australia have both promoted a minimum corporate tax designed to limit tax competition in favour of high-tax jurisdictions.

Both the US and Australia could have used these negotiations to promote a global minimum corporate cash flow tax that fully expenses investment. This more investment-friendly approach was previously considered by the OECD. As much as 40% of FDI globally flows through low-tax investment hubs.

In Australia, policymakers have recognised the need for corporate tax reform, but have mostly failed to deliver. A higher corporate tax burden in the US, together with a global minimum corporate tax, will make Australia more attractive to foreign investors on a relative basis.

However, this is likely to come at the expense of US and global investment in absolute terms. The recent underperformance of US investment in Australia highlights the sensitivity of global cross-border investment to changes in international tax rules.

As Australia recovers from the pandemic, it will return to being a net borrower in international capital markets. US investment in Australia is not completely fungible with other forms of foreign capital inflow. The recent weakness is US investment should remind Australian policymakers that they cannot take our appeal to global investors for granted.

Dr Stephen Kirchner is program director, International Economy, at the United States Studies Centre, University of Sydney. His report, Australia-US Bilateral Investment in 2020: Taxing Times, is released this week.

posted on 06 July 2021 by skirchner in Foreign Investment

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Australia-US bilateral investment in 2020: Taxing times

Australia-US bilateral investment in 2020: Taxing times, United States Studies Centre, University of Sydney, 5 July 2021.

posted on 05 July 2021 by skirchner

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Australia-US bilateral investment in 2020: Taxing times

I have a new report out with the United States Studies Centre, Australia-US bilateral investment in 2020: Taxing times. The report highlight Australia’s underperformance in attracting US investment since the passage of President Trump’s Tax Cuts and Jobs Act in 2017. While President Biden’s proposed corporate tax changes will improve Australia’s attractiveness on a relative basis, they also weigh on US corporate investment globally, with ambiguous implications for future US investment in Australia.

US direct investment in Australia is not completely fungible with other forms of foreign capital inflow. Many of the benefits of FDI, like knowledge and intellectual property transfers, access to managerial talent and global supply-chains is firm- and country-specific. The US remains the world’s most innovative economy and US FDI abroad is a major channel through which US productivity gains spillover to the rest of the world, including Australia. Portfolio investment and investment from other countries is not a perfect substitute for US direct investment.

posted on 05 July 2021 by skirchner in Foreign Investment

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G7 tax deal is a threat to reformers

I have an op-ed in the AFR arguing that the G7’s proposed cartelisation of the international tax system threatens reform-oriented small open economies, but Australia could perversely benefit given its high tax burden on capital. Ironically, the proposed 15% minimum corporate tax could backfire and become a floor target for international tax competition. Full text below the fold.

The finance ministers of the G7 countries have reached in-principle agreement on a global minimum corporate tax rate of at least 15 per cent, as well as taxing more of the income of multinational companies in the locations where it is generated.

While yet to be formally agreed and implemented, the proposals threaten to cartelise the international tax system in favour of high-tax and relatively closed economies at the expense of more reform-oriented small open economies.

The latest push for a global minimum tax has been led by the US under the new Biden Administration. It is part of a broader US effort to signal a return to global leadership and a renewed commitment to multilateralism.

The Biden Administration originally proposed a 21 per cent minimum, but this has been trimmed to 15 percent in an effort to win broader agreement.

The next hurdle is endorsement by the G20 countries at their meeting in Venice next month. The aim to is multilateralise the new tax arrangements under the auspices of the OECD.

The US interest in a global minimum tax is partly driven by the Biden Administration’s commitment to raise the US corporate tax to 28 percent. When combined with state taxes, this would give the US a combined statutory rate over 32%, the least competitive in the OECD.

This compares to a current combined federal and state average rate of just under 26% put in place under former President Trump’s Tax Reform and Jobs Act of 2017.

The higher tax rate would otherwise penalise US companies relative to foreign competitors and reduce investment and incentives to produce in the US relative to the rest of the world.

The US also wants to put a stop to the proliferation of digital services taxes (DST) that discriminate against US tech giants by agreeing on a multilateral framework for profit allocation. The US has threatened to impose retaliatory tariffs on six countries, including the UK, if they proceed with unilateral DSTs.

Australia shelved its proposed DST pending the outcome of these multilateral negotiations.

The OECD’s multilateral tax reform agenda has been driven by high-tax and relatively closed economies that face competition from low-tax and reform-oriented small open economies, although the average corporate tax rate in the OECD excluding the US is little changed over the last decade.

The global minimum tax would enable the high-tax countries to ‘tax back’ income earned in low-tax jurisdictions.

While meant to prevent a ‘race to the bottom’ on corporate tax, the changes could backfire and trigger a new race to the global floor of 15%.

Otherwise, the proposals will have effects that go beyond the distribution of global taxing powers. They would affect the global allocation of capital and encourage high-tax jurisdictions to maintain their existing barriers to cross-border trade and investment.

Small open economies like Ireland, the Netherlands and Singapore that have served as a haven for innovative, knowledge-intensive multinational enterprises at the forefront of globalisation and that have propagated new business models around the world would be rendered less attractive as destinations for new investment.

Instead, the proposals would redistribute global tax revenue and capital to some of the world’s worst performing governments and economies.

As a relatively high-tax jurisdiction for capital, Australia could perversely benefit from the proposed global tax redistribution framework. Australia has one of the highest corporate tax rates in the OECD and an average tax burden on capital of 46%.

Australia’s high corporate tax burden relative to the more competitive tax settings put in place by the former Trump Administration has seen a collapse in US investment in Australia.

While overall foreign direct investment (FDI) in Australia fell in 2020 in line with the OECD average, FDI from the US significantly underperformed.

Australian Bureau of Statistics data shows that US investment in Australia has fallen over the last three years.

Data from the US Bureau of Economic Analysis shows the US FDI position in Australia has fallen by 4.3% since 2017.

Australia has underperformed peer economies like Canada, the UK and New Zealand as a destination for US investment, partly because these economies have had more competitive corporate tax rates.

Foreign capital inflow from other countries is a poor substitute because of the knowledge transfers that uniquely attach to US FDI.

A study by the European Centre for International Political Economy found that eliminating the corporate tax differential among the OECD economies at a minimum
rate of 12.5% would raise foreign investment in Australia by 20% by making Australia more competitive with currently lower-tax jurisdictions. High-tax France was the only OECD country that would gain more.

Having abandoned corporate tax reform at home, the US and Australia have a common interest in promoting higher taxes abroad, but at the cost of a less dynamic and innovative global economy.

Dr Stephen Kirchner is program director, Trade and Investment, at the United States Studies Centre, University of Sydney.

posted on 08 June 2021 by skirchner in Economics

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