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Traps for Chinese investment overseas

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In Brief

China's overseas direct investment (ODI) has been growing rapidly over the past years. The total amount of ODI reached US$48 billion in 2009, meaning that China is ranked sixth globally in terms of ODI. In 2009, Chinese invested in about 180 countries. According to the goverment, China's ODI may reach $100 billion in 2013, with total ODI stocks reaching $500 billion.

While the rapid rise of China's ODI is consistent with its growing significance in the global economy, the scale of investment is still a unique phenomenon when compared to ordinary international experience.


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All of China’s major overseas targets, such the US, U.K, Japan, Germany and France, are advanced economies: rich in income level, abundant in capital, advanced in technology and management. By contrast, China still ranks about 100th in the world based on per capita GDP, according to IMF data.

The famous Japanese economist Kiyoshi Kojima once distinguished an American and Japanese models of ODI. According to Kojima, the main purpose of American ODI was to gain access to overseas markets, while the main purpose of Japanese ODI was to utilise cheaper production costs overseas. But the two types shared one thing in common: investors enjoyed obvious advantages in technology and management.

Chinese ODI shows some very different characteristics. It falls into three main areas: (1) the service industries: much of the investment facilitates exports (2) the resource industry: China has long-term goals of securing stable resource supply; and (3) the advanced manufacturing sector: China sees advantages in obtaining technologies and management skills through acquisition.

Clearly, this investment does not specifically aim at shifting domestic production overseas – it is aimed at strengthening production at home. And most investors do not enjoy any technological or management advantage.

It is probably too early to conclude that ODI coming from China is distinctively Chinese. Some of the characteristics we are observing may only be transitional. But, on preliminary observation, we can say a few things. First, massive investment without technological advantage means only that Chinese enterprises are ambitious. Second, Chinese ODI is characterised by the huge amount of capital available, evidenced by $2.5 trillion foreign exchange reserves. Third, Chinese investors face higher investment risks since in most cases the Chinese companies are sailing into unknown waters.

Chinese companies have been dealing with overseas markets for years. But for the most part, this has been through trade. Their knowledge about social, political and economic situations in foreign countries is extremely limited. And the Chinese companies are now paying dearly for this disadvantage.

One Chinese state-owned enterprise (SOE) I know of planned to make a major investment in the US. Since it was a sensitive industry, this deal required approval by the government. This SOE hired a very well-known commercial lawyer from Los Angeles. Unfortunately this lawyer knew nothing about politics in Washington and had no lobbying skills. The deal fell apart quickly. Another SOE acquired a coal mine in Australia and advertised as the world’s largest coal mine company. This, unfortunately, did not help improve the company’s image, since the Australian public generally has negative perceptions of coal mine companies based upon their causing environmental damage.

Statistics suggest that, excepting tax heavens such as Virgin Islands, Chinese ODI is concentrated upon countries with underdeveloped legal systems and serious corruption problems. This may be because well-regulated markets have higher entry barriers to Chinese investment. But it may also be because many Chinese investors carry with them a corrupt way of dealing. Sometimes these practices see companies making deals with ministers and even presidents.  This is very dangerous. Any perception that Chinese ODI involves the transmission of corruption would place in jeopardy the future expansion of Chinese enterprise.

A most contentious issue between China and the West is how to deal with dictators. The West prefers an interventionist approach while China insists on non-intervention.  For investors, whether they hail from SOE’s or are completely private,  it is difficult avoid the governments of host countries. And if Chinese ODI impacts positively upon local economies, then the people of individual countries can still obtain benefits. But all dictators will eventually fall.  An overly close relationship with dictators might turn into some heavy baggage in the future.

According to John Garnaut, Chinese ODI is facing widespread difficulty. ‘Chinese investors are tangling with unfamiliar regulations, labour markets and technologies. In unstable nations, particularly in Africa, they are aligning themselves with transient regimes. In South America and the Pacific Islands, which have pugnacious traditions of local community rights, they are finding that doing cozy deals at the state level does not solve grassroots problems.’

Currently, central government affiliated SOEs account for 63 per cent of all Chinese ODI. But if we look at the Chinese experience at the beginning of economic reform, most ODI came from small and medium enterprises from Hong Kong, Taiwan and Korea. These small and medium enterprises in labor-intensive industries are the ones desperately needing to migrate. They also enjoy an obvious advantage in technology, management and marketing. Why are SME’s falling behind in terms of ODI?

Currently, three government departments control ODI: the State Administration of Foreign Exchange (SAFE) approves foreign exchanges, the Ministry of Commerce (MOFCOM) issues licences, and the National Development Commission (NDRC) assesses the national interest. This means unnecessary duplication, and means that SME are unable to jump through bureaucratic hoops. There is a solution – condense the working of these three institutions.

For instance, rather than issuing useless licences, MoCom could instead provide services and consult using its intensive overseas consular networks. SAFE and NDRC could provide more room for the private sector to go overseas. As a side note, SOE’s face higher entry barriers overseas and they run higher risks of making wrong investment decisions because they have skewed incentives.

Chinese ODI is likely to continue to grow rapidly. But to make good investment decisions, it requires the government to put in place a good policy framework.  It also requires individual enterprises to do more homework in order to understand the political and economic backgrounds of host countries. Otherwise, much of the investment could be wasted and the reputation of Chinese enterprise  could be damaged.

Yiping Huang is professor of economics at the China Center for Economic Research at Peking University and in the Crawford School of Economics and Government in the ANU.

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