China has just had a birthday party for 70 years of Communist Rule. In that time, millions of people have been lifted out of poverty.
Credit is due. China itself, of course, is much older. It is one of the world’s oldest civilisations and goes back thousands of years. It missed the industrial revolution in the West and is now bent on catching up to restore its place at the world’s centre.
It had been hoped that by its 70th birthday, the Communist Party would be striving for greater balance with other countries moving towards a more open society. Recently it has moved in the opposite direction.
This does not appear to reflect the wisdom for which the Middle Kingdom’s ancestors are famous.
Why? Because after initial enthusiasm for China joining the World Trade Organisation, the West is now in the process of reassessing its attitude to the openness afforded to China.
The trade war is a part of this. Further restriction of Chinese foreign direct investment (FDI) is underway in the West, and countries that have signed up for the Belt & Road Initiative (BRI) are beginning to question the motivations of this supposed new order.
Here are the reasons why;
China is no longer a developing country. It ranks higher than Australia in education (check its PISA scores for maths and science), has more patent applications than any other country, provides 26 per cent of all world investment, is the world’s biggest exporter, has had 1327 anti-dumping initiations against it since 1995 (against 290 for the US), is leading in 5G technology, has income-per-head 55 per cent above the World Bank’s benchmark for “low and middle income” countries, and has invested more in BRI projects than all of the loans outstanding from other official multi-lateral lenders.
A quick look at the table nicely summarises China’s speed. In 2019, it has 117 of the Fortune 500 Global group, an increase of 107 since 2000.
The US has declined to 121 versus 179 in 2000. Most other Western countries have dropped in the rankings.
This speed has been owing to very heavy state-orchestrated saving and investment at home, and financial support for a global strategy to secure supply (food, energy, resources) and international infrastructure to connect it all up.
Similarly, the Made in China 2025 policies aim to acquire advanced technology companies to move further up the value-added chain.
Australia has been a big recipient of both types of Chinese investment. There have been $95 billion worth of corporate transactions since 2005 (ignoring those less than $100 million), including healthcare, energy (including gas, oil, coal, solar), real estate, tourism, entertainment, agriculture, lithium, copper, aluminium, steel, shipping, aviation, rail, technology and banking. What attitude should we and other countries take to these global ambitions?
China’s FDI isn’t needed by rich countries (where asset prices and exchange rates adjust to ensure any flows needed to fill the gap between domestic saving and investment). The structural benefits of openness to FDI for advanced countries lie elsewhere.
FDI promotes competition. Expanded markets permit economies of scale to be taken advantage of. Good companies succeed at the expense of poor ones, promoting productivity.
China, however, does not allow free and open access in the market for corporate control of its own companies, though it expects this for its own investments abroad.
The efficiency mechanism doesn’t work with lop-sided FDI, when subsidised state financial support for investments is present, and when bribery of officials and politicians is involved.
There have been more than 2000 foreign investments above $100 million by Chinese companies since 2005, totalling $US1.2 trillion ($1.78 trillion).
A Perth-based lithium mine was acquired paying 15 per cent more than the last bid of a hard-nosed American company (for the same lease period and production metrics the backed-out discount rate was much lower).
A part monopoly for lithium is being formed alongside that for rare earth: key ingredients of next-phase technology. Significant above-market purchases in other countries include Germany’s Kuka (robotics with commercial and military applications), Syngenta (food security), Omnivision Technology of the US (chips for smartphones), Nexen of Canada (energy), Global Switch of the UK (data centres), and many more.
At the corporate governance level, a mismatch is present. Subsidised state-owned-enterprise (SOE) finance faces no budget constraint.
The discount rate for stock valuations can be reduced to allow the state to take a long view about what it wants to achieve. It can pay a higher price to secure the assets for its global strategy.
Private investors can’t compete fairly, and boards can’t refuse high offers in the absence of regulatory intervention. This is because boards have a fiduciary duty towards shareholder value.
It is not the role of the private sector to look after the national interest and counter that of a foreign state. This is the role of our governments and they need to enforce it strongly.
In developing countries, China has “won” 1650 construction (above $US100 million) contracts, mostly for its BRI projects, totalling $US1.1 trillion since 2005. These concern government-to-government transactions or notionally private companies backed by SOE banks to achieve the new order.
The stories of the ports of Hambantota in Sri Lanka and Myanmar’s Kyauk Pyu and Madae Island facilities are instructive. Debt “diplomacy” is the key moving part. Non-concessional loans can’t be serviced so equity ownership of the asset is agreed, and loss of sovereignty over strategic assets follows.
Bribery & Corruption
Bribery and corruption are strongly associated with SOE companies. Procurement processes are not open and transparent (Chinese construction companies win the contracts if state finance is involved). Nor is the distinction between private and state companies very clear.
The way “Private” CEFC bought assets in the Czech Republic but is now owned by a Chinese SOE is one of many examples of debt-equity switches and alleged corruption.
While the Chinese model was useful in the early phase of development, doors in the rest of the world are now beginning to close and things are falling apart economically at home. It is perhaps time to draw on those thousands of years of Chinese wisdom:
“…and when I was 70 I had the freedom to do whatever my heart desires, within the rules of this world”, said Confucius. Committing to a more open society and global rules would help China.
Until then, it’s worth remembering that if we don’t want the government owning our companies, why on earth would we want those linked to non-democratic foreign governments doing so?