China Research

Are Tables Turning? The New FDI Pattern of Chinese MNCs

Foreign direct investment (FDI) by Chinese multinational corporations (MNCs) has been rising steadily during this century. Until 2004, the dominant motive for investing abroad was to seek new markets, which has increasingly been complemented by resource-seeking and asset-seeking investments. A major feature is the massive investments in the emerging markets of Asia, Latin-America, and Africa. The FDI even increased during the Great Global Recession of 2009-2010, in particular the asset-seeking investments, Chinese firms taking advantage of the opportunities to buy underpriced assets. The government flooded the Chinese market with liquidity, produced a massive stimulus and created massive spending on an unprecedented scale, and as a result has papered over some of the problems caused by the recession.

One main driver behind the Government support of the firms’ globalization is to strengthen and develop global competitiveness: going from cost advantages in low and medium-tech industries to differentiation advantages in hi-tech industries. This has helped Chinese firms to challenge the incumbents of global industries. The priorities of Chinese MNCs seem to have changed with first the global recession and later with the Euro crisis. E.g. while the majority of investments in Europe was previously market-seeking, they have now turned into being mainly asset-seeking.

Sweden stands out by being dominated by asset-seeking investments and a few resource-seeking investments, done by a few big Chinese MNCs. The first major investments took place by Huawei and ZTE in telecommunications industry and more recently in car industry by Geely acquiring Volvo Car and the on-going attempts by Youngman and others to acquire SAAB Automobile or parts of it. The major reasons are Sweden’s hi-tech industries, mineral resources, and small domestic market.

The priorities of Chinese MNCs market-seeking investments seem to change towards the emerging markets, especially the BRICS, which have continued to grow. This new development will create an even larger growth of the South-South trade and FDI compared to before, the large resource-seeking investments being complemented by market-seeking investments. Even if the economic climate in the EU and the US improves, the potential for market growth is much less than in the emerging markets. So this new pattern of primarily market-seeking investments in the emerging markets and primarily asset-seeking investments in mature Western markets will most probably continue and become stronger.

This development risks to undermine the competitiveness of the established Western MNCs, firstly, by losing the market shares more recently gained in emerging markets, and secondly, in the long run, by losing global competitiveness through an eroding hi-tech resource base. Moreover, the Chinese MNCs are becoming more competitive by achieving competitive parity and even sustainable competitive advantages through upgrading their resource base.

A first study of whether tables are turning was made by the Linnaeus Baltic Business Research Centre, Linnaeus School of Business and Economics about how Chinese firms gain competitiveness in emerging markets and how it affects Western MNCs. Major investments by two leading Chinese MNCs (Sany and XCMG) in the construction industry were studied in Brazil, where huge investments are done in infrastructure, e.g. for the World Cup and the Olympic games. This industry is highly globalized since many years with a few major dominating global players.

The Chinese MNCs are emerging from a past of inferior products offerings and cost savings, in which quality and customer service were sacrificed for the bottom line. They have learnt how to produce more reliable products and services that customers demand, mainly at home. Firms are beginning to offer full services for their products in Brazil, including financing. They are following their major Western competitors by employing many of the same strategies. They have established the same resources and capabilities configuration in Brazil as in China, which implies that the firms mainly copied the strategy pursued in the home market. So both companies continued the same strategic practices upon entry. They are in the process of developing their competitiveness in Brazil. So far, they have mainly transferred standard technologies and have reached competitive parity.

It is interesting to note that Chinese MNC:s now are developing systemic standard knowledge to achieve temporary competitive advantages, which they had done in the low-price segment. One MNC is on its way to create sustainable competitive advantages through the recently established R&D facility, making it possible to upgrade its technology to advanced level to compete in the high price segment. The establishments in Brazil were facilitated by the many similarities with China both economically and socially. Many emerging economies could therefore be attractive to the Chinese firms because there seems to be little to no adjustments required when entering.

These Chinese firms do not yet compete directly with major global competitors such as Caterpillar, Komatsu and Volvo CE. Thus far they have mainly built their international competitive strength in the low-price segment, while major competitors have relied on their perceived superior technologies, customer service and branding to differentiate themselves from Chinese CE firms, thereby justifying premium prices for their products and services in the high-price segment. Rather it seems that these major firms respond to the Chinese threat by entering the low price segment to compete head on with the Chinese firms.

