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Investabroad

Is China buying the world?

November 28, 2013 by Ken Davies

As China’s outward investment becomes more prominent in developed, as well as developing, economies, concern is growing that this may herald a Chinese takeover. What are the motives for this investment? How much of a threat does it really pose to the rest of the world? What should be done about it?

Chinese outward direct investment (ODI) was negligible until the beginning of this century, when the country’s leaders urged companies to “go global” (the Chinese phrase literally means “go out”, but “go global” has become the standard translation). It has risen at an accelerating pace since then, reaching US$84bn in 2012.

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In 2012, China was the third largest source of direct investment flows (after the United States and the United Kingdom).

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However, as a latecomer to overseas investing, was much further down the league table in terms of its cumulative ODI stock, way behind not only the US and the UK, but also Germany, France, Switzerland, the Netherlands, Japan, Belgium, Canada and Italy.

Chart04

In terms of ODI flows and stock per capita and the ratio of ODI flows and stock to GDP, China also lags behind other major economies, though it is catching up rapidly.

ODI has been gaining on inward FDI. It is envisaged that inward and outward direct investment will be roughly equal (literally “in balance”) by 2015, at the end of the current five-year plan.

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As in other areas of the Chinese economy, it is likely that official figures do not tell the whole story. Comparisons with inward FDI stock statistics in recipient countries suggest that China’s ODI may be understated by around 40%. One reason for this is that private enterprises may find it easier to circumvent the government’s approval procedures. On the other hand, there may be some over-counting, as a proportion of ODI may well return to China as “round-tripping” investment routed through Hong Kong and the tax havens that absorb a disproportionate amount of ODI.

China’s ODI has shot up since 2000 primarily because of the government’s “go global” policy, which has been embodied in successive five-year plans. In line with this policy, the authorities have relaxed controls on outward investment and streamlined its administration.

At the same time, Chinese enterprises have been increasingly investing abroad for commercial reasons. So the impulsions behind China’s ODI are a mix of national political/economic/strategic objectives and standard profit-seeking. In the OECD’s 2008 review of China’s investment policies, five motivations were detected: 1) the need to acquire natural resources; 2) the search for product markets; 3) the search for strategic assets, including advanced technology, brand names and customer/distribution networks; 4) diversification; and 5) efficiency (i.e. cheap labour).

These are not particularly unusual reasons for investing overseas, so why are potential recipients worried?

While an increasing proportion of China’s ODI is from private or semi-private enterprises, the bulk of it has been provided by state-owned enterprises, which frequently occupy a monopolistic or oligopolistic position in their home market, have access to apparently unlimited funding via state banks and are perceived as being in the pocket of the Chinese Communist Party, an organisation whose foreign policy aims may extend beyond commercial gain.

There are therefore suspicions that when a major Chinese corporation tries to acquire a company in the developed world it is acting on behalf of the Chinese state and competing unfairly because it has “deep pockets”. That is why Chinalco’s US$19.5bn bid for an 18% stake in Rio Tinto in Australia failed in 2009 and why CNOOC pulled out of its US$18bn offer to buy UNOCAL in 2005. Even if such a deal is not screened out by the host government on national security grounds, opposition from the public, the media and Congress can render such a deal unworkable.

A major cause of mistrust is the lack of transparency of most Chinese firms. This is a particular problem in the case of a company like Huawei, the world’s largest telecommunications manufacturer, which insists that it is not tied to China’s armed forces, despite having been founded by a People’s Liberation Army veteran. This mistrust has consequences, like the failure of Huawei (with Bain) to acquire 3C (which was then bought by Hewlett Packard) in 2008, and Huawei’s walking away from a deal with 3Leaf, after hostile Congressional investigations. Huawei has had similar problems in India and remains under suspicion in several countries (with the apparent exception of the United Kingdom) after reportedly supplying surveillance equipment to Iran and the Taleban.

Concerns in developing countries are not quite the same. In Africa, for instance, many people welcome Chinese investment that provides cheap, rapidly-built infrastructure, cheap consumer goods and jobs. Locals also complain that Chinese retailers import cheap clothing and other items that undermine Africa’s own nascent manufacturing industry. Chinese firms often bring in their own specialised personnel, even when skilled labour is available in the host country, reducing the spillover benefits to the local economy.

So would it be better to do without Chinese overseas investment altogether? Obviously not. Like any other large economy, China benefits from being both a large importer and exporter of capital. The rest of the world can also benefit from these investment flows. Both China and its FDI host countries need to work together to maximize these benefits.

Chinese companies need to be transparent. They need to comply with financial disclosure rules and open their operations to public scrutiny. When they make investments, including overseas, they should make clear the source of their financing, their ownership structure and their objectives, if necessary going well beyond minimum legal compliance requirements. Ultimately, though, the “deep pockets” suspicion will remain until the Chinese state truly lets go of its enterprises.

Host country governments should not adopt protectionist measures to shut out Chinese investment. Investment protectionism is self-harming: why refuse money to help develop the economy? As Chinese companies start to diversify out of their former focus on the tertiary and primary sectors, more of them are investing in manufacturing that provides much-needed jobs in developing countries and also in poorer regions of developed economies.

If an inward investment, whether from China or anywhere else, threatens national security, public order or public health, it should be stopped (just as it is by China’s own FDI catalogue régime). Any other investment should be allowed. If there are worries that a foreign investor is so large that it may dominate the market, they should be dealt with by the competition authority, in the same way as would a bid by a large domestic firm.

Finally, an important feature of China’s new role as a major outward investor is that the Chinese government is now actively seeking to negotiate international investment agreements that accord protection to foreign investors. This is a good opportunity for China to become a serious contributor to the international investment rule-making effort.

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