Foreign Direct Investment and Tax Incentives

POLI3001 | Organisations, Politics and Society | | The government is proposing to give significant tax incentives to foreign investors who are prepared to invest in expanding the nation’s economic base in telecommunication industries. | Reporting toThe National Business League | Submitted by:Andrea Cortez c3147295Kirstie Sullivan c3163627Abbey Sams c3162287Matt Davies c3147633 | Tutorial: Wednesday 5-6 PM SRR205a | Tutor: Mohammad Rahman | Due: 10 May 2013 |
Executive Summary

The objective of this report is to review and provide evidence of potential effects of a proposed government policy on Australia’s telecommunication industries and The National Business League, after which recommendations and/or suggestions or an alternative policy will be formulated for the government. The proposed policy surrounds the government’s intentions of providing significant tax incentives to foreigners investing in the Australia’s telecommunication industries. There will be a focus on tax incentives in the foreign direct investment (FDI) category for the purposes if this report, as the empirical evidence gathered applied to this category specifically.

The authors aim to first give a background on the intentions of such policy and then further explore the proposed policy’s negative and positive impacts on the telecommunications industries in a broader context through examining different studies and research papers that provide evidence on ‘spillovers’ into domestic firms in the industry, receiving foreign investments.

Together with the above, the authors will then move forward into discussing the proposed policy’s effects on The National Business League as a stakeholder of the proposed policy. <Abbey more details on how you will approach this> … by doing so three recommendations to the government have been provided:

Matt’s recommendations to government 1. …. 2. ….. 3. ….

Policy Background and Intent
International investment or cross-border investment happens when a foreign company or an individual, invests into another country. There are four main different types but the two most common are: portfolio investment and foreign direct investment (FDI). The country where the investment originates from is usually referred to as the ‘home country’ and the country which receives the inflow of capital is referred to as the ‘host country’ (Curran, G and van Acker, E. 2013, p.73).
Portfolio investments are a more temporary type of foreign investment where investors in this category are also known as ‘passive’ investors. This is due to the fact that they invest to earn a high interest but are not at all interested in gaining managerial control over the companies they have invested in. As they have no control over businesses they can withdraw out of an investment when there are no high returns fairly quickly. In comparison, FDIs are established to seek more stable form of cash flow in contrast to a portfolio investment (Cushman, 2006, p. 297). Foreign Direct Investment may take on many forms such as acquiring shares from a foreign company, setting up company branches, acquiring stakes on a project or participating in business joint ventures (Ahmed, 2006, p.81).
Governments in different countries make policies to both positively or negatively affect FDI flows and regulate “time, form, place and condition for FDI inflows” (Curran, G and van Acker, E. 2013, p.73) among their own countries. A deeper analysis of the effects of tax incentives and foreign direct investment will be discussed as the report progresses.
The currently proposed policy by the Australian government on giving foreign investors significant tax incentives aims to attract foreign multinational companies on investing in Australia’s telecommunications industry. Tax incentives are simply, a way to encourage a particular economic activity through forms of tax policies and codes such as being able to deduct particular costs from the taxed amount or perhaps only being taxed for a smaller percentage of income received. Foreign direct investment may be conducted through acquiring a percentage of ownership of any relevant telecommunication business or company, or investing on telecommunications projects in Australia such as the National Broadband Network, or perhaps being involved in a joint venture. That being said, tax incentives are not the only factor considered by foreign investors when deciding the location of their next investment. Other factors include but are not limited to: infrastructure, human resources and skills, and political stability in the host country and tax policies of both home and host countries (Morisset and Pirnia, 1999).

Governments all over the world have tried to influence foreign investments positively through tax incentives to “enhance associated technology ‘spillovers’, fiscal incentives of global phenomenon” (Morisset, 2003, p.1) with increasing competition to attract these foreign investors. The policy is intended to create new jobs in Australia, which will increase the employment rate, introduce knowledge of the telecommunications industry, stabilise existing jobs already in Australia and “bring access to overseas markets and promote competition amongst our industries (Australia’s Foreign Investment Policy, 2013, p.1).
The telecommunication industry is categorized as a sensitive sector. Restrictions do apply to sensitive industries due to community concerns and matters, which are resulted by national interest (PWC, 2010, p.98). This policy may come as a threat to national security as opposed to bringing benefits of economic development. The government is trying to protect national security through extensive foreign investment policy and approval procedures through FIRB (Foreign Investment Review Board) for certain investment proposals, especially from state-owned multinational companies (MNCs). State owned MNCs seeking for opportunities to invest in Australia, specifically sensitive sectors like the telecommunications industry, may pose potential threat to Australia’s security (Morisset and Pirnia, 1999). For example, in 2012, the Gillard government made a decision to ban Chinese telecommunication company Huawei from the $36 billion National Broadband Network project on the grounds of threat to national security (Stewart, C. 2012). Huawei was actually approved to invest in Britain’s telecommunications network but only under close supervision of Britain’s signals intelligence agency GCHQ (Stewart, C. 2012). It can be seen how the government puts Australian’s national security first before approving giant MNCs to invest in Australia even if they are a private or state-owned company. In the article by Stewart (2012) from The Australian, Huawei denies the claim that they may be a threat to Australia’s security and that they have nothing to do with China’s political interest in regards to doing business here in Australia.
By offering tax incentives, there will be such impacts such as reduced fiscal revenue and also high administrative costs for the government in making sure that such policy is well implemented (Morisset, J. 2003). The government should be more than marginally effective in managing the implementation of such policy in order to produce a net benefit (Morisset, J. 2003). Although offering tax incentives will reduce fiscal revenue and heightened costs of administering new policies for the government, they are ever so willing to use tax incentives to promote Australia has a main location for foreign investors to gain short-term and long-term profits and benefits- and this is to make sure that Australia’s economy continues to grow and industries such as the telecommunications industry, prosper, develop, innovate and create more Australian jobs.

