Chinese International Investments

Chinese International Investments I. Alon; M. Fetscherin; P. Gugler ISBN: 9780230361577 DOI: 10.1057/9780230361577 Palgrave Macmillan

Please respect intellectual property rights This material is copyright and its use is restricted by our standard site license terms and conditions (see palgraveconnect.com/pc/info/terms_conditions.html). If you plan to copy, distribute or share in any format, including, for the avoidance of doubt, posting on websites, you need the express prior permission of Palgrave Macmillan. To request permission please contact [email protected].

Edited by

Ilan Alon Marc Fetscherin Philippe Gugler

10.1057/9780230361577 - Chinese International Investments, Edited by Ilan Alon, Marc Fetscherin and Philippe Gugler

Copyright material from www.palgraveconnect.com - licensed to Interdisciplinary Center - PalgraveConnect - 2013-06-19

Chinese International Investments

This is one of the first books to take a close and informed look at Chinese foreign direct investment. With its clear and timely portrayal of the multi-faceted nature of these investments, it will prove highly useful for policy-makers, executives, and professionals – Dr Christian Casal, Officer Manager & Director, McKinsey & Company, Switzerland This book provides important new evidence and insights on foreign direct investment from China, a now-dominant feature of the international economy. Its coverage is unusually comprehensive, examining both macro- and micro-determinants as well as a wide range of host regions, and it is therefore a major source of reference – John Child, Emeritus Professor of Commerce, University of Birmingham, United Kingdom At a time when media hoopla on Chinese FDI is tremendous but solid scholarly analysis is rare, this book provides much-needed multidimensional analysis on this important phenomenon associated with the recent globalization. I expect this book to be widely read, cited, and debated – Mike W Peng, Provost’s Distinguished Professor of Global Strategy, University of Texas, Dallas, United States Are Chinese foreign direct investors different from investors from emerging markets? This book tells us that they are in some ways like others, but also that they have some very special and important characteristics. In developing its themes, the book provides insights for academics interested in the theory of foreign investment, but also help for Western managers who face new and little-understood competitors around the world – Louis T. Wells, Herbert F. Johnson Professor of International Management, Harvard Business School, United States The rise of Southern multinationals in general and the Chinese ones in particular are reshaping the global investment landscape. By offering a timely insight in this important phenomenon, the book gives just the perspective we need and helps us understand exactly what is at stake. It is a must-read for anyone seeking to understand the drivers and determinants of FDI from China, and its implications for host countries around the world – James X Zhan, Director, Investment & Enterprise Division, United Nations Conference on Trade & Development (UNCTAD), Switzerland



This is a rich volume on a vital topic. The authors and editors are to be commended on a timely, fascinating, and intriguing book on a vital current phenomenon – Peter J Buckley, Professor of International Business and Director of the Centre for International Business, University of Leeds, UK & Cheung Kong Scholar Chair Professor, University of International Business and Economics (UIBE), China



This page intentionally left blank

Chinese International Investments Ilan Alon Rollins College, United States

Marc Fetscherin Rollins College, United States

Philippe Gugler University of Fribourg, Switzerland



Edited by

Selection and editorial content © Ilan Alon, Marc Fetscherin and Philippe Gugler 2012 Individual chapters © the contributors 2012 Foreword © Peter J. Buckley 2012

No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2012 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN 978–0–230–28096–0 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. 10 9 8 7 6 5 4 3 2 1 21 20 19 18 17 16 15 14 13 12 Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne



All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

List of Figures

vii

List of Tables

ix

Foreword

xii

Acknowledgments

xiii

Notes on Contributors

xv

Introduction Ilan Alon, Marc Fetscherin, and Philippe Gugler

1

Part I Macro-Environmental Determinants of Chinese FDI 1 An Institutional Perspective and the Role of the State for Chinese OFDI Bing Ren, Hao Liang, and Ying Zheng

11

2 Home Country Macroeconomic Determinants of Chinese OFDI William Wei, Ilan Alon, and Liqiang Ni

38

3 The Role of Country of Origin and Chinese OFDI Paz Estrella Tolentino 4 Chinese SWFs: At the Crossroad between the Visible and the Invisible Hand Michael Keller and Laura Vanoli

54

81

Part II Micro-Environmental Determinants of Chinese FDI 5 Motives and Patterns of Reverse FDI by Chinese Manufacturing Firms Xiaobo Wu, Wanling Ding, and Yongjiang Shi

107

6 A Two-way Causal Link between Internationalization and CEO Equity Ownership in Chinese Firms Xiaohui Liu and Jiangyong Lu

122

v



Contents

vi

Contents

7 Effects of Absorptive Capacity on International Acquisitions of Chinese Firms Ping Deng

137

8 Push and Pull Factors for Chinese OFDI in Europe Yun Schüler-Zhou, Margot Schüller, and Magnus Brod

157

9 The Rise of Chinese OFDI in Europe Jan Knoerich

175

10 Chinese M&A in Germany Yipeng Liu and Michael Woywode

212

11 Chinese SMEs in Prato, Italy Anja Fladrich

234

12 Chinese State-Controlled Funds and Entities in Canada Xiaohua Lin and Qianyu Chen

257

Part IV Chinese FDI in Africa 13 Chinese OFDI in Africa: Trends, Prospects, and Threats Gayle Allard

279

14 Chinese OFDI in Sub-Saharan Africa Raphael Kaplinsky and Mike Morris

300

Part V Cases of Chinese FDI 15 The Case of Florida Splendid China Wenxian Zhang

329

16 Benelli and Q J Compete in the International Motorbike Arena Francesca Spigarelli, William Wei, and Ilan Alon

355

17 Geely’s Internationalization and Volvo’s Acquisition Marc Fetscherin and Paul Beuttenmuller

376

Final Reflections Ilan Alon, Marc Fetscherin, and Philippe Gugler

391

Author Index

396

Subject Index

405



Part III Chinese FDI in Europe and North America

1.1a Evolution of state’s examination and approval processes for China’s OFDI 1.1b Evolution of state’s foreign exchange control for China’s OFDI 1.1c Evolution of state’s inspection and evaluation processes for China’s OFDI 1.1d Guidance and support on China’s OFDI by state 1.1e Evolution of China’s international investment protection mechanism 1.2 Bureaucratic system in regulating China’s OFDI 1.3 Chinese OFDI stocks’ distribution by different types of investors (2009) 1.4 The role of state and Chinese multinationals’ institution-based OFDI 3.1 Orthogonalized impulse responses of FDI to one standard error shock in each system variable equation 3.2 Orthogonalized impulse responses of each system variable to one standard error shock in the FDI equation 4.1 Sovereign wealth funds and government activities 4.2 The accumulation of Chinese foreign exchange reserves (1981–2009) 4.3 Targeted regions of Chinese sovereign wealth funds (2007–2010) 4.4 Targeted sectors of Chinese sovereign wealth funds (2007–2010) 4.5 Number of deals by targeted regions and sectors, CIC (2007–2010) 4.6 Number of deals by targeted regions and sectors, SAFE (2007–2010) 4.7 Sovereign wealth funds: strategy and transparency 5.1 Summary of cross-case analysis: patterns 7.1 An absorptive capacity model of acquisition of strategic assets via M&A 8.1 Industries recommended for investment in Western and Eastern EU member countries 8.2 Incentives offered by IPAs to Chinese investors in the EU 9.1 Chinese OFDI into the EU (2003–2009, US$ billion) 9.2 Share of Chinese OFDI stock by region (2009)

20 20 21 21 21 22 24 31 69 71 82 85 88 89 90 90 100 118 139 163 166 176 182

vii



Figures

viii List of Figures

183 220 235 236 267 301 302 332

334 336 342 363

363 378 382 383 389 389

Map 17A.1 Geely automobile production plants

388



9.3 Share of Chinese OFDI stock in the EU by country or country groups (2003–2009) 10.1 A conceptual model of absorptive capacity 11.1 China’s dual approach toward sustainable economic development 11.2 Landmarks of China’s ambition to global leadership 12.1 Game structure 14.1 Four types of Chinese investors in SSA 14.2 Size, sector, and ownership of Chinese investors in SSA 15.1 Florida Splendid China’s miniature replica of the Forbidden City 15.2 The Great Wall at Florida Splendid China, which was constructed brick by brick by Chinese craftsmen, comprising 6.5 million one- and two-inch bricks, 16th of the original size. The dragonfly on top of the stick in the foreground provides a sense of the scale of the structure 15.3 Entrance to Florida Splendid China on US Highway 192 15.4 Trolley ride at Florida Splendid China. Note the few patrons, an indication of poor attendance 16.1 Market share of top 10 motorbike producers in the USA (sales estimates, 2008) 16.2 Market share of top 10 motorbike producers in Italy (share per year to month as number of registrations from March 1, 2008, to February 28, 2009) 17.1 Main car-producing countries 17.2 Geely automobile corporate structure 17.3 Sedan sales and breakdown by models (2009) 17A.1 Product portfolio 17A.2 Example of Geely car

1.1 The policy regime of China’s OFDI 1.2 The bureaucratic administration regime of China’s OFDI 1.3 Top 50 non-financial Chinese enterprises ranked by OFDI stocks (2009) 2.1 Regression results 3.1 Some empirical evidence on the macroeconomic determinants of inward FDI 3.2 Some empirical evidence on the macroeconomic determinants of OFDI 3.3 Autocorrelation coefficients of the variables (sample period from 1982 to 2008) 3.4a Tests for stationarity around a level using the KPSS test 3.4b Tests for stationarity around a trend using the KPSS test 3.5 The vector autoregressive model of China 3.6 Exogeneity tests for FDI and other system variables 3.7 Estimated system covariance matrix of errors 3.8 Decomposition of the orthogonalized forecast error variance 4.1 CIC’s foreign investments (2007–2010) 4.2 CIC’s domestic investments (2007–2010) 4.3 SAFE’s foreign investments (2007–2010) 5.1 Sany Group’s OFDI projects 5.2 Wanxiang Group’s OFDI projects 5.3 Geely Holding Group’s OFDI projects 5.4 Summary of cross-case analysis: motives 6.1 Correlation matrix 6.2 Results from the panel causality test 6.3 Results from the panel system equations 8.1 European countries and industries recommended for Chinese OFDI in 2004 and 2005 (based on the 2004 and 2005 ‘catalogs’) 8.2 European countries and industries recommended for Chinese OFDI in 2007 (based on the 2007 ‘catalog’) 8.3 Chinese OFDI flows and stocks (in total and in the EU, 2005–2008) 8.4 Geographical distribution of the Chinese OFDI in the EU (2003–2008) 8.5 Sectoral distribution of the Chinese OFDI stock in the EU at the end of 2008

17 23 25 47 56 57 60 61 62 64 66 67 68 91 94 95 111 113 116 117 129 130 131

160 162 168 169 170

ix



Tables

List of Tables

8.6 Comparing pull and push factors in Western and Eastern EU countries 9.1 Characteristics and types of Chinese investments in Europe: exploitation and sourcing of competitive advantages 9A.1 Chinese OFDI stock and flows into the EU by member states (2003, 2008, and 2009, US$ million) 9A.2 List of contacted European IPAs 9A.3 List of questions posed to European IPAs 9A.4 Overview of IPA survey results on Chinese OFDI in the EU (2007–2008) 9A.5 Examples of Chinese companies in the EU and typical sectors of investment 9A.6 Bilateral investment treaties concluded between China and EU countries as of June, 1, 2010 10.1 Samples in case studies 11.1 Top 10 recipient countries of Chinese ODIs flows in Europe (US$ million) 11.2 Respondent gender and age 11.3 Company size and industry 11.4 The Chinese community in Italy between 1991 and 2007 11.5 Comparison of Chinese firms in Prato, Veneto, and Hamburg (1991–2009) 11.6 Chinese SOEs, MNEs, and SMEs compared 12.1 China’s outward FDI flows and stocks (2002–2009, US$ billion) 12.2 Change of investment Canada Act 12.3 Canada: geographical distribution of inward FDI stock (2000–2008, US$ million) 12.4 Strategy combinations 12.5 Canada: inward FDI flows (2000–2008, US$ billion) 13.1 Main sectors for Chinese OFDI in selected Sub-Saharan African countries 13.2 Chinese OFDI projects in 20 African countries by sector (2001–2008) 13.3 Chinese OFDI stocks in African countries as a percentage of host-country GDP (2005) 13.4 Chinese OFDI stocks in African countries in comparison with world stocks (2005) 13.5 Growth of Chinese OFDI flows in Africa (current US$, 2004–2007) 13.6 Growth of Chinese OFDI stocks in Africa (current US$, 2004–2007) 13.7 Descriptive statistics 13.8 Correlation matrix

171

192 194 195 196 198 202 205 221 235 241 242 243 243 246 259 261 262 268 270 283 284 286 287 288 288 289 289



x

List of Tables

291 294 295 296 297 304 305 307 309 312 316 349 357 364 364 365 365 372 372 373 373 381



13.9 Regression results 13A.1 Chinese OFDI stocks in African countries as a percentage of host-country GDP (2003) 13A.2 Chinese OFDI stocks in African countries as a percentage of global OFDI (2003) 13A.3 The countries included in the regressions 13A.4 Results of regression of corruption perception index on dummy variable of missing values 14.1 Chinese OFDI flows and stocks, excluding HK, CI, BVI (2003 and 2008) 14.2 Distribution of China’s OFDI stock in Africa, 1990, 2005, and 2008 (%) 14.3 Significance of Chinese FDI in key sectors in selected SSA economies 14.4 Chinese, Indian, South African, and northern FDI compared 14.5 Africa’s share of global production and reserves (%) 14.6 Chinese SOEs and Northern MNC FDI in SSA: major features 15A.1 Chronology of major events of Florida Splendid China 16.1 Main facts and trends before the acquisition 16.2 Registrations in Italy (2008) 16.3 Top 10 motorbikes sold in Italy in 2008 (number of registrations) 16.4 Motorbike and scooter (more than 50 cc) registrations per year 16.5 The full range of Benelli products in 2009 16A.1 Outlook for China 16A.2 China’s main macroeconomic data: projections (as in 2009) 16A.3 Outlook for Italy 16A.4 Italy’s main macroeconomic data: projections (as in 2009) 17.1 Geely’s milestones

xi

At some point, variously estimated to be between 2016 and 2025, China will become the largest economy in the world. Despite this, the Chinese economy is under-internationalized compared with other large economies (USA, EU countries). It is inconceivable that large economies can remain for long without extending their international reach. Chinese international investment is therefore a crucial aspect of the global economy. For that reason alone, this volume is timely. In this book, an international group of experts concentrate mainly on foreign direct investment from China – an emerging and under-researched but vital aspect of China’s internationalization. The macroeconomic and institutional aspects of Chinese outward foreign direct investment (OFDI) are fascinating and crucial in this analysis because the relationship between ‘private’ and various forms of state ownership are important in our understanding of the amount, direction, and motivation of OFDI from China. At the micro level, the motives, patterns and causality of individual direct investment are analysed in Part 2. Managerial aspects of Chinese OFDI are central to explanations of success and failure of all FDI, and the determinants of success (or otherwise) are brought to the fore throughout this volume. It is particularly important to see cases of failure (often under-reported and under-researched in the international business literature) for the particular insights that such studies bring. We should expect high degrees of failure in early internationalizing companies (and source countries), and China is no exception. The case studies in this volume are illuminating and provide much food for further thought. Parts 3 and 4 represent interesting contrasts – investments in Europe, largely market- and asset-seeking, and those in Africa, largely resource-seeking, although full of intriguingly mixed motives (and mixed categories too – and FDI, trade, institutional support). This is a rich volume on a vital topic. The authors and editors are to be commended on a timely, fascinating, and intriguing book on a vital current phenomenon. Peter J. Buckley Professor of International Business and Director of the Centre for International Business, University of Leeds, United Kingdom Cheung Kong Scholar Chair Professor in the University of International Business and Economics, China

xii



Foreword

At Rollins College, we are particularly thankful to the institutional support provided by President Lewis Duncan, Provost Laurie Joyner, Dean Craig McAllaster, and Dean Deb Wellman. We would also like to thank Kirra Hughes for her assistance as book project manager, Kimberley Petersen for administrative support, and Nanci Healy for her editing services. At the University of Fribourg, we would like to thank Laura Vanoli, Xavier Tinguely, and Michael Keller for administrative support and for their assistance in the reviewing process for the chapters. We would also like to thank the Swiss National Science Foundation for having supported this research. All the chapters in our book were double-blind reviewed, and we are thankful to the reviewers who put numerous hours of their time into improving the quality of the paper submissions. It has been a truly international effort with experts from all over the world. Specifically, we would like to thank the following reviewers: Gayle Allard, IE Business School, Spain Nadia Almaraz, Tecnológico de Monterrey, Mexico Diana Bank, Universidad de Las Américas, Puebla, Mexico Magnus C. M. Brod, GIGA Institute of Asian Studies, Germany Doren Chadee, University of Southern Queensland, Australia Qianyu Chen, China Agricultural University, China Ping Deng, Maryville University of St Louis, USA, and Shanghai Lixin University of Commerce, China Wanling Ding, Zhejiang University, China François Duhamel, Universidad de Las Américas, Puebla, Mexico Anja Fladrich, Monash University, Australia Juan Carlos Gachúz, Tecnológico de Monterrey, Mexico Françoise Hay, Université de Rennes, France Dirk Holtbrügge, Friedrich-Alexander-University Erlangen-Nuremberg, Germany Raphael Kaplinsky, Open University, UK Michael Keller, University of Fribourg, Switzerland Jan Knoerich, United Nations Conference on Trade and Development, Switzerland Heidi Kreppel, Friedrich-Alexander-University Erlangen-Nuremberg, Germany Edmir Kuazaqui, Escola Superior de Propaganda e Marketing, Brazil Hao Liang, Tilburg University, Netherlands Xiaohua Lin, Ryerson University, Canada xiii



