Chinese outward investment: More opportunity than danger

There can be movement among dollar assets, however, particularly from U.S. government assets to the private sector. One hundred billion dollars seems like a huge amount, but it is not especially large in terms of China’s current American bond holdings. Such a shift would even be fairly easy to implement for the PRC, given the concentration of investment in state entities. The question is whether the U.S. will permit it.

What should China be able to buy?

There are factors weighing against a huge increase in Chinese purchases of private American assets. The PRC effectively self-imposes some restrictions. From the U.S. perspective, national security–related technology is off the table. That leaves finance, resources, and manufacturing, broadly construed.

Finance.The PRC has already invested extensively in the American financial sector with no problems beyond conventional market fluctuations. Market conditions will determine future spending.

Energy. The U.S. has a great deal of coal and gas. The CNOOC–UNOCAL fiasco suggested to the Chinese side that no resource investment would be permitted. This was an overreaction, and in late 2010, CNOOC proceeded with a multibillion-dollar shale investment with Chesapeake Energy. While large, this crucially involved a minority stake and met no objection. More investment will follow. It should be done carefully, since the PRC has been shown vulnerable to the countercharge that American companies cannot freely invest in China’s energy sector.

Land. Land itself is a possible investment target. Individual Chinese have bought personal property in various American cities, a phenomenon that is very likely to continue. The PRC has struggled to buy large tracts of land for agriculture in many countries, but the U.S. is arguably the most land-rich country in the world and will likely be more accepting. A remaining problem is that most Chinese agriculture enterprises are uncompetitive. Joint ventures with American companies may be helpful.

Manufacturing. Most of the confusion surrounding Chinese investment in the U.S. stems from manufacturing. Some manufacturing investments, such as AVIC in auto parts, proceed quickly and uneventfully. Others, such as Anshan in steel, become controversial and suffer delays. There is no apparent logic to what is permitted and what is not, and the process by which some transactions are delayed is extremely murky.

Technology. In technology, the U.S. has both a policy position and a formal review process centering on the Committee on Foreign Investment in the United States (CFIUS). With respect to manufacturing, there is no policy stance, and the review process can become driven by politics in unpredictable fashion. This is a flaw in the American investment environment that should be fixed. Reviews of Chinese manufacturing investment should be quick, clear, and typically grant approval as long as specific security issues are not involved.

On the PRC’s side, dramatically greater transparency is needed. Fraud inquiries into stock exchange listings of China-based firms are dangerous with respect to access to many foreign markets, not just the U.S. More important are direct subsidies provided by effective transfer of foreign exchange from the government to acquiring firms, usually in the guise of loans that are closer in nature to grants.

State firms will not acknowledge these or the huge internal subsidies that are provided through regulatory protection, free land, cheap energy, and so on. This is a difficult issue even in government-to-government talks. For inward investment, some subsidies benefit the U.S. by boosting the prices that Chinese entities are willing to pay American asset holders. Indeed, the PRC overpays for many of the assets it acquires.

However, subsidies also matter to post-acquisition behavior, giving Chinese firms the potential to distort American markets. U.S. competition laws and regulations need to be able to prevent such distortions and must be stringently applied. It is incumbent upon Chinese firms to be well prepared and willing to comply fully with all laws and regulations. Failure to do so will not be reasonably excused by claims of sovereign compulsion or other poor defenses offered to date and will properly result in severe penalty.

How the U.S. should react to Chinese investment