Local competitors with low-price brands are acquired to complement the own high-price brand. These acquisitions are used both to expand to new segments in the local emerging market, e.g. China, and to expand to low-price segments in other emerging markets, e.g. Brazil. This strategic move is also a way to tie-up emerging competitors on global markets at home. They now need more resources to defend the home-markets, reducing the resources available for investments in foreign markets, where Western MNCs are well-established. Thus, the tables are possibly starting to turn. But it is too early to say how long time it will take, or whether it will ever happen.

Hans Jansson
Professor of International Marketing and Business, Linnaeus University
Editorial board

Back to Start Page

Chinese exchange rate policy has been criticized many times in the past few years for being too cautious and leading to persistent undervaluation of the currency renminbi (RMB).

However, since summer 2005, when the hard Chinese linkage to the American dollar was abandoned in favor of a gradual appreciation process, the RMB has been appreciating by about 30 percent vis-à-vis the American dollar – apart from the stabilizing policy during the period of the worst days of the American subprime crisis and its global contagion.

Since June 2010, when China decided to move back to the stance of appreciating its currency quite cautiously, the RMB has been strengthening by 8 percent – not so bad at the end of the day.

Perhaps, we currently see something like the “end of the day” or rather “the end of the appreciation days” – at least for the time being. First, American currency pressure on China has become much softer. Second, China’s export performance has weakened substantially in the past months. Third, the U.S. and Europe may see its potential need of deficit-financing support from China nowadays more clearly than in the past. Forth. The U.S. administration may have understood by now that steady complaints about the too weak RMB won’t help – a conclusion that I have pointed at many times in the past. Fifth, can we be quite sure that the RMB still is so much undervalued when looking closer at all the structural problems of China? Some of them were clearly stressed by Prime Minster Wen Jiabao at the start of the annual National People’s Congress (NPC).

In other words: The calculation or estimate of a kind of equilibrium exchange rate for the RMB has become even more difficult. Apart from this, we have recently seen some slowing down of the surpluses in the current account and of the accumulation – or even stagnation – of the currency reserves. It is by far too early to say whether this may be the beginning of a new trend – but the phenomenon as such deserves more analytical attention.

Considering this development, it is only logical, from a Chinese perspective, that China at least for some time wants to keep the exchange rate “basically stable”- as announced by Mr. Wen – which also includes at least theoretically more two-way flexibility, i.e. short-term moves in the weakening direction – particularly if the obvious problems for China’s export industries will go on.

No doubt, Chinese leaders feel concerned about the current export problems. However, I have a feeling that the previous forecast and trend target of 8 per cent GDP growth for 2012 can still be met. But this should not mean that we should underestimate the structural problems that were mentioned quite openly by the Prime Minister. Progress in certain areas – for example the marketization of the financial sector, the way to convertibility of the RMB included – will be much more bumpy and determined by conflicts of interests than the speech of Mr. Wen the other day at the NPC obviously has pointed at.

Hubert Fromlet
Professor of International Economics
Editorial board

Back to Start Page

Chinese political authorities are concerned about their country which is feared to face a “middle-income trap”. The definition of such a trap is not clear but it could be understood as stagnation in the process of catching up to the rich countries and a significant decline in growth of per capita income.

To be more precise, what the Chinese authorities fear has not yet materialized. China is still a lower middle-income country following World Bank definition. The way to a high-income country passes via the upper middle-income country stage which China is expected to reach within the next few years. And it is there where in the past the majority of upper middle-income countries got trapped and failed to achieve the high-income status which starts at a level of about 12,200 US-$. Economic historians mark the 10,000 US $ per capita income level (PPP) as a junction from where economic growth tends to decline.