Acknowledgments

Acknowledgments

Xiaohui Liu, Loughborough University, UK Yipeng Liu, University of Mannheim, Germany Jiangyong Lu, Peking University, China Christian Milelli, Université de Rennes, France Mike Morris, University of Cape Town, South Africa Aloysius Newenham-Kahindi, University of Saskatchewan, Canada Liqiang Ni, University of Central Florida, USA Bing Ren, Nankai University, China Yun Schüler-Zhou, GIGA Institute of Asian Studies, Germany Margot Schüller, GIGA Institute of Asian Studies, Germany Yongjiang Shi, University of Cambridge, UK Francesca Spigarelli, University of Macerata, Italy Xavier Tinguely, University of Fribourg, Switzerland Paz Estrella Tolentino, University of London, UK Laura Vanoli, University of Fribourg, Switzerland William Vlcek, University of St Andrews, UK William Wei, Grant MacEwan University, Canada Loong Wong, Murdoch University, Australia Michael Woywode, University of Mannheim, Germany Xiaobo Wu, Zhejiang University, China Ren Yi, University of Southern Queensland, Australia Wenxian Zhang, Rollins College, USA Ying Zheng, Nankai University, China



xiv

Gayle Allard is a native of California who has spent most of her adult life working and living in Europe, especially in Spain, where she is Professor of Economics at the IE Business School in Madrid. She has a PhD from the University of California, Davis, and a Master’s in international affairs from the Johns Hopkins School of Advanced International Studies. Her research interests range from the effects of labor market institutions on employment and productivity in developed countries to the determinants of economic success (growth, foreign direct investment inflows, science and technology capabilities) in developing regions, especially Africa. In Madrid she directs the IE’s Africa Forum, which promotes research and disseminates information about business opportunities on the continent. Gayle is married with five children. Ilan Alon is Cornell Chair of International Business and Director of the China Center at Rollins College, and Visiting Scholar and Asia Fellow at Harvard University. He has published 27 books and more than 100 peer-reviewed articles. His recent books on China include Chinese Culture, Organizational Behavior and International Business Management (2003), Chinese Economic Transition and International Marketing Strategy (2003), Business and Management Education in China: Transition, Pedagogy and Training (2005), The Globalization of Chinese Enterprises (2008), Biographical Dictionary of New Chinese Entrepreneurs and Business Leaders (2009), China Rules (2009), and A Guide to the Top 100 Companies in China (2010). He has taught courses as part of top Chinese MBA programs, including those at Shanghai Jiao Tong University, Fudan University, East China University for Science and Technology, and China Europe International Business School. He is also an international business consultant, with experience in China as well as other countries in Asia, the Middle East, Europe, and America, and is a featured speaker in many professional associations. Paul Beuttenmuller is a recent MBA graduate with a concentration in international marketing from the Crummer School of Business at Rollins College, where he completed a five-year advanced management program. He has participated in a semester abroad at Shanghai Jiao Tong University, completed an internship with East China University of Science and Technology, and traveled to Istanbul to research its business environment. Paul also served as an organizer for Harvard’s 2009 China Goes Global Conference and for the Rollins College 2010 and 2011 International Colloquium on Consumer Brand Relationships. He has published three other book chapters.

xv




xvi


Magnus Brod is currently pursuing his Master’s degree in sociology at the London School of Economics, UK. He received a BA in social science from the Philipps University Marburg, Germany, with a minor in law studies. He has worked as project staff at the Institute of Asian Studies of German Institute for Global and Area Studies in Hamburg, Germany, where he conducted research on Chinese foreign direct investments in Europe and development aid in Southeast Asia. His research interests include quantitative methods, the economic sociology of trade, and socio-economic transformation and development processes of Asia, especially China. He has published on Chinese foreign direct investments in Europe and presented conference papers at the University of Toronto, Canada, and the Middle East Technical University Ankara, Turkey, among others. Qianyu Chen is a PhD candidate at the College of Agronomy and Biotechnology at the China Agricultural University, Beijing, and Visiting Scholar at the International Research Institute, Ryerson University. Her educational background has covered international economics and trade (BA in economics), rural sociology (MA in sociology), and farming systems (doctorate in agronomy). She has published several articles and conference papers on rural sociology and international business. Her current research focuses on Chinese outward foreign direct investment in developed countries, especially in Canada. Ping Deng is Professor of Business Administration in the John E. Simon School of Business at Maryville University of St Louis, USA, and he also serves as Eastern Scholar (Professor of Special Appointment at Shanghai Institutions of Higher Learning) at Shanghai Lixin University of Commerce, Shanghai, China. His current research interests focus on the internationalization of Asia Pacific firms and outward foreign direct investment by multinational corporations from emerging economies and particularly China. The research is supported partially by the Program for Professor of Special Appointment (Eastern Scholar) at Shanghai Institution of Higher Learning. Deng’s numerous publications have appeared in refereed journals such as Journal of World Business, Journal of Leadership and Organization Studies, Thunderbird International Business Review, Business Horizons and Asian Survey. Wanling Ding is a PhD candidate at the School of Management, Zhejiang University, Hangzhou, China. Her research focuses on global strategy, international management, and technological innovation. For more than three years she has participated in the national research project – Chinese Manufacturing Firms’ Outward FDI Strategy. She has published several



Paul hopes to continue studying Mandarin and the Chinese business environment while working in an international business environment within the marketing and branding fields.


xvii

Marc Fetscherin is Associate Professor at the Crummer Graduate School of Business and the International Business Department at Rollins College. He is also an associate of the Rollins China Center as well as an Asia Fellow at Harvard University. He received his PhD from the University of Bern, Switzerland. He holds two Master’s degrees: from the University of Lausanne, Hautes Etudes Commerciales, Switzerland, and the London School of Economics, UK. He has published the book China Rules: Globalization and Political Transformation (2009) as well as numerous peer-reviewed articles, book chapters, and conference papers. Fetscherin’s articles have appeared in refereed journals such as Management International Review, International Business Review, Thunderbird International Business Review, Asian Business & Management, Chinese Management Studies, International Journal of Emerging Markets, International Marketing Review and European Journal of Marketing. Anja Fladrich is Senior Lecturer in Management and National Program Manager Higher Education at Holmes Institute, Australia. She studied international management and Chinese (Mandarin) in Germany, China, and Australia. She is currently a PhD candidate at Monash Asia Institute, Monash University, Australia. Her thesis is concerned with the Chinese and Chinese entrepreneurship in Prato, Italy. Other research interests include higher education and graduate employment in China and Australia. Anja has published several articles and book chapters, and presented at various conferences in Australia, Hong Kong, and the USA. Philippe Gugler holds the Chair of Economics and Social Policy in the Faculty of Economics and Social Sciences and is the Director of the Center for Competitiveness at the University of Fribourg, Switzerland. He is an affiliate MOC faculty member of the Institute for Strategy and Competitiveness of the Harvard Business School, USA, and Guest Professor at the National Institute for Development Agency, Thailand, and at the Università di Roma, Italy. He is Vice-Chairman of the European International Business Academy as well as a member of the boards of several academic and economic associations in Switzerland and abroad. Philippe has published mainly in the fields of trade and competition, trade and investment, competition policy, multinational enterprises, and competitiveness.



peer-reviewed articles and conference papers on the topic of Chinese manufacturing firms’ outward foreign direct investment and internationalization. She was a teaching assistant for the course on strategic management in MBA programs at the School of Management, Zhejiang University, in 2007. She was a visiting doctoral student at the University of Cambridge from October 2008 to October 2009.

Raphael Kaplinsky is Professor of International Development at the Open University, UK. Building on extensive research and operational experience in the related fields of industrial development, technology and innovation, since the late 1990s he has focused and published on global value chains and the unequalizing characteristics of globalization. Within this, his primary research interest has been on the historical significance of the rise of China and India (the ‘Asian Drivers’) and their impact on low income economies in general, and Africa in particular. As part of this he has worked closely with the African Economic Research Consortium’s Asian Driver programme and on the impact of the Asian Drivers on the commodities-manufactures terms of trade. His new research focus is on the potential which China and India have for producing pro-poor innovations and how this might facilitate the emergence of a new pro-poor growth strategy in low income economies in general, and in Africa in particular. Michael Keller is a research assistant and PhD candidate at the Chair of Economics and Social Policy, Faculty of Economics and Social Sciences, University of Fribourg, Switzerland. His Master’s degree in economics and social sciences from the University of Fribourg, Switzerland, was obtained in 2009 (summa cum laude). He has been working as a researcher and consultant at the Center for Competitiveness, University of Fribourg, Switzerland, since 2008. Jan Knoerich is Departmental Lecturer in the Economy of China at the School of Interdisciplinary Area Studies, University of Oxford. He previously worked for the United Nations Conference on Trade and Development (UNCTAD) in the area of foreign direct investment and its development implications. He contributed to numerous UNCTAD publications, including studies on international investment agreements and the World Investment Report, and he has published several peer-reviewed articles and book chapters. His PhD research, undertaken at the School of Oriental and African Studies, University of London, focused on Chinese outward foreign direct investment in the European Union. He also received an MA in diplomacy and international relations from Seton Hall University in the USA, where he studied as a Fulbright scholar. Hao Liang is an MPhil student in finance at Center for Economic Research, Tilburg University, Netherlands. He received his Bachelor’s degree in management from Nankai University in China, and he was a visiting student at Singapore Management University and Cornell University in the USA. His research interests are in entrepreneurial finance, behavioral finance, corporate governance, and international business. As a Master’s student, he has presented papers at several high-level academic conferences and seminars in top business schools in the USA, Europe and China. Currently he



xviii Notes on Contributors


xix

Xiaohua Lin is Professor of International Business and Entrepreneurship at the Ted Rogers School of Management and Director of the International Research Institute at Ryerson University, Canada. He received his PhD from Oklahoma State University, USA. He currently serves as Chair of the Academy of International Business’s Canada Chapter and Vice President (research) of the Canadian Council for Small Business and Entrepreneurship. His publications have appeared in journals such as Strategic Management Journal, Journal of International Business Studies, Management International Review, and Journal of World Business. Xiaohui Liu is Chair of International Business at the School of Business and Economics, Loughborough University. She received her PhD in international economics from the University of Birmingham. She has published widely, with publications in Journal of International Business Studies, Research Policy, Entrepreneurship Theory and Practice, Management International Review, Journal of World Business, International Business Review, International Journal of Human Resource Management, and Management and Organisation Review. She has received the Best Paper awards from the Academy of International Business (UK) and the International Association for Chinese Management Research. She is Editor of the International Journal of Emerging Markets and Secretary-General of the Chinese Economic Association (UK). Yipeng Liu is a PhD candidate and lecturer at the Center for Research of Small and Medium-Sized Businesses at Mannheim University. He has been Visiting Scholar at Columbia Business School and China Europe International Business School. He obtained his BSc from Shanghai Jiao Tong University, his MSc from the Technical University of Munich, and professional education in Harvard participants-centered teaching methods at the IESE Business School. His research interests center on the intersection of organization theory, entrepreneurship, and strategy with a focus on emerging economies. Moreover, he explores the emerging phenomenon of the globalization of Chinese firms, especially Chinese cross-border M&A in Europe. Yipeng presents his research at various international conferences. His work has appeared in international academic journals as well as practitioner outlets, such as Journal of Chinese Entrepreneurship, Prometheus: Critical Studies in Innovation, and Business Forum China. Jiangyong Lu is Associate Professor of Strategic Management in Guanghua School of Management, Peking University. He obtained his PhD in



is working on several research projects, including private equity in emerging markets, executive compensation in China, and the role of the state in Chinese multinational firms’ outward foreign direct investment.


