Article

America Gains From Chinese Investment

Thilo Hanemann and Daniel H. Rosen November 7, 2011

Traditional macroeconomic issues — exchange rates, trade disputes, market access and the like — usually dominate U.S.-China economic conferences, such as the Strategic and Economic Dialogue (the “S&ED”) held in Washington this week. But beyond the familiar laundry list, a new topic has burst on the scene: direct investment by Chinese firms in the United States.

Between now and 2020, we expect Chinese firms to deploy between $1 trillion and $2 trillion of direct investments abroad. Americans could be a major beneficiary of this — if anti-China sentiment in Washington and around the country does not bring down the curtain just as the show is starting.

China started investing overseas in a big way in the mid-2000s, almost entirely in the natural resources sector. Chinese firms made some attempts to invest in the U.S. — notably CNOOC’s failed bid for oil company Unocal in 2005 — but through 2008, such forays were few and far between. Since 2009 that story has begun to change. In a new study, we find that over the past two years direct investment expenses by Chinese firms in America have grown more than 130% a year.

In 2010 alone, Chinese firms spent more than $5 billion in America on a combination of 25 “greenfield” projects built from scratch and 34 acquisitions of existing companies. While China still accounts for only a tiny share of total foreign direct investment in the U.S., Chinese firms are today invested in at least 35 of 50 states and an upward trend is clearly underway.

It is not politics but profit that is driving the vast majority of Chinese firms to invest in the U.S. With overinvestment leading to excess capacity in much of industrial China, Chinese companies increasingly see greater profit opportunities across the Pacific.

The shift of China’s growth model towards domestic consumption and increasingly intense competition at home forces Chinese firms to upgrade their technology; capture the higher levels of the value chain they traditional conceded to foreign partners; and augment their managerial skills and staff base to remain globally competitive. Investments abroad are a way to do this.

China’s gain could also be America’s gain, as demonstrated by an earlier round of Asian investments. Japanese firms had a difficult start in the U.S. in the 1980s, as they were greeted with skepticism and fear. Today, Japanese firms employ almost 700,000 Americans with an annual payroll of nearly $50 billion.

Yet, as with Japan, the high growth of Chinese investment — albeit from a tiny base — is already sparking a political firestorm in the U.S. Recent controversies have flared around various investments by telecommunications equipment supplier Huawei, as well as steelmaker Anshan in a Mississippi rebar plant, and the acquisition of small aircraft maker Cirrus by a Chinese state-owned comapny.

There is a clear danger that anti-China reactions will only grow louder as the numbers increase, and even result in more restrictive terms for firms from China. Such a closed-door policy would be bad for Chinese firms. It would also be tragic for American communities to lose the jobs, innovation and tax revenue additional investment dollars could create.

Preventing a bilateral investment shut-down will require effort by both sides. In America, clearer thinking on national-security issues is important. Congress and the White House together must send a clear bipartisan signal that Chinese investment is welcome in the U.S., lest Chinese investors take their checkbooks to less hot-headed countries.

China also has ways to help its cause. It’s little wonder deals get bogged down in Washington, given the nontransparent, politically influenced nature of many Chinese companies. Improving governance within companies will help this. So will regulatory changes to brighten the line between government and companies. For instance, a clearer separation between regulators and the firms they oversee would send a good signal.

China must recognize that its restrictions on American direct investment affect the political mood in Washington. Beijing maintains barriers to foreign investors in many sectors, such as telecommunications or financial services, and U.S. negotiators are working to remove those hurdles. China can help sustain openness to Chinese investment abroad by continuing to reform its inward investment rules.

That said, however, it is critical that Washington not play a tit-for-tat game with Chinese investment. America has tried to keep politics out of the foreign-investment screening process not to do foreigners a favor, but because openness to investment is good for American firms, workers, communities and the economy as a whole.

That logic applied to Japan in the 1980s, and it holds with China today. Now would be a terrible time for the U.S. to drop its own successful principle. If we do, we risk Chinese firms setting up plants in Ontario instead of Michigan, or Juarez instead of El Paso.