Stockholm China Forum

June 2011

Paper Series
Chinese FDI in the United States and Europe: Implications and Opportunities for Transatlantic Cooperation
by Thilo Hanemann
Issues such as trade, exchange rates, market access, and enforcement of intellectual property rights have long dominated the economic policy of the United States and Europe toward China. Beyond this familiar laundry list, a new topic is emerging: Chinese direct investment in the United States and Europe. Chinas outward foreign direct investment (OFDI) has been growing fast for the past decade but flows to developed economies were very limited. Now Chinese direct investment in Organisation for Economic Co-operation and Development (OECD) countries is taking off and flows to America and Europe are poised to grow substantially over the next decade. The heated reactions to recent Chinese investments illustrate that the United States and Europe are not yet ready for the coming surge of FDI from China. Policymakers urgently need to address related questions and formulate a coherent response. As the United States and EU member states are facing similar challenges from rising Chinese investment, there are plenty of opportunities for greater transatlantic cooperation. An Inflection Point for Chinese FDI in the United States and Europe China started investing overseas in a big way in the mid-2000s. Outward FDI flows grew from an annual average of below $3 billion before 2005 to $20 billion in 2006 and to more than $50 billion in 2008. After a slight crisis-related drop in 2009, Chinese OFDI hit another record in 2010 with flows of more than $60 billion, lifting Chinas total global OFDI stock to $310 billion. However, this early investment boom was almost entirely concentrated on developing countries and a handful of resource-rich OECD economies such as Australia or Canada. Chinese forays to invest in the United States and the EU were few and far between. Since 2008/2009, that story has begun to change. A new dataset that allows a real-time assessment of FDI flows shows that Chinese direct investment has taken off in both Europe and the United States (Figure 1). China still accounts for only a tiny share of the total foreign investment in the United States and Europe, but an upward trend is clearly underway. Direct investment by Chinese firms in the United

Summary: Chinese direct investment in Organisation for Economic Co-operation and Development (OECD) countries is taking off, and flows to America and Europe are poised to grow substantially over the next decade. The change from one-way to two-way direct investment flows will transform U.S. and European economic relations with China in the years ahead and openness to Chinese FDI, and the implications thereof, will become an important topic on the transatlantic policy agenda.

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Figure 1: Chinese Direct Investment in the United States and the EU-27, 20032010
70

60

Total Value of of Greenfield and M&A Deals in the EU, USD mn (RHS) Total Value of of Greenfield and M&A Deals in the US, USD mn (RHS) Number of Greenfield and M&A Deals in the EU (LHS) Number of Greenfield and M&A Deals in the US (LHS)

6,000 14,828* 5,355 5,000

50 4,000

40 3,000 30 2,060 20 1,859

2,307 2,050 2,000

1,196 10 767 397

1,062 590

1,000

689 83 2003 209 2004

208 0 2006 2007 2008 2009 2010

capture the higher levels of the value chain they traditionally conceded to foreign partners, and augment their managerial skills and staff base to remain globally competitive. Developed economies offer the assets, regulatory environment, and workforce that Chinese multinationals are looking for. Other macroeconomic adjustments such as a stronger Chinese currency add to this new momentum. These new motives will boost investment flows into developed economies. The United States and Europe can expect to receive a substantial share of the $1-2 trillion in direct investment that China will place around the world over the coming decade.

2005

Source: Rhodium Group; data for the EU-27 are preliminary only. For a detailed explanation of sources and methodology, please see http://rhgroup.net/china-investment-monitor/sources-and-methodology.html or the Appendix of the report referenced in footnote 1. * 2008 figure includes a $14.3 billion investment by Chinalco to acquire a 12 percent stake of London-listed mining firm Rio Tinto.

States has grown more than 130 percent each year for the past two years. In 2010 alone, Chinese firms spent more than $5 billion in the United States on a combination of 25 greenfield projects and 34 acquisitions. Today, Chinese firms have investments in at least 35 of the 50 U.S. states. The data on Chinese investment projects in Europe show a similar picture. Since 2008, there has been a clear upward trend both in the number of deals and total investment value, albeit less linear than in the United States. By the end of 2010, Chinese firms had investments in all of the 27 member states of the European Union. This new momentum in Chinese FDI into developed economies is driven by the changing commercial realities in the marketplace forcing Chinese firms to look abroad. In the past, the attraction of growth at home overshadowed the lure of overseas opportunities. Outward FDI was mostly limited to securing natural resources and building the infrastructure needed to boost cross-border trade. Now, this reality is receding and the shift in Chinas growth model is forcing firms to upgrade their technology,

The Policy Agenda The change from one-way to two-way direct investment flows will transform U.S. and European economic relations with China in the years ahead and openness to Chinese FDI will become an important topic on the bilateral policy agendas. However, there is no consensus yet in the United States or in Europe on how to deal with higher levels of investment from China and other emerging markets. The five areas outlined below can serve as a starting point for formulating a coherent response to growing Chinese FDI. 1. Defending open investment principles: Both the United States and the EU have long been champions of global investment openness, and their economies have benefitted tremendously from cross-border investment flows in the past. However, the rise of new players will put this consensus to the test. The combination of great economic uncertainty at home and higher levels of investment from China will give domestic interest groups an opportunity to play the protectionist card. Policymakers and pundits must be ready to defend the principle of investment openness. Leaders must be able to separate facts from fallacies, clearly communicate the

