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Fruits and foibles of foreign investment

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Table 1: three substantial examples of profits and interest payments that leave the island (Data compiled by Robert Stubbs)

This is part of a series examining not just the principal causes, but, even more importantly, the appropriate solutions to the island’s economic crisis.

This week we return to policy analysis and the somewhat contentious issue of foreign investment. Recall our interest in the issue was piqued by the Bermuda Monetary Authority’s advice regarding Bermuda’s exorbitant capital exports (Figure 1), the world’s very largest external imbalance.

Last week, the BMA advised our government their preferred means of reducing our vast capital exports is by stimulating greater foreign investment in Bermuda. In particular, the BMA is advocating we adopt further measures relaxing the 60:40 rule.

Foreign investment comes in a variety of forms, and perhaps we should begin with a few comments regarding the foreign ownership of Bermuda real estate, most notably local houses.

Housing is a somewhat hybrid investment representing not just a store of value for investors but also an essential cost of living for families, often comprising the largest component of household budgets for tenants and homeowners alike.

This can, and indeed often does, present significant conflicts of interest and problematic challenges for public policymakers.

While in the past Bermuda’s strict protectionist measures regarding foreign ownership of local houses may have appeared as antiquated to some, this is one area of economic policymaking where our forefathers are looking increasingly prescient.

As will illicit guffaws of protest no doubt from certain quarters of the island, it must be recognised, at least in this area of public policymaking, the rest of the world unquestionably is moving in our direction.

Protecting the public from sky-high property prices was always a key priority of the Bermuda Government, and yet our problem with housing affordability in the past suggests additional measures may well be necessary if we are to avoid similar problems re-emerging in the future.

The cross-border ownership of private corporations and government debt are by far and away the largest classes of foreign investment. Government debt is a relatively straightforward asset class with which Bermudians by now are intimately familiar, so here we’ll focus on issues pertaining to the foreign ownership of Bermuda companies.

Foreign investment in corporations comes in two general forms — foreign direct investment and foreign portfolio investment. The key distinction between the two is management control.

With foreign direct investment, foreign investors control the day-to-day management of a company, while foreign portfolio investment refers to the ownership of corporate stocks and bonds by “passive” investors holding minority interests and exercising no control over company management.

Foreign investment in corporations, particularly foreign direct investment, has long been viewed as critical to a nation’s economic development. Success in each of the “growth miracles” of China and the Asian Tigers was accomplished in their early stages by attracting significant levels of foreign direct investment.

Foreign direct investment offers countries a number of benefits including access to greater capital or corporate funding, the transfer of cutting-edge technologies, the opening of new overseas markets for exports and, of course, the creation of additional jobs and valuable training for locals.

Without question, Bermuda’s previous economic successes were driven to a large degree by foreign direct investment. Our development as one of the world’s first mass markets for tourism was facilitated largely by foreign direct investment in Bermuda hotels. Our international business sector also classifies as foreign direct investment and IB has provided the island with all the above-mentioned benefits. One of the distinguishing features of our IB and foreign-owned hotels is their products are sold to residents of other countries providing Bermuda with valuable exports.

As a result, one measure of Bermuda’s previous success with foreign direct investment is the degree to which our economy today is dominated by exports.

Historically in Bermuda, foreign investment in local companies competing in the island’s domestic markets was subject to our 60:40 restriction and as such classified as foreign portfolio investment.

Protectionist measures shielding domestic industries from foreign competition are common in developing countries, but over time public pressure to dismantle such protections typically mounts from various interest groups on the grounds of efficiency.

Subjecting local companies to foreign competition and allowing foreign investors to acquire controlling interests in local companies are commonly argued as effective means of lowering costs and achieving greater efficiencies.

As is often the case, soon after acquiring a controlling interest in a domestic company, foreign investors typically implement substantial cost-cutting measures entailing significant job losses. While such cost cutting initiatives undoubtedly prove challenging to workers experiencing redundancy, countries as a whole may well benefit from the accompanying productivity gains and potential reductions in cost of living.