economics and strategic management from the School of Business, University of Hong Kong. His research interests include Multinational Enterprises (MNEs) strategies in China, outward foreign direct investment and export strategies of Chinese firms, and knowledge flow between MNEs and local firms. His articles appear in international journals such as Journal of International Business Studies, Management International Review, Journal of Business Venturing, Management and Organizational Review, American Economics Review (Papers and Proceedings), Journal of International Economics, Journal of Urban Economics and Journal of Comparative Economics. He has also published papers in leading Chinese economics journals, including Economic Research Journal, China Economic Quarterly, China Journal of Economics, and Management World. Mike Morris is Director of the Center for Social Science Research, Head of Policy Research in International Services and Manufacturing, and Professor in the School of Economics at the University of Cape Town. He has a PhD from the Institute of Development Studies at the University of Sussex. He has significant experience working with national, regional, and international policymakers. He has been the recipient of a number of major international research grants and has managed a large number of research projects. Mike has published widely in the fields of development, political economy, international competitiveness, industrial restructuring and industrial policy, global value chains, social differentiation, and economic growth. He is also a director of a private sector company (Benchmarking and Manufacturing Analysts), which assists firms and government with upgrading, competitiveness and industrial strategies. Liqiang Ni is an associate professor in the Department of Statistics at the University of Central Florida. He received his BSc from Fudan University, China, and his PhD from the University of Minnesota, USA. Bing Ren is an associate professor in the Business School at Nankai University. She received her PhD from the Chinese University of Hong Kong. She has published a number of peer-reviewed articles, book chapters, and conference papers. Currently she is undertaking two research projects: one about the entrepreneurial growth and legitimation strategy of Chinese new ventures, the other about corporate governance and its relation to corporate social responsibility and sustainability of Chinese listed companies during institutional transitions. Bing visited the Jönköping International Business School, Sweden, and RMIT University, Australia. She is a reviewer for various journals and a member of various professional associations. Yun Schüler-Zhou is a PhD candidate at the Institute for Marketing and Media, University of Hamburg, and a research assistant in the Institute of Asian Studies of the German Institute for Global and Area Studies in Hamburg, Germany. She holds a Master’s degree in business administration



xx


xxi

Margot Schüller is a senior research fellow in the Institute of Asian Studies of the German Institute for Global and Area Studies in Hamburg, Germany. She holds a master’s degree in economics from the University of Paderborn and studied Chinese at the University of Liaoning during 1983–1985. For more than two decades she has closely followed China’s economic development. Her work covers a broad range of publications on economic transition, including specific topics such as the globalization of Chinese companies, banking sector reform, innovation policy, and China’s regional economic cooperation. Yongjiang Shi is Research Director and a lecturer in the Centre for International Manufacturing, University of Cambridge, UK. His research interests include technology transfer and manufacturing mobility, manufacturing strategy, designing effective manufacturing systems, international strategic alliances and foreign market entry modes, global supply chains, and value network management. He has published numerous peer-reviewed articles and conference papers. He joined the Cambridge manufacturing research group in 1994. He gained his PhD at Cambridge for work on international manufacturing network configurations and has taken a leading role in the conceptualization and delivery of the center’s research program. Before that he taught production and operations management at the School of Economics and Management in Tsinghua University, Beijing, China. Francesca Spigarelli is an assistant professor at the University of Macerata. She teaches economics and managerial economics in the Faculty of Law. She received her PhD from the University of Pescara, Italy, in banking and finance. She was Visiting Professor at the Toulouse Business School. She has taught courses in several MBA and PhD programs in Italy. She has published peer-reviewed articles, book chapters, and conference papers. Francesca is a reviewer for various journals and she is a consultant for national bodies and agencies in the international management and economics areas. Her main research topics are SMEs’ internationalization processes, foreign direct investments, and multinational companies from emerging countries. Paz Estrella Tolentino is Lecturer in International Business at the School of Business, Economics and Informatics at Birkbeck, University of London. She received her PhD from the University of Reading, UK. She holds a Master’s degree in international business and economic development, also from the University of Reading. She is the author of the books Technological Innovation and Third World Multinationals (1993) and Multinational



from the University of Hamburg. Her research interests center on the internationalization of Chinese enterprises, particularly on the impact of government policies on the decision-making of companies and the mechanisms applied in the control of foreign subsidiaries by Chinese headquarters.

xxii


Laura Vanoli is a PhD student affiliated to the project on Chinese foreign direct investment at the Center for Competitiveness, University of Fribourg. She obtained a Bachelor’s degree in economics from the University of Fribourg, Switzerland, and a Master’s in economics from Hautes Etudes Commerciales Lausanne. She has worked as an academic assistant in microeconomics and macroeconomics at Ecole Hôtelière de Lausanne. William Wei is Chair, Asia Pacific Management Program, Institute of Asia Pacific Studies, and faculty member in International Business at Grant MacEwan University Business School. He is Vice Chair, Sino-Canada Asia Pacific Economics Research Institute, jointly established by Jiangsu University of Science and Technology and MacEwan in Jiangsu, and also a senior research associate at the Center for China and Globalization, Beijing. He is a founding member of the International Association for Chinese Management Research and member of the Academy of International Business and Academy of Management. He has published over 40 publications, including journal articles, books, book chapters, business cases, conference proceedings, and presentations. His recently published book on China is EU Foreign Direct Investment to China: Location Determinants and Lessons from an Enlarged European Union (2008) and his recent business case book is Cross-cultural Business Cases (2011). Michael Woywode is Professor of Small and Medium Sized Business Research and Entrepreneurship at the Faculty of Business and Director of the Center of Small and Medium Sized Business Research (ifm Mannheim) at Mannheim University. Previously he held professorship positions in international management and innovation management at Aachen University (RWTH Aachen) and Karlsruhe University. He is co-author of the book Erfolgreich in China: Strategien für die Automobilzulieferindustrie (2006) with Garnet Kasperk. Michael received his habilitation in business administration from Mannheim University and holds a PhD in economics. He has been a visiting scholar at Stanford University for two years. His academic research has been published in the Academy of Management Journal, Organization Studies, American Journal of Sociology and Journal of Industrial Economics. Xiaobo Wu is Executive Dean of the School of Management and Director of the National Institute for Innovation Management at Zhejiang University,



Corporations: Emergence and Evolution (2000). Her PhD dissertation received the 1989 Academy of International Business Richard N. Farmer prize for the best PhD thesis on international business. She has published a number of peer-reviewed articles, book chapters, and conference papers. She is a reviewer for various academic journals and member of several professional associations.

xxiii

Hangzhou, China. He has taught courses on strategic management and technological innovation in graduate programs, including MBA and EMBA programs. He has participated in more than 20 national research projects and four international projects on global manufacturing, sustainable development, and regional policy. He has published widely on the topics of strategic management and technological innovation, co-authoring several books on this subject. He received his PhD in management of technology innovation from Zhejiang University. He was a visiting professor at the University of Cambridge, UK, and a Fulbright Senior Visiting Fellow at the Sloan School of Management, MIT, USA. Wenxian Zhang is a research associate at the Rollins China Center, a recipient of the Cornell Distinguished Faculty Service Award and is Arthur Vining Davis Fellow of Rollins College. He has taught courses on Chinese culture and frequently taken students on field study trips to China. Zhang is also a recipient of the 2010 Patrick D. Smith Award for his academic work with Dr Maurice O’Sullivan on A Trip to Florida for Health and Sport. In addition to editing the books The Biographical Dictionary of New Chinese Entrepreneurs and Business Leaders (2009), A Guide to the Top 100 Companies in China (2010), and The Entrepreneurial and Business Elites of China: The Chinese Returnees Who Have Shaped Modern China (2011), he has published many scholarly articles on information studies, historical research, and Chinese business management. Ying Zheng is a Master’s student in the Business School at Nankai University. Her research interests are in the areas of international business and Chinese firms’ globalization. Currently she is undertaking a research project on liability of foreignness and Chinese firms’ internationalization.







Introduction

Chinese International Investments, edited by Ilan Alon, Marc Fetscherin, and Philippe Gugler, contributes to the literature on the internationalization of Chinese enterprises with a special focus on Chinese Foreign Direct Investments (FDI), including its macro- and micro-environmental determinants, its development in Europe, North America, and Africa, and a number of case studies. Complementing the series of books available on the globalization of the Chinese political economy, including The Globalization of Chinese Enterprises (2008) and China Rules (2009), this book provides authoritative academic and professional insights into the strategies of Chinese FDI in Europe, Asia, Africa, and the Americas. Distinguished authors from across the world make a contribution to the growing literature on Outward FDI (OFDI) from China, offering a wide range of up-to-date academic insights and findings. Those findings are rounded off with lessons learned from historical developments (success and failure stories), an evaluation of current trends and the motives and modes of entry that Chinese companies use. Contributions on OFDI from China in different regions of the world, and specific industry studies, case studies, and theoretical contributions, highlight the need for additional research on this emergent area in international business.

Part 1: Macro-Environmental Determinants of Chinese FDI Bing Ren, Hao Liang, and Ying Zheng, all Chinese academics, provide an institutional perspective on the role of the state in China, which serves as a good overview for readers. This first chapter assesses the role of the state and how associated institutional factors shape Chinese firms’ OFDI. To analyze the role of the state, the authors discuss the wider economic and social context of China and how formal and informal institutional elements shape the role of the state and the unique features of Chinese OFDI. The authors find that formal institutions play crucial roles in determining 1



Ilan Alon, Marc Fetscherin, and Philippe Gugler

Introduction

OFDI motives of Chinese firms through policy influence and bureaucratic administration. State ownership also maintains a large presence. Informal institutions such as state ideology and national pride also play a role in shaping corporate OFDI trajectories. These formal and informal institutional factors lead Chinese firms to choose different investment modes, locations, and industries. Chapter 2 complements the introduction with an empirical analysis of the determinants of Chinese OFDI between 1987 and 2009. William Wei, Ilan Alon, and Liqiang Ni review the literature on Chinese outward foreign direct investment and its determinants by testing seven home country macroeconomic determinants. Based on Dunning’s investment development path (IDP) theory, regression results confirm that exchange rates, imports, interest rates, and foreign currency reserves are the most significant environmental home-country factors in determining Chinese OFDI. Research of home market determinants of Chinese OFDI explains the indigenous policies and the institutional environmental factors discussed in Chapter 1 that affect Chinese internationalization. Chapter 3, like Chapter 2, examines China’s OFDI from the countryof-origin perspective. Paz Estrella Tolentino’s research analyzes the relationships among a range of macroeconomic factors specific to the home country and the level of China’s OFDI flows, using data from 1982 to 2008. The focus is on the inference of Granger causality as well as on the determination of the endogenous structure and dynamic relationships of the multiple time series. The methodology employs a vector autoregressive (VAR) model which assesses the relationships of the endogenous variables. Her chapter also investigates the impact of the changes in one variable on the other system variables. Apart from OFDI itself, the openness of the Chinese economy to international trade, domestic technological innovation, and domestic interest rates and exchange rates is a significant home country-specific determinant of China’s OFDI flows. These variables contain useful information for predicting China’s OFDI (in the linear least squares sense) over and above the history of OFDI itself. China’s OFDI flows in turn are essentially exogenous to all system variables other than itself. The research explains the direction of causality between a range of home country-specific macroeconomic factors and China’s OFDI flows where common sense, theory, or previous empirical studies do not provide clarity. China’s rapid advancement and its growing multinationals provide a basis for re-evaluating current views and perceptions, and for re-examining and augmenting old theories in new contexts. Another type of investment driven by the state are sovereign wealth funds (SWFs), examined by Michael Keller and Laura Vanoli in Chapter 4. The chapter identifies the objectives of Chinese SWF investments and the role of the government in their investment decisions based on the question,



2

3

do Chinese SWF investments reflect only a pure financial consideration (i.e. the maximization of return on investment) or a strategic and geopolitical objective? An affirmative answer to the latter question would raise concerns about SWFs. To answer this question, the authors identify and analyze Chinese SWF investments in terms of targeted countries/regions and targeted sectors to understand the investment strategy. They compare the strategy with the objectives defined in the ‘Go Global’ policy to assess the possible involvement of the Chinese government. An analysis of the investment deals shows that China Investment Corporation (CIC), the Chinese SWF, invests domestically as well as abroad. Its foreign investments are primarily concentrated in the US in financial companies and in resource-rich regions such as Canada, Eurasia (Russia) and Oceania (Australia and Indonesia). Comparing the targeted sectors with government objectives, the authors conclude that the Chinese government influences SWF decisions, reinforcing the thesis of strategic behavior. In fact, access to natural resources, scarce in China, is the main motivation for OFDI supported by the government. But Chinese SWFs also make purely financial investments. Due to the lack of transparency, it is difficult to classify the funds either as financial or strategic investments. Recipient countries thus have concerns and have established SWF legal and regulatory frameworks.

Part 2: Micro-Environmental Determinants of Chinese FDI While the first section of the book broadly examines the macroenvironmental determinants of Chinese OFDI, section two shows how micro-environmental determinants, or firm-specific factors, can influence Chinese investments abroad. In Chapter 5, Xiaobo Wu, Wanling Ding, and Yongjiang Shi explore the motives and patterns of Chinese manufacturing firm investments in developed countries. Their study uses the resource-based view as the fundamental theoretical perspective to explain the ‘asset exploration’ motive of OFDI from emerging economies and ‘resource augmentation’ dimension of investment patterns. By using an exploratory case study method comprising both single case and cross case analysis, the authors show that Chinese manufacturing firms have mixed motives for investing in developed countries, although market-seeking and strategic asset-seeking are the two primary motives. The chapter classifies the patterns of Chinese manufacturing firm investments in developed countries based on two dimensions: the degree of resource augmentation and the degree of control, which are both high. Managers in Chinese manufacturing firms will understand more about the different motives and patterns of OFDI after reading this chapter. They can then make more informed investment decisions.




Introduction

Going deeper into internal, managerial-specific factors, Chapter 6 by Xiaohui Liu and Jiangyong Lu tests a two-way causal link between internationalization and CEO equity ownership in Chinese listed firms. The chapter uses panel data analysis based on Granger causality tests and finds a bi-directional relationship between internationalization and CEO equity ownership. These two factors mutually affect each other, implying that CEO equity ownership and internationalization should be treated as interrelated issues. Any separate examination may produce biased results. The chapter challenges existing studies that neglect the reverse causation between internationalization and CEO compensation and helps enhance an understanding of the complexities of these two issues. Of course, the ability of Chinese firms to go global depends in part on their ability to integrate knowledge and intangible resources into strategic assets. Ping Deng, in Chapter 7, examines the ‘Effects of Absorptive Capacity on International Acquisitions by Chinese Firms.’ Chinese multinational corporations (MNCs) increasingly use cross-border mergers and acquisitions (M&As) to acquire strategic assets or knowledge for greater competitive advantage in the global marketplace. This chapter considers the strategic and performance dimensions of such M&As by drawing from an absorptive capacity perspective. By comparing two international acquisitions by leading Chinese firms, Lenovo and TCL, the author uncovers some of the key firm-level factors and mechanisms that may contribute to international M&A outcomes. The author finds that firm-level mechanisms such as prior related knowledge, combinative capabilities, and strategy execution are critical factors that determine the success or failure of cross-border acquisitions by Chinese MNCs.