Policy Effects on the Telecommunications Industry
Telecommunications is a sub-sector of the Information and Communication Technology (ICT) sector. Investors can choose to invest in this sector through many ways such as: direct government projects, through acquiring shares from industry companies or setting up telecommunications facilities in the country. Within the sector, the telecommunication segment spending is third amongst the major segments, which is reportedly US$4614 million in 2011 after ICT spending on Consumer and Financial Services sector, first and second respectively (AusTrade 2013).
There are multiple ways tax incentives applied on foreign direct investments can help reach the government’s aim of expanding the nation’s economic base in the telecommunication industry. It will be hard to measure the direct financial costs and financial benefits of tax incentives to foreign and domestic firms as there may be different ways and different types of incentives that they may be eligible for. In such circumstances, this report will be focusing on positive and negative impacts of particular ‘spillovers’ on domestic firms in Australia receiving FDIs (Buckley, et al 2007).
Buckley, et al. looked into the effects of FDI on China’s automobile industry. Their findings are applicable to Australia in terms of perceived increase in labour productivity and negative and positive effects of ‘spillover’ despite empirical evidence originating from studies of FDI effects on productivity levels of developing countries. They investigated a number of different ‘spillovers’ including the following but are not limited to: the demonstration-imitation effect, the competition effect, and the training effect (Buckley, et al 2007).
According to Blomström and Kokko (1999), ‘spillovers’ from MNCs has often been indicated as one of the reasons FDIs might benefit a host economy. ‘Spillovers’ like the demonstration-imitation effect occurs when a foreign firm with more advanced technologies enter the domestic market and introduce newer technologies (Buckley, et al 2007). Domestic firms are able to watch and learn these new technologies and soon be able to apply what they have learned and imitate these new technologies in improving their own procedures and skills (Buckley, et al 2007). This will lead to improvement in productivity levels but also the need for domestic firms to increase their competitiveness which brings us to the competition effect (Buckley, et al 2007). These MNCs entering the domestic market will create more competition for domestic firms. The fact that competition has increased will lead to domestic firms to perform more efficiently and increase innovative activities to maintain their market position.

Applying this to Australia’s telecommunications industry will mean that our dynamic and rapidly growing ICT industry (AusTrade 2013) and Australia’s market will benefit from these ‘spillovers’. Firms within the telecommunications industry will be able to take advantage of potential new technological advancements and methodologies brought about by foreign firms. The industry will become more and more competitive as advancements are made. “In an early study Caves (1974) tested several hypotheses concerning the effects of FDI on domestically-owned firms in Canada and Australia competing with foreign subsidiaries” (Buckley, et al 2007). He found the presence of foreign firms reduced excess profits of domestic-owned competitors and improving its allocative efficiency into developments and innovation. Domestic firms may decide to invest their excess profits into research and development (R&D) activities to increase competitiveness and productivity. Goto and Suzuki (1989) found that supplying industries R&D efforts, contributed to the productivity growth of user industries. In Australia, the government is currently promoting R&D incentives to companies involved in such activities as part of their plans to increase Australian jobs and initiate R&D ‘spillover’ to different industries involved presently and in the future (AusIndustry,2013).

