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June 25, 2012

China, the Game-Changer

Chinese overseas direct investment is reshaping the global economy. A stellar panel of experts, including Jeffrey Sachs of the Earth Institute, shed light on why this next wave of overseas investment will be unlike anything the world has seen before.

Rebecca McReynolds

It’s almost impossible to overstate the impact that China’s growth has had — and will continue to have — on the world’s economy, says Jeffrey Sachs, director of Columbia University’s Earth Institute. “It’s fundamental. It’s not a bubble. And it’s not going to be reversed.”

So what happens when the world’s second-largest and fastest growing economy decides to reverse the flow of capital flooding across its borders over the past three decades by actively pursuing outward direct investment (ODI)? “It’s a game changer,” Sachs says.

Because of its size, China already plays a fundamental role in global culture, science, technology, and history. “It is changing the entire world,” he says. “Nothing will be more important to the world’s economy, for past and for future generations, than China’s development.” As China ramps up its ODI efforts, the pace of that change will only accelerate, he adds.

To gain perspective on how China’s rapidly expanding ODI could shift the balance of economic and political power around the world, the Chazen Institute of International Business and The Australian National University invited leading Chinese experts to Columbia Business School in May 2012 to share their insights and explore the global ramifications. This forum, cosponsored by Columbia University’s APEC Study Center and the Vale Columbia Center on Sustainable International Investment, focused on three key areas of concern:

  1. The drivers behind China's rush to invest in developing and developed countries;
  2. The economic and social impact on a country when China sets up shop;
  3. And the political reactions in host countries to Chinese overseas direct investment and how to ensure that both parties benefit.

We’re Already There

The seismic shifts are already being felt. Over the past decade, China’s capital outflow has grown tenfold, to an estimated $60 billion this year, making it the fifth largest ODI player in the world, says Ilan Alon, director of The China Center at Rollins College in Winter Park Florida. Given China’s growth and its estimated $3.5 trillion in capital reserves, estimates of the country’s ODI by 2020 range from $500 million to $5 trillion, says Alon, who chaired the forum.

Of course, there are a lot of assumptions built into these wide-ranging projections, but regardless of the final number, China is already carving its own unique and indelible imprint into the global ODI market, says Yiping Huang, Chief Economist for Emerging Asia for Barclays Capital, an adjunct professor at Australian National University and professor of economics at the China Center for Economic Research, Peking University.

For example, most developing countries don’t have the economic wherewithal to even consider investing their limited capital resources outside of their own borders, Huang says. China, though, has been able to build its capital reserves on the strength of more than $1.2 trillion in foreign direct investment that has flowed into the country over the past 25 years.

The Chinese Model

Another factor unique to China is how it is investing its outward capital. “When you look at ODI you find that when most companies move capital overseas, they are doing that by moving their factories overseas,” Huang says. That usually happens for one of two reasons. Companies are either seeking a cost advantage for their manufacturing output, such as Japanese firms did in the 1980s, or they are seeking access to once-closed markets, which has been the motivation for many US businesses moving into China.

Chinese companies have neither of these concerns, Huang says. Even though labor costs are rising in some areas of the country, Chinese manufactures still enjoy a comfortable cost advantage compared to Western economies. Also, with the world’s largest population, Chinese manufacturers don’t need to look beyond their own borders for sustainable consumer demand.

What Chinese companies do need, though, is direct access to raw materials and the technological and managerial expertise required to become globally competitive, Huang says. So China is leveraging its ODI to buy natural resources, acquire strategic assets, and set up companies that will facilitate exports. “The single focus of all these activities is to strengthen and improve the competitiveness of [their] factories at home,” he says.

Huang calls this the “Chinese model” of ODI but says it is hardly unique to China. Other rapidly developing economies, such as Korea and Brazil, are pursuing similar strategies, but those countries’ outside initiatives have been overshadowed by China’s massive capital resources, he says. “The difference between China and Korea is that Korea is a small country,” Huang says.

Building a Two-Way Street

As quickly as China has become a major force in the flow of international capital, this is just the tip of the tiger’s tail, Huang says. Up to now, most of China’s ODI has come from state-owned enterprises (SOEs), but these first steps are simply paving the way for China’s private sector to enter the global market, he adds.

The Chinese government is already advancing financial reforms that will boost the ability of private companies to expand overseas. At the same time, capital costs within China continue to rise, which will encourage more private-sector firms to look for offshore new opportunities. “The next wave of ODI may look very different than in the past,” Huang says.

This fact is a growing concern for many governments and private enterprises that are increasingly suspicious of Chinese SOEs as they move beyond their own shores, Huang says. “There are always issues about what is their motivation and strategic plan,” he says. “My view is that they mostly behave like the ordinary corporate sector.”

Of course, China will have to take additional steps to reform its financial and regulatory systems as more Chinese enterprises move into the global markets, he says. “But I would say that this is a two-way street,” Huang advises. “Even if China takes substantial steps to liberalize and reform its systems, it will never become another United States.”

If China is going to become a major phenomenon it will have to adapt to the international system, he acknowledges. At the same time, though, “maybe the international community, at some stage, will have to recognize that the Chinese way is part of the global reality,” Huang adds.

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