Part 3: Chinese FDI in Europe and North America While sections I and II cover the main external and internal determinants of Chinese OFDI, section III shifts the focus to the host (recipient) countries for Chinese investments. Yun Schüler-Zhou, Margot Schüller and Magnus Brod, in Chapter 8, discuss the pull and push factors of Chinese OFDI in the European Union. Their chapter investigates the factors explaining the pattern and development of Chinese OFDI in Europe. In applying the concept of structural and institutional pull and push factors, they describe the policy guidelines of the Chinese government toward investments in the European Union, taking into account policies toward specific industries and countries and the incentives which EU countries provide to attract Chinese OFDI, with a particular focus on European investment promotion agencies (IPAs). To understand the specific incentives offered by IPAs, the authors conducted a survey among the 92 IPAs in Europe in 2009. The Chinese government has introduced a bureaucratic tool to direct investments toward specific industries and countries in the EU that is similar to its policy tool



4

5

for inward FDI. For Europe, to some extent the pattern of Chinese OFDI corresponds to the government’s recommendations. The analysis of IPA policy for Chinese investments shows that Eastern European countries have more complex incentive schemes compared to Western European countries. By analyzing the IPA incentive schemes, the authors add a new perspective to analyze the pull factors for Chinese OFDI. Dovetailing with Chapter 8 is Chapter 9 where Jan Knoerich also examines the rise of Chinese OFDI in the European Union. He focuses on location choice, investment decisions, entry mode, and firm competitiveness, juxtaposing the exploitation and sourcing of competitive advantages by Chinese outward investors in the EU and assessing their relative importance. The study draws on descriptive statistics derived from Chinese data and qualitative information obtained primarily from a survey of investment promotion agencies (IPAs). Chinese OFDI in the EU is undertaken for both the exploitation and sourcing of competitive advantages. Exploitation occurs through incremental internationalization, based on pre-existing competitive advantages derived from low-cost production in China. Small-scale investments are sufficient for such purposes while sourcing of competitive advantages often requires larger-scale projects. The chapter explores the early stages of internationalization from emerging economies in mature markets, which is valuable for companies in developing countries as they expand internationally. The authors of Chapters 8 and 9 are among the first to consider the EU as one entity when analyzing Chinese OFDI and European investment promotion agencies. The literature on competitive advantages of developing country firms in mature markets has more room for growth, however. Chapters 10 and 11 provide a detailed country description of Chinese investments in Germany and Italy, respectively. In Chapter 10, Yipeng Liu and Michael Woywode investigate Chinese M&A in Germany. Departing from the strategic intent perspective in the new literature on Chinese OFDI, the authors focus on the integration approach of Chinese crossborder M&As in Germany and identify possible causes of the light touch approach. This qualitative study includes seven Chinese M&A cases in the German machine tools industry. Semi-structured interviews were conducted with German managers and CEOs from the acquired companies. In addition, governmental institutions and Chinese CEOs and managers involved in Sino-German business cooperation were interviewed. Crosscase analysis was conducted to test and illustrate the explanatory power of the conceptual framework. Contradicting the conventional wisdom on M&A integration, the authors find that Chinese cross-border M&As in Germany adopt light touch integration. A conceptual framework integrating individual-, organizational-, and national level dimensions into the concept of absorptive capacity is proposed to explain the light touch integration approach. This study suggests that for maximum value creation by




Introduction

unleashing the potential of realized absorptive capacity, managers should consider cross-border M&A from a multidimensional perspective. In addition, the authors stress the important roles played by intermediaries, such as professional firms, to smooth Sino-German cooperation in general and cross-border M&A in particular. In Chapter 11, Anja Fladrich links the Chinese diaspora in Northern Italy to trade and investment. By looking at small and medium enterprises in Italy rather than the large multinationals most other chapters concentrate on, this chapter provides a fresh look into the ‘bamboo capitalism’ of expatriate entrepreneurs. The chapter asks two key questions: First, to what extent do Chinese SME investment paths and patterns mirror those of their larger brothers, and, second, what is the significance of the relatively large ethnic enclave in Prato, Italy? Building on the concept of cluster theory, the authors interview 36 Chinese entrepreneurs in Prato. The study suggests that Chinese investment in Italy is linked with immigration, that Chinese entrepreneurs have had a large economic impact on the region, serving both the ethnic enclave and local clientele, and that trade in textiles has formed a cluster within the industrial enter of Prato, breeding new life into this traditional sector. Shifting from Europe to North America, Xiaohua Lin and Qianyu Chen examine investment by Chinese state-controlled entities in Canada in Chapter 12. Chinese OFDI through state-controlled funds and entities (SCFEs) is increasing, but progress in the developed nations is slow. The chapter examines the interests, concerns, and strategic options associated with OFDI in Canada. Game theory perspective is invoked in the chapter, involving the developed nations, local enterprises and SCFEs. The authors analyze their interactions and predict the future role and extent of SCFEs in developed nations. Using a model from a game perspective to analyze SCFE investments in the developed nations, with Canada as an example, the authors predict a mode of restrictive investment. The model is applied to a case based on the resources sector in Canada, which has substantial SCFEs. A win-win situation could emerge if all players in the game, including the developed nations’ governments and SCFEs, can compromise to ensure a conditioned deal. The chapter helps to fill the research void by analyzing strategic situations where developed nations encounter SCFEs.

Part 4: Chinese OFDI in Africa In Chapter 13, Gayle Allard investigates whether Chinese OFDI is different in Africa. China’s highly visible presence in Africa is one of the most commented-on facets of globalization in the twenty-first century. To understand not only trends in global OFDI but the prospects of Africa itself, it is important to analyze the features, the motivations and the implications of this investment push. Data limitations, however, make this difficult.



6

7

Official OFDI data is used from the Chinese government to explore differences between Chinese and global OFDI to African countries. A ratio for Chinese/global OFDI is used as the dependent variable in a generalized least squares regression. The independent variables are corruption, metal/ore and fuels exports, and GDP growth for the period 2000–2005. Allard finds that Chinese OFDI in Africa has not only risen much faster than global OFDI, but appears to be more resource-driven and more closely associated with corrupt environments. Limitations to research exist. For example, reliable data is irregular and long time series cannot be constructed to permit more sophisticated analyses. Some key countries and years are missing from the data set, but despite the limitations, the chapter sketches a global picture rather than a partial and anecdotal view of Chinese investment in Africa. Focusing more narrowly, in Chapter 14 Raphael Kaplinsky and Mike Morris examine large scale Chinese OFDI in Sub-Saharan Africa, where natural resources are concentrated, along with deep social and political divides. The authors focus on Sub-Saharan Africa, where large state-owned Chinese companies have invested mainly in the resource and infrastructure sectors. They identify streams of Chinese FDI and place them in a historical context, with a focus on large and predominantly state-owned enterprises (SOEs). The authors show that Chinese investments are often integrated with Chinese aid and trade projects. The authors conclude that China should establish suitable policy responses to allow for net gains to be maximized in the continent’s intercourse with these SOE investments from China.

Part 5: Cases of Chinese FDI The last section of the book presents three cases on Chinese investments around the world. Wenxian Zhang in Chapter 15 discusses Chinese investments in the State of Florida, United States, in building Splendid China. Despite the rapid growth of the Chinese economy and its OFDI, researchers have not paid enough attention to failed overseas ventures by Chinese firms, especially during the early part of the reform era. One such case is Florida Splendid China, which represents not only a major fiasco in the history of Florida tourism, but one of the most disastrous international investments ever made by a Chinese company. Through a historical review, the chapter examines the development of Florida Splendid China to understand why the theme park designed to promote cultural understanding failed. The author looks at why the investment group misread the tourism culture of the mature American market. Opened in 1993, Florida Splendid China was one of the first and largest joint investment ventures by a state-owned enterprise at the time. The theme park, optimistically conceived yet poorly researched, well-executed but improperly managed, never flourished in the competitive Central Florida market. Political controversies and demonstrations plagued the park during its 10-year history, and it finally fell victim to the region’s




Introduction

struggling tourism business following the 2001 terrorist attacks. The chapter contains the first and only study that examines the lessons learned from Florida Splendid China. Chapter 16 describes a struggling Chinese acquisition by a motorcycle company in Italy. Benelli was acquired by Qiang Jiang to compete on an international scale and to bring both technical expertise and the European market into the company’s portfolio. Written by Francesca Spigarelli, William Wei, and Ilan Alon, the chapter shows what can go wrong with a Chinese acquisition. The case study provides a practical example of difficulties in integration when the M&A encounters major cross cultural differences. Among the factors identified are: different national cultures, different fiscal rules, different operating philosophies, and lack of a common vision. This chapter points out that, with M&As between Western and Chinese companies, problems in communications and cultural differences can create a rift between management and employees, impeding or delaying the implementation of strategy, and limiting the company’s profitability. The concluding case, in Chapter 17, was written by Marc Fetscherin and Paul Beuttenmuller, who examine the competitiveness of the Chinese automotive industry with a specific focus on Geely’s internationalization efforts and their acquisition of the Volvo brand. The chapter discusses the different drivers of automobile industry competitiveness as well as the underlying challenges and opportunities Chinese automotive companies encounter when going global. Specifically it discusses the challenges and opportunities when a developing country brand (Geely) acquires a developed country brand (Volvo). The book concludes with comments on the major themes and findings presented in the five areas and identifies areas for future research.

References Alon, Ilan and John McIntyre, eds. (2008), The Globalization of Chinese Enterprises, New York: Palgrave MacMillan. Alon, Ilan, Julian Chang, Marc Fetscherin, Christoph Lattemann, and John McIntyre, eds. (2009), China Rules: Globalization and Political Transformation, New York: Palgrave Macmillan.



8

Part I


Macro-Environmental Determinants of Chinese FDI





An Institutional Perspective and the Role of the State for Chinese OFDI Bing Ren, Hao Liang, and Ying Zheng

Napoleon called China a ‘sleeping dragon’, but recent economic developments as China enters the twenty-first century show that the dragon is awakening. China has maintained strong economic growth since 1979 and sustained a GDP increase of more than 9 percent over the years. The total volume of economic output increased from 2.8 percent in 1970 to 7.23 percent in 2008, ranking China as the third largest economy in the world (United Nation Statistics Division Statistical Databases). China launched its ‘Go Global’ policy in 1999 to encourage highperforming Chinese firms to invest abroad and upgrade their global competence. Since then, outward foreign direct investment (OFDI) flows reached US$55.91 billion in 2008, equal to the FDI inflow in 2003. The annual growth rate of OFDI averaged 65.7 percent from 2002 to 2008 (Ministry of Commerce of China). OFDI flows via mergers and acquisitions (M&As) accounted for 54 percent of the total volume of OFDI (US$30.2 billion) and an annual increase rate of 379 percent (from 2002 to 2008). China’s OFDI volume reached USD52.15 billion in 2009 (excluding Hong Kong, Macao, and Taiwan), equaling 3 percent of global OFDI (World Investment Report, 2009). How are Chinese firms able to ‘go global’ so quickly – given their relatively weaker competencies in technological know-how and management skills and weak ability in integrating global value chains (Deng, 2004; Sun, Peng, Ren, & Yan, 2010)? According to multinational enterprise (MNE) theories based on Western firms, such as the Ownership-Location-Internalization (OLI) paradigm (Dunning, 1980, 1993), it is difficult to explain why this aggressive international expansion by Chinese firms works so well despite weaker firm-specific ownership advantage. We also note that China’s international expansion is largely undertaken by state-owned enterprises (SOEs). State policies have played a key role in pushing Chinese firms to go abroad, which poses a challenge to existing MNE and FDI theories (Dunning & Lundan, 2008; Sun et al., 2010). 11



1


To answer these questions one must examine the driving forces of Chinese firms’ internationalization, especially the institutional forces and the role of the state that the literature has not yet explored. As China’s economic development involves a high degree of state involvement, it constitutes a unique institutional foundation that shapes OFDI trajectories at the level of both the country and the firm. Integrating the recent literature on how formal and informal institutions such as state policies and national pride influence the OFDI of emerging market enterprises (EMEs) (e.g., Buckley, Clegg, Cross, Lin, Voss, & Zheng, 2007; Buckley, Cross, Tan, Liu, & Voss, 2008; Luo, Xue, & Han, 2010; Hope, Thomas, & Vyas, 2011), we argue that the fast growth of China’s OFDI is a consequence of the state’s involvement and formal and informal institutional motivating forces. We define the formal institutional drivers as governmental policy, the bureaucratic administrative system, and the government ownership arrangement in firms. Informal institutions include the state ideology and national pride (Hope et al., 2010). Driven by these institutions, Chinese firms are highly motivated to conduct OFDI for country-level political and economic objectives, or for firm-level global competence. The importance of this study is as follows. Most studies on international business have focused on OFDI by mature market enterprises through studying the motivations, processes, and outcomes of their internationalization (Johanson & Vahlne, 1977; Hennart, 1982; Dunning, 1988; Dore, 1990). More recent studies explore the motivations for internationalization of EMEs (Luo & Tung, 2007; Witt & Lewin, 2007; Rui & Yip, 2008). However, except for a few studies (e.g., Buckley et al., 2008; Luo et al., 2010), the role of the state in the OFDI of EMEs is largely ignored. Similarly, among the studies emphasizing the institutional perspective of EMEs’ internationalization, there is no in-depth discussion of how macro-level institutional foundations shaped by the state could influence micro-level firm strategic choices. Our study helps fill these gaps by analyzing the specific roles of the state and the broader economic and social contexts that may influence how the state performs its role. We also analyze how these state institutions might become sources of comparative ownership advantages and help shape Chinese firms’ OFDI trajectories. The remainder of the chapter is organized as follows. Section 1 reviews the literature. In Section 2 we analyze the role of the state and the formal and informal institutions by looking at their influence on Chinese firms’ OFDI motivations and strategies. We also discuss contingency views of our theoretical propositions and provide our conclusions.

1. Literature review 1.1. Motivations for OFDI There is a vast literature examining the motivations for FDI (see Meyer & Nguyen [2005] for a survey). The theory of capital movements suggests that



12

FDI is a part of the firm’s portfolio investments (Iversen, 1935; Aliber, 1971). Hymer (1960), Kogut and Zander (1993) argue that FDI is a means of transferring knowledge and other tangible and intangible firm assets to organize production overseas. Vernon (1966) uses the concept of product lifecycle to theorize that firms set up production facilities abroad for standardized mature products in their home markets. Other literature sees FDI as a motive for risk diversification (Rugman, 1981) and a bandwagon effect exhibited by MNEs when they follow their rivals into new markets as a strategic response to oligopolistic rivalry (Knickerbocker, 1973). The international business (IB) literature, especially Dunning’s OLI paradigm, sees OFDI as a primary means by which firms can appropriate rents in overseas markets by exploiting their idiosyncratic resources and capabilities (Dunning, 1958; Caves, 1971). The internalization theory (McManus, 1972; Buckley & Casson, 1976; Rugman, 1981; Hennart, 1982) sees OFDI as a way to reduce the transaction costs associated with coordinating activities across national boundaries, while the resourcebased view (Lippman & Rumelt, 1982; Dierickx & Cool, 1989; Teece, Pisano, & Shuen, 1997) argues that firms enter foreign markets to create value. The literature suggests that the OFDI of EMEs is different from that of enterprises from developed economies (e.g., Makino, Lau, & Yeh, 2002). Studies on comparative ownership and governance suggest that the unique mode of governance and control in emerging economies is particularly important in determining the OFDI decision (Claessens, Djankov, & Lang, 2000; Filatotchev, Strange, Piesse, & Lien, 2007). Other studies on EME international strategy emphasize the institutional perspective (e.g., Tihanyi, Griffith, & Russell, 2005; Witt & Lewin, 2007; Dunning & Lundan, 2008; Peng, Wang, & Jiang, 2008; Seyoum, 2009; Ge & Ding, 2011), suggesting that institutions, both formal and informal, influence EME OFDI behavior – either through positive or negative effects (Luo & Tung, 2007; Witt & Lewin, 2007). Formal institutions, such as policy, influence EME outward investment: this has been manifested in the home and host country markets (e.g., Loree & Guisinger, 1995; Lien, Piesse, Strange, & Filatotchev, 2005; Buckley et al., 2008; Seyoum, 2009; Luo et al., 2010). Informal institutions may determine OFDI flows and strategies such as choice of location and entry mode (Buckley et al., 2007; Elango & Pattnaik, 2007; Yiu, Lau, & Bruton, 2007; Lu & Ma, 2008). Examples include institutional distance or cultural proximity between the home and host country markets (e.g., Buckley et al., 2007; Seyoum, 2009), and host and home country business networks. Formal and informal institutions together may influence OFDI strategy in a more dynamic way (Dunning & Lundan, 2008; Peng et al., 2008). Chinese firms that invest abroad, especially large multinationals, are typically state-owned or state-controlled. Recent studies on Chinese and Indian multinational cross-border M&As reveal that SOEs constitute a bigger



Bing Ren et al. 13


proportion among the main players conducting cross-border M&As in China than in India (Sun et al., 2010). As China’s global push accelerates, many observers believe that institutional factors should act as advantages for generating more aggressive OFDI activities (Luo et al., 2010; Sun et al., 2010), which is usually not the case for mature market economies (Dunning, 1988; Gomes-Casseres, 1990; Hennart & Park, 1994). Many even suggest that Chinese firms’ OFDI is to a large extent designed to follow the state’s policy guidance, especially now (Child & Rodrigues, 2005; Buckley et al., 2007; Boisot & Meyer, 2008; Deng, 2009; Sutherland, 2009; Yao & Sutherland, 2009; Luo et al., 2010). Chinese OFDI trajectories are likely shaped by the specific institutional regime developed under the state, although little research on the topic exists.

2. Framework 2.1. The role of the state To some extent, China is still a state-controlled political economy where the state plays a dominant role in driving economic transactions and performance (Chang, 1994; Deng, 2004; Dunning & Pitelis, 2009; Huang, 2010; Nee, 2010). The state designs and influences formal institutions and regulates economic and business activities through the formal policy at the central and local government levels. The state also establishes the administrative system and arranges government ownership within various industrial sectors. The state helps shape informal institutional frameworks such as firm–government relationships, political connections and inter-bureau or inter-firm network ties that influence business behavior (Peng & Heath, 1996; Xin & Peace, 1996; Keister, 1998; Yiu et al., 2007). The rise of China on the global political and economic stage cultivates the role of the state in shaping China’s national pride and ideology. The state’s role is even more significant when considering the wider economic and social context into which China has stepped. China is now facing both external and internal pressure to develop better and stronger economic and social systems. Internally, the state faces pressure to enhance national wealth. Although the economy has sustained a high growth rate in the past several decades, the government is yet not sure about the sustainability of future growth. Externally, China’s economy and society now depend heavily on other economies and societies, for more successful participation in the global economic and social stage. The Chinese state has aimed to develop both hard and soft power for coping with these challenges and to construct long-term development goals (‘The Economic Observer’ [in Chinese], May 31, 2010). The state has tried to maintain strategic control over national-level formal and informal institutional development.



14

Bing Ren et al. 15

2.2. Formal institutional regime The Chinese government has, to a great extent, played a crucial role in shaping the structure of China’s approved outward investment through external policy influence. However, the OFDI policies went through an evolutionary process. According to Luo et al. (2010) and others such as Buckley et al. (2008), Chinese OFDI policies moved through three major phases: the initiation of OFDI policy; the enrichment of the institutional frameworks; and setting up ‘going global’ as a country-level strategy. In Phase 1 (1979–1990), the Chinese state played a key role in initiating the OFDI policies. In 1979, with the launch of the ‘open door’ policy by Deng Xiaoping, the State Council came up with the concept of ‘setting up enterprises overseas’ (Zhao, 2007, p. 56). The state issued concrete policies and principles to guide OFDI. In 1984, the Ministry of Foreign Trade and Economic Cooperation (MFTEC, today’s MOC) released the first regulations on OFDI, called ‘Circular concerning approval authorities and administrative principles for opening up non-trade joint venture overseas’. The State Administration of Foreign Exchange (SAFE) also published the first regulations on administration of foreign exchange: ‘Measures for foreign exchange control relating to overseas investment’ (1989). Since then, a primary structure of policy and administration of OFDI was established. During this period, the Chinese government was perceived as taking the plunge in OFDI activities. In Phase 2 (1991–2000), the Chinese state enriched the institutional framework of OFDI policy. On 12 October 1992, Jiang Zemin, the representative of third-generation leaders of the Chinese Communist Party, gave a report to the Fourteen Chinese Communist National Congress, emphasizing the deepening of reform and opening up policy to ‘expand OFDI and multinational operations of Chinese enterprises’ (Jiang, 1992). Following Jiang’s talk, more specific and detailed provisions were added to formulate the regulatory and administrative system on firms’ OFDI activities. For example, the Administration of Overseas Investment Projects (National Planning Commission [NPC], March 1991) normalized the approval procedure and gave more specific requirements for OFDI. In Phase 3 (2001–present), the state set the ‘Going Global’ policy as a country-level strategy to enhance competitive advantages through OFDI strategies. The Chinese government initiated the ‘going abroad’ policy as country-level strategy in 2000. (This was reflected in ‘Suggestion on Constructing the 10th Five Year Plan for National Economic and Social Development’.) In 2003, the State Development and Reform Commission (SDRC) specified the boundaries for key OFDI projects, including: (1) seeking natural resources in areas where China is lacking; (2) investing in manufacturing



Policy


that promotes export of technologies, products, and equipment; (3) setting up R&D collaborative projects which could bring in advanced technologies, managerial experience, and specialized talents; (4) conducting M&As to increase international competitiveness and market exploration of firms. The Chinese government encouraged firms to pursue the above projects to upgrade firm-level competence. In the meantime, joining the World Trade Organization demanded a higher level of openness, and this also encouraged the Chinese government to modify the existing strict policies to create a friendlier institutional environment for OFDI. For example, the central state deregulated investment approval and foreign exchange controls. The government provided support for finance, credit, and insurance (Enterprise Institute of Development Research Center of the State Council, 2006) and strengthened supervision of multinational operating performance to monitor the effectiveness of the ‘go global policy’. Table 1.1 provides a detailed illustration of major policies released by the state on Chinese firms’ OFDI. Five important institutional elements are particularly emphasized by the state and successfully advanced the OFDI of Chinese firms. The first institutional element refers to the approval process. The state streamlined the approval procedure and decentralized approval authority for OFDI. The state relaxed foreign exchange control gradually, especially in the examination of capital resource and exchange risks. In providing concrete investment support, the state supported investment projects for credit, capital, information, subsidies, and tax collection. The state also aimed to set up more efficient supervision mechanisms on post-investment performance of OFDI enterprises. Lastly, the state has been seeking better international protection for firms’ overseas investment through setting up bilateral investment treaties and multilateral and regional protection mechanisms (for more straightforward descriptions of the five institutions’ evolution, see Figures 1.1a–1.1e).

Bureaucratic administration Bureaucratic administration policy is usually made by important players in particular bureaucratic systems, and important operating systems are also implemented by the administrators to utilize the policy effect. In general, the bureaucratic administration related to Chinese OFDI is complex due to the multiple bureaucratic players involved in decision-making, regulation and, supervision for OFDI. In the bureaucratic administration system, the first layer is the State Council, which plans China’s overall OFDI for the long term. Under the leadership of the State Council, the State Development and Reform Commission (SDRC, formerly the National Planning Commission) is the major institution of the second layer responsible for studying and advancing strategies and plans for OFDI, and examining the optimization of the policies. Guided by the strategic plan of the SDRC, the Department of



16

17 The policy regime of China’s OFDI

Examination and approval

Key policy

Key point

Approval Authorities and Administrative Principles for Opening up Non-trade Joint Venture Overseas (MFTEC, May 1984)

1. Authorize MFTEC to approve OFDI; prior to this, all OFDI has to be approved by State Council 2. Major projects concerning resource and projects exceeding US$10 million to be approved by State Council 3. Projects concerning state property to be approved by NPC and METEC Opens OFDI for all economic entities with financial resources, foreign joint venture partners, and relevant capabilities

Approval Procedures for Setting up Overseas Subsidiaries (MFTEC, July 1985) Administration and Approval of Establishing Non-trade Enterprises Overseas (MFTEC, July 1985) Administration of Overseas Investment Projects (NPC, March 1991)

Verification and Approval Procedures for OFDI (SNRC, October 2004)

Examination and Approval of Investment to Run Enterprises Overseas (MOC, October 2004)

1. Approval result should be handed down in no more than 3 months 2. Chinese OFDI should focus on using overseas technologies, resources, and markets 1. Projects exceeding 1 million to be approved by NPC, exceeding 30 million to be approved by the State Council. 2. Projects concerning state-owned assets must be approved by State Council 3. Project proposals, feasibility reports, corporate contracts, and articles should be provided by OFDI enterprises 4. Approval result should be handed down in no more than 60 days 1. Projects exceeding US$10 million to be approved by SNRC (except projects concerning resources), exceeding US$50 million approved by State Council 2. Approval result should be handed down in no more than 20 days 1. All companies are permitted to run enterprises overseas 2. Project proposals, feasibility reports are substituted by project application 3. Approval result should be handed down in no more than 15 days



Table 1.1

18

Foreign exchange control

(Continued) Key policy

Key point

Administration of OFDI (MOC, May 2009)

Projects exceeding US$100 million to be approved by MOC

Foreign Exchange Administration of Overseas Investment (SAFE, March 1989)

1. SAFE evaluates the source of funds to be invested abroad as well as the foreign exchange risk 2. Five percent of the OFDI sum has to be deposited in a special account 3. Profit earned abroad should be remitted back to China

Supplemental Provisions on Administration Measures on Foreign Exchange for Overseas Investment (SAFE, September 1995)

Chinese investors are allowed to purchase foreign exchange for an OFDI project; prior to this, a Chinese investor had to earn the foreign exchange

Canceling the Deposits that Guarantee Profits from Investments Abroad (SAFE, November 2002)

Deposits that guarantee profits are no longer needed

Simplifying Foreign Exchange Administration Relating to OFDI (SAFE, March 2003)

1. SAFE will only investigate domestic foreign exchange sources 2. Foreign exchange obtained from a source outside of mainland China no longer examined

Further Measures on Foreign Exchange Administration Stimulating OFDI (SAFE May 2005)

1. Local SAFE named as authority on OFDI projects with a higher threshold (from US$3 to US$10 millions) all over the country 2. Total foreign exchange available for all investors is increased from USD3.3 to USD5 billion

Administration Measures on Foreign Exchange for Overseas Investment (SAFE, 2009)

The necessary foreign exchange for the domestic investors to invest abroad may be self-owned foreign exchange, the foreign exchange purchased by RMB or entity, intangible assets, the domestic and overseas foreign exchange loans, and other permitted source



Table 1.1

Inspection and evaluation

Guidance and support

International investment protection mechanism

Interim Measures for the Joint Annual Inspection of Overseas Investments (MFTEC, October 2002)

Provides post-investment evaluation of OFDI projects

Measures for Comprehensive Assessment of OFDI Performance MFTEC (October 2002)

Clarification of standards and procedures for evaluating OFDI projects which have been operating overseas

Annual Report System on Operational Obstacles in Major Target Countries (MOC, November 2004)

Using annual reports from enterprises investing abroad, MOC collects all kinds of obstacles and problems confronted by OFDI companies

Providing Credit Support to Key OFDI Projects Encouraged by the State (SNRC, May 2003)

OFDI projects fulfilling specified requirements will be provided with a lower lending rate credit fund

Guiding Directories of Target Nations and Industries for OFDI (MOC, July 2004; MOC, October 2005; MOC, January 2007)

Provides industries and countries information for enterprises to conduct investment encouraged by the state through preferential treatment concerning funding, tax collection, foreign exchange, customs and others

Using and Managing Special Funds for Foreign Economic Cooperation (MOC; MOF, December 2005)

1. Sets up special funds to encourage Chinese enterprises to invest abroad 2. Special funds may be used to support foreign economic cooperation by the following means: (1) subsidies for pre-operational fees; (2) interest discounts for medium- and long-term loans; (3) subsidies for operational fees

Bilateral Investment Treaty

1. In 1980s, China signed BITs with most developed countries, but in this period, most treaties are raised by developed countries to protect their investment in China 2. In 1990s, China began to conclude BIT positively with developing countries to protect investment in these countries



19

20 (Continued) Key policy

Key point

Multilateral investment protection measures

Acceding to WTO in 2001, China could enjoy the multilateral investment protection provided by agreements abided by WTO members, such as, Agreement on Trade-Related Investment Measures (TRIMS), General Agreement on Trade in Services (GATS)

Regional protection mechanism

China-ASEAN Free Trade Area, founded in 2002, providing adequate protection to investment in this area, benefits more and more investors both from China and ASEAN

Sources: www.mofgov.com; He (2009); Luo et al. (2010).

1985

2004 Examination and approval of investment to run enterprises overseas

Approval procedures for setting up overseas subsidiaries 1985

1991

Administration and approval of establishing non-trade enterprises overseas 1984 Approval authorities and administrative principles for opening up non-trade joint venture overseas

1979

Approval and administration of non-trading overseas enterprises

1991 Examination and approval of OFDI project proposals and feasibility reports

Initial regulations on OFDI 1990 Strict examination of projects Highly centrally controlled authority

Figure 1.1a

2004 Verification and approval procedures for OFDI

2003 Reply on decentralization authority reforming pilot of non-trade investment overseas approval

2009 Administration of OFDI

Normalization of the approval and Further procedure simplification administration system 2000 and decentralization of authority 2009 Decentralization of authority Relaxed examination of projects

Evolution of state’s examination and approval processes for China’s OFDI

1990 Rules for implementation of measures on foreign exchange control in investment abroad

2005 Enlarging the reform pilots regarding the administration of foreign exchange for overseas investment

2002 Canceling the deposits that guarantee 2003 1993 profits from investments abroad Rules for implementation of Procedural and approval standards on measures on foreign exchange OFDI-related foreign exchange 1989 2009 control in investment abroad risks and capital resources Opening special account of Administration measures on 1995 deposits that guarantee profits foreign exchange for 2003 Supplemental provisions on overseas investment 1989 administration measures Simplifying foreign exchange Foreign exchange administration on foreign exchange administration relating to OFDI of overseas investment for overseas investment

Rigid control on capital resource and foreign exchange risk Profit deposits are required

1979

Figure 1.1b

1990

More standard control on foreign Streamlining the examination on exchange risk, source of investment risk and capital resource, 2000 fund Chinese investors are allowed to canceling deposits and 2009 purchase foreign exchange decentralization authority.

Evolution of state’s foreign exchange control for China’s OFDI



Table 1.1

Bing Ren et al. 21 2005 2004 Notice on adjusting the management Guiding directories of target nations and industries for OFDI mode of overseas financial guarantees 2000 for overseas investment enterprises 2005 Measures of capital support for 2004 Providing more financing support small and medium enterprises to Notice on setting up a risk to key overseas-invested projects develop international markets prevention mechanism for key 1999 overseas investment projects 2005 2003 Guidance on granting credit

1979

Providing credit support to key OFDI projects encouraged by the state

Support on capital, credit, and finance, guidance on target nations and industries are provided to encourage OFDI

2000

Figure 1.1c

Using and managing special funds for foreign economic cooperation

2009

Evolution of state’s inspection and evaluation processes for China’s OFDI

2003 2002 Circular on setting up an information 2004 Measures for comprehensive bank of overseas investment assessment of OFDI performance intention of enterprises Annual report system on operational obstacles 2002 in major target countries 2005 2002 Provisions on statistical Interim measures for the joint annual Report requirements for overseas report of OFDI inspection of overseas investments mergers and acquisitions

Annual inspection, comprehensive assessment, and other report systems are set up 1979

2000

2009

Figure 1.1d Guidance and support on China’s OFDI by state 2000 Signed BIT with 54 1996 developing countries by 2000 Signed BIT with most 2004 developed countries by 1996 2001 China-ASEAN

1985 First BIT with developing countries Thailand 1982 First BIT with developed countries Sweden

As investment host country, most BITs

WTO free-trade area

As investment output country, most BITs

1979 were concluded with developed countries were concluded with developing countries 1990 2000

Seeking multilateral and regional protection

2009

Figure 1.1e Evolution of China’s international investment protection mechanism

Foreign Capital and Overseas Investment drafts the catalogs of guidance for foreign investment industries, and approves key OFDI projects. The Ministry of Commerce, formerly the Ministry of Foreign Trade and Economic Cooperation and Ministry of Domestic Commerce, is the primary government unit responsible for conducting multilateral negotiations on investment and trade treaties. Finally, the Department of Outward Investment and Economic Cooperation drafts concrete regulations on OFDI and administrates and supervises OFDI. Other important governmental departments in the second layer include the People’s Bank of China, which is responsible for making monetary policy and foreign exchange policy; the Ministry of Foreign Affairs, responsible for



for overseas processing and assembling


drafting the catalog for guiding the target countries of OFDI in cooperation with other agencies; and the Ministry of Finance and Ministry of Taxation, responsible for drafting policies of taxation related to OFDI. The Ministry of Taxation is also responsible for providing financial support to OFDI through special funds. A special organization, the State-owned Assets Supervision and Administration Commission, was established under the State Council to manage and supervise the national state-owned assets in the non-financial sectors, including those that invest in overseas markets. In the third layer are several departments and units that implement the policies made by the above authorities. For example, the State Administration of Foreign Exchange helps supervise and check the authenticity and legality of the receipts and payments involved in OFDI and regulates management of overseas foreign exchange accounts. Three policy-oriented financial institutions help to provide credit and insurance for OFDI firms: these include the China Development Bank, the Export-Import Bank of China, and the China Export & Credit Insurance Corporation. Figure 1.2 and Table 1.2 illustrate the Chinese OFDI bureaucratic administration system. The government ownership The third formal OFDI institutional regime relates to the wide presence of government ownership of firms in the economy. Since market reform in the late 1970s, the Chinese government has maintained control of the economy. The central and local government bureaux provide funding to the SOE

State council

Ad hoc organizations

SDRC

MOC

PBC

SASAC

DFCOI

DOIEC

SAFE

MOF

MFA

MOT

CECIE

Policy financial institution

EIBC

CDB

SOE

Figure 1.2

Bureaucratic system in regulating China’s OFDI

Notes: MOC – Ministry of Commerce; DOIEC – Department of Outward Investment and Economic Cooperation; SDRC – State Development and Reform Commission; DFCOI – Department of Foreign Capital and Overseas Investment; MFA – Ministry of Foreign Affairs; MOF – Ministry of Finance; PBC – People’s Bank of China; SASAC – State-Owned Assets Supervision and Administration Commission; MOT – the Ministry of Taxation; SAFE – State Administration of Foreign Exchange; SOE – State-Owned Enterprise; EIBC – Export-Import Bank of China; CDB – China Development Bank; CECIE – China Export & Credit Insurance Corporation. Sources: www.gov.cn; www.mofcom.gov.cn; zcq.mofcom.gov.cn; www.sdpc.gov.cn (2010).



