22 March 2014

China's investment in the West

Foreign direct investment coming from China is making waves in countries like Australia, Canada and the United States. Is it really a problem?

Foreign direct investment (FDI) coming from Chinese enterprises, especially state-owned enterprises (SOEs), is making waves in countries like Australia, Canada and the United States.

In Canada recently, there have been tortured debates and confused decision-making regarding the bid by China's National Offshore Oil Company (CNOOC), an SOE, for the Canadian oil producer Nexen, whose main property is in Alberta's oil sands. The Canadian government finally approved the controversial $15.1 billion bid, deeming it to have a significant economic benefit to Canada -- even though half of Canadian business leaders and the majority of public opinion were against the deal.

But from now on, bids by SOEs for Canada's oilsand businesses will only be considered in “exceptional circumstances”. This is "not the beginning of a trend, but rather the end of a trend".

At the same time, Canadian Prime Minister Stephen Harper laid out new, more stringent guidelines for future takeover bids by SOEs. Harper said, "Canadians have not spent years reducing the ownership of sectors of the economy by our own governments, only to see them bought and controlled by foreign governments instead."

The US government now has to consider CNOOC's bid for Nexen's American operations in the Gulf of Mexico, and some US Congress members are already expressing their opposition.

This case is reminiscent of the politics surrounding CNOOC's 2005 failed bid for the US oil company Unocal, and Chinalco's 2009 failed bid for Rio Tinto in Australia.

Even more recently, in September 2012, the US Obama Administration nullified the purchase of four wind-farm projects sited within or near restricted air space in Oregon by a company owned by two Chinese nationals. Soon after a Congress report warned against telecommunications equipment made by Huawei and ZTE. In 2011, the Australian government also excluded Huawei from tendering for the National Braodband Network.

Why is there all this fuss about FDI coming from China?

After all, FDI brings much needed fresh capital and jobs. In the US, foreign-owned firms account for 5% of private-sector employment, 17% of manufacturing jobs, 21% of exports, 14% of research and development, and 17% of corporate-income taxes. Foreign investors tend to pay higher wages, about $72,000 on average, significantly higher than the median US compensation.

FDI increases competition and consumer welfare through lower prices, and can improve productivity and innovations. Moreover, it can help keep China's market open, and can lead to regulatory congergence as Chinese firms absorb global business norms and practices. Indeed, over the longer-term, the participation of Chinese SOEs might push them to become more commercially-oriented, and encourage the state to ultimately privatize them.

In any event, Western countries like Australia, China and the US have a screening process for foreign investments above certain limits to protect themselves, and can attach conditions to investments. For example, in Canada CNOOC has committed to spend an additional $5-$8 billion on oil and gas development, to keep Nexen's headquarters in Calgary, and to make an annual report to Industry Canada (the relevant government ministry) on the implementation of its commitments.

The first reason for this fuss may simply be that China is a very new player in international investment. While the Chinese government has spoken about its "Go Global" policy since the 1990s, Chinese outward FDI has only really taken off over the past 7 years.

Chinese FDI has grown from an annual average of less than $3 billion before 2005 to $20 billion in 2006, and to more than $50 billion in 2008. By 2010 and 2011, China's annual FDI topped $60 billion, making it one of the world top 10 sources of FDI. At year-end 2011, China's stock of FDI reached $365 billion. And 2012 is set to be a record year.

Although there has been much discussion of Chinese investment in Africa, over the past 8 years, the top four national destinations for China's outward investment have been Australia, the US, Brazil and Canada. In 2012, China's FDI in the US could rise to $10 billion, making it the important destination.

Being new players, Chinese investors have been going through a learning experience for transacting and managing assets. Investing in a democratic country with critical media, stridant NGOs, and open political debates has proved to be a cultural shock for some Chinese enterprises. Then there are the cultural barriers of language, and different business practices.

Back home Chinese companies may have a free hand once they have received government approval for a project. In democratic country like Australia, Canada or the US, they may not be free to bring in large numbers of Chinese workers and suppliers. They will also have to respect environmental regulations and workers rights.

Although there have been some misunderstandings by Chinese investors and their host countries, both sides are now learning to work together more effectively, as was very clear in the case of CNOOC's acquisition of Nexen. Moreover, most Chinese companies are now armed with a team of professional external advisors and more experienced internal execution teams.

By contrast, India's entrepreneurs are more globally savvy than their Chinese counterparts. Don't forget that some 90% of companies listed on the Bombay Stock Exchange are from the private sector, while 90% of those listed on the Shanghai Stock Exchange are state-owned!

