Social instability is the main threat to China’s overseas investments

Mei Xinyu is a researcher at the Ministry of Commerce’s Chinese Academy of International Trade and Economic Cooperation.

Chinadialogue (CD): How would you evaluate China’s overseas investments?

Mei Xinyu (Mei): China’s overseas investments take two forms. One is project contracting, the other direct investments.

China’s construction industry is the world’s biggest, and in 2010 it became the world’s biggest overseas contractor. In 2011, Chinese firms signed engineering contracts overseas worth US$140 billion. In 2012, that rose by more than 10% to US$156.5 billion.

 

Generally speaking, Chinese firms have high technical and management skills and their overseas investments have developed in a regular way. But there has been some bad investment behaviour, which the government should do more about at the macro-level.

Chinese business expansion is hugely helpful to the host nations. Many developing countries have very poor infrastructure, something that Chinese engineers and technicians can often provide at half the cost, or less, than host nations could manage. China also has the technical ability to carry out some of the work of planning the infrastructure.

  

Direct investment plays a positive role in opening up markets, increasing profits from overseas trade, and acquiring resources, but in some cases there have been mistakes.

 

For example, direct investment in the resources sector has been high in recent years, at about 20%, the third largest sector, and individual projects tend to be quite large. But many of these do not make financial sense. Overseas investments should be counter-cyclical: invest less in a bull market, then buy in a bear market. That way you get a better price. But many investors buy high, and so some firms may go bust.

Regardless, overseas investment is a requirement for China’s economic growth. Outwards expansion is now the only way to maintain the speed of economic growth and use up excess production capacity. China’s big companies also need to spread their operations across different countries and markets to balance fluctuations in income.

China is the world’s biggest resource market. Other countries need Chinese investment in order to guarantee their share of the Chinese market, and also to resolve their capital and export issues.

CD: What risks and problems do China’s overseas investments face?

Mei: One of the bigger risks is unstable political circumstances in the host nation. This has caused many investments to fail.

A classic example is Mongolia. It has large coal mines, but lacks the technology and capital to develop them, so it welcomes foreign investment.

In 2012 Chalco signed a long-term coal sales agreement with Mongolia’s ETT. Chalco provided a US$350m loan, with ETT to repay the loan by supplying coal at an agreed price. But that same year ETT executives were replaced after a change of government, and the company failed to provide the agreed quantity of coal – only half was delivered. In January 2013, Mongolia reneged on the agreement, demanding a higher price for its coal. Last year coal sales to China were stopped outright. Chalco is unlikely to earn back its original investment.

Mongolia has also lost out. It failed to understand its role in the market, and understands China even less. The price of coal in China started to drop in 2012, and half a year later Mongolia tore up the contract. Even if they start mining again they won’t be able to sell it.

 

Canadian investors have run into a similar problem. Canada invested in a world-class copper mine in Mongolia, intending to sell the output to China. But high taxes meant production halted for a year. And during that year world copper prices plummeted. This meant huge losses for both the investor and Mongolia itself. It’s hard for investors to control these kinds of losses.

 

Also, in countries where the rule of law and economic stability are lacking, Chinese companies have faced unreasonable demands for compensation or fines from the local government. For example the China National Petroleum Corporation was fined US$1.2 billion for damaging the environment in the central African nation of Chad.

Over the long-term, things have been better in South-East Asia as cultural differences are less significant, and communication is easier. The main obstacle is political pressure from the US and Europe. In Africa and Latin America the problems are more local: there are deeply rooted cultural and social traditions that won’t change easily and that means conflicts arise as projects start and progress. Turbulent political and social circumstances also threaten investor interests.

CD: In the last year or two, there’s been a debate in Chinese media about failings in environmental protection, use of local workers, and community relations; and also improper methods being used to win projects in poorly-run countries. Is that the biggest problem facing Chinese firms investing overseas?

Mei: These are issues, but shouldn’t be major concerns for the companies. Business runs by its own rules, and political issues should be considered separately.

Environmental disputes are a political matter for the host nation to resolve through higher environmental standards and tougher enforcement. Companies do have social responsibilities, but you can’t expect them to do the job of protecting the environment.

When it comes to labour, Chinese firms have experienced technical staff who can help increase efficiency. In Nigeria, for example, China built a port using its own staff. It cost 200 million yuan and took two years. It would have taken a decade and one billion yuan using local staff. Which is the government going to choose? The government wants to spend as little as possible and get both efficiency and quality.

 

Chinese firms that take their staff overseas have to cover living and travel expenses, and pay salaries three times higher than those they pay at home. One Chinese employee costs 15 times as much as a local. Even so, companies choose to use Chinese workers because overall costs are still lower.

 

The question is how to improve the standards of the local workforce so they can do the job.

On community relations, I think it’s necessary to maintain a distance. One, there’s no shared language; two, more contact can mean more friction; three, there are cultural differences and Chinese habits may impact on the life of the local community.

There’s another more important issue: the places China invests in are usually not stable or safe. Less contact can protect Chinese workers.

As for winning project contracts via improper methods, that’s not something investors can solve. Companies adapt to the local rules. And anyway, the political traditions of the former European and US colonies were created by Western countries; they set the rules of the game. It’s a political matter, and it’s unreasonable and unrealistic to expect foreign companies to resolve it.

If these problems are to be solved the host nation needs to set some basic standards to regulate investment.

CD: Is there a need for changes to China’s overseas investment policies and strategy?

Mei: Two changes are needed. First, relax market controls, so the market can develop more freely. Second, improve protection of overseas investments through bilateral or multilateral agreements. And in extreme cases, do not rule out the use of force to protect the assets of Chinese companies.