22

Bing Ren et al. 23 The bureaucratic administration regime of China’s OFDI

Department

Main functions

State council MOC

1. Blueprinting China’s overall OFDI in the long term 1. Bilateral and multilateral negotiations on investment and trade treaties

DOIEC

1. 2. 3. 4.

SDRC

1. Studying and putting forward strategies and plans for OFDI 2. Studying policies concerning aggregate balance and structural optimization

DFCOI

1. Drafting the Catalogue for the Guidance of Foreign Investment Industries in cooperation with relevant agencies 2. Examining and approving key OFDI projects, major resources related and consuming substantial amount of foreign currency

SAFE

1. Supervising and checking the authenticity and legality of receipts and payments 2. Regulating management of overseas foreign exchange accounts

SASAC

1. Managing and supervising the nation’s state-owned assets in non-financial sectors

MFA

1. Drafting the Catalogue for the Guidance of Foreign Investment Countries in cooperation with relevant agencies

MOF

1. Providing financial support to OFDI though special fund, etc 2. Drafting policies of taxation related to OFDI in cooperation with MOT

MOT

1. Drafting policies of taxation related to OFDI in cooperation with MOF

PBC

1. Designing the monetary and foreign exchange policy, etc

EIBC; CDB

1. Providing credit for OFDI firms as policy banks

CECIE

1. Providing insurance for OFDI firms as policy insurance corporation

Drafting concrete regulations on OFDI Administrating and supervising OFDI activities Examining and verifying non-financial enterprises’ OFDI Statistics for OFDI

Source: www.gov.cn

sector; the state also directs funds to SOEs via state-owned banks. As the market economy develops further, SOEs seek financing from domestic and international financial markets. Through listing their stocks on the stock exchange markets, SOEs are transformed into corporations and joint stock companies. In a joint stock company, government ownership comprises one type of shares and, as the dominant shareholder, the state exerts tight control over both political and economic objectives. For example, SOEs are



Table 1.2


Joint stock company 5.6%

Foreign investment enterprise 0.5%

Joint equity cooperative enterprise 1.0% Limited liability company 22.0%

Enterprise funded from Hongkong, Macao, Taiwan 0.1% Collectively owned enterprise 0.3%

Others 0.3% Private enterprise 1.0% Figure 1.3

State owned enterprise 69.2%

Chinese OFDI stocks’ distribution by different types of investors (2009)

the main players in OFDI, relative to other types of enterprises, and behave aggressively in their internationalization. Figure 1.3 describes the presence of SOEs within Chinese OFDI. Table 1.3 lists the top 50 SOEs ranked by FDI outflow. SOEs, in their drive toward globalization, have encountered strong criticism from global stakeholders for their lack of accountability, transparency, and trustworthiness (Pistor and Xu, 2005; Luo & Tung, 2007; Li, 2009). When Chinese SOEs invest overseas, their strategies may be purely economic, such as maximizing profits, or they may include political goals that take priority over economic ones. In fact, the influence of the state and adoption of the administrative governance framework in SOE business activities make economic efficiency largely unclear. The literature argues that the highly concentrated ownership gives the state substantial discretionary power to use the resources of companies and results in problems such as insider control and the exploitation of minority shareholder interests (Young, Peng, Ahlstrom, Bruton, & Jiang, 2008). Control by the government may also create a fertile soil to nurture corruption (Luo & Tung, 2007). A recent study suggests that the newly transformed SOEs are ‘dynamic dynamos’ rather than ‘dying dinosaurs’ (Ralston, Tong, Terpstra, Wang, & Egri, 2006), suggesting that government ownership may influence the performance of Chinese firms positively, including OFDI. 2.3. Informal institutional regime The state also plays a role in cultivating, advocating, and strengthening informal institutions to enhance its economic and political objectives through OFDI. Except for the formal institutional frameworks discussed above, informal institutions – especially when non-existent or non-enforced legal systems fail to support business – influence firms’ overseas investments.



24

25 Top 50 non-financial Chinese enterprises ranked by OFDI stocks (2009)

No. Enterprise name

Main business

Firm type

1

China National Petroleum Corporation

Crude oil and gas exploitation, petroleum refining, engineering

Centrally controlled SOE

2

China National Offshore Oil Corporation



3

China Petrochemical Corporation



4

Aluminium Corporation of China

Bauxite, rare-earth metal, engineering


5

China Resources (Holdings) Co., Ltd.

Consumer goods, power, property, cement, gas, medication, finance


6

China Ocean Shipping (Group) Company

Water transportation, shipbuilding, logistics


7

China National Cereals, Oils & Foodstuffs Corporation

Foodstuffs, grain and oil, hotel, real estate


8

Sinohem Corporation

Oil, fertilizer, gas, hotel, real estate

SOE

9

China Merchants Group

Transportation, infrastructure, finance, real estate


10

China National Aviation Holding Corporation

Air transportation


11

China Shipping (Group) Company

Water transportation, shipbuilding, logistics


12

SinoSteel Corporation

Metallurgy, engineering


13

SINOTRANS Changjiang National Shipping (Group) Corporation

Transportation, recreation, real estate


14

China Minmetals Corporation

Metal and mineral, transportation


15

CITIC Group

Finance, real estate, engineering, resource, manufacture, information, commercial service

Limited liability company



Table 1.3

26 (Continued)

No. Enterprise name

Main business

Firm type

16

China Unicom Corporation

Telecommunications


17

China State Construction Engineering Corporation

Civil construction


18

China Power Investment Corporation

Electric power, investment, engineering


19

China Huaneng Group

Electric power, finance, resource, finance


20

China National Chemical Corporation

Chemical engineering


21

China Mobile Communications Corporation

Telecommunications


22

China Metallurgical Group Corporation

Metallurgy, resource, real estate, engineering


23

Shum Yip Holdings Company Limited

Real estate, infrastructure, transportation

Locally controlled SOE

24

Legend Holdings Ltd.

IT, investment, real estate


25

Hunan Valin Iron & Steel (Group) Co., Ltd.

Iron and steel


26

GDH Limited

Investment


27

Huawei Technologies

Telecommunication service


28

China Noferrous Metal Mining & Construction (Group) Co., Ltd.

Non-ferrous metal, engineering


29

China Norh Industries Group Corporation

Military supplies


30

Baosteel Group Corporation

Steel, resource, finance, manufacture, service


31

Shanghai Baosteel Group Corporation

Steel

32

Shanghai Overseas United Investment Co., Ltd.

Investment


33

Guangzhou Yuexiu Holdings Limited

Investment


34

Anshan Iron & Steel Group Corporation State Grid Corporation of China

Iron, steel

Centrally controlled SOE Centrally controlled SOE

35

Power grid



Table 1.3

36

Shanghai Automotive Industry Corporation

Auto manufacture


37

Shougang Corporation

Steel, resource, service


38

Sinohydro Co., Ltd.

Water conservancy, investment, engineering, service, trade


39

Nam Kwong (Group) Company Limited

Consumer goods, real estate, hotel, logistics


40

Shenzhen Investment Holdings Co., Ltd.

Investment


41

Shenhua Group Corporation

Resource


42

China Poly Group Corporation

International trade, real estate, culture, resource


43

TCL Group Company

Electronic products


44

Aviation Industry Corporation of China

Aerospace manufacture, military


45

Jinchuan Group Limited

Resource


46

Xinjiang Zhongxin Resource Co., Ltd.

Resource


47

Guangdong National Shipping Corporation

Transportation, logistics, real estate, recreation


48

Wuhan Iron & Steel (Group) Co., Ltd.

Metallurgy, engineering


49

ZTE Corporation

Telecommunication service


50

China Guangdong Nuclear Power Holding Co., Ltd.

Nuclear resource


Sources: 2009 Statistical Bulletin of China’s OFDI (MOC, 2010); www.sasac.gov.cn.

The state helps to create two important informal institutions that generate ideological influence on Chinese OFDI: state ideology and national pride. State ideology is a set of ideas that constitutes state goals, expectations, and actions, and it can be thought of as a comprehensive vision of the state held by all members of society. According to Smith and Kim (2006), national pride is ‘the positive effect that the public feels towards their country, resulting from their national identity (P127)’. These two factors are to some extent interrelated. A strong state ideology may increase national



Bing Ren et al. 27


pride, and national pride can also enhance state ideology. While the economic organization is intertwined with the ideological state, major Chinese multinationals usually incorporate national missions and national pride in conducting overseas strategies. Such ideology and pride may stem from the collective expectation of ‘carrying a great torch and striving to better develop the country’. Sometimes, a particular strategy at the firm level (such as a cross-border acquisition) is economically irrational (Hope et al., 2010). This could stem from an individual enterprise leaders’ greater ambition to pursue a successful ‘country image’ to foreign counterparts and infiltrate the ‘Chinese brand’ into a global market. We argue that state ideology and national pride are two soft power institutions that may function as growth engines for Chinese firms to compete with international players. The effect of state ideology and national pride are more likely to be cultivated in the Chinese context because the Chinese culture is strong in collectivism and nationalism in comparison with the West. Such national culture allows the state to communicate ideology and pride through tangible and intangible social and cultural platforms as well as to create incentives and enforcement mechanisms. To fulfill its country-level strategies and thus have greater influence on the international investments of Chinese firms, the government stresses such state ideologies throughout its policy and administration process, as well as directly implements them in its wholly controlled SOEs. Hence, the formal OFDI institutional regimes further ensure the efficiency of the informal institutional-enforced effects on OFDI in China.

2.4. Institutional and Chinese MNE-based OFDI We argue that the state plays important roles in shaping Chinese OFDI institutional regimes, including the formal and informal institutions. It is important to explore more thoroughly what theoretical implications we can draw from this phenomenon. Dunning and Lundan (2008) suggest that institutions influence multinational ownership, internalization, and location advantages, and thus determine the internationalization strategy of a company. Integrating institutions into the OLI paradigm offers a profound tool to understand how institutions help the formation of emerging multinational firms. Sun and colleagues (2010) propose a comparative ownership advantage framework to explain why EMEs such as those from China and India can internationalize and conduct specific cross-border M&As. The theory suggests that EMEs in developing countries can leverage country-specific advantages and combine them with firm-specific advantages to form comparative ownership advantages to drive their internationalization. Combining the ideas of Dunning and colleagues (Dunning, 2001; Dunning & Lundan, 2008) with those of Sun and colleagues (Sun et al., 2010), we argue that not only the factor endowment structure but also the



28

institutional structure help EMEs generate comparative ownership advantages. Hence, we can broaden the country-specific advantages concept to include an institutional dimension, suggesting that institutions could be leveraged by EMEs to combine with company advantages to form specific ownership advantages. These institutional factors could be the formal and informal ones shaped under the role of state. For example, formal institutions (such as favorable credit and financing policies and the establishment of resource and information platforms overseas) can be combined with company production and entrepreneurial capabilities to exploit international market opportunities. From the informal institutional perspective, managing the state ideology and national pride institutional elements in the strategic management processes of companies can help them better co-opt the formal institutional regimes, thus maximizing globalization benefits. In essence, through a successful integration of the national level institutional advantages and the company level advantage, EMEs can build ‘institution-based comparative ownership advantages’. With this institutionbased comparative ownership advantage, EMEs can cultivate business opportunities in specific host country markets and conduct institution-based OFDI. Proposition 1: The formal and informal institutions developed under the role of the state are sources of comparative ownership advantage for Chinese firms, to ‘pull’ Chinese firms to conduct institution-based OFDI. 2.5. The strategic choices of OFDI by Chinese multinationals While institutions are helpful for developing firm-specific ownership advantage, corporate executives may view the institutional framework as a favorable pull factor for internationalization (Lewin, Long, & Carroll, 1999). On the one hand, they increase EME confidence in internationalization. On the other hand, they can be exploited to change the cost and benefit structure in a multinational’s potential OFDI activity in a host country market. We will discuss Chinese multinational strategic choices in OFDI below. Choice of OFDI mode In contrast to mature market multinationals, EMEs have fewer incentives for efficiency-seeking and cost-minimizing outward investments, as the EME itself has ample supplies of low-cost, productive labor and inexpensive land. Rather, Chinese firms have higher incentives for asset-seeking and marketseeking OFDI. In comparison to independent OFDI and contractual joint ventures, M&A strategy can help Chinese firms to more quickly access strategic assets and potential markets, and thus upgrade their global competence more efficiently. However, in these aggressive cross-border M&As, the pressures of managing strategic and operating risks are much higher



Bing Ren et al. 29


than when seeking only cost efficiency (Kumar, 2009). We believe the formal and informal institutions mentioned above will help overcome the risks and facilitate adopting the M&A mode. Formal institutional support will help the resource and domestic market demand of potential multinationals and thus facilitate more entrepreneurial and aggressive international exploration. Formal institutional support also allows firms to focus on managing the strategic and operating risks in M&As with greater efficiency. The informal institutions can help intrinsically reinforce political or strategic objectives of the involving parties. These arguments suggest that formal and informal institutional supports can help Chinese multinationals adopt more aggressive OFDIs such as M&As. Proposition 2: In relation to independent OFDI and greenfield joint ventures, Chinese multinationals are more likely to adopt acquisition in their internationalization. Choice of OFDI location Multinationals invest in the most advantageous locations to fulfill the firm’s efficiency, asset- and market-seeking strategic objectives (Dunning, 1980, 1988). In Chinese OFDI, the endogenous formal and informal institutions, shaped by the role of the state, help determine location choice. Regarding formal institutions, the government encourages firms to target resource and strategic asset-intensive regions through various preferential policy supports such as credit and tax incentives, as well as other administrative methods. For example, Chinese SOEs enter countries such as Africa and South America more extensively because they are resource-intensive countries where the Chinese state can acquire strategic raw materials to enhance the country-level resource endowments. Examples include Capital Iron & Steel’s acquisition of Hierro Peru Mining and Baosteel’s investment in a steel plant in Brazil. Informal institutions also influence which countries Chinese firms enter, including those helpful for maintaining Chinese national pride. The Chinese prefer to invest in regions where national pride and state ideology can be better maintained and leveraged. For example, regions such as Japan, South Korea, Taiwan, Singapore, Hong Kong (the so-called ‘four dragons’), as well as Malaysia, one of the new ‘four tigers’, give better location advantages (Sun et al., 2010). These institutional enforcements will help set the boundaries of locations for Chinese OFDI. Proposition 3: Chinese multinational firms tend to invest in countries or regions where both formal and informal institutions developed under the role of the state are more likely to play a role. Choice of OFDI industry We believe formal institutions play a major role in guiding OFDI industry choice. As the Chinese government views OFDI as an important means