To discuss the reasons of such decline, it is beyond doubt, that in China, the average productivity of physical investment, often measured by its reciprocal, the incremental capital-output ratio ICOR, has declined. In 2009, the Chinese ICOR has been found to be twice as high as its average in the 1980s and 1990s. That, by itself, must not necessarily mean a waste of capital if high physical investment coincides with slow growth in the world economy because of a global crisis and if ICORs rise globally.  But as Chinese fixed-asset investment has increasingly gone into infrastructure, such investment, especially in remote regions, will not immediately pay off. Hence, the price to paid by China for possible (or likely) future returns of massive investment in infrastructure in a vast and geographically dispersed country, is that today much more physical capital is needed to achieve a specific level of growth than in the past.

Furthermore, other bottlenecks which were already identified as barriers against sustained double-digit growth rates some twenty years ago appear more binding than at that time. The quality and quantity of labor supply which is needed to match the rise in per capita- income in terms of skill content is no longer as elastic as it used to be. Physical bottlenecks such as energy availability and the use of the environment as a sink have become serious and the rise of income inequality to a Gini coefficient of close to 0.5 ( historically high for  a non-resource-rich economy in general and for China in particular) puts the normally high degree of social coherence and stability at risk. Disparities are present at any level, between coastal provinces and the Western and Central provinces, between rural and urban areas, and between the property and income positions of those working in profitable export industries and those confined to activities for the domestic market. Social security schemes lack sufficient coverage and discriminate against or even exclude thus those who are in most need of support (for instance, rural workers).

Finally, financial repression hampers an allocation of domestic funds to efficient investment. Such repression comprises barriers against investment abroad of domestic savings, upper caps on deposit rates for private savers, biases in domestic lending against private households and in favor of the corporate sector, in particular in favor of SOEs, and credit controls instead of the free play of interest rates. As a result, bond and equity markets are still in a state of infancy. Each of these bottlenecks can individually prevent China from fully exploiting its growth potential. Taken together, doubtlessly, they will slow down economic growth.

It seems, however, that the general question of China approaching a middle-income trap or not, is misplaced. The real issue is whether beyond the big cities or agglomerations like Beijing/Tianjin, Shanghai and Guangshou/Pearl River Delta which are already close to or within the high-income status, the rest of the country will be trapped. For the time being, China is separated in a number of “economies”. This is not a new phenomenon. Some twenty years ago, the ratio between income measured at PPP rates and income at current exchange rates, was measured between six in remote areas in the West and close to unity in the coastal cities.

The size of the difference is determined by the prices for non-tradables and the size of the non-tradable sector relative to the tradable sector. While in the coastal cities prices for non-tradables such as consumer services were close to international prices, they were far from international prices in the remote areas. In spite of sizable cross-country labor mobility through migrant workers, labor markets in China are still far from being integrated.

Large skill differentials play a role but also policy-rooted restrictions, such as the internal registration scheme (Hukou) which ties people to their traditional place of residence and forces migrant workers to live in an environment of illegality cut off from public services which normal citizens enjoy.   The Hukou system fragments Chinese labor markets and is responsible for some part of persistent income disparities over regions and people.  Nevertheless, the catching up process of backward areas is under way, no doubt. Growth rates in low-income provinces exceed those of higher-income provinces but if endowment differentials are taken into account, the catching up process must be expected to take much more time.

In other words, the superior endowment of higher-income provinces with technology, infrastructure, and skills protects these provinces against fiercer locational competition with lower income areas. While the latter provinces can still embark upon the catching up model of high investment ratios, the former provinces must raise their total factor productivity through innovations to better use of the existing capital stock. Actually, they do it. With labor supply getting tighter in the high-income provinces and with the low-income provinces impeded in their growth path by a relatively high share of employment in the agricultural sector, labor-saving investment in this sector will be important to release labor for other activities and for productivity improvement in the low-income provinces. Again, a reform of the Hukou scheme would be helpful.

As a result, the issue of a middle-income trap for China seems to be a problem of how fast lower-income provinces achieve the status of high income provinces. Estimates by Richard Herd from the OECD suggest that by 2020 13 instead of only 3 provinces (in 2015) will arrive at the high-income level and that it will be not earlier than 2030 that almost all of the 33 provinces will have followed. By that time, China will already be in the stage of becoming an aging economy. To defend the status of a high-income country after having achieved it, will then probably be a tougher task than to initially reach it.

Rolf J. Langhammer
Professor & Vice-President of the Kiel Institute for the World Economy

Back to Start Page