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NZCPR
Guest Forum
Fact or Counterfactional? Unpacking the Crafar Controversy.
Bronwyn
Howell
8 April 2012
Justice
Miller’s setting aside of the Ministerial consent given
under the Overseas Investment Act 2005 for the highly
contentious sale of the Crafar farms to Chinese interests
(Pengxin) in the High Court in Wellington on February 3 [1] raises
more questions than it answers about the processes that must
be undertaken when foreigners seek to purchase sensitive
assets – including any farm land – in New Zealand. Whilst
many have hailed the decision as a vindication of the stated
purpose of the Overseas Investment Act 2005 ("the
Act‟) “to acknowledge that it is a privilege for
overseas persons to own or control sensitive New Zealand
assets”, Justice Millar’s interpretation of how the
current Act should be applied risks cementing in a
countervailing “curse‟ on the current (New Zealand)
owners of all assets of the class to which the sale to foreign
interests is declined [2].
If the
current (New Zealand) owners cannot sell to the highest
valuing individual, regardless of nationality, then the
consequences for the New Zealand economy in the long run could
be substantial. The necessarily lower market values
eventuating for the relevant "sensitive assets‟
such as farm land will flow through to lower capital
valuations. In respect of farm land, New Zealand owners risk
becoming "locked in‟ to owning lower-valued
businesses with consequently lower borrowing capacity which
will constrain the extent to which they can fund the expansion
and development necessary to remain competitive in world
markets. And perhaps most importantly, the current
concentration of New Zealand’s scare capital resources in
relatively less productive property investments subject to
highly volatile farm gate commodity receipts will also likely
persist, contrary to the widely-espoused policy aspirations of
substantial diversification of New Zealand’s capital stocks
across the wider primary production value chain (e.g.
downstream dairy production) and into other industries.
The
Counterfactual Test
At the nub of
Justice Miller’s finding is the “counterfactual” against
which the Overseas Investment Office (OIO) is required to test
the “factual” case proposed by the prospective purchasers.
Justice Miller found that the OIO could not count the funds
invested by prospective purchasers Pengxin to bring the
dilapidated farms back into full production as a benefit of
the foreign investment, because under a forward looking
counterfactual, it could reasonably be expected that any (New
Zealand) purchaser would have also made a similar investment.
The case for the purchase to be approved must therefore rely
upon the additional investments being brought to the table by
Pengxin being “substantial and identifiable”.
On face value
this would appear to be a reasonable expectation. The
objective of an Overseas Investment Act should be to foster
beneficial foreign investment and ensure that transactions
that are deleterious to the national interest are prevented
from proceeding. As the Act covers investment, then the
criteria on which the assessment is made ought to be primarily
economic in nature. Furthermore, the assessment must be
forward-looking, taking into account not just the effects of
the current transaction "on the table‟, but the
effects of the decision made by officials on the suitability
of that transaction on subsequent transactions – including
the information that the decision conveys about the likelihood
of future transactions of a similar nature being acceptable.
Heatley &
Howell (2010)’s [3] review
of the Act concurs with Justice Miller’s finding that the
current OIO processes incorrectly use the status quo as the
relevant counterfactual – albeit that they propose the
relevant counterfactual is what will occur if the application
is declined. However, they also postulate that the current OIO
and Ministerial processes are further flawed because the
assessments explicitly exclude from consideration the gains to
the vendor of selling to a foreigner who values the asset more
highly than the highest-valuing New Zealander. This results in
the assessment process being based upon highly subjective
criteria surrounding additional investments brought only to
the current transaction (such as specific expansion plans for
the business under consideration and funding peripheral
activities such as scholarships and increasing public walking
access) whilst ignoring the consequential benefits of
newly-enriched New Zealand owners and the benefits brought to
the wider New Zealand economy as a consequence (e.g.
reinvesting the proceeds; alterations to market values).
Sorting
Facts from Frictions
Somewhat
surprisingly, therefore, Justice Miller’s decision finds
that in assessing the benefits, the OIO was correct in
omitting from consideration the very much higher price that
Pengxin was prepared to pay for the farms than a hypothetical
New Zealand purchaser (noting that at the time of the
judgement, no formal offer had been received from the
consortium of New Zealand purchasers who sought to have the
decision of the Ministers of Land Information and Finance to
approve the sale reviewed, and that the indicative price
suggested to the receivers was deemed “unworthy of
acknowledgement” [4]). Indeed, it was found that even though
such a sum would enter the New Zealand economy as a benefit to
the purchaser if the sale proceeded, it could not be
considered part of the benefit assessed by the OIO as it was
not part of the exclusive list of criteria which the Act
specifies as economic benefits of the foreign investment.
