China’s US Investment: A State Of Attraction

With the ‘Phase One’ US-China trade deal due to be signed on January 15, our man in Tokyo alerts us to a timely article in the Nikkei Asian Review. It examines the continuing Chinese investment in US agricultural and manufacturing states that could be considered Trump heartland, despite Washington’s general chilling of inbound direct investment from Chinese firms.

These are ‘Red’ states where the US president was successful during his 2016 election campaign in blaming China for their economic ills, but equally where Beijing’s retaliation to his tariffs on China’s exports have caused the most pain and thus where Trump’s bid for re-election in November risks coming unstuck.

The article highlights a disconnect between attitudes towards China at the federal and state government level. Many state governors, including Republican ones, have pursued inbound Chinese investment on the basis that any jobs, even Chinese-owned ones, are better than none. They have made a pragmatic peace with the Trump administration’s economic hawkishness towards China and its continuing appeal to the president’s electoral base.

The other lessons from the article are that it provides a further example of how difficult decoupling the US and Chinese economies is, and of why domestic US electoral politics weigh heavily in Trump’s trade calculations — as they always have done.

The Costs Of China’s Over-Investment

Most economists and policymakers agree that infrastructure investment more than exports drove China’s double-digit growth over the past decade. It is not an uncommon development path for emerging economies that do not rely on natural resource exports. China’s sheer scale makes it look an unique achievement, and it is, but in quantity rather than kind. Now close to 50% of GDP, investment is 10 percentage points higher on that measure than the ratio typical of Asia’s emerging economies in the run up to the Asian financial crisis.

The scale of China’s domestic savings has, however, let the country run such high levels of investment without becoming reliant on external funding. This has let it avoid what tripped up so many other emerging economies going down this path, not just Asian nations in the 1990s but even more painfully Latin American ones in the 1980s, a banking and/or foreign exchange crisis once foreign investors start to question the returns on their capital and realize that the cost of financing such high rates of investment had been mispriced.

It has not, however, let China avoid the underlying questions of whether the return on its capital spending is sub-par, and, if it is, whether that is distorting the cost of capital to the detriment of the broader economy and Chinese as a whole. A recently published IMF working paper, with the refreshingly to-the-point title, Is China Over-Investing and Does it Matter?* addresses those questions head on. In short, its answers are yes and yes.

That China hasn’t hit an external debt crisis, say the authors, Il Houng Lee, Murtaza Syed, and Liu Xueyan, the first two from the IMF’s China office, the third from the National Development and Reform Commission,

does not mean that the cost is absent. Rather, it is distributed to other sectors of the economy through a hidden transfer of resources, estimated at an average of 4 percent of GDP per year.

The burden of that cost, the authors believe, falls on households and, to a lesser extent, small and medium sized enterprises. The financial system effectively makes them subsidize the main vehicles of investment large, state-owned enterprises (SOEs). In other words, social welfare could be improved by increasing consumption at the expense of investment.

Meanwhile, China now requires ever higher investment to generate the same amount of growth. Absent a dramatic surge in productivity rates or exports, the authors estimate that investment would have to account for 60%-70% of GDP to sustain current growth rates. That would be both expensive and dangerous in terms of the potential threat to domestic stability.

It also suggests that, as most economic policymakers if not all within the Party recognize, the current growth model has run its course. Investment growth has to be moderated and consumption promoted. The policy implications for the new leadership, which has a more traditional SOE-centric state-capitalist cast of mind than the outgoing one, are self-evident.

*Is China Over-Investing and Does It Matter? By Il Houng Lee, Senior Resident Representative, China office, IMF; Murtaza Syed, Deputy Resident Representative, China office, IMF; and Liu Xueyan, Senior Fellow, Institute of Economic Research, National Development and Reform Commission of China. IMF Working Paper No. 12/277.

The Long Dark Shadow Of A Sharp Slowdown Of Investment In China

The effect of China’s slowdown on the growth of Asian countries that have come to constitute its supply chain is well known. Less attention has been paid to the potential impact on capital exporters such as Germany, South Korea and Japan. The IMF spillover report published last month finds the impact could be significant in cutting growth in all three countries, and notably Germany.

The Fund’s annual spillover reports examine the external effects of domestic policies in the five key economies, China, the Euro Area, Japan, the U.K. and the U.S. While the risks of financial shocks and the global lack of demand are primary focuses, the report also looks at policy risks, which in China’s case are China growth and rebalancing. It notes the progress in adjusting the exchange rate and reducing the current-account surplus. But warms that “the adjustment investment-led in an economy with already high investment rates, an abrupt reversion could yield negative spillovers”.

The charts, taken from the report, assume a sharp reduction in investment, not the gradual one, accompanied by a switch to greater consumption that is a key policy goal for Beijing. The first pair are based on a simple regression analysis, the second pair on more complex factor augmented vector autoregressions, which also include second and third round effects, as highly open economies like Germany’s are hit not only directly but also via the hit to their own trading partners.

Contribution of investment in China to Germany’s exports.

The third chart looks at the contribution of China’s investment to Germany’s exports specifically.

