Yukon Huang via Caixin | China’s outward direct investment, a relatively recent phenomenon, has drawn considerable attention because of its size and geo-strategic importance. The aggressive overseas acquisitions of a few ambitious companies such as Dalian Wanda Group, HNA Group and the mega-insurer Anbang Insurance Group Co. have drawn global attention, much of it unflattering. From negligible a decade ago, outward direct investment reached a monthly average of around $15 billion in 2016 before government restrictions led to a sharp drop off. The bulk of these outflows were private, although many of the major deals involved state-owned enterprises or private firms with strong political connections.
In the US, these flows have become contentious. Property prices have surged in places like San Francisco or Seattle causing complaints about affordability for local residents. The larger state-owned firms have sparked concerns by accessing technology and natural resources. While many localities welcomed these inflows for their job creation benefits if the investments supported new industries, some senior officials raised alarm bells about unfair competition and potential security risks in cases where technology transfer was involved.
Although early on Beijing encouraged an outward strategy, the sharp decline in China’s foreign reserves beginning in 2015 led the financial authorities to believe these investments had gotten out of hand. The People’s Bank of China, the country’s central bank, has warned that some deals were putting China’s financial system at risk. Thus it is not surprising that recent media headlines, for example, have questioned the ownership structure of HNA and highlighted the arrest of the head of Anbang. All of this has alarmed markets and regulators both in China and abroad.
The pressure to cut back has eased more recently as capital flight diminished. In the new environment, many now believe that private firms with global ambitions will find it harder to invest abroad, but state-owned companies that adhere to Beijing’s priorities will be allowed to resume their acquisitions. This reinforces the sentiment that the state sector is advancing at the expense of the private sector. The big question is the criteria for future approvals. Firms and banks are now asking for clarification on the rules of the game and are scrambling to secure regulatory approval before proceeding on future deals.
The geopolitical significance has been intensified by a general perception that the bulk of China’s outward investment has been going to the United States. This perception, however, is misguided. Only about 2% to 3% of China’s outward investment over the past decade has been going to the U.S., while multiples more have been going to Europe, which is of comparable size based on GDP and trade volumes. (These amounts understate the realities because a lot of the foreign investment is channeled through tax havens and their destination is unknown.)
Economic factors partially explain Europe’s higher levels, but political sensitivities also play a role. Chinese firms are more attracted to Europe because of stronger complementarities in their respective industrial structures than with the U.S. But in addition, the EU is more “willing to let” Chinese investment come than the U.S.
There are significant differences between the sectors targeted by China’s foreign investment in the EU and the U.S. China invests significantly more in the EU’s utilities and energy sectors and higher amounts are also going to the automobile, transportation and machinery businesses, reflecting the dominance of such products in the EU’s trade with China. American strengths are clear from the attractiveness of its entertainment and metals and minerals sectors.
For Chinese companies, the EU also represents a much easier market to penetrate because it offers a greater choice of partners. This could be seen as a form of a “divide and conquer” strategy. If one EU country restricts access to its market, a Chinese company could still enter through a different member country to gain access to the greater EU market.
Security concerns are clearly more contentious in the U.S. Many Chinese investments are subject to a security review by the US Committee on Foreign Investment. Years ago, the committee blocked acquisitions involving Huawei Technologies Co. Ltd., but Huawei has had better luck in Europe, where it now accounts for nearly a quarter of mobile-network infrastructure spending. More recently, the committee has held back several seemingly routine deals, including Alibaba Group Holding Ltd.’s interest in a US payments firm, for review.
Nevertheless, China’s successes in Europe may turn out to be short-lived. In recent years, officials in the UK and Germany have expressed concerns about Chinese acquisitions and most recently, France’s President Emmanuel Macron warned about China’s investments on security grounds.
The best means to deal with these issues are the bilateral investment treaties (BITs) that have been under negotiation rather than the much broader format that was used for the recently concluded U.S.-China Comprehensive Economic Dialogue where the discussion covers too many topics and is too formal. Particularly important is liberalizing the negative list for foreign investment, which is the focus of the BIT. Discussions with the EU, however, have been disrupted by Brexit, and the Trump administration may resist any agreement that would encourage American firms to invest more abroad.
But the more important lesson coming from China’s outward investment is the murkiness of corporate structures of China’s private mega-firms and their links to the financial system. Both China’s state-owned banks as well as global giants such a Deutsche Bank AG have played a role in providing financing for deals that are now seen as shaky. That the regulatory authorities have had to intervene indicates systemic weaknesses in how Chinese corporations and banks are managed. The key question is whether the authorities will move to more market-based solutions or continue to rely on ad hoc state interventions.
In market-based economies, investments of private firms would not have regulatory agencies reviewing the commercial viability of an investment since the risks would be borne by the firm and its creditors. And whether the investment is domestic or foreign would also not be a concern if there are no capital controls. But for this to happen firms would have to be more transparent in their ownership structures and their boards would have to be more independent and responsible in scrutinizing corporate decisions. Banks would also have to be held responsible in judging the quality of the investment and integrity of the firm itself and be prepared for the consequences of bad decisions. Accountability should rest with the economic players themselves and not state agencies. All this is central to the current dispute between China and the U.S. and EU on whether China should no longer be classified as a nonmarket economy for World Trade Organization purposes.