If this
adjudication is indeed correct, then current Act requires that
the economic assessment of the benefits of selling farm land
to foreigners must exclude from consideration what is almost
certainly a very substantial economic benefit to the New
Zealand economy of the transaction proceeding (given that a
rational seller would not have accepted an offer from a
foreigner if it was not higher than the highest New Zealand
offer). The justification offered is that it was the intention
of the politicians in passing the Act that simply paying more
than a New Zealander is prepared to pay is not sufficient to
justify the “privilege” of owning or controlling sensitive
New Zealand assets.
The
implications of this judgement are not trivial. Nor are they
independent of the issue of the relevant counterfactual
against which the application must be assessed. If one
considers the act of foreign investment as a means of
improving the financial state of the economy into which the
investment is made, then it appears naïve to discount what is
almost surely the most substantial economic gain – the price
premium paid by the foreigner – from consideration in the
assessment of the "substantial and identifiable
benefits‟ to New Zealand of the transaction proceeding.
They are substantial, and indeed identifiable, as a firm offer
is already on the table (as opposed to a hypothetical bid that
might never eventuate).
Consequently,
they should enter into the “factual” assessment. If they
are not part of the “factual”, then the inability for them
to enter the local economy if the transaction is declined
should be considered as part of the counterfactual. That is,
the correct counterfactual is not "what would happen if a
hypothetical New Zealander bought the farms”, but “what
will occur if the currently-proposed transaction is
prevented”.
Intervention
under the Act to prevent a sale negotiated between two willing
parties from proceeding is not costless. If there is a
“price” to be paid for the "privilege‟ of a
foreigner owning or controlling “sensitive” New Zealand
assets, then there must also be a corresponding “value”
placed on the ongoing New Zealand ownership or control of the
self-same assets. However, rather than being a
“privilege”, it is a “curse” – as it translates as
the profit foregone by the (New Zealand) vendors when the
transaction is overruled. In effect, intervention under the
OIO is the uncompensated “taking” of the right a New
Zealand owner has to freely decide to whom the property can be
sold [5].
If there were
valid economic reasons for preventing the transaction, then
the economic gain to New Zealand from intervening would be
greater than the loss incurred by the owner, and compensation
could in principle or in fact be paid to the affected party
and the national economy would still be better off than if the
transaction had proceeded (as occurs when, for example, land
is acquired under the Public Works Act for roading or
electricity developments). A comprehensive economic
cost-benefit analysis would identify if such circumstances
actually prevail. However, if the reason for intervention is
not economically motivated (for example, intervention arises
from a popular political perception that New Zealand ownership
of farm land is desirable in itself and should be maintained
at any cost) and no compensation is paid (as indeed there is
no pool from which it can be paid if there is no economic
benefit arising), then the individual New Zealand owners bear
the costs directly. They, and by extension, the New Zealand
economy in total are poorer, albeit that many people favouring
ongoing New Zealand ownership of the assets are happier as a
consequence.
Costing
the Curse
So if Justice
Miller’s interpretation is upheld, then what are the
possible consequences of intervening in the Pengxin
transaction? On a short-run analysis, if the OIO finds that
the additional peripheral “economic benefits” [6] over
and above what a hypothetical New Zealander would pay renders
the Pengxin (or another foreign) proposal unable to meet the
test of “substantial and identifiable”, the Crafar
receivers now have an asset which can only be sold to New
Zealanders. Whereas the rival consortium suggested a price
that was “not worthy of acknowledgement” in an open market
against a higher-valuing foreign bidder, without competition
from foreign purchasers the price offered by New Zealanders
post-refusal will likely be even lower than the pre-Pengxin
one7. Both the Crafar family and their creditors will be in a
very much worse financial position than if the Pengxin sale
went ahead.
In the long
run, however, there will also be a “knock-on effect” in
the dairy farm property market. Regardless of whether a local
offer for the Crafar farms is accepted, the signal to the farm
property market is that dairy farm sales to foreigners are now
highly unlikely to be acceptable. The market value of all such
farms will now fall as prospective buyers and sellers take
account of the new information. Whilst this may be good news
for those New Zealanders wishing to buy a farm, it is bad news
for those currently owning them. As farms are businesses, a
fall in market value translates to fall in the capital value
of all farm businesses – all of which is borne by the (New
Zealand) equity owners (given that the outstanding debts of
these businesses will not alter as market values fall).
All New
Zealand farmers are now poorer as a consequence of the
refusal. Some may now be in the position of having debts that
exceed the new lower capital value of the business, and like
the Crafars, be forced into receivership. It cannot be
discounted that this will set in train yet another round of
declining market values for farm businesses. Even farmers
without debt overhang will be affected, as their ability to
borrow to fund new developments is correspondingly
constrained. This will likely have the effect of restricting
the pace of on-farm productivity improvements in New Zealand,
relative to other countries where there are more liberal
approaches to foreign farm ownership. This would not bode well
for the competitiveness of New Zealand’s main exporting
businesses.
Going
Forward or Looking Back?
Even if there
is not a substantial fall in the market values of farms (as
some might argue that the current rate of foreign purchase is
so small that turning down one or two sales will have
negligible effect on the market value of farms), the foregoing
analysis shines some light on the conundrum of why, after
thirty years of policies aimed at diversifying New Zealand’s
economy away from reliance upon commodity returns for primary
produce, our predominant export-focused business investments
are in property – and noticeably, farm land.
New Zealand
is unusual in that its Overseas Investment Act is concentrated
almost exclusively upon controlling the sale of very small
blocks of rural land (sale to foreigners of all farm land and
any rural land in excess of 5 hectares is subject to the Act,
whereas sales to foreigners of assets without land are not
even subject to an economic analysis – only a „good
character‟ test is applied to the purchaser). It is also
unusual in that the Department of Land Information, not a
department with an economic focus and experience in
undertaking cost-benefit analyses (such as The Treasury or
Ministry of Economic Development), is responsible for its
administration.
These
observations are best explained by the fact that the current
Act is the consequence of the amalgamation of the original
Overseas Investment Act 1973 established in order to
liberalise the ownership of financial institutions, and the
foreign purchase provisions of the Land Settlement Promotion
and Land Acquisition Act 1952 (repealed in 1995).
Consequently, the current Act has “grandfathered” into it
a number of restrictive farm land controls, many of which
originate from the 1880s economic and social vision of New
Zealand as an agrarian utopia populated by small-holding
farmers. These policies were directed as much against the
aggregation of farm land under common ownership as against
sale to foreign interests. For example, intending purchasers
of lots larger than five acres were required to sign a
declaration that they did not already own farm land. If they
did already own farm land, they were subject to an assessment
of whether the acquisition could be deemed “excessive” –
that is, would create a holding that was more than sufficient
to support an individual farmer and his immediate dependents
“in a reasonable standard of comfort”. The consequence was
the entrenchment of the concept of the “family farm”.
Until 1961, the government required all owners of farm land to
be living on the land and actively farming it, effectively
ruling out all "absentee owners‟, regardless of
whether they were domiciled in New Zealand or overseas. This
reinforced the concept of farm land ownership and farm
business ownership being inextricably tied together, even
though there is no legal or practical reason why those
arrangements should always prevail.
The historic
approach to the regulation of farm ownership has had
substantial legacy effects on the industry. Whilst many
controls were relaxed in the 1970s and 1980s in order to
enable aggregation of farms to access the economies of scale
necessary for modern farming, the culture of New Zealand
family farm ownership prevails in both the urban public
consciousness and rural economic reality [8]. If, as has been
claimed by many, the existing Act has been successful in
preserving this artefact by precluding sales to foreign
interests, then it is likely that there has already been some
depressing of local farm market values. This could explain the
relatively low levels of existing foreign ownership of New
Zealand farms. However, if this is the case, then it has
likely occurred at the expense of the diversification of the
New Zealand economy away from over-exposure to investments in
rural (farm) property.
