Last year the Treasury provided a report to its ministers headed Should we be concerned about profits going offshore? It is a competent analysis and very relevant to the privatisation debate.
The report begins with some important factual observations which are not well understood. One is that New Zealand’s current account deficit is dominated by investment income and transfers because goods and services have been largely in balance over the past decade.
Another is that:
The result of a long period of current account deficits is a very high net international investment position (NIIP), at about -90% of GDP. The overall position is predominantly made up of net debt rather than net equity. That is, New Zealand’s investment position with the rest of the world is better characterised as owing a lot rather than being owned.
The report then moves on to analytical issues. It makes a point I have made repeatedly in this series:
There are two sides to the sale of an asset: a one-off payment to the seller and an expected stream of profits to the buyer. If the price is efficient, these two sides of the transaction should be equivalent: that is, the purchase price represents the net present value of the future stream of profits (i.e. the commercial value). In general, in respect of sales of government assets the value of the business to the purchaser should exceed the commercial value of the asset if retained in Crown ownership because of the greater efficiencies likely to be achieved in private ownership. A competitive sale process should ensure that the value of those expected efficiency gains are captured by the Crown in the sale price.
As regards the effect of ‘profits going offshore’ on the balance of payments, the report states:
The fundamental drivers of the current account deficit are national saving and domestic investment. Selling an asset to foreigners will only have a significant effect on the current account deficit if it affects these fundamental drivers.
A quibble here is that I would not I would not take an identity A ≡ B and C and argue that B and C are the drivers of A. We could as easily write that B ≡ A-C and A and C are the drivers of B. It follows that I (investment) and S (saving) are not the drivers of CAD (the current account deficit) just because CAD ≡ I – S. All three variables are endogenous outcomes, even in a model as simple as the closed economy IS/LM model.
The report then correctly points out that:
When an asset is sold to overseas investors, these overseas investors will be required to pay for their purchase of the New Zealand asset. The impact on the current account deficit will depend on how the seller of the asset uses these funds:
- If the funds are used to increase [consumption] spending, national saving would fall and the overall current account deficit would increase.
- If the funds are used to invest in overseas equity, there would be no change in national saving or domestic investment and therefore no effect on the current account deficit.
- If the funds are used to repay overseas debt, there will be a deleveraging of New Zealanders’ balance sheets. The composition of New Zealand’s NIIP would change by reducing debt owed to foreigners and increasing equity owned by foreigners. Overall this would be expected to reduce New Zealand’s vulnerability, because the vulnerabilities associated with a high NIIP are somewhat greater for debt than equity
It is also important to explain that it is not New Zealand that owes the NIIP to foreigners. New Zealand is a place, not a person. The place owes nothing. Foreign entities operating in New Zealand can and do borrow offshore. So do entities operating in New Zealand that are owned by New Zealanders. New Zealanders are only liable for debts they have incurred. They are not liable for debts foreign-owned entities have incurred. If this is not explained, lay people (and even too many economists) are led to assume that the NIIP is a liability of New Zealanders. They then start thinking that New Zealanders are ‘not saving enough’ if national savings (which is only savings by New Zealanders) is not equal to the sum of capital formation in New Zealand by New Zealanders and by foreign-owned entities. It is then an easy step for them to then start worrying that if gross fixed capital formation is greater than national savings then ‘we’ must be spending more than ‘we’ are producing. This does not automatically follow.
The Treasury report concludes:
In sum, we think focussing on ‘profits going offshore’ has a weak economic basis because it focuses on only part of the picture. So we do not think it makes sense to be concerned about ‘profits going offshore’ per se. The more important places to focus from a macroeconomic perspective are the overall saving and investment balance and New Zealand’s overall external vulnerability.
In the final analysis, a concern about ‘profits going offshore’ applies to all foreign direct investment. Particularly in an era of globalisation it is hard to make a general argument that foreign investment is bad for New Zealand.