Daniel H. Rosen is a founding partner of RHG and leads the firm’s work on China. Mr. Rosen has more than two decades of experience analyzing China’s economy, corporate sector and U.S.-China economic and commercial relations. He is affiliated with a number of American think tanks focused on international economics, and is an Adjunct Associate Professor at Columbia University. From 2000-2001, Mr. Rosen was Senior Adviser for International Economic Policy at the White House National Economic Council and National Security Council. He is a member of the Council on Foreign Relations, and board member of the National Committee on U.S.-China Relations. On April 8, 2016, he spoke with Shivani Pandya CMC ’18.
Biography and photograph courtesy of Rhodium Group, LLC, 2016.
China’s outbound FDI has been growing extremely rapidly in recent years. In your opinion, what is the driving trend, and can you speak more to the key characteristics of Chinese outbound FDI?
There are a variety of drivers in work. Our position is that the preponderance of factors involved are commercial in nature. Changes in China in the phase and state of the Chinese domestic economy are creating an incentive for Chinese firms, who were content to stay home previously to venture abroad, and pursue their commercial interests.
For example, production costs are changing in China – it is getting more expensive to manufacture in China. So firms that previously could make a good margin just being an OEM, Original Equipment Manufacturer or contract manufacturer, to Western retailers, like JCrew, are finding that they can no longer be profitable just being the contract manufacturer. They now need to think about being closer to where their ultimate consumer is for the things they make. That’s changed from 10 years ago where many Chinese firms could find unlimited amount of low cost labor to just keep costs very stable and grow their global market share. For resources, from 2005 until recently, many firms were motivated to find a greater investment interest in raw material production for use back in China. That’s changing lately as well, as China’s economy goes into a period of structural adjustment. Therefore, the resource driver is not what it used to be.
The consumer seeking, technology seeking, brand seeking – all these commercial factors are as strong as ever in growing.
Your consulting firm has quite the expertise in this area and is regarded as a pioneer in doing this research. Could you illuminate how you overcame the problem of accessing data and data availability in China’s FDI numbers?
Some of the data problems is really no secret; I mean everyone has known for quite some time that even the best official statistics in direct investments kept in the U.S. aren’t really reflecting the full value of activity. Rather, they are the affecting the net flow of FDI from the world into the United States. But there are a lot of factors that obscure the real level of activity by firms from a given country, say China. What I mean by the first couple of examples – a lot of Chinese investment coming to the U.S. and vice versa doesn’t go direct. It goes through tax havens for tax optimization purposes (Hong Kong, British Virgin Islands). In official statistics, it may not be showing up with the correct country assigned to it. When we looked at China’s outbound direct investment data, for example, starting about 7-8 years ago, it was clear that what they were showing was only the first destination of outgoing funds. The Chinese number said that 70% of their outbound direct investment was in Hong Kong, which clearly was not the case. It was going there and then it was being invested on to other parts of the world. Step one was simply to understand how the official existing numbers were calculated recognize what the shortcomings of those are. Step two was to ask, “how would one go about trying to get a more accurate count of what is taking place” In our case, it meant starting to check and see whether we could identify from public records what a very high percentage of what we surmise was likely to be the total the output was. Then we start building strategies for tracking and identifying those flows based on public information such as SEC filings, press re-releases, press coverage, etc. The third level is to do quality control on the numbers and make sure, since we’re not using the official methodology in counting, we need to do our own check to ensure that the investment in question meet the definition of FDI. For instance, it means that it has to be a 10% stake in the target company, not a stake less than 10% which would then be considered a portfolio investment. Those are the high points of how we went about doing things differently.
The process is well-detailed in the methodology appendix in American Open Door, which is one of the first studies that we did.
How is Chinese outbound FDI being received across the world, and are countries like the U.S. opening its arms to this?