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benefits of FDI, and put in place the right policies to alleviate legitimate concerns from potential investors. 2. Competing for Chinese investment: FDI flows from China and other new exporters of capital offer plenty of opportunities for local economies. Policymakers should not only allow but actively encourage such flows. The United States and Europe will be in direct competition for Chinese investment. Both sides will need to ensure that competition does not damage transatlantic relations. In addition, policymakers should move beyond current investment promotion efforts on the bilateral level and jointly assess the potential of new multilateral initiatives and frameworks that encourage south-north investment, strengthen global investment norms, and further cement an open global investment climate. 3. Addressing national security risks: Foreign ownership of assets is a deeper form of economic integration than trade. Chinese FDI deserves particular attention. Not only is it not a military ally, it is also a state with nondemocratice values and an economy with a both a high degree of leverage and state intervention. In addition, China has a negative track record in industrial and political espionage and the proliferation of sensitive technologies to rogue regimes. Given these characteristics, it is indispensable that governments monitor investment from China for national security risks. However, the approaches of developed economies to screening foreign investment for security threats are very different, and a greater degree of coordination is needed. The OECD is leading a debate about the best institutional setup for such regimes, but there is still a lot of work to be done with regard to improving transparency and reducing the risk of politicization. Enhanced dialogue about threat scenarios is crucial as there are clearly different sensitivities in the United States, the EU, and even among the various European governments. Dialogue is especially critical in areas where varying threat perceptions could potentially undermine the other sides vital security interests: Chinese investment in European telecommunications infrastructure or high tech industries, for instance. 4. Identifying economic risks: While there are some economic risks related to FDI, they are generally

Enhanced dialogue about threat scenarios is crucial as there are clearly different sensitivities in the United States, the EU, and even among the various European governments.
dwarfed by the potential benefits for the local economy. The emergence of new players raises the question of whether investment from these countries should be treated differently as a result of the extent of state intervention, firms lack of experience in managing overseas operations, poor corporate governance, and corruption at home. In the case of China, there are concerns about the extent of capital subsidies in the domestic economy, which might undermine fair competition and distort the efficient allocation of capital in world markets. These are legitimate concerns, but there is no consensus on how to approach questions such as defining and identifying unfair capital subsides or measuring their impact on other countries welfare. The United States and the EU should launch a joint initiative to systematically explore common concerns and discuss potential solutions: for example, a global regime that disciplines investment subsidies, akin to the role that the WTO plays in monitoring trade. 5. Assessing political leverage: Policymakers need to think about how they can leverage Chinas new found investment interests in the most productive and beneficial way. The central question is whether or not OECD countries should play the reciprocity game and threaten to deny Chinese investors access to those sectors in which foreign firms face restrictions in China. Although this strategy may sound compelling, it would choke off badly needed investment whilst having very little effect on loosening investment restrictions in China. A threat to impose investment controls would also seriously undermine OECD leadership in its promotion of

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global investment openness, and could further increase protectionist sentiment in an already fragile global economy. While threatening to close our borders to Chinese FDI is not a good idea, there are plenty of areas in which Chinas new investment interests can be leveraged by U.S. and EU policymakers to reach common goals, including Chinas adherence to international investment norms and rules, improvements in Chinas legal and regulatory system, and better corporate governance and greater transparency of Chinese firms. Addressing these questions and formulating a coherent response is not only timely given the fast-growing levels of Chinese investment but also crucial in preparing for a major shift in the structure of global capital flows. Europe and the United States together account for more than 70 percent of todays $18 trillion global OFDI stock, reflecting their dominant position in the global economy. However, their share in global OFDI flows dropped from more than 70 percent in the early 2000s to around 60 percent in 2009. In the same period, the share of emerging economies jumped from 2 percent to 14 percent, reflecting the beginning of a catch up process. China will serve as a test case for how Europe and the United States deal with these new realities in the global FDI arena.
About the Author
Thilo Hanemann is the research director at the Rhodium Group (RHG). His research focuses on Chinas macroeconomic development and the implications for global trade and investment flows. Hanemann works with the private and public sectors in assessing Chinas role in global cross-border investment transactions. He is a frequent speaker and commentator on Chinas outward investment and has published numerous articles on the topic.

About the Stockholm China Forum

This is part of a series of papers informing and informed by discussions at the Stockholm China Forum. The Stockholm China Forum is an initiative of the German Marshall Fund, the Swedish Ministry for Foreign Affairs, and the Riksbankens Jubileumsfond. It brings together policymakers, intellectuals, journalists, and businesspeople from Europe, the United States, and Asia on a biannual basis for an ongoing and systematic dialogue to assess the impact of Chinas rise and its implications for European and U.S. foreign, economic, and security policy.

About GMF
The German Marshall Fund of the United States (GMF) is a nonpartisan American public policy and grantmaking institution dedicated to promoting better understanding and cooperation between North America and Europe on transatlantic and global issues. GMF does this by supporting individuals and institutions working in the transatlantic sphere, by convening leaders and members of the policy and business communities, by contributing research and analysis on transatlantic topics, and by providing exchange opportunities to foster renewed commitment to the transatlantic relationship. In addition, GMF supports a number of initiatives to strengthen democracies. Founded in 1972 through a gift from Germany as a permanent memorial to Marshall Plan assistance, GMF maintains a strong presence on both sides of the Atlantic. In addition to its headquarters in Washington, DC, GMF has seven offices in Europe: Berlin, Paris, Brussels, Belgrade, Ankara, Bucharest, and Warsaw. GMF also has smaller representations in Bratislava, Turin, and Stockholm.