If much of
New Zealand’s productive capital is tied up in farm land
ownership, and the Act and social mores derived from past
times bias against the sale of these assets to foreigners,
then despite many policy intentions to the contrary, the
ability to change the investment mix in the economy is also
very limited. It may be that current land-owning farmers would
like to free up capital from land ownership in order to invest
in other industries (e.g. dairy processing), but a tight
interpretation of the Overseas Investment Act has been if not
preventing them, at least discouraging them from sharing the
risks of highly volatile commodity farm gate receipts with
overseas investors at the same time as it has been limiting
their ability to further diversify by investing in industries
with complementary business cycles. Indeed there is some
evidence to suggest that some foreign investment in the dairy
industry may have been structured so that New Zealanders
retain land ownership and foreigners control downstream
processing in order to avoid scrutiny under the Overseas
Investment Act. If, as is often claimed, the benefits of
value-added to agricultural products comes from downstream
processing investments, it may well be that the
“countervailing curse” that comes as the cost of denying
some foreigners the “privilege” of owning and controlling
farm land has already made itself felt.
Future
Proofing
Justice
Miller’s judgement has sent the Crafar farms sale decision
back to the OIO for reconsideration. But this is not the end
of the saga. He found one process error that requires
consideration, but has also unveiled another issue that is
potentially more significant. It is not at all clear that the
Act does in fact preclude the profits to New Zealand vendors
entering into consideration. Regulation 28(g)(i) requires
consideration of “whether New Zealand’s economic interests
will be adequately promoted by the overseas investment,
including, for example, matters such as any or all of the
following …(iv) whether New Zealand’s key economic
capacity is or will be improved”. If approving the bid helps
maintain farm property values at a higher level and frees New
Zealand capital for reinvestment, then this must enter into
the factual. If turning down the bid harms property values,
then this too must enter into the consideration of the
counterfactual, as suggested by Heatley and Howell in their
analysis.
The
foregoing analysis indicates that the use of a forward-looking
counterfactual opens up a whole range of new factors that must
be taken into account in the event of the bid being declined.
If farm land really is too sensitive to be owned by
foreigners, then it begs the question of why it is subject to
an Overseas Investment Act in the first place, and whether it
might not be more transparent and less distorting if it was
specifically excluded from such transactions. However,
answering this question begs a reasoned debate about
why farm land should be considered so differently from other
business assets. Importantly,
this debate must address whether the current owners of farm
land assets should be expected to pay the price for others'
preferences about their ownership or whether the exercise of
such public preferences via legislative instruments should be
constrained by the obligation to compensate the losers. Not
least, it begs more research of the extent to which views
about the ownership of different assets may be harming, and
not helping, New Zealand’s long-term economic prospects.
Importantly, the focus must be on the future, and not on the
past.
FOOTNOTES
1 TIROA E AND
TE HAPE B TRUSTS V CHIEF EXECUTIVE OF LAND INFORMATION HC WN
CIV-2012-485-101 [15 February 2012] . Subsequently referred to
as „the judgement‟.
2 For a fuller
analysis of the decision and the consequences, see Howell,
Bronwyn (2012), Comments on the ‘Crafar Farms
Counterfactual’, Wellington, New Zealand: ISCR available
on
http://www.iscr.org.nz/f722,19938/19938_Crafar_Counterfactual_full_Feb_2012_BH.pdf
. A subsequent version of this paper will be published in a
forthcoming edition of the New Zealand Law Journal.
3 Heatley, D.
& Howell, B. (2010). Overseas Investment: Is New
Zealand ‘Open for Business’? Wellington, New Zealand:
ISCR. Available on
http://www.iscr.org.nz/f578,16550/16550_Overseas_Investment_Act_paper_v20_15Jun10_final_.pdf
4 Judgement at
[6].
5 Evans, L.,
Quigley, N. & Counsell, K. (2009), Protection of
Private Property Rights and Just Compensation. Wellington,
New Zealand: ISCR. Available on
http://www.iscr.org.nz/f493,14385/14385_Property_rights_as_human_rights_final_27_09_2_Edited_ExWS_KM.pdf
6 One might
even be tempted to call them „bribes‟ due to their
highly (politically) subjective nature and specificity to the
transaction in question.
7 Indeed this
possibility would be a credible strategic explanation as to
why the rival consortium has not yet made a formal offer to
buy the farms.
8 It is noted
that the current controversy relates to several tracts of farm
land that have come to be known colloquially as the „Crafar
Family Farms‟
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