This article is by Pete Sweeney, a Fulbright Scholar researching business policy in Chengdu, China.
The surge of investment developing countries are pouring into more developed economies is a phenomenon that is receiving increasing attention. According to Kofi Annan’s preface to the 2005 United Nations Committee for Trade and Development (UNCTAD) World Investment Report:
The conventional wisdom of developed countries as capital and technology exporters and developing countries as importers is gradually giving way to a more complex set of relationships. The geography of international investment flows is changing. Developing countries are emerging as outward investors, and their importance as recipients of foreign direct investment in more knowledge-intensive activities is increasing.
Outbound investment from the People’s Republic of China is part of this trend. A recent article in the China Daily claimed that outbound investment from the BRIC countries (Brazil, Russia, India and China) and other developing nations is a “sign of a new world order.” The claim sounds dramatic, but it is nevertheless indisputable. According to MOFCOM statistics compiled by Professor Lu Bo, Deputy Director of the Chinese Academy of International Trade and Economic Co-operation (CAITEC), China has established about 10 thousand companies in 172 countries and regions with a total investment of $90.63 billion. Thanks to its attraction of inbound investment and its accumulation of foreign currency reserves, China is now one of the world’s largest sources of investment. This naturally includes investments in developing countries. “Nearly half of US capital inflows over the past year and a quarter came from China, Brazil, Mexico, and Russia,” the Xinhua News article claimed.
Indeed, during the recent global economic downturn, driven by the subprime mortgage crisis in the United States, Chinese firms have emerged to inject cash into troubled firms like Morgan Stanley and Citigroup. Michael Heise, writing for the International Herald Tribune, called these firms “white knights from afar.” “Is [this] something to fear?” asks Heise. “The answer is no, at least, not directly.” If the Chinese Ministry of Commerce has its way, we are likely to see more of such Chinese knights in the near future. A recent article on the Chinese Council for the Promotion of International Trade (CCPIT) website quoted Fu Zi Ying, Vice Minister of the Ministry of Commerce (MOFCOM), who argued that the current economic crisis offered Chinese firms unprecedented M&A opportunities. “Several well-known enterprises and research organizations have fallen into difficult positions. This offers Chinese firms a great acquisition opportunity. These [Western] firms possess well-known brands, formidable international sales networks, and relatively strong research capabilities. If our firms can successfully acquire them, we can use these resources to greatly enhance Chinese firms’ international competitiveness.”
In the current political climate, however, Chinese firms still face obstacles investing in developed economies, particularly when it comes to taking control of US firms. The Committee on Foreign Investment in the United States (CFIUS) recently blocked an attempt by Huawei, a well-known Chinese telecommunications firm, from acquiring a $2.2bn stake in the US firm 3com, citing security concerns related to 3com’s technology assets. Huawei is hardly the first Chinese firm to run into a wall when it comes to acquiring controlling stakes in US firms. The Chinese National Offshore Oil Corporation (CNOOC) attempted to acquire Unocal and was rebuffed due to security concerns. While not subject to a security review, Haier’s attempt to acquire Maytag was politically unpopular in the US and was ultimately stymied.
Predictably, the Chinese are irritated and blame US protectionism and paranoia. Opinion in the US varies according to the speaker’s assessment of Chinese intentions. In short, a lot of political sound and fury. What does it signify?
First, much of the popular fear of Chinese investment in the US is hysterical, reminiscent of the widespread fear that swept through the US when Japanese firms began buying up US assets, or more recently the Dubai port acquisition controversy. This is largely due to a poor understanding of the purpose of international direct investment, which can vary from deal to deal, and how it can affect national interests. The most dangerous canard is that foreign firms are more likely to destroy jobs when they acquire American firms than American firms are.
Indeed, what is the national interest when it comes to foreign direct investment? For example, the logic supporting the acquisition of Unocal deal (and the blockage of same) rested on the premise that oil is not, in fact, a fungible market product for sale anywhere to anyone, but rather a strategic resource that should be physically controlled by the nation. Therefore if China acquires an American oil firm, it can turn off US oil at the tap. But since most of Chinese oil currently passes through the Straits of Malacca under the eyes of the US Pacific Fleet, China’s control of Unocal would hardly allow it to dictate terms of oil supply to the US. In short, if either the US government or the Chinese trusted the oil market to function, there would be little point to the acquisition from a national strategic perspective.
