Chinese investment in the United States is at an all-time high. In the first quarter of 2016 alone, Chinese firms invested more than $8 billion in the United States, the strongest first quarter ever recorded. China’s investment worldwide also soared in the first five months of 2016, up more than 60 percent compared with the same period last year. A lot of business leaders are asking: Why is this happening, and will it continue?
Many think China’s slowing economy and currency volatility are causing this investment surge. In the short term, these factors certainly play a role, but they are not the main reasons why Chinese investment is at such a high level. In my view, the current situation is a result of the natural progression of China’s development model, which has been in the making since 2007, when then President Hu Jintao outlined a plan for the next phase of China’s modernization.
Hu set a priority on globalization, transitioning China from heavy manufacturing to a domestic consumer economy, and building up sustainable businesses in the long run. The momentum picked up from 2010 to 2012, when the United States lobbied China for more investment dollars, and many Chinese investors made the rounds at various U.S. companies. Now China has reached a development stage at which companies have the incentive and maturity to internationalize rapidly, and the recent liberalization of outward investment restrictions allows them to do so. China’s catch-up in global investment is a trend that will be with us for many more years. Businesses need to be prepared to seize the opportunities arising from this new era of Chinese capital.
"Businesses need to be prepared to seize the opportunities arising from this new era of Chinese capital."
For the past three decades, China’s globalization efforts were predominantly focused on attracting foreign direct investment (FDI) and expanding cross-border trade. The global investment footprint by Chinese companies remained marginal, as they had neither the motive nor the permission to invest overseas. This has changed in recent years and corporate China is catching up on global investment, marking a new era of Chinese capital outflows.
The most important driver of Chinese outbound investment growth is the maturing of the Chinese economy. After three decades of successful economic modernization, China is now approaching middle-income status, which requires the leadership to overhaul the country’s economic growth model. This economic maturation and structural adjustment have forced Chinese companies to reinvent their business models to remain globally competitive. Instead of relying on low-cost labor and other cheap factor inputs, Chinese businesses now urgently need to upgrade technology, streamline global value chains, develop brands and other consumer capabilities, and increase their modern services capability.
Recognizing the importance of outward FDI for achieving those goals, the Chinese leadership has gradually loosened the restrictions and controls on outward investment. The gradual liberalization of outbound FDI rules began in the year 2000 with the “going abroad” policy, but was accelerated during the past five years with the transition from an approval to a registration system. The combination of greater commercial incentives and a more liberal policy environment has propelled annual Chinese outbound FDI to grow from less than $20 billion before 2005 to more than $130 billion in 2015. It’s clear that Chinese outbound FDI will remain a major trend for the coming decade in the United States and other major economies.
The United States has become a preferred destination for Chinese capital because the U.S. economy offers attractive opportunities for expanding overseas market share and acquiring valuable and complementary assets. The transactions announced in the first months of 2016 illustrate these attractions.
The United States is home to technology leaders in many industries, offering Chinese companies the opportunity to acquire firms with cutting-edge technology and to tap America’s talented and diverse workforce. Recent examples include acquisitions in the semiconductor industry (Omnivision Technology), large investments in electric vehicle research and production (Faraday Future), and smaller acquisitions in the biotech industry (MP Biomedicals, Avioq).
In light of declining competitiveness in lower-end manufacturing, Chinese companies are also eyeing brand names and other consumer-related assets, which are abundant in the U.S. economy. One such example is Haier’s $5.4 billion acquisition of GE Appliances. The increasingly positive growth outlook for the U.S. economy and changes in relative cost structures have also incentivized Chinese companies to expand their local presence in manufacturing. Recent examples include investment in a $1.8 billion petrochemical facility by Yuhuang Chemical in Louisiana and a $2 billion paper mill by Tranlin Paper in Virginia.
Finally, investments in the United States also allow Chinese companies to increase their ability to serve the fast-growing Chinese middle class with modern services. This is perhaps best exemplified by recent investments in the entertainment (Legendary Entertainment), health care (Alliance Healthcare Services) and hospitality (Strategic Hotels & Resorts) sectors.
"Chinese outbound FDI will remain a major trend for the coming decade in the United States and other major economies. "
One major unknown for the future trajectory of Chinese outbound investment is political risk. For one, there is uncertainty about how much outbound FDI Chinese regulators will allow, as China is experiencing unprecedented levels of capital outflows. Two, the rapid increase of China’s outbound investment has also triggered political responses in host economies, as politicians debate potential national security risks and the economic implications from rising levels of Chinese investment.
Although these risks are real, there are reasons for optimism. It is true that Chinese leaders have become more concerned about outflows, but they recognize the value of outbound FDI for the competitiveness of Chinese companies and the Chinese economy as a whole.
In the United States, attempts to politicize Chinese investment in certain sectors could backfire if lawmakers attempt to crack down on legitimate deals. Chinese companies now provide about 100,000 direct jobs in the U.S. economy. An unfriendly climate may drive investors to take their money to Europe, Canada or Australia. Ultimately, to stay competitive, we have to keep the door open to Chinese investment or risk losing an important ingredient in U.S. economic prosperity.
"We have to keep the door open to Chinese investment or risk losing an important ingredient in U.S. economic prosperity."
It is possible that the pace of China’s global deal-making will slow down in the remainder of 2016 compared with the unprecedented levels seen in the first few months of the year. However, talk of “peak China outbound FDI” is premature and exaggerated. Despite the fast growth in recent years, China’s current OFDI stock-to-GDP ratio is a mere 6 percent, much lower than that of any developed economy and, in fact, much lower than its emerging economy peers. That means we can expect at least another decade or two of elevated outward investment before China has caught up with other countries.
Currently pending acquisitions by Chinese investors in the United States add up to more than $25 billion. Chinese companies have also become more confident in organic growth recently: announced greenfield FDI projects are worth more than $10 billion. In short, 2016 will likely be a record year for Chinese FDI in the United States and there is room for many more years of elevated Chinese capital inflows.
Local communities and companies need to be ready to tap these new sources of productive investment and the jobs, technology, exports and other benefits they can bring. At East West Bank, we will continue to build the bridge between East and West for Chinese capital making its way to the United States and to support U.S. companies in seizing new opportunities in the Chinese market.