30

of integrating global resources and value chain markets, its aim is carried out mainly through securing stable sources of raw materials and obtaining technological assets scarce in China. The government has specifically encouraged OFDI in the resource exploration and extraction industries (Cai, 1999) as well as the manufacturing (processing and assembling) industries where Chinese companies have a competitive edge. But these Chinese industries are weak in designing, researching and developing (R&D) and, through preferential policies and direct administrative control, the government is encouraging OFDI. The government has recently favored more investments in the financial sector overseas. China Investment Corporation (CIC) invested in Blackstone and Morgan Stanley to use the global financial crisis to leverage China’s huge foreign currency reserves. However, we do not regard these overseas investments as traditional MNE behavior explained by theory. Informal institutions support formal institutions in deciding which sectors should be involved in OFDI. Some target OFDI industries may involve greater elements of national pride and state ideology to help generate greater political benefits. Because of the ideology concern, it may be hard for Chinese multinationals to conduct OFDI in industries that generate ideology conflicts such as the media sector. Figure 1.4 synthesizes the above propositions in this chapter. Proposition 4a: Chinese multinational firms tend to invest in overseas manufacturing (design and R&D) industries that can help upgrade their domestic industrial structure and global value chains. Proposition 4b: Chinese multinational firms tend to invest in overseas resource exploration and extraction industries that can help China pursue and secure scarce natural resources. Hard power (economic)

The state

Formal institutional determinants State policy

Soft power (political)

Informal institutional determinants Chinese multinationals’ comparative ownership advantages

State ideology

Administrative system Government ownership

Figure 1.4

Chinese multinationals’ OFDI: motivation strategy

National pride

The role of state and Chinese multinationals’ institution-based OFDI



Bing Ren et al. 31

32


As China emerges as an important player in the world economy, the role of the state is crucial through the promotion of OFDI by Chinese multinationals. The Chinese state executed its role through constructing formal and informal institutions to influence OFDI trajectories. Under such circumstances, we observe an extensive interplay between the macro-level state policy and institutional frameworks and the micro-level firm and OFDI strategic choices. In both cases, formal and informal institutional factors drive Chinese firms to conduct OFDI in different investment modes, location choices, and types of industries. Due to space limitation, there are some important issues our chapter did not capture in detail although they deserve attention. Institutions do not matter to all firms, and they do not matter in similar ways (North, 1990; Scott, 1995). This suggests that the institutions derived from the role of the state may generate contingent effects on OFDI by Chinese firms. The first contingent factor is related to a stratified structure that the state constructs in developing the formal and informal institutional OFDI regime. In such a structure, the institutional regime is exclusive in nature where the state renders the advantageous institutions only to certain groups of firms: not all Chinese multinationals enjoy the benefits in their internationalization. The state makes such exclusions using criteria such as how important the firm is to the whole economy. Only influential firms such as large firms or firms in more important industries benefit from the supportive regime. The second contingency factor is related to a ‘double-edged sword’ or ‘dark side’ of the institutional influence. In contrast to the ‘benefits’ generated by institutional regimes for ‘some’ firms, there may be ‘costs’ or ‘liabilities’ assigned by similar institutions to other firms. While we discuss the pull role of the state and institutional regimes on Chinese OFDI, we cannot ignore the push role of the same institutional regime to some OFDI activities (e.g., Luo & Tung, 2007; Witt & Lewin, 2007). The ‘supporting’ institutional regime may create costs and disadvantages to some firms’ domestic market competition, and thus crowd them out to the international markets to pursue growth. This is reflected by the large number of Chinese overseas investments in Latin America, many of them in three tax havens (Witt & Lewin, 2007). The third contingency factor is related to the ‘mixed’ objectives that the state sets for OFDI (Luo and Tung, 2007; Luo et al., 2010). Except for the economic driving forces (mostly efficiency and effectiveness from the firm’s perspective), Chinese firms are also pulled to conduct political OFDI that mostly satisfies country-level objectives. Key Chinese multinationals are forced to exert ‘helping hand’ behaviors to fulfill the country-level political goals such as strengthening inter-governmental political ties (Luo and Tung, 2007). This was particularly evident in China’s investment in some Third



3. Discussion and conclusion

World countries (Luo and Tung, 2007). The state is more likely to mandate SOEs to conduct such OFDI activities because the state has a direct control of the SOE sector. Such political mandates may also be possible with private firms, especially when the private parties’ interests are intertwined with the state’s interests. However, compared with SOEs, private sector firms are more likely to act independently in OFDI and be driven by economics, even when such OFDIs result from exploiting the state’s supportive institutional regime. The last contingency is that to leverage better the advantageous OFDI institutional regime, firms must have specific internal conditions. The most important internal conditions are capabilities that can facilitate successful integration of company resources and OFDI objectives with the countryspecific institutional supports. Such capabilities include strong adaptation capabilities in relation to the external institutional environments (Elango & Pattnaik, 2007; Yiu et al., 2007); cross-border learning and absorptive capacity (Johanson & Vahlne, 1997; Teece et al., 1997); and creativity and innovation in company integration of global value chains (Sun et al., 2010). Other factors can be managerial intentionality (Hutzschenreuter, Pedersen, & Volberda, 2007; Kumar, 2009) and international entrepreneurship (Yiu et al., 2007). Given the supporting institutional environments, these factors are important for generating effective strategic choices and adjustments in exploiting international market opportunities. The capability factor is more important than resources (Deng, 2007; Sun et al., 2010) because firms with unique capabilities can obtain essential resources that they lack, either through exploiting the home country institutional environments or through integrating the global resource platform. These four contingency views suggest future research directions on Chinese firms’ internationalization, to derive better predictions on the path and trajectory of Chinese OFDI: these need to include other theoretical approaches such as political economy perspectives; views on resource and capability; evolutionary theory; and the institutional perspective.

References Aliber, R.Z. 1971. The multinational enterprise in a multicurrency world. In J.H. Dunning (ed.), The Multination Enterprise. London: Allen and Unwin. Boisot, M. & Meyer, M. 2008. Which way through the open door? Reflections on the internationalization of Chinese firms. Management and Organization Review, 4(3): 349–365. Buckley, P.J. & Casson, M. 1976. The Future of the Multinational Enterprise. London: Palgrave Macmillan. Buckley, P.J., Clegg, L.J., Cross, A.R., Lin, X., Voss, H. & Zheng, P. 2007. The determinants of Chinese outward FDI. Journal of International Business Studies, 38: 499–518.



Bing Ren et al. 33


Buckley, P.J., Cross, A.R., Tan, H., Liu, X. & Voss, H. 2008. Historic and emergent trends in Chinese outward direct investment. Management International Review, 48(6): 715–748. Cai, K.G. 1999. Outward foreign direct investment: A novel dimension of China’s integration into the regional and global economy. China Quarterly, 60(4): 856–880. Caves, R.E. 1971. Industrial corporations: The industrial economics of foreign investment. Econometrica, 38: 1–27. Chang, H.-J. 1994. The Political Economy of Industrial Policy. London and Basingstoke: Palgrave Macmillan. Child, J. & Rodrigues, S.B. 2005. The internationalization of Chinese firms: A case for theoretical extension? Management and Organization Review, 1(3): 381–410. Claessens, S., Djankov, S. & Lang, L. 2000. The separation of ownership and control in East Asian corporations. Journal of Financial Economics, 58: 81–112. Deng, P. 2004. Outward investment by Chinese MNCs: Motivations and implications. Business Horizon, 47(3): 8–16. Deng, P. 2009. Why do Chinese firms tend to acquire strategic assets in international expansion? Journal of World Business, 44(1): 74–84. Dierickx, I. & Cool, K. 1989. Asset stock accumulation and sustainability of competitive advantage. Management Science, 35(12): 1504–1511. Dore, R.P. 1990. British Factory – Japanese Factory. Berkeley: University of California Press. Dunning, J.H. 1958. American Investment in British Manufacturing Industry. London: George Allen and Unwin. Dunning, J.H. 1980. Toward an eclectic theory of international production: Some empirical tests. Journal of International Business Studies, 11(1): 9–31. Dunning, J.H. 1988. Explaining International Production. London: Unwin Hyman. Dunning, J.H. 1993. Multinational Enterprises and the Global Economy. Wokingham: Addison-Wesley. Dunning, J.H. 2001. The eclectic (OLI) paradigm of international production: Past, present and future. International Journal of the Economics of Business, 8(2): 173–190. Dunning, J.H. & Pitelis, C. 2009. The Political Economy of Globalization – Revisiting Stephen Hymer 50 Years On. Available at SSRN: http://ssrn.com/abstract=1505450. Dunning, J.H. & Lundan, S.M. 2008. Multinational Enterprises and the Global Economy, 2nd edition. Cheltenham: Edward Elgar. Elango, B. & Pattnaik, C. 2007. Building capabilities for international operations through networks: A study of Indian firms. Journal of International Business Studies, 38(4): 541–555. Enterprise Institute of Development Research Center of the State Council. 2006. The Internationalization Strategies for Chinese Enterprises. Beijing: People’s Publishing House: 356–387. Filatotchev, I., Strange, R., Piesse, J. & Lien, Y.C. 2007. FDI by firms from newly industrialized economies in emerging markets: Corporate governance, entry mode and location. Journal of International Business Studies, 38: 556–572. Ge, G.L. & Ding, D.Z. 2011. The effects of the institutional environment on the internationalization of Chinese firms. In I. Alon, J. Chang, M. Fetcherin, C. Lattemann & J.R. McIntyre (eds), China Rules – Globalization and Political Transformation. London: Palgrave Macmillan. Gomes-Casseres, B. 1990. Firm ownership preferences and host government restrictions: An integrated approach. Journal of International Business Studies, 21(1): 1–22.



34

He, L. 2009. China’s overseas investment strategy and legal countermeasure. Beijing: The University of International Business and Economic Press. Hennart, J.F. 1982. A Theory of Multinational Enterprise. Ann Arbor: The University of Michigan Press. Hennart, J.F. & Park, Y.P. 1994. Location, governance, and strategic determinants of Japanese manufacturing investment in the United States. Strategic Management Journal, 15(6): 419–436. Hope, O.-K., Thomas, W.B. & Vyas, D. 2011. The cost of pride: Why do firms from developing countries bid higher? Journal of International Business Studies, 42(1): 128–151. Huang, Y. 2010. Debating China’s economic growth: The Beijing consensus or the Washington consensus. Academy of Management Perspective, 24(2): 31–47. Hutzschenreuter, T., Pedersen, T. & Volberda, H.W. 2007. The role of path dependency and managerial intentionality: A perspective on international business research. Journal of International Business Studies, 38: 1055–1068. Hymer, S.H. 1960. The international operations of national firms: A study of direct foreign investment. Ph.D. Thesis, Cambridge, MA, M.I.T Press. Iversen, C. 1935. Aspects of International Capital Movements. London, Copenhagen: Levin and Munksgaard. Jiang, Z. 1992. Enhancing the reform and opening up and accelerating the modernization drive to make more progress of building socialism with Chinese characteristics. Report on 14th National Congress of Chinese Communist Party. Beijing: People’s Publishing House. Johanson, J. & Vahlne, J.-E. 1977. The internationalization process of the firm: A model of knowledge development and increasing foreign market commitments. Journal of International Business Studies, 8(1): 25–31. Keister, L.A. 1998. Social ties and the formation of Chinese business groups. Sociological Analysis, 1: 99–118. Knickerbocker, F.T. 1973. Oligopolistic Reaction and the Multinational Enterprise. Cambridge, MA: Harvard University Press. Kogut, B. & Zander, U. 1993. Knowledge of the firm and the evolutionary theory of the multinational enterprise. Journal of International Business Studies, 24(4): 625–645. Kumar, N. 2009. How emerging giants are rewriting the rules of M&A. Harvard Business Review, 87(5): 115–121. Lewin, A.Y., Long, C.P. & Carroll, T.N. 1999. The co-evolution of new organizational forms. Organization Science, 10(5): 535–550. Li, W. 2009. China’s corporate governance transition: From administration governance to economic governance. NanKai Business Review, 1 (title page) (in Chinese). Lien, Y.-C., Piesse, J., Strange, R. & Filatotchev, I. 2005. The role of corporate governance in FDI decisions: Evidence from Taiwan. International Business Review, 14(6): 739–773. Lippman, S.A. & Rumelt, R.P. 1982. Uncertain imitability: An analysis of interfirm differences in efficiency under competition. Bell Journal of Economics, 13(2): 418–438. Loree, D. & Guisinger, S. 1995. Policy and non-policy determinants of US foreign direct investment. Journal of International Business Studies, 26(2): 281–299. Lu, J.W. & Ma, X. 2008. The contingent value of local partners’ business group affiliation. Academy of Management Journal, 51(2): 295–314.



Bing Ren et al. 35


Luo, Y. & Tung, R.L. 2007. International expansion of emerging market enterprises: A springboard perspective. Journal of International Business Studies, 38: 481–498. Luo, Y., Xue, Q. & Han, B. 2010. How emerging market governments promote outward FDI: Experience from China. Journal of World Business, 45: 68–79. Makino, S., Lau, C.-M. & Yeh, R.-S. 2002. Asset-exploitation v.s. asset-seeking: Implications for location choice of foreign direct investment from newly industrialized economies. Journal of International Business Studies, 33(3): 403–421. McManus, J. 1972. The theory of the multinational firm. In G. Paquet (ed.), The Multinational Firm and the Nation State, Don Mills, ON: Palgrave Macmillan, pp. 66–93. Meyer, K. & Nguyen, H. 2005. Foreign investment strategies and sub-national institutions in emerging markets: Evidence from Vietnam. Journal of Management Studies, 42(1): 63–94. Nee, V. 2010. Bottom-up economic development and the role of the state: A focus on China. Sociologica, 1: doi: 10.2383/32063 North, D.C. 1990. Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press. Peng, M.W. & Heath, P. 1996. The growth of the firm in planned economies in transition: Institutions, organizations, and strategic choice. Academy of Management Review, 21: 492–528. Peng, M.W., Wang, D. & Jiang, Y. 2008. An institution-based view of international business strategy: A focus on emerging economies. Journal of International Business Studies, 39(5): 920–936. Pistor, K. & Xu, C. 2005. Governing stock markets in transition economies: Lessons from China. American Law and Economics Review, 1: 184–210. Ralston, D.A., Tong, J.T., Terpstra, R.H., Wang, W. & Egri, C. 2006. Today’s state-owned enterprises of China: Are they dying dinosaurs or dynamic dynamos? Strategic Management Journal, 27(9): 799–898. Rugman, A.M. 1981. Inside the Multinationals: The Economics of Internal Markets. New York: Columbia. Rui, H. & Yip, G.S. 2008. Foreign acquisitions by Chinese firms: A strategic intent perspective. Journal of World Business, 42(2): 213–227. Scott, W.R. 1995. Institutions and Organizations. Thousand Oaks, CA: Sage. Seyoum, B. 2009. Formal institutions and foreign direct investment. Thunderbird International Business Review, 51(2): 165–181. Smith, T.W. & Kim, S. 2006. National pride in comparative perspective: 1995/96 and 2003/04. International Journal of Public Opinion Research, 18(1): 127–136. Sun, L., Peng, M.W., Ren, B. & Yan, D. In press. A comparative ownership advantage framework for cross-border M&As: The rise of Chinese and Indian MNEs. Journal of World Business, doi:10.1016/j.jwb.2010.10.015. Sutherland, D. 2009. Do China’s national team business groups undertake strategic asset-seeking OFDI? Chinese Management Studies, 3(1): 11–24. Teece, D.J., Pisano, G. & Shuen, A. 1997. Dynamic capabilities and strategic management. Strategic Management Journal, 18(7): 509–533. Tihanyi, L., Griffith, D.A. & Russell, C.J. 2005. The effect of cultural distance on entry mode choice, international diversification, and MNE performance: A meta-analysis. Journal of International Business Studies, 36: 270–283. Vernon, R. 1966. International investment and international trade in the product cycle. Quarterly Journal of Economics, 80(2): 190–207.