Huawei, on the other hand, is more complicated. For starters, Huawei’s original foray into the US resulted in a large lawsuit. Cisco alleged that Huawei’s router products were made from pirated Cisco technology. While a confidential settlement was reached between the firms, Cisco did not formally close the case, presumably to retain leverage. Huawei went on to establish US affiliates and research centers in the US, but its business performance in the US market has been less-than-spectacular. Even Lenovo’s successful acquisition of IBM’s laptop unit’s performance in the US has been spotty; most of Lenovo’s growth remains in Asia.
Nevertheless, many Chinese find these investment barriers insulting, unfair, and counterproductive. One article in the Guangzhou Daily argued that not only are such barriers unfair, but if the US wants to resolve the trade surplus, it should encourage Chinese firms to export capital to the US in the form of direct investment as a counterbalance. Other Chinese economists make arguments that such investment can help tame China’s inflation problem caused by the renminbi glut. In order for such investment to make an impact on the enormous trade surplus, its scope would have to be amplified geometrically, but nevertheless.
However, it’s unwise to mix conversations about trade with conversations about direct investment. Trade is the movement of goods, direct investment (as opposed to portfolio investment, which is the simple purchase of stocks and bonds) is the movement of management control. The latter is far more complex than the former and requires market similarity, not complementarity. This is why the bulk of direct investment flows are between the US and Europe, not the US and developing economies. The learning curve is much shorter for European managers, who operate in a similar legal and business environment as their American counterparts (not to mention language ability), than it is for Chinese managers.
If China wants to export capital for macroeconomic reason, it can do so simply by investing in bonds, as indeed it is already doing, or by letting the renminbi float, as is already underway. But direct investment should be a microeconomic firm-level decision, not a facet of macroeconomic strategy.
In the short run, Chinese direct investment’s impact in the US should not be overestimated. It makes up a relatively low portion of China’s GDP, even in comparison with other developing countries like India, and the average transaction amount is small, less than $5 million according to CCPIT. China, in short, invests less than it probably should, and despite aggressive moves like the Unocal bid, most Chinese investors are quite cautious about direct investment.
In the long term, however, Chinese direct investment in the western countries should be ultimately provide a net benefit to both parties, provided it creates value, local jobs, and avoids sensitive sectors. From the Chinese perspective, acquiring foreign experience (and training staff) is key to developing the competitive capacity they need to move up the value chain and pull the millions of impoverished Chinese trapped in dead-end manufacturing jobs along with them. As importantly, China needs to provide more jobs for its college graduates, among whom the unemployment rate (around 40%) is unsustainably high and is a long-term security problem for everyone.
From the foreign perspective, closer and healthier linkages with Chinese firms would not only facilitate business operations along the supply chain, it would provide greater legal leverage in conflicts of interest. As the recent controversy over quality control illustrate, it is quite difficult to gain recompense from Chinese firms that have no foreign assets to seize. As Chinese firms internationalize their operations, they become more accountable to international norms, as the Huawei-Cisco case illustrates.
However, reforms on both sides are necessary. Many American policies towards China are, in fact, discriminatory, particularly those directed towards protecting US agriculture and textile sectors, and many of the US security concerns regarding China are paranoid. At the same time, China’s reliance on SOEs to drive direct investment is problematic as it is difficult to ascertain whether an SOE’s acquisition strategy is driven by the profit motive or by political strategy. Therefore it is in everyone’s interests that private Chinese firms, as opposed to state behemoths, be allowed to lead outbound direct investment overseas. This means giving them better access to capital from Chinese banks, and removing barriers in the US that stifle Chinese competition in sectors in which they enjoy the greatest comparative advantage. For example, part of the reason Chinese manufacturing is so cheap is they have near unlimited access to a Chinese peasantry that cannot survive on their farm incomes. Were the US and Europe to open their agriculture markets, the result would drive up the price of manufacturing labor in China as peasants return to an economically-viable agriculture sector.
China must also stop encouraging domestic firms to invest abroad for non-business reasons. Obviously national pride is a poor reason to invest, as is national security, neither of which are the responsibility of the business sector. There are also other policies that have perverse effects. For example, the Chinese tax structure currently gives preferential treatment to foreign-invested firms. This encourages a phenomenon called “round-trip” investment, in which a mainland firm creates a foreign affiliate abroad whose sole purpose is to return to China as a foreign firm. This means lowering domestic firms’ tax treatment to the same rate as foreign firms, and at the same time equalizing the regulatory treatment of foreign firms (who already operate under an information and “guanxi” deficit) so that everyone plays on a level field. In short, increasing the depth and quality of investment flows in both directions can only serve to harmonize both nations’ national interests.