As the new ANZ PwC Asialink Services Report: Australia’s Jobs Future - The Rise of Asia and the Services Opportunity explains, 41 per cent of Australia’s export earnings when measured in terms of total value-added are services. That compares with 37 per cent for mining and 23 per cent collectively for agriculture and manufacturing.
"Services has historically been underappreciated in an economy where making things has been venerated above doing things."
Services has historically been underappreciated in an economy where making things has been venerated above doing things. Car manufacturing, digging things up, forging widgets, these are things done with the hands. Services are done in the office – and somehow are considered more ephemeral.
It is of course a vision of the economy from the white picket fence days when the country still had knights and dames. Australia is a modern economy and like other modern economies, more than two thirds of GDP comes from services.
However not only are services often forgotten, the value of offshore services is almost unknown. Australians have a passing familiarity with the value of educating foreigners in Australia or the yuan, yen or dollar value of Chinese or Japanese or American tourists but not the more complex embedded services or the sale of services by foreign affiliates of Australian companies.
Analysis of the role of foreign affiliates was a particularly remarkable component of the research in the Asialink Report. It estimated sales of services by foreign affiliates of Australian companies totalled $A138 billion in 2013, providing an important source of income and employment benefits for Australia.
“As Australia’s banks, construction companies and universities expand their presence abroad, these revenues and the benefits they bring back to Australia – including more jobs and greater productivity – are tipped to continue rising,” the report said.
“Importantly, international research shows that foreign investment generates new high-value jobs in the home economy and is a complement to – rather than a substitute for – domestic investment.”
That is, while there may be fears of offshoring of jobs or that investing in another country erodes value back home, there is growing evidence of onshore benefits to offshore activity. The whole pie gets larger.
“Sales of services by foreign affiliates of Australian companies – such as overseas branches of ANZ Bank, Qantas, Toll Group, Linfox and Westfield – are also not reported in official trade statistics,” the Services Report found.
The estimated $A138 billion of revenue generated is more than double Australia’s direct services exports, which in 2013 were $A55 billion.
There are two critical gaps in our knowledge of the value of offshore affiliate income which will become more significant as Asia’s demand for services rises – as hopefully will demand for Australian services.
The first is this point that the value of trade is not actually reported in trade statistics. Not reporting the value of a significant component of trade value is inexcusable.
The second gap is in the value of the earnings of offshore affiliates.
The so-called “headquarter effect”, where offshore revenues have a flow-on impact in terms of greater use of services like legal, accounting and technology back in the home town has often been argued, most notably in Australia in lobbying to stop Shell moving to full ownership of Woodside in 2001.
However hard data is scarce. The Australian Bureau of Statistics has done some work, including a report in 2011 focussing on finance and insurance. The ABS work suggests financial services are the largest earners of affiliates, accounting for 40 per cent of total foreign affiliate sales of services.
The Asialink report cited recent US research on the wider economic impact, arguing, not unreasonably, that the impact in Australia would be of similar proportions.
“US research demonstrates significant benefits from sales of services by foreign affiliates,” the report said. “This effect is very likely to hold for Australian firms that expand internationally. The diverse benefits that outward foreign investment delivers – including increased company spending on employment, tax, and research and development in Australia – present a strong argument for government policy that supports Australian firms establishing a commercial presence abroad.”
In particular, the US work found “expanded activity at foreign affiliates of US corporations is associated with more production, greater employment, higher exports, and more R&D in the United States”.
The Asialink report noted this contradicts the common fear that when domestic companies establish international operations, jobs are lost in the home economy and shipped abroad. “While US firms do offshore some jobs, resulting productivity gains allow them to expand at home, leading to a net increase in the number of people employed by the same companies in the United States,” the report said.
These potential benefits and economic value are clearly important but for financial services the size of the prize is proportionally greater.
As Asia does continue to outpace mature western economies over the coming century, more of that growth will come from financial services.
This was a central argument of ANZ’s insight 5 report “Caged Tiger: The Transformation of the Asian Financial System”. It noted Asian growth to date has largely been driven by production and export of globally competitive manufactured goods.
But modelling for Caged Tiger suggested:
- Asian (excluding Japan) bond markets will grow to be six times their current size over the next 15 years to match the size of US debt markets.
- The equity market capitalisation across the Asian (excluding Japan) region is also expected to explode, rising from US$9 trillion to almost US$55 trillion by 2030.
- The Asian financial system is on track to be bigger than the US and Europe combined by 2030.
There was a significant aside in Caged Tiger: “Price discovery in financial markets, in the sense of the most influential trading zones for price setting, will gradually shift towards Asia. At the very least, we will see financial asset price volatility increasingly occur through the Pacific time zone rather than the Atlantic time zone. No more sleepless nights for Asia’s FX traders in the future!”
That means significantly larger regional financial centres and significantly larger broader service sectors to support that seismic shift in Asia. That considerable financial deepening in Asia should mean more opportunity for on-the-ground affiliates of Australian companies.
Obviously this is a vision ANZ buys into with its super-regional strategy and growing physical presence in the region but the wider implication of the Asialink report is that such expansion in offshore services benefits the whole economy.
However, if this opportunity is to be exploited, there are both foreign barriers to entry – which can be significant – and domestic shackles.
The Asialink reported made some key recommendations, notably around tax:
- Australia’s tax regime creates disincentives for investment in offshore businesses. Dividends from profits derived offshore do not benefit from the franking credits available for Australian profits. As a result, Australian investment portfolios will be biased against offshore investment. Incentives will be created to sell Australians’ offshore assets to foreign investors who will value those assets more highly. Small and medium size companies will face higher capital costs when investing offshore. Revising this tax treatment could lead to increased outward foreign direct investment, resulting in… domestic economic and employment benefits.
It’s unlikely iron ore is going to be back at the halcyon levels of just a couple of years ago in the forecastable future. Coal meanwhile has its own particular challenges in a carbon constrained world – just look at AGL’s decision last week to move out of conventional coal generation and China’s moves against the fossil fuel.
Yet the Asialink report shows Australia does have a new resource already at scale, services. And a particular opportunity exists to grow offshore affiliates – or at least to better measure the rewards they offer to offset the risk of offshore ventures.
Photo: Lewis Tse Pui Lung / Shutterstock.com.