Before achieving any of these (innovation, increase in competition, more advanced technology), Australia’s telecommunications industry needs a highly trained skilled workforce bringing us the training effect. It may be that ICT workforce in Australia are already highly trained or foreign joint partners, foreign buyers or suppliers might facilitate training so Australia’s ICT workforce will be prepared to handle any new technology or adapt new methods and skills. Fosfuri et al (1998) found that an MNC can transfer knowledge and superior technology to its foreign partner only after having appropriately trained local managers or lead staff. Making it very important for the skills and knowledge gap between foreign and host firms to be as small as possible (Buckley, et al 2007).
‘Spillovers’ from FDI inflows can also have positive effects on Australia’s consumers and other businesses that might use telecommunications services. This is because both domestically-owned firms and foreign firms will be able to deliver newer and more advanced services and products. For example, the NBN Co, an Australian government business enterprise is delivering the National Broadband Network service across Australia. Some locations already have this service but there are still ongoing and pending constructions in many locations but they aim to reach 100% of Australian premises. They see this advancement as a service that will benefit the general public and businesses (NBN Co, 2013). It is possible that universities, businesses and governments can create and improve services that makes use of the capacities of NBN and offer them to their stakeholders (Chesher, C. 2010).
Unfortunately, the impact does not stop in such good terms. Significant tax incentives to attract FDI may cause foreign firms to invest in Australia but their presence may result in the transfer of skilled labour from domestic firms to foreign subsidiaries or projects resulting in an increase in industry labour turnover. This will leave domestic firms with a low wage and less efficient and productive workforce (Buckley, et al 2007). If domestic firms’ labour force performs below standards needed to adapt well to incoming new technology and skills, they will fall back and not be able to reach the same competitiveness as other firms and eventually may be displaced by foreign firms (Cantwell, 1995). Another negative impact will be that if there is too much FDI on the telecommunications industry because of favourable tax incentives, there may arise a problem of a distortion in resource allocation and those industries that also need investors to stimulate their economic base, may be overlooked and resources will be drawn towards the use of foreign and domestic firms in the telecommunications industry (Easson and Zolt, 2003, p.11)
Buckley et al. concluded in their paper that FDI plays a positive role in increasing industrial productivity and also improve labour productivity as it did within China’s automotive industry. Caves (1974) also concluded that host countries benefit from FDI inflow through increase in technical-efficiency and allocative efficiency because of the presence of foreign firms in his investigation of Australia and Canada. However even though FDI was a significant variable in these improvements (Buckley, et al 2007), governments should not overlook the growing importance of encouraging domestic firms to invest in their own R&D activities and not rely heavily on technologies and knowledge of foreign investors to oil their own competitiveness . Besides that, if offering tax incentives to foreign companies will result in more FDI inflow into the telecommunications industry which in turn will positively affect the industry in matters as stated above, then it will be a great way to boost the industry’s economic base. Companies will be wise to welcome such foreign investments to open up new possibilities going forward in a rapidly growing market and a dynamic industry.
Reference List
Ahmed, F. R. R. a. A. A. (2006). The Influence of Policy Instruments on Manufacturing Direct Foreign Investment in Developing Countries. Journal of International Business, 9(3), 81-93.
AusIndustry (2013). R&D Tax Incentive. Retrieved from: http://www.ausindustry.gov.au/programs/innovation-rd/RD-TaxIncentive/Pages/default.aspx
AusTrade (2013). Information and Communication Technology Sector. Retrieved from: http://www.austrade.gov.au/Invest/Opportunities-by-Sector/ICT/
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Buckley, P., Clegg, J., Zheng, P., Siler, P. and Giorgioni, G. (2007) The Impact of Foreign Direct Investment on the Productivity of China’s Automotive Industry. Management International Review. Vol. 47, 2007/5, pp.707-724
Cantwell, J. (1995). The Globalisations of Technology: What Remains of the Product Cycle Model? Cambridge Journal of Economics. Vol. 19, 1, 1995, pp.155-174
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Curran, G and van Acker, E. (2013). Government and Business in Volatile Times: Pearson Australia.

Cushman, D. O. (2005). Real Exchange Rate Risk, Expectations, and the Level of Direct Investment. The Review of Economics, 67(2), 297-308.

Easson, A., & Zolt, E. M. (2003). Tax incentives. Prepared for a course on “Practical Issues of Tax Policy in Developing Countries,” World Bank, 28. Retrieved from: http://siteresources.worldbank.org/INTTPA/Resources/EassonZoltPaper.pdf

Fosfuri, A., Motta, M. and Ronde, T. (2001). ‘Foreign Direct Investment and Spillovers through Worker’s Mobility’. Journal of International Economics. 53, 1, pp.205-222
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Morisset, J. and Pirnia, N. (1999). How Tax Policy and Incentives Affect Foreign Direct Investment: A Review. Retrieved from: http://elibrary.worldbank.org/content/workingpaper/10.1596/1813-9450-2509

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NBN Co. (2013) About us. Retrieved from: http://www.nbnco.com.au/about-us/index.html

Stewart, C. (2012). Malcolm Turnbull briefed on NBN Chinese ban. The Australian. Retrieved from: http://www.theaustralian.com.au/business/in-depth/malcolm-turnbull-briefed-on-chinese-nbn-ban/story-e6frgaif-1226482965339