2 October 2014

China: The Next Major Investor in American Markets?

September 29, 2014


"We should be ready to welcome Chinese investment as it grows to European levels, while remembering to review its origins from an enduringly statist system of politics."

American and Chinese negotiators are hard at work on a Bilateral Investment Treaty (BIT), the next step in closer, more productive relations between the world’s two largest economies. While U.S. negotiators have rightly focused on improving access for U.S. firms to Chinese markets, policy makers should not lose sight of the growing importance of Chinese investment here. Just a few years ago, Chinese foreign direct investment in the United States was measured in tens of millions of dollars, but that inbound capital has now progressed well into the billions, a trend expected to continue. Yet while foreign investment in the United States is almost always seen as an unambiguous good—shoring up domestic operations of existing businesses or spurring the creation of new jobs and capital—many view this new development with caution, if not outright suspicion.

When Toyota invested in Tesla’s advanced battery operations in 2010 and launched a joint-development deal 2011, it was seen as a critical validation for a company that is quickly becoming an iconic American brand. InBev’s acquisition of Anheuser-Busch bruised the patriotic pride of some, but there was little sense of social dread about a change in ownership. Investment from China, in contrast, is viewed with a more jaundiced eye. Smithfield Foods, an American meat-processing brand for more than seventy-five years, was recently purchased by Chinese agricultural giant Shuanghui Group. Few worry that Japan plans to derail American electric car technology or that Belgium is plotting to destroy the U.S. domestic bar and pub industry. Yet at a meeting of the Senate Committee on Agriculture, Senator Debbie Stabenow warned, “we need to evaluate how foreign purchases of our food supply will affect our economy broadly.” Is foreign investment from China really different and deserving of more scrutiny than investment from other countries?

Put simply, yes.


In China, the role of the state and the Communist Party looms large. Because of their influence, Chinese companies operate in a legal, political and economic framework very different from our own or those of many of our largest trade partners. Giant state-owned enterprises (SOEs) were the initial pioneers of China’s early economic boom and still command impressive market positions to this day. These companies, whose top officials are appointed by the Chinese Communist Party, sometimes spent those early years acting as instruments of state policy, prioritizing strategic incentives over market-based ones. As a result, some investment projects were intended to strengthen Beijing’s ties to Hong Kong or to cultivate allegiances in the developing world, rather than to make money. Later, China sought to protect SOEs from foreign competition and create domestic champions in key industries. The Chinese government heavily subsidized SOEs or used policy measures such as investment approval to advance its nonmarket goals. Recent Chinese export restrictions on rare-earth metals, over which state-owned Baotou Steel holds a near global monopoly, are a prime example. While these restrictions are certainly protectionist, they could also be seen as asserting national control over a strategic asset: rare earths are crucial components of advanced technology manufacturing, such as that practiced by countries like the United States and Japan.

These kinds of behaviors are why Chinese investment should be viewed differently from that of Japan or Belgium; when the companies doing the investing are closely tied to a government considered a geopolitical rival, their actions warrant extra scrutiny. The Committee on Foreign Investment in the United States (CFIUS) exists to provide that scrutiny. Charged with reviewing foreign transactions with potential national-security implications, CFIUS approves the vast majority of the cases that come before it. However, the operations of state-owned enterprises likely receive close attention from CFIUS, because the sheer size of such firms may make them capable of manipulating strategic assets and resources if their state owners so wish it.

While CFIUS certainly should monitor such threats, their likelihood seems to be diminishing. As the Chinese economic system liberalized and grew in the 1980s, state-owned enterprises became more numerous and more responsive to economic forces (though many subsidies persisted). Market goals began to reach at least parity with state goals, though basic materials and resource extraction remained the hallmark of early Chinese outbound investment. Scholars like Kevin Cai found that, by the 1990s, most state-owned enterprises were reliably prioritizing market goals more highly than state goals. That said, a large portion of Chinese economic activity abroad remained dominated by these subsidized institutions of the Chinese state.

As China’s private sector develops, however, private Chinese firms are beginning to play a larger overseas role. According to data gathered by the Rhodium Group, over the last two decades the total value of Chinese private-sector investment in the United States has expanded substantially, matching or exceeding that of state-owned enterprises. Since the year 2000, government-owned investment in the United States has topped $18 billion, while smaller but much more numerous privately owned companies have invested almost $22 billion.

The rise of Chinese private-sector investment has numerous positive implications. Less likely to be subsidized by the Chinese government, private companies are forced to act in more predictably market-oriented ways. They have demonstrated a qualitatively different set of market aspirations than their state-owned counterparts. The Rhodium Group’s Thilo Hanemann and Daniel Rosen described the boom in Chinese investment in American high-tech sectors as driven largely by private Chinese companies. Because high-tech investments frequently center on building human capital and expertise, these investments are not easily acquired and then moved overseas. Chinese investments in high-tech areas are also substantially more likely to be greenfield projects—creating entirely new businesses and jobs—than other types of investments. Seventy-one percent of Chinese high-tech investments are greenfield projects, mostly in California, where 90 percent of those investments are being made by private Chinese firms.


