Foreign Direct Investment (FDI)
There are two main kinds of foreign direct investment that China engages in with respect to the United States. The first is of private Chinese companies buying or investing significantly in smaller U.S. firms. The second is investment by the Chinese government, either through their Sovereign Wealth Funds (SWFs) or state-owned companies purchasing stake in larger American companies or shifting their investments from U.S. Treasury bills to U.S. stocks. Sovereign Wealth Funds are usually government investment funds, funded by foreign currencies that allow governments to invest for profit including directly buying into large private firms.
A weak U.S. dollar and ailing U.S. economy tend to make smaller U.S. companies fallen on hard times attractive to foreign investors. In 2007, foreign acquisitions of American companies totaled $407 billion, an increase of 93% from the previous year. Although Canada, Britain, and Germany topped the list of foreign investors, China is becoming an increasingly important player, and this issue of Chinese acquisition of U.S. assets has been generating ambivalence and unease among Washington’s politicians and in the U.S. business media.
Concerns About Chinese Investment In The U.S.
Private Firms: Investment in or buyout of smaller American firms by private Chinese individuals and companies are slowly becoming more commonplace from auto parts plants to printing-plate factories. Chinese companies engage in this kind of investment as a way of gaining or establishing global brand recognition or just greater market share. For American firms fallen on hard times, this investment is welcome as it helps to create or maintain jobs especially as the U.S. economy continues to weaken. Of course, there is usually some hesitation and ambivalence on the part of American workers about “working for the Chinese,” but that tends to dissipate if the Chinese owners are able to adapt to American labor laws and practices. Such investment does not usually attract much media attention except in the local papers in the towns of the affected companies.
Sovereign Wealth Funds and State-Owned Companies: The Chinese acquisition of bigger and more high-profile companies, especially those in the more sensitive and strategically important sectors like energy, information technology, or security (ports, for example) has met with much greater resistance from the U.S. government. Congress is particularly concerned about the motives of potential Chinese buyers who are usually owned by or have deep ties to the Chinese government, such as oil companies or sovereign wealth funds (SWF), or other ostensibly “private” companies that nevertheless lack transparency vis-a-vis their ownership. The main questions here appear to be:
• whether SWFs may have access to government officials and information not available tot the ordinary investor and engage in insider trading or use their investments to eradicate competition in favor of their own homegrown companies
• whether SWFs can destabilize U.S. companies by threatening to withdraw their equity over any number of issues large or small.
Track Record Of Chinese FDI In The United States
Limited Success: With regard to high profile investments and buyouts, China has so far had very little success in the U.S. In 2005, the state-owned China National Offshore Oil Corporation (CNOOC) attempted but ultimately failed to buy American oil company Unocal Corporation due to intense political pressure from Congress, which questioned the communist-owned CNOOC’s motives and argued that it did not represent a free-market transaction. A similar bid by Chinese appliance maker Hai’er to buy Maytag also failed in 2007 due to foreign ownership concerns, as did an attempt by Chinese firm Huawei’s attempt to partner with U.S. firm Bain Capital Partners in a $2.2 billion buyout of 16.5% of 3Com Corp, an American company that makes systems to protect against computer hackers. Although Huawei denied that the Chinese government owns or controls any part of the company, the lack of transparency as to who actually owns Huawei and research (by Rand Corp) that indicates Huawei has “deep ties” to the Chinese military made U.S. lawmakers nervous enough about the potential transfer of sensitive military technology to pressure Bain to scuttle the deal. The one exception is Chinese firm Lenovo’s (around 28% owned by the Chinese government) success in purchasing IBM’s PC division in 2005.
Sovereign Wealth Fund: In 2007, to get a better return on their foreign exchange reserves (about 70% of which were heretofore tied up in low-yielding U.S. Treasury notes), the Chinese government also established the Chinese Investment Corporation (CIC) to manage a $200 billion sovereign wealth fund. Unfortunately, CIC’s first move was a bust as it invested $3 billion of China’s national savings into the IPO of America’s best known equity firm Blackstone Group, purchasing 8% of B shares (non-voting and with no operating control), only to have the investment lose almost half its value since then. In December 2007, CIC also invested $5 billion for a 9.9% (non-voting) stake in the second biggest U.S. securities firm, Morgan Stanley, hard-hit by the U.S. sub-prime crisis. (After its several failed major acquisitions, China seems to have realized that its chances for success are enhanced by being “passive” investors with no operating control.) To date, however, both deals are seen as losses for CIC. Pressured to invest smartly as the Chinese people will only tolerate so many bad investments, CIC has now hired international fund managers, including the American private equity firm JC Flowers (for $4 billion) to manage its investments in global equity markets.
Reasons For China’s FDI In The U.S.
Secure Resources to support Economic Expansion: While China critics may see in all its foreign investments nefarious intentions, defenders point to the fact that China’s main overseas investments have been in the energy and mineral sectors is indicative that China is merely trying to secure resources important to her development. After the hostile reception the Chinese encountered in CNOOC’s purchase of Unocal, Chinese oil companies have been looking to invest elsewhere like Ecuador, Sudan, Venezuela, Kazakhstan, and Russia, countries that are not exactly friendly to the United States. The state-owned China National Petroleum Corporation (CNPC) has oil and gas assets in 22 countries, while Chinese mineral companies have investments in places like Australia, Brazil, Chile, and the Philippines. Chinalco which controls China’s largest aluminum producer, smartly partnered with American firm Alcoa to buy a 12% stake in mining giant Rio Tinto, to ensure it had continued access to aluminum for its continued building and economic expansion.
Commercial Expansion: While China has a cheap, effective manufacturing base at home, China doesn’t have any globally recognized brands. Chinese investments in everything from footwear, garments, electronics, and appliances are cited as allowing Chinese companies to secure the complimentary resources they need to become internationally more competitive. Economists are divided, however, as to whether buying foreign companies is the best way for Chinese enterprises to succeed.
Excessive Foreign Reserves: Besides trying to secure resources for its continued development, the Chinese government is trying to encourage outflows of capital from China to relieve pressure on the RMB and to reduce excess liquidity that is fueling inflation. To that end, they have planning to allow Chinese individuals to invest directly in foreign stock markets such as Hong Kong, London, Tokyo, and Singapore.
U.S. Investment In China
Although the perception, fed by the media, may be that China is on a global buying spree, the fact is that inward FDI into China ($74.8 billion in non-financial FDI in 2007, or $82.7 billion in total FDI, representing an almost 14% increase over the previous year) far exceeds China’s outward FDI, said to be around $20 billion. China in fact has historically been one of the greatest recipients of foreign investment.
U.S. foreign investment into China, while only a small fraction of total U.S. foreign investment in the world (less than 1% of total U.S. FDI in 2006 on a historic cost basis-Kiplinger), and only a small component of total FDI into China, is nevertheless still considerably larger than Chinese investment in the United States ($600 million China FDI in the U.S. in 2006 compared with $22.2 billion of U.S.FDI in China on a historic cost basis). Therefore, the complaints by many American businesses and politicians that China can invest in U.S. companies with relative ease while China still tightly restricts access to Chinese markets and companies appear not to be borne out by these numbers.
Restrictions on Inward Chinese FDI
Although China has welcomed foreign investment in the last two decades because it needed to grow, and inward investment has surged since China joined WTO in 2001, there are some restrictions on inward foreign investment. Newly issued rules by China’s National Development and Reform Commission in 2007 as to what sectors foreigners may invest in reflect a move away from “quantity FDI to quality”, that is a move from traditional, export-oriented, high energy and resource-use, and high polluting industrial enterprises into areas such as environmental protection, modern manufacturing, and high-tech. Investment in financial services is still restricted but gradually opening up (for example, allowing qualified foreign-invested companies and banks to issue RMB denominated stocks, corporate bonds and financial bonds). Still prohibited is investment in publications, broadcasting, media, and various internet-based businesses. The Chinese government has also been stemming investment capital flow by making it more difficult for foreigners to buy and profit from real estate, and by taxing foreign firms and creating new labor laws targeting foreign firms.
While potential investors may claim that China’s inward FDI policies are unfair, Steve Dickinson, an international lawyer working in China, argues that these are simply China’s laws and policies, which it has always been very clear on. It is just that these laws do not “fit with [the complainers’] idea of how China should be.”
Josh Kurlantzick, a visiting scholar at the Carnegie Endowment for International Peace writes the rise of states as global economic players (in contrast to the past when private enterprise was the dominant force shaping global economics, finance and commerce) has significantly shifted global power from free-market democracies to more authoritarian nations such as China, the United Arab Emirates, and Russia, which all have massively wealthy sovereign wealth funds and state owned companies. This raises the question of whether American private corporations can compete with foreign state-owned firms in the long run. It also bears watching if the backlash and media attention to this issue will single out China. In the meantime, one can expect:
Sustained Levels of FDI in China: Inward FDI into China will likely sustain at current levels for a few more years. While China doesn’t need the extra capital, it needs the technology, market know-how, and managerial expertise that come with foreign investment. Despite the appreciation of the yuan, increase in prices from more stringent labor laws, and taxes on foreign firms, American business will continue to invest in China for its comparatively skilled workforce, its good infrastructure, and most importantly, its access to the Chinese consumer, though some companies are expected to move their factories inland as costs in the booming coastal cities like Shanghai and Shenzhen have increased. As China attempts to move into more high-end manufacturing and high tech enterprises in the future, American companies that can match China’s needs and goals (for example in high-tech, sustainable resources or environmental protection) will be well positioned.
Continued Growth of Chinese FDI in America: If the U.S. economy continues to falter, expect Chinese investments in the U.S. to increase. The weaker the U.S. economy becomes, the greater Americans will be ambivalent, torn between the need for jobs and the fear that Americans are going to end up “working for the Chinese.” Also expect the usual political scrutiny and sturm und drang should these investments be attempted in sensitive sectors like security and energy. The United States has asked China to participate in the drafting of voluntary international “best practices” for sovereign wealth funds to be coordinated by the International Monetary Fund.
While China may have stricter laws on the books regarding FDI into their country, it is ironic that it is more difficult in practice for Chinese to invest in certain sectors in America due to overwhelming political pressure, a move seen by the Chinese as protectionist. In contrast, Great Britain has been wooing China’s sovereign wealth fund with its promise for government not to intervene in investment deals.
More on Sovereign Wealth Funds can be found at Peterson Institute for International Economics.
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China Law Blog: Written by two lawyers, one in China, the other in the United States, this blog focuses mostly on legal issues surrounding doing business in China, but often has insightful and balanced analysis on the topical China issues.
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