Countries are most likely to benefit from the opening of domestic markets to foreign competition if the job losses occur in inefficient industries and unemployed local workers are able to find new jobs in expanding, higher-value industries paying higher wages. Such conditions are ideal, promoting higher levels of real gross domestic product, productivity, incomes and overall employment.

But the conjectures of theory and realities of practice may diverge substantially. In our case, a closer look at the facts on the ground suggests that indeed they do.

The Bermuda Government has already taken significant steps in relaxing 60:40. Today, the island’s banking and telecommunication sectors are almost exclusively controlled by foreigners, bringing over half the island’s corporate sector, at least as measured by corporate profits, under foreign control.

In fact, the scale of Bermuda’s asset sales to foreigners orchestrated by both our Progressive Labour Party and One Bermuda Alliance-led governments in recent years is so large, our ongoing, associated financial commitments to this foreign constituency is proving now to be a significant drag on our economy.

As listed in the accompanying table, the annual interest payments to overseas holders of our government debt and the profits of HSBC and Butterfield Bank, almost all of which is owned by foreign investors, total approximately $465 million.

This is now a sizeable sum comprising almost 40 per cent of our $1.2 billion in net capital exports.

Indeed, our flows of interest payments and corporate profits owed to overseas investors have grown so quickly, today they’re almost twice Bermuda’s pension contributions, which currently, of course, are invested exclusively overseas.

In other words, the BMA’s proposed remedy to our vast capital exports has been exercised already to such an extent, it’s become a significant contributing factor to the very ailment it is intended to cure.

This strongly suggests our policymakers are not even monitoring the effects of past policy changes, let alone providing us with accurate assessments of the future impact of current policy proposals.

Considering over the entire period of these asset sales Bermuda possessed the world’s largest capital outflows, we were under no pressure to make any of these sales to foreigners.

What’s more, our government’s ill-advised decision to denominate our government debt sales in a foreign currency unnecessarily subjects the island to significant currency risk which is recognised now internationally as reckless public policymaking.

Perhaps this is a topic for further consideration in the future, but the IMF today recognises the critical importance of carefully managed and competently executed economic liberalisation.

In particular, the IMF’s development advice to governments globally stresses the need for establishing an adequate regulatory framework of financial-sector oversight and management prior to the opening of domestic banking industries to foreign control and competition.

Further, eliminating protectionist measures is more advisably implemented at some points in the business cycle than others. Moreover, there are numerous respectable reasons to permanently protect some industries from foreign competition.

Finally, a key measure of a country’s lack of development or immaturity is its reliance on exports. As is top of the policy agenda in China, the self-sufficiency gained through the expansion of domestic markets can enhance a country’s resilience and sustainability considerably.

Of course, after the policy shell game we witnessed last week, we might take a moment to consider an alternative possibility.

Given our political and economic establishment’s penchant for sleights of hand and confidence tricks, our sustained vigilance for the possible “interested error” of island elites is clearly advisable. You see our elites have a particular personal interest in the island’s foreign investment as each additional dollar we attract to the island facilitates the extraction of one more of their own.

For sure, an aversion among island elites to curtailing Bermuda’s vast capital exports would help explain the abject failure to date of the BMA and our Government to implement the prudent policy advice offered by our Financial Policy Council.

Indeed, without the attraction of further foreign investment to Bermuda, our elites are under added pressure to develop the island internally.

And perhaps therein lies our real problem — Bermuda’s residents have been so consumed with getting their money out of here for so long, no one’s ever given that due consideration. Oh, dear.

Robert Stubbs is an economist, CFA, holds an International Bond Dealer Diploma and has completed the ACAS actuarial exams. He was formerly head of research for Bank of Bermuda and his professional interests at present lie in enterprise risk management

Figure 1: Bermuda's capital outflows amount to 20 per cent of GDP (Graphic by Robert Stubbs)
Robert Stubbs