The final pair of charts look at real estate investment, which accounts for a quarter of all investment in China and whose managed slowdown has been a policy priority for Beijing. That a sharp 1% slowdown in investment in Chinese real estate could knock upwards of 0.5% off real GDP growth in Germany, South Korea and Japan and have smaller but not insignificant impacts in Europe and the U.S. makes for sobering reading.

Hu Woos Warily Welcoming Africa

China is giving the triennial two-day ministerial Forum on China-Africa Cooperation in Beijing the full-court diplomatic press. President Hu Jintao, seen above addressing the gathering against a backdrop of African flags, promised to have doubled China’s credit lines for African governments to $20 billion by the time the meeting reconvenes in 2015. The idea is to reinforce the notion that the Beijing consensus model of development is better for the continent than the Washington one.

Many African leaders have sufficient concern about Western development aid, with its baggage of conditionality and legacy colonial perceptions, to make Beijing a preferred partner on large-scale development projects. But it is a pragmatic choice, not unalloyed affection. Chinese investment is concentrated in natural resources and infrastructure construction (and in a relatively few resource-rich African countries), while cheap Chinese manufactures and workers flood in. That raises concerns among African policymakers that China’s trade and investment doesn’t necessarily boost the continent’s overall capacity and competitiveness or its intra-continental trade. Growing popular unease over Chinese insularity, labour practices and immigration has led to local violence on several occasions from Algeria to Zambia.

Aware that it has an image problem, Beijing is countering these concerns with a diplomatic charm offensive, and, inevitably, a five-point plan. Hu promised to diversify and rebalance China’s Africa trade and investment, and to create more local jobs by supporting African manufacturing. This Bystander, for one, will believe it when he sees it.

A Glittering Year For China’s Gold Bugs

Demand for gold in China shot up by 20% last year, according to the World Gold Council’s latest Gold Demand Trends report. Some of that reflects a long-standing Chinese affection for the metal; some a newer obsession with all things conspicuously luxurious. The Council says Chinese consumers bought 510.9 tonnes of gold jewelry in 2011, worth $25.8 billion and a 13% increase over the previous year (the global market shrank 3%). China surpassed India as the world’s largest market for gold jewelry in the second half of last year, the Council says.

The fastest growing demand for the metal in China came from investors, however. Only a slither of that is likely accounted for by the People’s Bank of China. Globally, central banks more than quintupled their net gold buying last year from 2010’s levels, to 439.7 tonnes, to diversify their foreign exchange reserves and reduce exposure to the travails of the two main reserve currencies. However, China’s is not among the eight central banks the Council names as prominent official buyers, with Mexico and Russia’s accounting for nearly half of net purchases.

Instead it was individual Chinese, now able to buy more easily through both the official exchange in Shanghai and unofficial exchanges in other big cities, that were the driving force behind China’s investment demand in 2011. In a year that saw the gold price hit a record of $1,895 an ounce in September before falling back, consumers bought a record volume of 258.9 tonnes of gold bars and coins, worth $12.9 billion, up 38% on 2010’s purchases. Domestic investors saw gold both as a traditional hedge against the year’s high inflation and as a better alternative than stocks, property or cash savings in an uncertain year. The appreciation of the currency meant the metal’s price rose by only 4.3% in yuan terms over 2010 compared to its 8.9% rise in dollar terms.

With the gold price pulling back 15% from its record high, authorities cracking down on illegal trading and inflation moderating, will China’s gold bugs be as bullish in 2012? “Signs of economic slowdown in China, and the increasing maturity of the market, are likely to result in a deceleration of recent growth rates, evidence of which was already coming through last quarter,” the Council warns.

China’s Diplomatic Push For Its Foreign Direct Investors

Prime Minister Wen Jiabao’s European tour provides a foretaste for the sort of diplomatic push in support of Chinese investment in developed countries that is only likely to increase over the next decade in line with Beijing’s extortion to Chinese companies to “go global”. While the headlines of Wen’s visit to Germany in particular were taken by the deal intended to grow two-way trade to $280 billion by 2015, it is the mostly overlooked agreements on growing investment, struck on the other two stops on his trip, Britain and Hungary, as well, that matter more to Beijing.

Access to natural resources is the driving force behind Chinese companies’ foreign direct investment (FDI) in developing economies, but in developed nations they are looking to buy commercial assets, particularly those that can provide value-added services, brands, management and technological expertise, raising local concerns about the influx and calls for more controls to regulate it. In the U.S. in particular, where protectionist sentiment is ever lurking in the legislature, there are competitiveness concerns about technology transfer, especially if it has military application, subsidies to state-owned banks, noncommercial motivations of state-owned companies, and the routing of Chinese FDI via third countries such as Hong Kong and tax havens to disguise its origin.

China’s outward FDI , at 1% of the world’s total, lags its share of global trade (8%), but its annual flows are growing rapidly. It hit $59 billion last year, up from an average of $3.8 billion in 1995-2005. Given the size of China’s foreign exchange reserves and the growth rates of its economy, $1 trillion of FDI could come out of China over the next 10 years. Hence the diplomatic push to forestall the erection of further barriers to Chinese trade and investment and to dismantle those that already exist. Some of this is done by signing bilateral trade and investment treaties like the ones struck on Wen’s visit, and some through multilateral organizations such as the G20. It seems inevitable that Wen’s successor will be doing a lot of globetrotting to pave the way for more Chinese investment in developed economies. There is going to be a lot of it.

