international analysis and commentary

What to make of Chinese foreign investment – in the US and elsewhere

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The rise of China’s economy and the growth of its international trade have provoked distrust and fear in the West. Recently China’s influence has been extending beyond trade to foreign investment. Many wonder if this is China’s newest attempt to exert greater power and influence around the world. One alternative story, though, is that this most recent spurt of Chinese foreign investment is more a sign of domestic weakness than a projection of strength. 

China’s economy continues to expand at 7.5% per year despite a recession in Europe and the lackluster economic performance in the US and elsewhere.  Although its growth rate is down from over 10% a few years ago, China appears to possess an economic vitality that is unstoppable. In the past few decades the growth of China’s trade has put pressure on manufacturing industries around the world as lower-priced goods have entered their markets. The consequence has been a decline of manufacturing jobs in the US and Europe, with production shifting to China and other low-wage economies. 

Recently China seems to be going on an international shopping spree.  But it isn’t buying more goods and services from the West, which would act to reduce its trade surplus; instead it is buying whole companies. In the past year, Chinese firms have expanded their presence in the US, Europe, South America and Australia.  In the US alone, Chinese investment has grown from about $2 billion in 2007 to over $9 billion in 2012. Because large acquisitions from China often inspire political scrutiny, as when the US prevented the sale of Unocal oil to the Chinese in 2005, more recent investments have been smaller in scale, as with the Chinese expansion in the auto parts industry in the Detroit region. Still, when last month a Chinese company made a bid to purchase Smithfield Foods, the largest US pork producer, alarm bells rang again in the halls of the US Congress and hearings were scheduled. 

Among the fears prompted by investment of this kind is the control of resources by foreign powers, especially in the eventuality of an emergency. Suppose for example there is a sudden international food shortage. Would a Chinese-controlled company reduce its US sales in favor of exports to China? Clearly this is also the concern when the Chinese invest in raw material businesses such as oil companies and iron ore mines. This has happened widely in Latin America, where the majority of Chinese investments have been in the natural resource sectors, displaying China’s appetite to secure the factor inputs necessary for its continuing rapid growth. 

China’s propensity to hoard raw materials was demonstrated several years ago when it placed export restrictions on several critical natural resources such as bauxite, fluorspar, manganese, yellow phosphorus and zinc. This resulted in several WTO dispute cases against China, which it ultimately lost and is currently in the process of taking corrective action. A second WTO dispute is now pending on China’s more recent export quotas on the rare earth minerals tungsten and molybdenum. 

Of course, these kinds of supply disruption fears run both ways. If the Chinese intention to invest abroad is to secure resources for itself in an emergency, then how can it be sure that the foreign country will honor its ownership rights? If supplies of important raw materials or food products become extremely scarce, countries might choose to expropriate resources from foreign owners to secure their own national interest objectives. In this case it is China, the foreign owner, which faces an unknown risk.

Nevertheless, there are other reasons for China’s foreign investment, such as to expand its knowledge, absorb new technologies and provide a better product for its customers everywhere. The positive side of this is that China’s participation in, say the auto parts sector in Michigan, will allow its auto companies to learn how to make a higher quality and more environmentally friendly product. The agglomeration of firms in a particular area is known to produce positive spillover effects such that all can benefit. Chinese firms operating in the US are also more likely to adopt Western practices of licensing the new technologies instead of copying the techniques surreptitiously. In short, best practices in manufacturing can migrate to Chinese companies in the US first and then to China afterwards. Of course, a more pessimistic way to look at this is that Chinese auto part companies locating in the US will attempt to steal technologies and apply them back at home at a much larger scale thereby further eroding the competitiveness of the US auto industry.   

Finally one last trigger behind the increase in Chinese foreign investment may not be immediately obvious; namely the lack of good investment opportunities in China itself. Although China’s economy continued to grow at breathtaking rates even after the financial crisis hit in 2008, this was, at least in part, thanks to a considerable increase in domestic investment. China’s investment rate reached almost 50% of its GDP in 2010, up from the high thirties earlier in the decade. In contrast, the US investment rate has stayed between 10 and 15% of GDP for several years. In normal times such increases in investment can fuel future growth as workers are merged with the increased capital stock to produce more goods and services. Capital therefore generates a stream of future profits, ensuring a return on the investment. 

However in China the investment of the past few years is not really being utilized. In many cities, especially in the country’s interior, construction continues at a phenomenal pace, but the new structures are not being filled with households and businesses. Many completed towers, both apartments and offices, stand completed but empty, while nearby many more such buildings are on the rise. In industry, overcapacity is just as prevalent. In many cases these investments were financed by provincial governments who now control assets whose future return is unlikely to match the current book value.  In other words, a more realistic accounting might reveal that China’s provincial government budgets are about as sound as the City of Detroit, who just filed for bankruptcy this month.

This is perhaps the primary motivation for the increase in Chinese overseas investment. Anyone in China with money to invest is going to find foreign opportunities that are much more attractive than domestic ones. Anyone who can move money out of China, not an easy thing given the restrictions in place, has the incentive to do so. 

Regardless of the motivation, hopefully some of the investment will promote learning, adaptation and licensing of new technologies in the West so that these can be applied in China once the financial storm is finally over. Hopefully, the Chinese presence in areas like Detroit will usher in a new era of understanding and cooperation that will expand benefits for both sides. It is important to remember that international trade and investment can benefit all, but to do so everyone must be constantly willing and able to adjust to changing circumstances. Chinese investment abroad is one such changing circumstance.