Opinion & Analysis
OPINION: Any foreign investment that improves the New Zealand economy deserves a very warm welcome.
Unfortunately, though, Shanghai Pengxin's purchase of Lochinver Station would be an economic negative for the country, if the government approved the deal.
If precedent counts, the government will say "yes", making exactly the same mistake it did two years ago with Shanghai Pengxin's purchase of the Crafar Farms.
This is not an attack on a particular company, or its country of origin. Rather it is an indictment of our lack of rigour as a country on the crucial issue of foreign investment.
Of course the two deals make great business sense for Shanghai Pengxin. It is developing a business vertically integrated from its farms here to its supermarkets in China. It will capture all the value created along the way from farming to consumers. Integration is a profitable business model for owners of the assets. But not much of the value they create will stick to the ribs of the New Zealand economy.
In Shanghai Pengxin's case, it says it currently has neither the farming nor processing skills its model requires. So, some people will earn wages and management fees for running the farms, as Landcorp does with the Crafar assets. Other companies will supply fenceposts, grass seed, fertiliser, transport and all the other inputs into farming. Downstream, processors will get a fee for turning the milk and meat into products.
But that's about it for the New Zealand economy. Even our export data won't look that flash. Logically, Shanghai Pengxin's products will leave the country at the lowest possible price and the lowest possible level of sophistication so it can capture the maximum profit in China. For example, Shanghai could export its milk powder at commodity prices and blend them into highly valuable infant formula in China.
This model is how our primary sector now operates. For example, some 80 per cent of Fonterra's sales are whole milk powder. It does make some infant formula. But vastly more of that is for foreign companies under their brands than for sale under its own.
Stunning evidence for this came two years ago when Pfizer of the United States sold its human nutrition business to Nestle for US$12 billion. The bulk of the business was infant formula and its prize asset a large share of the branded market in China.
Fonterra remains a substantial manufacturer of infant formula for the business now owned by Nestle. But its only reward is a toll fee for processing. Its farmer-shareholders' only reward is the commodity price for the milk the sell to their co-op.
The red meat industry differs only in one big respect. While an excellent cut of meat attracts a high price in a foreign supermarket, the upside is far less than dairy companies enjoy with infant formula. But that point is largely irrelevant. Our meat processors capture little of the value they create for others.
This commodity trap is deeply rooted in our psyche and our economy, as the World Economic Forum proves in its annual competitiveness ranking of countries. One of its criteria is competitive advantage, with countries ranked on a scale of one (low cost natural resources) to seven (unique products and services). We score 4.1, ranking us 36th in the world.
It also ranks value capture from one (role in the value chain is mainly confined to one step such as resource extraction) to seven (involved all the way down the value chain, capturing extra value along the way). We score 3.8, ranking us 58th.
Some people will say: "Oh, well, we might as well approve some more foreign investment deals. They are small and won't change things much."
But things are changing fast. Previous dairy farm sales to the likes of US and German investors have had little impact because they sell their milk to NZ processors. The processors, in turn, still have the opportunity to do something more valuable with it, even if they are ineffectual at doing so.
Now, however, foreign buyers are increasingly seeking to create vertically integrated businesses.
Recently, for example, Danone of France bought Sutton Group, an infant formula producer and manufacturer of dairy processing equipment, and Gardians, the farming and processing joint venture Sutton owned with Grant Paterson, an Otago farmer. Thus, Danone is reducing its dependence on Fonterra.
The National-led government understands the dangers. In 2010, Finance Minister Bill England changed the Overseas Investment Act to include two specific tests on these issues:
*Would an investment harm the primary sector's vertical integration from farming through processing to product distribution?
*Would aggregation of farmland by foreign owners harm NZ's ability to be a reliable supplier to world markets?
But in 2012 the Overseas Investment Office (OIO) approved Shanghai Pengxin's purchase of the Crafar Farms. Remarkably, it judged the new owner would create more economic value to the country than a NZ owner could. This was challenged in court, leading the High Court to set more meaningful tests of economic benefit.
In due course, the OIO back-tracked. From unequivocal approval first time around, the OIO decided on the crucial economic tests that the benefits of Shanghai Pengxin's ownership were "unknown." Simply, the OIO wimped out and passed the buck to the Cabinet. Prime Minister John Key and his colleagues took the easy way out too. They approved the deal on the grounds that our free trade agreement with China requires investment reciprocity between our two countries.
But that's not what we have. Fonterra is pouring capital, technology and skills into China, giving the country a massive increase in dairying capability. This is possibly good for Fonterra, and is certainly good for China.
But back here there is no evidence that foreign investors building vertically integrated farming and food businesses are delivering a substantial benefit to our economy. Worse, they are reducing our ability to build those valuable enterprises ourselves. It is time we as a country were much more confident about the upside of our primary sector. It's time to develop deals that benefit foreign investors and us.
- Sunday Star Times