Too much (investment) screen time?

Is this the reason why New Zealand doesn’t feature more prominently on global business and investment maps?

The Commission’s recently-released first draft report argued that New Zealand needs more technology if it is to see faster growing productivity and incomes. One way in which new technologies can enter and diffuse through an economy is through closer engagement with leading international firms. These firms are closer to the global ‘frontier’ of technology, and bring new assets, ways of doing business, and goods and services into a market. International research suggests that the entry of a multinational enterprise into a market and its connection to global value chains¹ can drive technology adoption, skills upgrading and productivity growth in local supplier firms.

There are many ways to build stronger links with leading international firms. One is foreign direct investment, where firms set up shop or invest in existing businesses here. So how easy is this?

New Zealand is often thought of as an open economy, with few barriers to entry and an easy place to do business. The “few barriers to entry and an easy place to do business” story is supported by NZ’s good rating on international surveys of openness, such as the World Bank’s Doing Business index, the Economist Intelligence Unit’s Business Environment Ranking, and the Heritage Foundation’s Economic Freedom index.

But the OECD’s 2018 Foreign Direct Investment Regulatory Restrictiveness index tells a different story, giving New Zealand a high score, which means a more restrictive investment environment.

Few would associate NZ’s regulatory environment with that of China, Jordan or India – so why does it score so poorly?

Most OECD countries apply screening requirements to selected industries or don’t require screening at all. NZ’s screening requirements apply to all industries, hence the high restrictiveness score.

NZ law requires that all acquisitions of “significant business assets” by “overseas persons” over a specified value have to be screened by the Overseas Investment Office.² These criteria are broader than might be immediately apparent and can end up capturing organisations that most people would think of as NZ-owned. For example, a firm that is 75% owned by NZ citizens with a 25% foreign-ownership stake would be considered an “overseas person” for the purposes of the law.³

Further, the screening criteria around “sensitive land” are much more onerous than those around business assets – catching more potential investments. “Sensitive land” includes all non-urban land over 5 hectares, all foreshore land, and all land over 0.4 hectares that is held by conservation purposes, recreation or open space purposes, or that is subject to a heritage order or an application for registration as a historic place. More land is deemed “sensitive” simply because it is located next to land that meets these criteria. In its inquiry into using land for housing, the Productivity Commission found that the “overseas persons” and “sensitive land” criteria could make it harder and costlier for some NZ-registered companies to develop land for houses.

Of course, the existence of a general screening requirement does not necessarily mean that New Zealand is opposing or blocking investment. In 2017/18, the Overseas Investment Office only declined 3 applications.⁴ But screening does involve costs and delays for applicants: a recent Treasury consultation document on the Overseas Investment Act noted that the costs of applying for a consent (excluding the actual application fees) can exceed NZ$100,000, and it can take 100 working days or more to process an application.

For many investors, it may simply not be worth the costs, delays and hassle. And no-one knows how many investments didn’t occur because overseas firms knew they could not meet the criteria, or because modification of their plans to meet those criteria would make the investment unviable or unattractive.

According to the Treasury, New Zealand “attracts proportionately less, and has correspondingly lower stock of, foreign direct investment than many other small, advanced economies” and has “struggled to attract the most valuable forms of investment, such as greenfield investment”.

New Zealand has historically been a poor adopter and diffuser of technology, with negative implications for its productivity growth. To get faster technological diffusion and productivity growth, it might be worth taking another look at the policies governing foreign direct investment.

Notes
1. One oft-cited example is the production of the Apple iPhone, which is designed in California but assembled in China with components sourced from 43 countries.
2. The exact value at which screening requirements apply differs depending on the nationality of the investor. The basic threshold is an investment over NZ$100m to which foreign investors contributed 25%. Screening requirements also apply for the establishment of a new business in New Zealand above that value.
3. That 25% foreign-ownership stake need not be wholly overseas owned. Only 25% foreign ownership is required to make it an “overseas person” under the Overseas Investment Act. In practice, less than 10% foreign ownership has been sufficient to make a NZ firm an “overseas person”.
4. As my colleague Dave is fond of pointing out, the rejection rate for a screening regime is a good measure of the predictability of that regime, as no applicant lodges an application they expect to be refused. The rejection rate is, however, a misleading measure of the number of applications discouraged, especially if applications are costly for applicants.