The second factor of importance is that Chinese SOEs and the China Investment Corporation (the country's sovereign wealth fund) have been major sources of this FDI, representing two-thirds or more. Many believe that these companies are, or have the potential to act as, instruments of the Chinese government and Chinese Communist Party, rather than being purely commercially-oriented enterprises.

The third factor is that an important share of Chinese FDI has targeted natural resources, like energy, minerals and farmland. In Australia some 90% of Chinese FDI is in the mining industry, and in Canada about half of China's investments are in resources. Host countries can be concerned about losing access to such resources, and their purchase by foreigners can provoke nationalistic reactions. While China does invest in the US resource sector, it American investments are overall more diversified.

A fourth concern is that Chinese investment could be a vehicle for intellectual property theft, and the possible sale of such intellectual property to rogue regimes, like North Korea.

And fifthly, while China is eager to invest in Western countries, it is much less open to investment itself. In a survey by the OECD, China is assessed to have the highest FDI regulatory restrictiveness ranking of the 54 countries covered, and much higher than Australia, Canada or the US. In other words, the Chinese government would never ever have approved a proposal for Nexen to purchase CNOOC.

It is important to stress that FDI is fundamentally different from financial investments, as it involves significant management influence and a long-term relationship (with the common threshold being 10% of voting rights). FDI investors literally get their hands on foreign assets through greenfield investments or mergers and acquisitions. They can however have a local partner in a joint-venture.

Before rushing to any conclusions, it is important to explore the nature of China's FDI. Through its large current account surpluses over the past decade or more, China has built up large international assets. But it has put too much of its international assets in US Treasury Bills and other official reserves, leaving it exposed to sovereign risk. The move to increase its FDI represents a diversification of international asset portfolio.

There have also been a few waves of China's FDI. The initial wave centered on energy and resources. In the second, service firms followed those resource pioneers. And the most recent wave has been targeting new technology, brands, management skills, and customers in advanced markets. Indeed, outward FDI is a means for Chinese enterprises to improve their productivity and competitiveness, and explore new markets.

In many ways, the rise of China as a foreign investor is reminiscent of the anxieties caused by Japanese investments in the 1980s, but which ultimately became a happy experience. Today, Japanese US affiliates employ nearly 700,000 Americans, export products to the value of $60 billion, spend $4.6 billion on R&D, and have a payroll of $50 billion.

In this context, China's FDI still represents a very low share of its economy and international asset position, and it is set to increase dramatically over the coming decade. An Asia Society report predicts that China will ship $1 to $2 trillion in direct investment abroad by 2020!

A large share of this investment will go to Western countries. While Chinese investors balk at the political and regulatory barriers to their investments in Western countries, the experience of Libya and other developing countries has shown that they may have underestimated the political/security risk in developing countries.

Many Chinese investors complain about a lack of trust or even discrimination, as Larum and Qian have documented for the case of Australia. But every country has the right to receive foreign investment on its terms, and to maximize the benefits of that investment. Some Western countries are criticized for the lack of clarity and transparency of their foreign investment policies. But this can provide the necessary flexibility for responding to the great diversity of investment cases.

China chooses to have different systems from Western countries (and indeed from most of the planet) -- communist politics, state capitalism, weak rule of law, weak corporate governance and limited respect for human rights. As its own leadership recognizes, corruption within the government and the Communist Party is a massive problem.

CNOOC itself is in many ways a microcosm of this, with a wide variety of charges levelled against it, like drug trafficking, human rights abuses in Burma, persecution of Falun Gong members and immense environmental damage.

There are also cases where the Chinese government has bullied its neighbors who are also strong allies and partners of the West, countries like Japan, the Philippines and Vietnam.

In light of these factors, it is perfectly understandable that Western countries examine very closely Chinese investment proposals. Foreign ownership of domestic assets is a much deeper form of economic integration than simply importing and exporting.

If China really wants Western societies and politics to look more favorably on its investments, it will need to make greater efforts at improving its soft power and image with Western publics and political classes. Even so, its investment relationship with the West can never be a normal one, whilst ever its own economic and political systems are global outliers.

Ultimately, we must all endeavor to live together. And both the West and China must make efforts to do so. A strong investment relationship can bring many economic benefits to both sides. Moreover, a deep investment relationship will surely improve mutual strategic and political understanding, and hopefully push China's economic and political systems towards convergence with global norms.


John West
Executive Director
Asian Century Institute
Tags: china, investment, FDI, canada, CNOOC, Nexen

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