Chapter 8: China’s Foreign Investment in the United States and European Union
Trade Patterns Explain US and EU FDI DifferencesThe EU’s top exports to China are dominated by machinery and transport as well as items targeted to both high- end consumers and industrial firms, making up 59% and 17% of total trade, respectively (see Figure 8.3). These sectors logically lead to FDI flows to support market penetration and servicing as well as the establishment of localized production capacity when conditions warrant. Compared to the United States and Japan, Europe has dominated China’s transport and machinery import market for over a decade, accounting for about half of China’s imports for transport and a quarter for machinery—twice as high as US or Japanese shares.In comparison, the top three categories of US exports to China over the past decade and half have been oilseeds and grains, followed by aerospace products and then, surprisingly, by recycled waste (scrap metal and discarded paper) (see Figure 8.4). None of these categories have led to significant FDI. The reasons are obvious regarding food products and recycled waste. For aerospace products, Boeing has refrained from opening production plants in China, while its European competitor, Airbus, has had manufacturing centers in China since 2008 and has continued to expand its operations as China expanded flight services to its interior.The recent surge in exports of cars from the United States to China surprisingly is accounted for largely by European luxury SUVs such as Audi and Mercedes. These are made in the United States but given China’s tax policies can be imported at a price that is lower than those made in China. The related FDI then turns out to be European rather than American.EU and US trade relations with China illustrate how composition matters in shaping FDI flows. Manufacturing exports and investments are largely welcomed in China’s domestic market and cater more to EU strengths, while China’s closed services sector has a disproportionately more negative effect on the United States, whose strengths lie in higher- value services, notably information technology (IT) and finance. Of total US services exports in 2014, 19% came from the use of intellectual property (IP), compared to the EU’s 6.4% of total service exports from royalties and licensing fees. Financial services also made up 12% of US services exports compared to the EU’s 8.6%.China’s economy has one of the most restrictive FDI services sectors in the world. According to the Organization for Economic Cooperation and Development FDI Restrictiveness Index, on a scale from 0 = completely open, to 1 = completely closed, the United States is less than 0.1, and China stands at over 0.4— well above the other BRICs— while the average for the European Union is around 0.05 (see Figure 8.5). China’s most restricted industries are in high- value services such as communications, mobile telecoms, legal, insurance, finance, and banking services— precisely the areas of special interest to American firms. Given the recent decline in FDI, Beijing seems to have finally recognized the importance of this issue. In mid- January, 2017, a directive was issued liberalizing investment in several sectors, including financial services, telecommunications and education.Another reason for lower US investment in China compared to the EU is that EU trade provides about twice as much value added in the manufacturing process within China than does such trade with the United States (see Figure 8.6). American firms like Apple also operate in a way that tends to involve little direct FDI coming from the United States. Although Apple products are manufactured in China, the company actually responsible for production is a Taiwanese firm— Foxconn— which accounts for the bulk of the FDI required. Thus, while most Americans think that Apple must be heavily invested financially in China, the reality is that most of the investment comes from other sources.Furthermore, major US companies with a visible presence in China, such as fast food restaurants and hotel chains, operate as franchises. These US companies do not own their local affiliates but rather license and receive franchise fees, although they may be involved in providing some of the products needed by their franchisees. Thus the presence of these US multinational icons in China does not necessarily show up as FDI in the official tallies.While the United States considers itself a relatively open economy, CFIUS’s category of “critical infrastructure” includes eleven sectors including basic areas such as agriculture and transport, as well as more sensitive areas such as finance and defense industrial bases. Even Chinese company Shuanghui’s purchase of US pork producer Smithfield Foods had to overcome political opposition in the form of Congressional petitions opposing the acquisition on the grounds of “critical infrastructure.”Contrary to the high-profile negative sentiments over SOE investments in the United States, a majority of Chinese investment to the United States may actually be private. Nevertheless, the negative sentiments around CFIUS cases may be counterproductive to attracting smaller private Chinese investors. According to the 2015 report to Congress by CFIUS, China ranks number one in terms of CIFIUS reviews, although it ranks fourteenth regarding the amount of foreign investment that is coming into the United States.
Technology Transfers Exacerbate Tensions with the WestWhile China draws a lot of attention, China’s theft of IP is not so different from what other countries have done historically. Centuries ago, the United States was once a thorn in Britain’s side, snatching up valuable technology that was protected by British law. The United States did the same in the post-World War II period, using Germany’s technology to develop industries that could compete with European companies. The mechanisms through which China manages to acquire foreign IP are also nothing new— weaknesses in China’s IP protection today are similar to those of Korea and Japan in the 1980s and early 1990s.The US trade representative’s Special 301 Report designates countries that do not provide adequate IP protection. China has been “watch-listed”— in other words, deemed a “violator”— in each of the last twenty- five years. Countries that began their development earlier, like Japan, Korea, and Taiwan, were all flagged in the early years of the report and eventually fell off the list as their domestic industries developed and regulatory performance improved. Japan was cited yearly until 2000.Plotting the trends of both GDP growth and overall GDP per capita of these economies and highlighting the designation of these countries in the Special 301 Report in a given year shows us that, for the period over which we have data, these countries tended to be listed as violators when they were growing rapidly and also poor. And they generally fell off the list as they reached a higher level of development. China is in a phase of development where countries are frequently listed as violators—China, India, and Indonesia are listed in every year, and Brazil in twenty- three years. Malaysia and South Korea are cited in thirteen and nineteen years, respectively. Japan was often cited in the early years of the report as well.Of course, just as not all of Asia’s success can be chalked up to IP piracy, not all of China’s efforts to acquire IP are state sponsored, and not all of it is dependent on the theft of foreign IP. China’s lax IPR protection is not exceptional in a historical context and it is not making more use of technology than we would expect for a country of its level of development, but its size sets it apart from the others.