Five Principles For China’s Miners In Africa To Live By

Ngozi Okonjo-Iweala (left) is not only a managing director of the World Bank but also a former Nigerian finance and foreign minister. Thus she brings a singularly well positioned perspective to the controversial question of Chinese investment in Africa, and particularly investment in the extraction of the continent’s natural resources.

Speaking to a mining industry conference in Tianjin, she outlined five principles to create what she described as a mutually beneficial and lasting marriage between Africa’s investment needs and resources and China’s interest and demand. (Full text of speech.)

More than 1,5000 Chinese firms are now estimated to have set up shop in Africa. Given the contentious nature of some of their operations, including those from Algeria to Zambia that have caused a local backlash that has on occasion turned violent, Okonjo-Iweala laid out a set of recommendations that bluntly address the most frequently leveled criticisms of Chinese companies operating in Africa.

1. Make investments consistent with national development priorities.

Above all, this means to create jobs locally. The only labor brought in from outside must be those people whose skills are clearly missing in a country.

2. Practice transparency.

In the event of problems with the population or government, you want recourse to adequate legal support to resolve the issue. That can’t and won’t happen if transactions are mired in secrecy. You need to let the people know the scope and broad terms of your engagement. If the public doesn’t know what you do, they will turn against you as they do not see the benefits of the investment or when accidents happen.

3. Support the development of a value chain.

Mining companies should not just come in to extract natural resources in a raw form and ship them away. This is colonial history. Today, they should establish some degree of processing adding value to the raw materials. This creates employment, develops skills, and leads to more buy-in from the local people.

4. Pay what is due and do what is right.

Investors must pay taxes and avoid falling into well known tax evasion techniques such as transfer pricing or bribes to a few high level officials. Bribe paying is not only abhorrent but is counterproductive in the longer term. Many developing countries need tax revenue to invest in their people – a move which will lead to easier investment for you, but for that to happen, you must pay your proper taxes and royalties.

5. Engage with local communities and communicate your values.

Ensuring workers and community safety is an important part of this agenda. Mining companies must operate with the highest safety and environmental standards. It is your company’s reputation at risk if you ignore these standards. You must adhere to them and seek to establish them.

These amount to a decent set of best practices for any foreign direct investor anywhere. When it comes to Chinese investors in Africa, though Okonjo-Iweala didn’t explicitly say so, we suspect that her five principles are now mostly honored in the breach — which, of course, would be precisely the point of stating them.

China Takes Another Step To Internationalise The Yuan

The decision to broaden foreign banks’ access to the $2.9 trillion domestic interbank bond market is part of China’s attempt to internationalise its currency. The People’s Bank of China says foreign central banks, lenders in Hong Kong and Macao that already clear yuan and foreign banks involved in cross-border yuan trade settlement have been invited to join a pilot project to “encourage cross-border renminbi trade settlement” and “broaden investment channels for renminbi to flow back”. The goal is to cut China’s dependency on the U.S. dollar for trade and to promote the yuan’s standing as a potential reserve currency.

Less than one fifth of one percent of China’s foreign trade is denominated in yuan. If foreigners are going to use the yuan more widely, trade alone won’t do it; they have to have somewhere to invest in yuan. So for the first time non-resident firms will be able to buy and sell yuan-denominated government and corporate debt directly (there is already limited ability to do so indirectly via exchange-trade securities). There will, however, be quotas on volumes. How quickly those are expanded will be a measure of of how well the central bank thinks the experiment is going.

Slowly Spreading Jam

The latest Strategic Economic Dialogue meeting between China and the U.S. has concluded with a long study list for the two governments and few parting gifts from Beijing in the form of more financial markets opening.

Foreign firms will be allowed to invest again in domestic securities companies, though a cap of a maximum 33.3% stake will stay in place for a while. However, Beijing said as long ago as May that it would resume licensing securities joint ventures later this year after a two-year hiatus. Foreign banks and other companies that do business in China will also be allowed to issue debt and equity in the domestic markets if the capital raised is to be used for expanding their Chinese businesses.

What the Americans didn’t get was freedom for foreign companies to take bigger stakes in Chinese financial firms and for Chinese-foreign joint ventures to be allowed to undertake a wider range of businesses. That is jam being held back for tomorrow.

In a little dig reminiscent of the product safety row between the two countries, Zhang Xiaoqiang, vice head of the National Development and Reform Commission, China’s top economic planner, called on the U.S. to be more open to Chinese investments and to clarify which parts of the economy were off-limits to foreign investors on national security grounds. Under new U.S. legislation that came into force in October, foreign investments in infrastructure and high-tech and those coming from foreign state-owned enterprises face intensified review. Zhang identified the chemical, medical, mechanical, space and electronic businesses as areas where Chinese companies were interested in investing, but clearly feel they will face discriminatory scrutiny.