The increasing share of investment from private Chinese firms is certainly a positive development for the United States. Such firms are more likely to create new jobs, less likely to distort their markets due to sheer size, and generally compete on a level playing field. However, smaller, private firms may bring their own national-security concerns—Shuanghui Group’s investments are still not quite as anodyne as Toyota’s. Private Chinese firms may still become tools of the state because China lacks a robust rule of law to protect them from government pressure. The smaller size of private firms and their focus on technology and business over resource extraction and basic materials make their actions less likely to distort entire markets or industries. Nevertheless, foreign intelligence concerns and intellectual-property theft are still greater risks than if that investment were coming from Belgium.

The very attributes of private Chinese companies that make them more desirable than large, state-owned enterprises may also bring some unique disadvantages. By operating for so many years on an international scale and with complex supply chains, many state-owned enterprises have thoroughly adapted to global financial norms and are accustomed to local compliance procedures. Smaller, private companies may run afoul of regulatory and governance expectations simply through ignorance. American trade and investment offices in Chongqing and Shanghai have found tremendous interest among small, private Chinese investors. These offices also discovered, however, that many have no idea how to even begin moving their capital out of the country, much less build a business overseas in a way compliant with local laws and norms.

The smaller and more dispersed nature of private Chinese investment ensures that no one firm can distort local markets the way a larger enterprise might, but overseeing compliance and preventing fraud may require greater effort beyond the scope of CFIUS reviews and the language of a BIT. For example, the EB-5 visa program, also known as the “immigrant investor visa,” has become a favorite of Chinese businesspeople. The program, providing provisional permanent U.S. residency status for up to 10,000 foreign nationals a year for investments of at least $500,000 (and ostensibly creating at least ten jobs), has traditionally been a favorite of overseas oligarchs. While originally largely consisting of European investors, EB-5 visas have in recent years been completely overtaken by Chinese applicants. Last year, 6,895 were granted to Chinese investors—the next closest country was South Korea, which fielded 364.

Surveys and domestic reporting suggest wealthy Chinese applicants to this program may not be driven by long-term U.S. investment opportunities, but by an urgent desire to escape urban life in China. The country’s choking pollution, inadequate education system, and political and legal uncertainty leave many of China’s first generation of wealthy citizens concerned for the well-being of their families and their assets. Polling from Shanghai’s Hurun Report has found that as many as 64 percent of China’s rich have either left the country or plan to emigrate as soon as they can. $500,000 is cheap for a healthy environment, an American education and access to Western financial institutions. This rush to leave China—or at least to have an escape option—has transformed the EB-5 from a lightly used and obscure program into an overwhelmed and backlogged one overnight. More data on the validity and viability of the investments these visas create is needed to determine if we are indeed getting a vital boost to employment and capital or simply a collection of front companies facilitating the sale of American residency.While these concerns may sound daunting, they should not overshadow the considerable value of increased commercial exchange between the United States and China. Greater collaboration between the world’s two largest economies could bring better lives to vast numbers of people. While hundreds of millions of Chinese have moved out of poverty thanks to foreign capital, Americans also stand to benefit from growing investment from China. For each story covering the opening of a new Chinese-owned Silicon Valley research center, there are also instances of blighted post-industrial towns being revitalized by the arrival of Chinese factories that put rural Alabamians back to work. Creating virtuous cycles of mutually beneficial trade and investment will not only benefit these two countries, but will also be an important supporter of global prosperity. Moreover, the more interdependent the United States and China are, and the more contact and exchange that takes place, the less likely the two geopolitical rivals are to come to blows. U.S.-Chinese commercial collaboration can help bring both peace and prosperity.

A properly negotiated Bilateral Investment Treaty has the potential to help achieve these goals. However, the formal language and scope of such a treaty is not sufficient to achieve U.S. objectives. U.S. policy makers should not only seek expanded opening of Chinese markets to American firms, but also shape incentives and provide support for Chinese firms to continue investing and acting responsibly in American markets. Strategies to do so should include:

· Negotiating a model bilateral investment treaty, particularly one that delivers reciprocal levels of market access to American firms that match what the United States provides to Chinese firms.

· Ensuring that the BIT does not compromise CFIUS’ ability to review Chinese investments that might involve national-security concerns.

· Establishing criteria for identifying new projects for review, particularly those associated with EB-5 visa applications, to ensure their status as robust and viable investments.

· Charging the Department of Commerce with developing an investor-education strategy, potentially through American consulates in China, to make the U.S. marketplace more approachable to small businesses and Chinese entrepreneurs.

With these support strategies, greater and more successful private Chinese investment in the United States will pay dividends for both countries—financially and politically. We should be ready to welcome Chinese investment as it grows to European levels, while remembering to review its origins from an enduringly statist system of politics. Expanding global prosperity and deepening Sino-American peace may well depend on it.

James “Harry” Krejsa is a researcher with the Center for the Study of Chinese Military Affairs at the Institute for National Strategic Studies. He served as a Fulbright Fellow in Taiwan and worked as a consultant to government agencies including the State Department, the Department of Energy, and USAID. The views expressed are his own and may not reflect those of the National Defense University, the Department of Defense, or the U.S. government.

No comments: