Thirty years of Chinese outward foreign direct investment
Hinrich Voss, Peter J. Buckley, and Adam R. Cross
Hinrich Voss[1]Postdoctoral Fellow
White Rose East Asia Centre
National Institute of Chinese Studies
University of Leeds
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Professor of International Business
Centre for International Business
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University of Leeds
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E-mail: / Adam R. Cross
Director of the Centre for Chinese Business and Development and Senior Lecturer at the Centre for International Business
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University of Leeds
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Thirty years of Chinese outward foreign direct investment
Abstract (up to 150)
Since the instigation of the ‘Open-Door’ policies in 1978, China has experienced three decades of steady economic reforms. These reforms have been aimed at changing the domestic industrial and economic structure and increasing the integrationChina’s economy and its businesses into the global economy. As a result, China has evolved from a position of marginal relevance for outward foreign direct investment (OFDI) to becoming an important source country among developing countries. This paper assesses the development of China’s OFDI since 1978 from a political economy perspective and traces the effects of policy and regulatory changes on scope and quantity of OFDI.
Keywords (5)
Chinese MNEs Outward foreign direct investment, Institutional framework, Political Economy
Introduction
Since the instigation of the ‘Open-Door’ policies (gaige kaifang) in 1978, China has experienced three decades of economic reform. These reforms have been aimed at changing the domestic industrial structure and increasing the degree of integration of China’s economy and its businesses into the global economy. As a result, China has evolved from a position of marginal relevance in terms of its outward foreign direct investment (OFDI)[2] to becoming an important source country among developing countries. The Chinese Ministry of Commercereports that domestic firms invested USD 21bn abroad in 2006, raising China’s OFDI stock to USD 90bn (MOFCOM, 2007).
This paper assesses the development of China’s OFDI over thirty years from a political economy and institutional theory perspective. Institutional theory of Scott (2001) and North (1990) has increasingly been applied to explain patterns and behaviour of international business. Institutions are important, because they determine ‘the rules of the game’, and shape the environment in which international business takes place, and the information collection costs, and transaction costs, that firms incur abroad. However, much of the work on the application of institutional theory focus inbound foreign business (e.g. Meyer and Nguyen, 2005; Delios and Henisz, 2003). In this paper, we adopt an alternative standpoint, by examining the effect of institutions on outbound business activities. China represents an ideal lens through which to examine the relationship between home country institutions and outbound international business because the Chinese economy was a closed, planned system until 1978, grew into a ‘two economic systems, one country’ arrangement during the 1980s until the mid-1990s and out of the plan (Naughton, 1995) and then to a much more market-based economy by ‘finding the stones to cross the river’. This is also true for the development of China’s OFDI, which can be divided intofive major periods.We find evidence that the value of international acquisition investments in particular has been influenced by regulatory and policy changes. The volumes of greenfield investments has also changed over time, but this activity does not fit as well into the regulatory phases as does acquisition investments. Moreover, since the instigation of the ‘Go Global’ policy in 1999, a plethora of regulatory changes and measures to support outward investment have been implemented. These have contributed to the rise of Chinese OFDI since 2000.
The contributions of this study are threefold. First, it contributes to the understanding on the applications of institutional theory to international business by relating institutional changes in China to outbound FDI. Second, by synthesising extant understanding of the key government actors working ‘behind the scenes’ and their roles and activities, and by charting the decentralisation and localisation of regulatory measures, the paper provides, a comprehensive analysis of institutional change in a key aspect to China’s political economy. Third, the paper provides a framework for policy-makers and practitioners to understand the factors that have shapes the character, scope and strategic intent of Chinese OFDI activities in the past, and into the future.
This paper is organised as follows. The next section describes the major government actors affecting China’s OFDI. In the third section, we describe the evolution and changes in OFDI regulation over the past thirty years and the range of responsibilities of the major government actors. The fourth section summarises and concludes this paper.
Political and administrative actors
There are a number of key political and administrative actors in China that impinge upon OFDI from China by setting the laws and regulations confronting outward investing firms and by being actors in the investment approval process. The main actors are the State Council, the State Administration for Foreign Exchange, the Ministry of Commerce, the People’s Bank of China, the National Development and Reform Commission, and the State Asset Supervision and Administration Commission. The State Council drafts and develops law and regulations as well as coordinates the national economic development. It also manages foreign affairs and concludes bilateral treaties. The State Council decides upon major economic policies and liberalisation measures, although the policy initiatives for these steps may come from subordinate organs such as SAFE or MOFCOM (Zhao, 2006). The State Administration of Foreign Exchange (SAFE) was established in 1979 under the Bank of China and is responsible for administering usage and flow of foreign exchange (Zhang, 2004; Lin and Schramm, 2003; Shan, 1989).[3] SAFE consolidated the activities and responsibilities that were formerly distributed across several ministries in relation to the supervision of China’s foreign exchange control (Lin and Schramm, 2004). Although the authority over SAFE moved in 1982 from the Bank of China to the newly created central bank, the People’s Bank of China, SAFE remained relatively independent until a subsequent government restructuring in 1998 (Lin and Schramm, 2003; Shi and Gelb, 1998). The restructuring led to SAFE strengthening its OFDI-related mandate in the following ways: (i) the reporting of the balance of payments (BOP) data to the State Council and the International Monetary Fund, (ii) recommending foreign exchange policies to the People’s Bank of China, (iii) overseeing the transfer of foreign exchange out of and into China under the capital account of the BOP, and (iv) managing China’s foreign exchange reserves (Zhang, 2004).
The Ministry of Commerce (MOFCOM)[4] was established in its current form and function in 2003. The major responsibilities of MOFCOM with regard to Chinese OFDI relate to: (i) the supervision of Chinese OFDI by drafting and implementing policies and regulations and considering non-financial OFDI projects for approval; (ii) bilateral and multilateral negotiations on investment and trade treaties and representing China at the World Trade Organisation and other international economic organisations; (iii) ensuring the alignment of China’s economic and trade laws with international treaties and agreements; and (iv) coordinating China’s foreign aid policy and relevant funding and loan schemes (Munro and Yan, 2003). These functions provide MOFCOM with direct and indirect opportunities to guide and influence the scope and direction of Chinese OFDI. Indeed, MOFCOM issued the first regulation on Chinese OFDI in 1984 (Zhang, 2003).
The People’s Bank of China (PBC) was established as China’s central bank in 1983 and is currently directly supervised by the State Council (Zhang, 2004). The PBC is responsible for the overall financial policies and rules and dealings with international financial organisations such as the World Bank. It also supervises and manages the foreign exchange reserves of China (Chang, 1989). With respect to the latter function, the PBC imposed significant changes to China’s foreign exchange regime in 1994 and this provided it with tighter foreign exchange control (Barale and Jones, 1994). The combined powers over domestic monetary and financial policies and foreign exchange control give the PBC the ability to arbitrage one function against another. Careful management of China’s foreign exchange reserves used in international investment projects by Chinese companies has helped the PBC to fulfil a number of domestic monetary objectives, including a stable and low inflation rate because domestic enterprises could be encouraged to spend Yuan to reduce pressure on the monetary supply side (Pettis, 2005). Prior to 1992, the PBC regulated the financial service sector and hence the foreign investments of financial institutions. In 1992, securities, insurance and banking services were spunoff into separate regulatory authorities including the China Banking Regulatory Commission that today approves OFDI projects by Chinese banks (Pearson, 2005).