There is no simple answer to this. There are mixed reactions. There are many in the areas of security studies and folks who are concerned with transnational investments – no matter where it’s from – who focus on potential for social disruption coming from big international companies going into sensitive ecosystems or into less developed countries that don’t have the ability to protect labor rights. They’re concerned with rapidly growing inflows, no matter where they come from and that includes China as well. There have been plenty of folks who have taken a kind of anxious stance towards it and have focused on concerns about: what are Chinese motives, are they going to be operating with corporate-social responsibility in mind? Those reactions are most pronounced in other part of the developing world – Africa, parts of Latin America, Southeast Asia. In the advanced economies, the OECD (United States, Canada, Europe, Australia), the reaction has generally been very open and embracing because we all have adequate rule of law and standard set up to make sure that we are not going to be subject to any negative externalities from those inflows from China. Of course, there are some deals that get a lot of attention and get publicized. By in large, what’s more notable about the story has not been those handful of controversial cases, but rather has been the general openness to Chinese investments.
In your opinion, what are the specific mistakes that you have seen surrounding Chinese investors and their approach to FDI. Do you see a level of sophistication within Chinese investors?
The first point I would make is that is it very early days, and Chinese firms have only been going out to operate far a field for a brief period of time. Thus, it is too soon to say whether history will consider Chinese firms to have done well or poorly. There are mistakes that have been made, but that is not unusual for firms from other economies either. I mean I can go on for days about mistakes the U.S. corporations made when they wen to China that are normal doing business mistakes. Not yet being familiar on how to operate in a highly regulated, rule of law based economy like the U.S. or Europe is going to be challenging to any Chinese firm, even if that Chinese firm is expecting that to be a challenge.
The bottom line is that the vast majority of Chinese investment into the U.S. and Europe that have been made are continuing to operate. The number that has absolutely blown up since they were established in the OECD had to be shut down because of catastrophic mistakes – that’s a very very small number of overtures. The vast bulk of them have made the kind of normal mistakes that tend to happen in operating in a new environment, but they haven’t been so catastrophic to dominate the story.
There have been certain groups of people in the West that have voiced concerns about Chinese investor’s ability to close deals. For example, the Starwood Hotels and Angbang deal that went awry. Do you think such concerns are valid?
The concerns are valid. In dealing with firms from a very lightly regulated economy, where you have companies that are not accustomed to doing transactions sin the type of environments you find in the U.S. or Europe, you definitely have reasonable grounds to be concerned about whether they’ll be able to get through the whole process without getting cold feet or making errors along the way. I think the Angbang-Starwood drama is a perfect example of that. The seller had some concerns all along that they voiced about whether Angbang and its partners knew what they were doing and had full confidence to carry through with their deal. It’s legitimate to ask those questions. On the other hand, there are examples of deals that did go through where the Chinese side figured out how to manage the challenges involved, managed to get the financing done, managed to through the process. Many of the investment happening now are second or third investments by firms that have already successfully run the traps a couple of times. Take Lenovo for example, or CNOOC, all of them have done deals in the U.S. and Europe. So once they gotten through that a couple of times, a lot of those questions tend to become more acute.
What should China’s policy be towards outbound FDI, and do you think Beijing’s concerns about capital flight and forex reserves will influence their approach?
This is a very complicated questions. On the one hand, these are two totally separate policy issues and concerns for Beijing. Beijing has to be concerned about overall balance of payments stability as any country needs to think about that, and how it’s monetary policy decisions affect its balance of payments. On the other hand, going abroad for most of these Chinese companies is not optional. For certain Chinese companies, well over 50% of their revenues are global. For a lot of Chinese construction services companies, like Zoomlion who has been in the news recently looking at a U.S. company called Terrex as a potential target. The construction market in China is slowing down very rapidly for what they traditionally do. China can either put outbound investments on ice and say, “well, we’re a little bit worried about capital flight right now and balance of payments issues, so we’re going to ask you to cool it for a couple of year.” If they do that, they are putting their competitiveness in severe peril I would say. And so you can’t have it both ways. What Beijing needs to do is address the more fundamental structural reasons for that capital flight, so that China can both permit countries to go abroad when they legitimate business motivations to do so and expect to have a reasonably stable balance of payments position.
Graph Source: BEA, MOFCOM
Featured Image Source: By Richter Frank-Jurgen [CC BY-SA 2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons