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 the relationship. US investment in Australia significantly underperformed in 2020, continuing a three-year trend.
Benchmarking US Investment in Australia
For the OECD (Organisation for Economic Co-operation and Development) area, foreign direct investment (FDI) inflows fell 51 per cent in 2020. The US experienced a 45 per cent decline in FDI inflows over the same period. Australia’s experience was in line with this performance, with a 48 per cent decline in inbound FDI. However, US direct 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 in relation to holdings of Australian debt securities and unwinding financial 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 2020 and into 2021. In flow terms, Australia has become a net lender rather than a borrower internationally, reducing the overall need for foreign capital inflow. However, the decline in US investment in Australia in 2020 is much larger than its historical share of foreign investment in Australia would lead us to expect.
Australian Investment in the US Continues to Grow
Australian investment in the US continues to grow, in particular portfolio investment in US shares and bonds. Australia’s domestic capital markets are saturated with superannuation saving, which is increasingly invested abroad. With the world’s largest capital markets, the US is a natural destination for the growing Australian savings pool. 2020 was a record year for Australian investment in the US based on consistent data since 2001. The increase in the Superannuation Guarantee from 1 July, to the extent that it increases national saving, will only make Australia’s excess saving problem worse.
Australia’s increased regulation of FDI and application fees for foreign investors have also weighed on inbound investment. Treasurer Josh Frydenberg lowered the monetary screening thresholds for reviewing FDI transactions to zero during 2020 to guard against the opportunistic acquisition of distressed Australian firm by foreign interests. This led to significant delays in approving foreign investment transactions. 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 and the Australian government imposed what many analysts considered to be an unofficial ban on large Chinese acquisitions in Australia.
US and Global Tax Changes
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 Australian government’s efforts to reform the corporate tax system have met with political resistance.
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. The Trump tax reforms broadened the US corporate tax base, which will increase the burden of Biden’s proposed corporate tax increase.In the context of international negotiations under the auspices of the G20, the US and Australia have both promoted a minimum corporate tax designed to limit tax competition in favour of high-tax jurisdictions. The G20 has now agreed on a global minimum corporate tax rate of 15 per cent, as well as a scheme for the allocation of global taxing rights, albeit with significant carve-outs, including extractive industries. The 15 per cent rate was a compromise on an earlier US proposal for a 21 per cent rate which was supported by the Australian government.
The G20 deal will have a small impact relative to Biden’s proposed revamp of the US corporate tax system. The higher tax burden on US corporates will likely see a significant restructuring of the ownership and global operations of US multinational enterprises. There has been a steady erosion of the US corporate tax base, with US equity capital increasingly held by tax-exempt pension funds and foreigners rather than US taxpayers.
Both the US and Australia could have used the multilateral tax 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, but did not feature in the final deal. As much as 40 per cent 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 cross-border investment in absolute terms. The recent underperformance of US investment in Australia highlights the sensitivity of cross-border investment to changes in international tax rules.
US Investment not Fungible
As Australia recovers from the pandemic, the current account will likely return to deficit and Australia will once again become a net borrower in international capital markets. While Australia has no trouble attracting foreign capital, 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 spill over to the rest of the world, including Australia. Portfolio investment and investment from other countries is not a perfect substitute for US direct investment.
The recent weakness is US investment should remind Australian policymakers that they cannot take Australia’s appeal to global investors for granted. The effects of the pandemic and the Trump corporate tax cuts are likely to be transitory. Australia’s appeal as a destination for US investors will improve on a relative basis under the Biden tax plan. The danger for Australia is that the Biden administration’s corporate tax changes and changes to the G20 tax rules led to a pullback in cross-border investment globally just as Australia’s demand for foreign capital increases again.