Economic dynamics are driving companies to sow their seeds in foreign fields

China's outward foreign direct investment has risen greatly in recent years, and this is likely to bring large benefits to the country.

The Ministry of Commerce says net outward FDI flows were worth $68.81 billion (55.7 billion euros) in 2010, almost 70 times what they were 10 years earlier.

But as Chinese FDI has grown, so have the misconceptions about it. If these go uncorrected, they are likely to hinder the growth of such investment, to the detriment of both China and the countries to which the investment flows.

Some people think that underlying Chinese FDI is a political base, one carefully put in place by the Chinese government. That is not so.

The rapid growth of Chinese FDI has been forged by nothing more than the dynamics of economic law. When China was opening up to the world in the 1980s it faced a serious problem, one that involved two deficits: one of domestic savings and one of foreign exchange. Regulating outward FDI was seen as an effective way of preventing those deficits from growing.

As China's economy developed and its foreign exchange reserves rose, the two deficits developed into two surpluses. The Chinese government thus needed to adjust economic policy and began to relax controls on outward FDI. In essence, this was done in three ways: encouraging Chinese companies to go out into the world; relaxing strict approval procedures; and reforming the management systems that govern FDI.

The rapid growth of Chinese FDI is also a result of a relatively stable world. Although there have been wars and conflicts, these have essentially been regional, so the conditions have been favorable for China's FDI to grow.

The 2008 global financial crisis helped with this. During the crisis some countries lowered barriers to foreign investment in many industries, hoping to ward off recession. At the same time, many countries adopted trade protectionism, and the method that Chinese companies used to get around this was direct investment. In 2007 Chinese outward FDI was worth $26.5 billion and after 2008 it almost doubled, to more than $50 billion.

In addition, along with economic growth, China has ample foreign exchange reserves, which have created the conditions and the impetus for its FDI. Chinese foreign reserves were worth $3.2 trillion last year, compared with $165.6 billion in 2000.

Some have suggested that what drives China's FDI is its desire to get its hands on the energy and resources of other countries, but this is simply not so.

Chinese FDI covers many industries that provide goods and services that enlarge consumer choice, which has nothing to do with national security.

Mining comes only third in a ranking of Chinese FDI, and this is because of the role the country plays in the global production chain and the structure of the international energy and resource market. The world's mineral resources are rich but unevenly distributed, and in the past few decades China has rapidly become involved in the regional and global production network. Indeed, the country has become a veritable factory for the world, producing a variety of products for global consumption. China's own natural resources are insufficient to satisfy its huge demand as a factory for others so it needs global energy resources to maintain the stability of global supply.

However, the supply and pricing of global resources and energy are controlled by just a few companies, and there is a tendency to politicize the issue. International capital markets and financial derivatives also target energy resources. Because of increasing speculation, the prices of energy resources have not adhered to the laws of supply and demand and have grown increasingly volatile. To reduce fluctuations in and uncertainty of international energy prices, Chinese enterprises have leveraged FDI to create joint ventures, make acquisitions or buy shares in companies involved in overseas energy and resource exploration, development, and production.

Some people say Chinese State-owned enterprises are the agents of the Chinese government, ergo FDI by Chinese SOEs is unacceptable. This is a misconception. True, SOEs account for the bulk of Chinese FDI - 66.2 percent in 2010 - but there is a legitimate reason for this: the uneven development of Chinese enterprises. But thanks to reforms, Chinese SOEs have improved how they work and what they produce, thus becoming more competitive internationally. The resulting strength of the SOEs has greatly enhanced their multinational operations and their capacity to expand globally.

The idea that the SOEs are under the thumb of the Chinese government and march to its tune is a fallacy. The government has no hand in the operations of such companies, and most SOEs have undertaken shareholding reforms and have diversified their ownership.

It should be noted, too, that the operational goals of the SOEs are no different to companies anywhere else: They need to turn a dollar, so the competition between them is fierce, and the pressure to expand is strong. In the end, where the SOEs invest or what they invest in is up to them, not the Chinese government.

China's private enterprises, especially small and medium-sized ones, suffer from a widespread lack of core technology, innovative capacity and management talent. Because the domestic market can meet the profit needs of Chinese SMEs' development, these companies lack the motivation to invest outward.

In Chinese FDI, especially investment in Africa, some people see ulterior motives that have a neo-colonial hue. Once again, this is plain wrong. Figures show that Asia and Latin America are the main destinations of Chinese FDI. True, investment in Africa has grown rapidly in recent years, but it accounted for just 4.1 percent of the total Chinese outward FDI in 2010. What's more, investment in Europe and North America has also been rising.

In 2010 Chinese FDI in Asia totaled about $228 billion, 72 percent of Chinese FDI; in Latin America the figures were $44 billion and 13.8 percent; and in Europe $17.7 billion and 5 percent.

That geographical distribution reflects China's economic development, FDI essentially following this sequence: countries and regions at the same level of economic development, neighboring countries, other developing countries, and finally developed countries.

Chinese FDI has mostly targeted developing countries because Chinese enterprises are as yet ill equipped to compete with the enterprises of developed countries. In addition, developing countries also need China's capital to develop their own economies, and have gone out of their way to court Chinese investment.

Some people see Chinese enterprises as predators in mergers and acquisitions that, they say, have a sole beneficiary: the Chinese companies. This again is wrong.

The number of cross-border mergers and acquisitions has soared in recent years, accounting for 18 percent of total FDI in 2003 and 43.2 percent in 2010. Mergers and acquisitions offer an effective way for an investing company to work with a target company on technology, brand and sales channels, so there is little doubt that cross-border mergers and acquisition investments of Chinese companies will become even more prevalent.

What is fueling this push for this type of investment is a desire by Chinese companies to streamline and improve their structures, thus improving their competitiveness.

The author is an associate professor at China Center for International Economic Exchanges in Beijing. The views do not necessarily reflect those of China Daily.

(China Daily 08/24/2012 page9)