China's quest to climb up further the value-added chain by acquiring leading-edge technology firms has made Germany a favorite M&A target in the recent past years. Audi's slogan "Vorsprung durch Technik" (lead by tech), that's what the Chinese are currently after: producers of high-end machines (Krauss Maffei, Putzmeister), fork-lift trucks (Kion), LED chip plants (Aixtron), graphic electrodes (SGL Carbon) and now industrial roboters (Kuka). Early 2016, the Chinese conglomerate ChemChina offered to purchase the Swiss agribusiness Syngenta (NYSE:SYT) for $43 billion, the biggest deal so far. A storm of protectionist sentiment is greeting these Chinese acquisitions, not only by politicians (EU competition tsar Oettinger, German Economic Minister Gabriel) but also by academics, such as former IFO president Hans-Werner Sinn and Merics (Mercator Institute for China Studies) director Sebastian Heilmann .
As summarised in Table 1, China's old growth model, embracing trade integration with a fairly closed capital account, has come to an end ten years ago. Since then, China's global inward FDI has first boomed from 2005 to 2010 but since then stagnated, as rising dollar wages have reduced its appeal for investment in the manufacturing sector. Meanwhile, China's outward FDI has been booming and increasingly targeted advanced countries rather than resource-rich developing countries.
Table 1: China's FDI flows and FDI Restrictiveness
|Inward FDI, $billion||104.1||243.7||249.9|
|Outward FDI, $billion||13.7||58.0||187.8|
|FDI Restrictions (0 to 1)||0.56||0.42||0.38|
Following (what is now mainstream) economic policy advice, capital-account liberalisation has been gradual but continuous. It is noteworthy that China has received far more inward FDI than it invested abroad, despite being relatively closed as measured by the OECD restrictiveness index. This index, running from 0 (very open) to 1 (closed), indicates a composite of equity restrictions; screening and approval requirements; restrictions on foreign key personnel; and operational restrictions such as on land acquisition and capital repatriation. Despite all the noise from Western industry lobbies and politicians, China has steadily liberalised its capital account, from an index score of 0.56 in 2005 to 0.38 in 2015. Importantly, however, China still allows joint ventures only.
China's state-guided outbound industrial and technology policies aimed at technological leapfrogging through acquisitions pose more industrial, competition and security concerns than acquisitions by SWFs that seek higher risk-adjusted returns and diversification via passive investments2. Some of these policy concerns have been thoroughly discussed by Hanemann and Huotari (2015)3. The most relevant, in my mind, are:
- Asymmetry in market access. Between Germany (as part of the EU) and China, there is no level playing field. Germany belongs to the most open economies (the OECD restrictiveness index score is 0.023 since 2010) while high (> 60%) Chinese local content requirements ("Made in China 2025") hit German companies in sectors where Germany is very competitive: power equipment, new energy, medical technology, industrial robots, large tractors, and IT for connected cars.
- Subsidies and non-market advantages. Many of China's globally operating companies are receiving preferential treatment from local or central governments. These subsidies are a source of unfair competition leading, e.g., to distorted bidding processes in global markets.
- Technology transfer and industrial hollowing out. It is feared that Chinese state-controlled owners will end up absorbing key technologies and know-how, leading to a hollowing out of the industrial base of their Western competitors. As quipped in a comment to Heilmann's FT article: "Those takeovers are like the giant bug in the movie Starship Troopers. It punches a hole in the head and sucks out the brain, leaving a dead shell." The erosion of network externalities - strong in the case of Germany's car upstream suppliers - can punctuate and ultimately destroy an entire industry as well as industrial region.
- National security threats. Concerns relate to the erosion of national defence industries, the creation of new channels for infiltration, surveillance and sabotage. To be sure, the German AWG (Aussenwirtschaftsgesetz, or Foreign trade & Payments Law)) or CFIUS, the Committee on Foreign Investment in the United States, provide sufficient tools to restrict Chinese FDI.
In the absence of a multilateral agreement on foreign direct investment, these policy concerns, however valid, give easily rise to distortive and discriminatory policy response. It needs strong independent minds to not follow Professor Heilmann's FT (op.cit.) fatal ad-hoc recommendations such as to combat state-driven Chinese companies through state aid or to build discriminating rules based on the nationality of acquirers. Let's hope that Angela Merkel did not fall prey to such bad advice on her recent China trip. Given China's market size, policymakers should be aware of costly retaliation measures.
From an economic (rather than from an industry-lobby) perspective, most of China's FDI acquisitions provide no reason for policy intervention. An important yardstick to gauge the broad welfare effect of China's high-tech acquisitions from a trade theory perspective is how it impacts on Germany's terms of trade4. Welfare gains from international trade are unaffected by China's acquisitions as long as they don't move Germany's terms of trade, present and future. China's inward FDI and the ensuing technology transfer can even improve Germany's welfare if it falls on industry branches with a competitive disadvantage (net import position): Germany's terms of trade improve, as net imports become cheaper. The reverse holds if China acquires high-tech in areas where Germany is a net exporter as its competitive advantage will suffer from lower premium prices; in that case, China's FDI will likely worsen Germany's terms of trade. The Kuka (OTCPK:KUKAF) acquisition may be such a case. Trade theory provides economic food for thought to reset the examination of Chinese FDI.
1 Sebastian Heilmann (2016), "Europe needs tougher response to China's state-led investments," FT 9th June.
2 Helmut Reisen (2008), "How to spend it: Sovereign wealth funds and the wealth of nations," Voxeu, 5th June.
3 Thilo Hanemann and Mikko Huotari (2015), "Chinese FDI in Europe and Germany: Preparing for a New Era of Chinese Capital," Merics/Rhodium Group, Berlin, June.
4 See Henning Klodt (2008), Müssen wir uns vor Staatsfonds schützen?" Wirtschaftsdienst, Vol. 88, Iss. 3, pp. 175-180, for excellent analysis (in German).