The National Development and Reform Commission (NDRC), sometimes referred to by its old name, the State Development and Reform Commission, emerged from the institutional structure of the State Planning Commission (Munro and Yan, 2003). The NDRC is the main government body that designs, regulates and coordinates the economic development and industrial policy of China. As part of this function, it regulates government investments in domestic industries (Pearson, 2005). One key function of the NRDC is to develop “strategies, goals and policies to balance and optimise […] China’s overseas investments.” (Munro and Yan, 2003: 4). As part of this role, the NDRC has issued guidelines concerning access of domestic firms to soft loans to finance their internationalisation (Schwartz, 2005). In a similar vein, the NDRC, in cooperation with MOFCOM, has published a host country catalogue that lists the countries for which the Chinese government subsidies FDI projects (Zweig and Bi, 2005). The NDRC is also involved in the approval process of Chinese OFDI. Large-scale Chinese OFDI projects in industry sectors such as natural resources and other projects involving larger sums of foreign exchange need prior investment approval from the NDRC. The threshold has changed over the years and has stood at USD 30 million since 2006. The involvement derives from NDRC’s responsibility to maintain equilibrium in balance of payments (Munro and Yan, 2003).
A relatively new governmental authority is the State Asset Supervision and Administration Commission (SASAC). SASAC was established by the State Council in 2003 to represent the Chinese government in non-financial state-owned enterprises (SOEs). As the Chinese government is the ultimate owner and investor in SOEs, SASAC has wide-reaching responsibilities and powers (Naughton, 2007; Pearson, 2005). Prior to SASAC’s establishment, its functions were divided between the State Economic Trade Commission and several ministries and other government authorities that controlled and supervised ‘their’ companies independently from each other. This sometimes created competing SOEs (Munro and Yan, 2003; Mueller and Lovelock, 2000; Pearson, 2005). In this respect, it is the objective of the SASAC as an investor to ensure that the SOEs under its supervision remain competitive and increase their profitability and the value of the assets under their control (Pearson, 2005). However, it remains questionable if such an institution can fulfil this type of objective (Clarke, 2003), since its supervision is split: the national SASAC directly controls nearly 170 national SOEs while sub-national SASACs act at a provincial level (Naughton, 2006, 2007). Both types of SASAC exercise their power through the appointment of senior managers to SOEs and through involvement in major decision-making of firms under its control (Naughton, 2007). A considerable number of senior management positions are actually appointed directly by the Chinese Communist Party (Naughton, 2007). This structure and the strong influence of the party do not necessarily lead to the appointment of the most suitable, but rather the most rewarded, managerial candidates, and this has a number of implications for the company’s domestic and international operations. OFDI projects by SOEs under the supervision of SASAC are unlikely to be decided without the explicit approval of SASAC. The decision to invest overseas, either through a greenfield investment or an acquisition, can be regarded as a major decision that impacts on the company’s profitability and the value of the involved assets. Any OFDI project by an SOE therefore touches upon the key objectives of SASAC. Examples of overseas invested Chinese firms under the direct control of SASAC include the following (each of which rank among the Top 100 developing country MNEs as published by UNCTAD [2006]), namely, China National Offshore Oil Corporation (CNOOC), China National Petroleum Corporation(CNPC), Sinochem Corporation, China State Construction Engineering Corporation, China Minmetals Corp, China Cereals, Oils and Foods Company (COFCO), and TCL (through SASACs’ holdings in Huizhou Municipal Investment Holdings). SASAC also controls smaller SOEs such as China Aviation Oil, which has operations in Singapore, and the international trading company, Sinosteel.
The basic model of involvement is depicted in Figure 1. Each outbound investment project has to pass a thorough approval process in which several institutions are involved. The key political actors in the two stage process are the State Council, MOFCOM, SAFEand the NDRC (Ye, 1992; Tseng and Mak, 1996).[5] Although the process has been modified several times since, the basic procedure remains unchanged to date. A firm applies, first, to SAFE to use foreign exchange earnings abroad and, second, to MOFCOM or the NDRC for the approval of the project business case (Deschandol and Luckock, 2005; Yin et al., 2003; Horsley, 1990). The first step is necessary because SAFE is responsible for the administration of sourcing, conversion, remittance and monitoring of the repatriation of foreign exchange and of investment profits (Yin et al., 2003; Lin and Schramm, 2003).
