[Viewpoint] The benefits of Chinese FDI

In a rare act of bipartisanship, the United States Congress recently passed legislation to encourage more inward foreign direct investment. Democrats and Republicans agree that FDI, or “insourcing,” is important to U.S. jobs and competitiveness. They are right.

But, even as they propose new measures to court foreign investors, many members of Congress in both parties harbor deep concerns about FDI from China, on both national-security and economic grounds. These concerns are unwarranted, and discriminatory policies to restrict such investment are ill-advised.

The U.S. government already has adequate controls in place to review and block FDI from all countries, including China, that pose anti-competitive and national-security risks. Investments that clear these controls benefit the U.S. economy in numerous ways and should be welcomed.

To be sure, the U.S. remains the world’s leading destination for FDI, accounting for 15 percent of global flows. But its share is declining, while China, using both carrots (like tax holidays and special enterprise zones) and sticks (like explicit and implicit local-content requirements) to attract foreign companies, has become the second-largest destination.

China has remained a small source of FDI outflows, but that, too, is changing rapidly. Chinese outward FDI soared from an average of $3 billion per year before 2005 to $60 billion in 2010, catapulting China into the top five sources of FDI on a three-year moving-average basis. Given the size of China’s economy, its growth rate, and the experience of other developing economies, FDI from China is likely to increase by $1-2 trillion by 2020.

An increase in FDI outflows is a priority in China for two reasons. First, China has an understandable interest in diversifying its substantial holdings of foreign-exchange reserves away from low-yielding U.S. Treasuries to real productive assets with higher returns. That is why China established its sovereign-wealth fund, China Investment Corporation, and why CIC decision-makers are seeking more FDI opportunities.

Second, China’s businesses have been encouraged to “go global” and invest abroad to find new markets, secure access to energy and raw materials, and enhance their competitiveness by acquiring new technologies, brands and management skills. In a recent report, the People’s Bank of China urged Chinese companies to acquire foreign firms as the first stage of a 10-year plan to ease China’s capital-market restrictions - long a goal of U.S. policy makers.

So far, China’s FDI outflows have been concentrated in developing countries and a handful of resource-rich developed countries, including Australia and Canada, and have been aimed at facilitating trade and acquiring access to natural resources. But the patterns and destinations of China’s outward FDI will change as rising wages, an appreciating real exchange rate, and the entry of new suppliers from other emerging countries erode Chinese companies’ competitiveness, motivating them to invest abroad to upgrade their technology and management capabilities, find new growth opportunities, and move up the value chain.

Currently, the U.S. receives only about 2 to 3 percent of FDI flows from China. But China’s direct investments in the U.S. have increased rapidly, from less than $1 billion annually in 2003-8 to more than $5 billion per year in 2010-11. At least 38 U.S. states now host FDI projects from China, and competition for Chinese investment has intensified as states’ budgets have contracted.

Of course, alongside the potential economic benefits of attracting a much larger share of Chinese FDI, legitimate competitive and national-security concerns do need to be addressed. First, like all mergers and acquisitions involving both domestic and foreign investors, investments in or acquisitions of U.S. companies by Chinese companies, whether state-owned or private, must be evaluated by the U.S. Justice Department for their impact on market competition. Investments with significant anti-competitive effects must be modified or blocked.

Second, the Committee on Foreign Investment in the United States (CFIUS) must screen investments in or acquisitions of U.S. companies by foreign companies, including Chinese companies, for national-security risks. Such screening is a common and justifiable practice around the world. In recent years, CFIUS has defined national security broadly to encompass not only defense activities and dual-use technologies, but also critical infrastructure, including telecommunications, energy and transport - areas of particular interest to Chinese companies.

Many Chinese investors view the CFIUS screening process as protectionist and targeted at them, but there is no evidence of this. The United Kingdom, Canada, France and Israel accounted for more than half of all CFIUS cases reviewed in 2008-10, while China accounted for only about 5 percent. Only a small fraction of Chinese FDI in the U.S. is subject to CFIUS review, and most of these projects, like most reviewed by CFIUS, are approved, sometimes with mitigation measures.

But Chinese FDI, especially in sensitive sectors like energy, does often trigger Congressional hearings, ad hoc resolutions, and calls for tougher CFIUS action. As a result of high-profile Congressional opposition, China’s state-owned energy company CNOOC withdrew its bid for Unocal, an American energy company, in 2005, before a CFIUS review that most likely would have cleared the deal on national-security grounds. China still points to this episode as evidence that Chinese FDI is not welcome in the U.S.

Feeding this perception, some members of Congress are now exhorting CFIUS to block CNOOC’s proposed acquisition of Nexen, a Canadian energy company with holdings in the Gulf of Mexico, until China resolves ongoing disputes with the U.S. over preferential government procurement policies and barriers to FDI by U.S. companies in China. Heeding these calls would be a costly mistake that would undermine the objective, non-discriminatory CFIUS process and encourage Chinese companies to look elsewhere at a time when Chinese FDI is poised to explode and the U.S. economy sorely needs the jobs, capital, and trade benefits that it would bring.

*The author is a professor at the Haas School of Business at the University of California, Berkeley.
By Laura Tyson