The following descriptions of these administrative actors also reflect the numerous restructurings of the Chinese government system to accommodate the transition of the economic system (Pearson, 2005).
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INSERT FIGURE 1 (basic political economy model) AROUND HERE
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The division of responsibility between state actors is not always clear and has changed numerous times during the institutional reforms process. Overlapping duties, conflicting interests (between and within bureaucracies) and the multiple government authorities that an outward investor has to approach illustrates the potential of the institutional framework to hamper the development of Chinese OFDI. It is easy to envisage that, in particular, smaller SOEs and privately-owned companies without well established relations (‘guanxi’) with the administrations may be discouraged especially by such an institutional environment.
Having introduced the major government actors, we now turn to the evolution of the regulatory framework in which Chinese OFDI takes place. The next section makes reference to the political actors outlined above and provides information about the changes and company responses to the regulatory framework which are partly responsible for changes to the spatial distribution, amount, and number of OFDI projects undertaken by Chinese MNEs since 1979.
Chinese OFDI is described by Wong and Chan (2003) and Wu and Chen (2001) as having developed in five distinctive phases (cf. Ye, 1992; Tseng and Mark, 1996).[6] The classification followsadjustments to China’s political and regulatory environment towards OFDI and developments of China’s OFDI and international mergers and acquisitions (see Figures 2 and 3). We examine three main phases, and five sub-periods, as follows paraphrasing Deng Xiaopeng’s “crossing the river by feeling each stone”: 1979-1991 “Tasting the water” (sub-periods 1979 to 1985, 1986 to 1991), 1992-2001 “Finding the stepping stones” (sub-periods: 1992 to 1998, 1999 to 2001) and from 2002 onwards “A bridge is built”.
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INSERT FIGURE 2 ABOUT HERE
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INSERT FIGURE 3 ABOUT HERE
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1979-1991 – “Tasting the water”
This phase includes two sub-periods. The first sub-period (1979-1985) encompasses the beginning of the beginning of the Open-Door policy and the first steps on international grounds by Chinese investors. Sub-period two (1986-1991) describes first attempts by the Chinese government to encourage OFDI.
Sub-period 1: The Open-Door policy and first steps on international grounds (1979-1985)
From the outset of the ‘Open-Door’ policy, the Chinese government endeavoured to create an institutional environment to attract foreign MNEs to Chinaandencourage Chinese companies to invest internationally (Zhang, 2003). The State Council authorised selected state-owned trading companies under the auspices of the Ministry of Commerce (MOFCOM) and sub-national economic and technology cooperation enterprises to establish foreign affiliates (Zhang, 2003; Ye, 1992; Taylor, 2002; Tan, 1999). Such projects had to fall into one of the following four categories: (i) securing access to domestically scarce natural resources, (ii) accessing and transferring technology to China, (iii) enhancing export possibilities for Chinese companies, and (iv) augmenting managerial skills through ‘on-the-job training’ (Guo, 1984). The Chinese government especially supported the establishment of a foreign joint venture to enable the Chinese partner to transfer technology and managerial knowledge back to Chinaand to attenuate the business risk.
The objective of allowing a certain amount of controlled Chinese OFDI was to ensure that it became an integral part of the Chinese economy and contributed to social welfare. The extent to which OFDI benefited the Chinese economy or signalled a departure from socialistic ideology, was heavily discussed among politicians and policy-makers during the 1980s and reflected the classic dispute about the potential (diversionary) impact of OFDI on domestic investments and economic development (Zhang, 2003; Buckley et al., 2008). This conflict of interest is also reflected in the corporate reforms during the 1980s, which were constrainedby the emphasis laid on state ownership and state control of industrial production as well as the reluctance by bureaucrats to diminish their power and interests in the companies they supervised. Moreover, Chinese managers were generally inexperienced in running large industrial companies in a market-oriented environment (Chow, 1993). The nature of the economic system and international inexperience did not favour a liberal approach to OFDI.