36

Witt, M.A. & Lewin, A.Y. 2007. Outward foreign direct investment as escape response to home country institutional constraints. Journal of International Business Studies, 38(4): 579–594. World Investment Report (WIR). 2009. Transnational corporations, Agricultural Production and Development. New York and Geneva: United Nations Conference on Trade and Development (UNCTD). Xin, K.R. & Peace, J.L. 1996. Guanxi: Connection as substitutes for formal institutional support. Academy of Management Journal, 39: 1641–1658. Yao, S. & Sutherland, D. 2009. Chinalco and Rio Tinto: A long march for China’s national champions. China Quarterly, 199: 829–840. Yiu, D., Lau, C.-M. & Bruton, G.D. 2007. International venturing by emerging economy firms: The effect of firm capabilities, home country networks, and corporate entrepreneurship. Journal of International Business Studies, 38(4): 519–540. Young, M., Peng, M.W., Ahlstrom, D., Bruton, G. & Jiang, Y. 2008. Corporate governance in emerging economies: A review of the principal–principal perspective. Journal of Management Studies, 45(1): 196–220. Zhao, X.D. 2007. The Long-Term Trend of Chinese Outward Direct Investment, Xinhua Publishing House, pp. 56–58 (in Chinese).



Bing Ren et al. 37

2 William Wei, Ilan Alon, and Liqiang Ni

Compared with foreign direct investment (FDI) inflows, Chinese outward foreign direct investment (OFDI) used to be quite small. According to UN statistics, China’s FDI inflow-outflow ratio was 6.4:1 in 2005 (Cheung & Qian, 2008). However, Chinese investment abroad has increased dramatically since 2007. In 2008, Chinese OFDI outflow reached US$52.1 billion, which equals China’s 2003 FDI inflow. In 2009, Chinese OFDI outflow was US$48 billion, more than double 2007’s outflow (US$22.5 billion) (UNCTAD, 2010). In 2010, it reached $57.9 billion. According to recent statistics from the Department of Outward Investment and Economic Cooperation of the Ministry of Commerce in the People’s Republic of China, US$255.4 billion has been designated for non-financial direct investment by Chinese investors to more than 15,000 enterprises in 174 countries and regions by the end of 2010. Theory suggests that home country market imperfections can exert a significant impact on the decisions of foreign investors (Dunning, 1988). In addition, the location advantages of the FDI host country may account for determinants to invest in foreign countries, which offer superior markets or production. However, Chinese government policy and special macroeconomic conditions may have led to a distinctive pattern of Chinese OFDI in terms of home country determinants. Therefore, in this chapter we analyze Chinese OFDI from the perspective of China’s economic development. On the basis of Dunning’s investment development path (IDP) hypothesis, we test the macroeconomic determinants of Chinese OFDI from a home country perspective from 1987 to 2009. We first review recent studies on Chinese OFDI and its determinants. Then, we propose a model and test seven home country macroeconomic variables as determinants of Chinese OFDI and discuss the results. 38



Home Country Macroeconomic Determinants of Chinese OFDI

William Wei et al. 39

Chinese OFDI has been analyzed from various theoretical and empirical perspectives since the middle of the 1990s (Zhan, 1995; Wang, 2002; Child & Rodrigues, 2005; Buckley et al., 2007; Alon & Mclntyre, 2008). Generally, the studies concentrate on the regulatory framework and the influence of the government regarding OFDI growth, sectoral patterns, geographical distribution, and the investment motives of Chinese companies (e.g., Zhan, 1995; Wang, 2002; Taylor, 2002; Hong & Sun, 2004; Wu, 2005). Other studies take an international management perspective and focus on the internationalization strategies of Chinese companies (e.g., Warner, Ng, & Xu, 2004; Liu & Tian, 2008; Rui & Yip, 2008; Deng, 2009). A variety of explanatory variables may account for growing Chinese OFDI and its global economic and political impact. These include firm-level variables which belong to the specific ownership advantages of each firm and mainly refer to the organization and management know-how the firm is able to apply. The firm acquires, trains, and coordinates research to develop methods, technologies, and products that enable it to supply markets (Dunning, 1993). Macro-level variables include both host and home country variables. The host country variables focus on location advantages, including market characteristics, natural resources, and comparative advantages. Home country variables involve factors such as institutional environment, capital market imperfections, exchange rates, and level of economic development. The mainstream perspective on FDI, developed by Dunning (1981, 2001), draws together elements of previous theories to identify ownership, location, and internalization (OLI) advantages that motivate OFDI. It assumes that firms conduct OFDI on the basis of a definable competitive advantage to secure enough return to cover the additional costs and risks associated with operating abroad (Caves, 1993; Buckley & Ghauri, 1999). According to Dunning’s theory, known as the Eclectic Paradigm Theory, OFDI firms should possess internally transferable ownership advantage such as superior proprietary resources or managerial capabilities that they can apply in a foreign country (Barney, 1991). Studies on firms in developed economies examine many firm-specific factors, such as age (Autio, Sapienza, & Almeida, 2000), size (Akoorie & Enderwick, 1992; Chetty & Hamilton, 1993), capabilities (Autio et al., 2000; Zahra, Ireland, & Hitt, 2000), financial and physical resources (Bloodgood, Sapienza, & Almeida, 1996; Westhead et al., 2001; Zucchella, Palamara, & Denicolai, 2007), location (Leonidou, 1998; Zhao & Zou, 2002), technological advantages (Chang & Grubb, 1992; Evangelista, 1994), and products (Akoorie & Enderwick, 1992). However, other studies suggest that firms move across geographic boundaries for resource and knowledge acquisition as well as capability enhancement (Bartlett & Ghoshal, 1988; Madhok, 1997; Luo, 2000). With the rise of Asian multinationals, an asset-augmenting or asset-seeking perspective can explain



1. Literature review


how these latecomers are employing international expansion as a way to seek resources and overcome their competitive disadvantages (Makino et al., 2002; Mathews, 2002, 2006; Child & Rodrigues, 2005). This view indicates that there may not be a direct relationship between firm-specific ownership advantages and the pursuit of FDI. Instead, firms from developing economies may engage in OFDI to improve competitiveness rather than to exploit their existing set of advantages. Accordingly, market characteristics, natural resources, and comparative advantages of host countries are considered significant factors for Chinese OFDI. First, for market-seeking, host market characteristics are considered a significant determinant. Numerous studies show that FDI flow and market size are associated positively, and this also applies to Chinese OFDI. For example, a 1 percent rise in host market size increases Chinese OFDI by 0.35 percent (Buckley et al., 2007). Second, the natural resource endowment of the host country is also a significant determinant of Chinese OFDI, especially after 1992 (Buckley et al., 2007). Third, for asset-seeking OFDI, Deng (2007) examines its motivation and rationale by conducting a detailed analysis of both primary and secondary data sources. The author suggests that when investing in advanced economies, Chinese multinationals are motivated primarily by the quest for strategic resources and capabilities. The underlying rationale for asset-seeking OFDI is strategic need. Deng (2007) finds that a quest for strategic resources is the primary motivation behind Chinese firms’ investments in industrial countries. Cui and Jiang (2009a) analyze survey data collected from a sample of 138 Chinese firms. The authors find that Chinese firms prefer wholly owned subsidiary entry mode when adopting a global strategy, facing severe host industry competition, and emphasizing asset-seeking in OFDI. Firms prefer joint ventures when investing in a high-growth host market. But Buckley et al. (2007) indicate that asset-seeking variables (patents) are insignificant, which suggests that Chinese firms were not motivated to acquire strategic intellectual capital assets over the period of the study. In addition, Boisot and Meyer (2008) examine the motivation behind early stage internationalization of small Chinese firms and conclude that domestic limitations such as local protectionism and inefficient domestic logistics increase the costs of doing business domestically in China. This, combined with decreased costs, associated with entry into foreign markets, encourages firms to exit domestic markets via internationalization. Child and Rodrigues (2005) argue that the Chinese case conforms more closely to the latecomer perspective than to the analyses derived from the exploitation of firm-specific advantages in the developed economy. Voss et al. (2008) indicate that Chinese firms internationalize when domestic institutions are sufficiently well-developed and the institutional environment allows them to exploit their competitive advantages across borders. From this point of view, some macro-level factors relating to the government, such as government support and government finance, appear to



40

be more distinctive variables in the Chinese case. For example, a favorable relationship with the government exists for most firms with overseas activities, such as Haier, Lenovo, and TCL (Child & Rodrigues, 2005). An ‘acquisition fund’ and cheap loans from state-owned banks influence investment decisions of Chinese firms and constitute an invaluable source of competitive advantage (Child & Rodrigues, 2005). Zhao and Wang (2008) find that firm-specific advantages such as governance advantage and bank loan access are at work simultaneously, driving the internationalization of Chinese private firms. However, in a more recent empirical study, Södermana et al. (2008) identify 12 ‘key driving forces’ of Chinese OFDI, and find that ‘improved quality of production’ and ‘improved customer service’ were the most significant drivers, and ‘government support and finance’ became less important. From an institutional perspective, the legislation and regulation in the host country may be determinant variables in explaining Chinese OFDI (Child & Rodrigues, 2005). Host country culture proximity also has a highly significant and positive effect on Chinese OFDI (Buckley et al., 2007). In a non-empirical study based on host country characteristics, Deng (2004) categorizes five investment motivations for Chinese firms to go overseas: seeking natural resources, technology, the markets and strategic assets of the host country, as well as diversification of investment. Many studies on firm-level analysis focus on Chinese offshore mergers and acquisitions (OMA) since Chinese mergers and acquisitions (M&As) jumped from US$7 billion to US$21.8 billion from 2004 to 2009 (MOFCOM, 2010). Cross-border M&As by Chinese firms are primarily motivated by market development (i.e., increasing market share) to enable faster entry into new markets, promote diversification, and to access foreign advanced technology and other resources. M&As also create value (wealth creation) for Chinese acquiring firms. Rui and Yip (2008) explore how Chinese firms strategically use cross-border acquisitions to achieve their goals. They suggest a strategic intent perspective, supported by data collected from dozens of interviews conducted in three firms, including Lenovo. They propose that Chinese firms use cross-border acquisitions to achieve goals such as acquiring strategic capabilities to offset their competitive disadvantages and leveraging their unique ownership advantages while using institutional incentives and minimizing institutional constraints. Building on institutional theory and using data collected from a multiple-case study of three leading Chinese firms (TLC, BOE, and Lenovo), Deng (2009) proposes a model of resource-driven motivation behind Chinese M&As. He concludes that the unique Chinese institutional environment allows cross-border mergers and acquisitions by Chinese firms to acquire strategic assets. Since Chinese OFDI entails active government involvement, both through ownership and regulation (Peng, 2001), most studies on home country variables of Chinese OFDI adopt an institutional perspective to explore the role





of the government and the OFDI firms. Buckley et al. (2007) find that the policy liberalization variable is positive and significant for Chinese OFDI. Voss et al. (2008) develop an analytical framework based on the institutional change and test its effects on transactions costs and market imperfections. Based on non-empirical research, Voss et al. (2008) argue that the institutional environment of China’s OFDI has undergone significant change over the last 30 years. These two studies believe that the qualitative changes in Chinese policy that took place in 1992 liberalized a number of OFDI-related areas and increased the amount of Chinese OFDI. Cui and Jiang (2009a, 2009b) examine the differences between Chinese firms and multinational corporations (MNCs) in developed countries in OFDI ownership decisions and ask what factors influence decisions. The authors conclude that Chinese firms place a stronger emphasis on strategic intent than strategic fit, enjoy government support that eases their asset constraints, and are influenced by institutions in the host country and their own government. Cui and Jiang (2009c) develop a conceptual framework that integrates resource-based and institutional-based international business strategy perspectives, using data collected from an examination of existing literature as well as an analysis of data collected from their case study of ten Chinese outward-investing firms. The authors propose that, according to the resource-based perspective, Chinese OFDI both exploits and augments assets. Thus, transaction costs and strategic intent affect Chinese OFDI ownership decisions. According to the institution-based perspective, in order to attain institutional legitimacy in foreign markets and host countries, Chinese firms adjust their entry strategies when investing overseas, while at the same time adhering to domestic government restrictions and incentive regulations. Since studies on the OFDI positions of countries show that the mix of ownership, location, and the internationalization advantages of a country’s firms differs depending on the country’s economic development (Dunning, 1993, pp. 76–86), it is argued that OFDI should be considered a function of home country-specific characteristics such as income, exchange rates, technology, interest rates, and so on (Kyrkilis & Pantelidis, 2003). Thus it is necessary to explore the relationship between OFDI and the home country’s economic development variables. More recently, a few empirical studies have sought to model and analyze features of Chinese OFDI in this direction. For example, Liu et al. (2005) use Dunning’s IDP theory to analyze a narrow set of data on Chinese OFDI published by MOFCOM, while Buckley et al. (2007) use project data collected by the State Administration of Foreign Exchange (SAFE). However, such research is rare and the statistics are outdated. Based on Dunning’s IDP theory, we therefore propose a model and test the hypotheses based on home country macroeconomic variables to explain Chinese OFDI. These variables include income, technology, interest rates, exchange rates, openness of the economy, and foreign currency reserves. The



42


data used cover the period from 1987 to 2009. The model and hypotheses are discussed in the following section.

2. The model and hypothesis 2.1. Dependent variable

2.2. Independent variables Technology Technological capability is positively related to OFDI and this receives theoretical and empirical support (Cantwell, 1981; Prugel, 1981; Grubaugh, 1987; Pearce, 1989; Dunning, 1993). Under Dunning’s ownership competitive advantage theory, if technology is information-intensive in a country, the exploitation of technologically intermediate goods across national boundaries is achieved by firms via OFDI. With the dramatic development of the Chinese technology market, high-tech firms that have already captured the domestic market want to exploit the market abroad. In addition, we can use the technology variable to test whether Chinese OFDI is asset-seeking or not. We expect that Chinese MNEs would direct such asset-seeking OFDI toward economies with significant levels of human and intellectual capital, especially the industrialized countries, to help them strengthen their competitiveness elsewhere (Dunning, 1998; Dunning, 2006). Many Chinese companies use M&A to access high-tech companies for internal technology upgrading. The Lenovo–IBM deal and the TCL–Thompson deal are examples. We use the number of patents issued in China annually to evaluate the technological capability of Chinese firms and derive the first hypothesis: Hypothesis 1: The number of patents issued annually in China reflects the technological input of Chinese firms and therefore is positively related to Chinese OFDI. Income The crude relationship between OFDI and gross national product (GNP) per capita can be criticized as mere common sense. The income of a country reflects its economic structure and competitive advantages. As a growing share of GNP comes from manufacturing and services, the capital intensity of production increases, demand patterns move toward the consumption of differentiated products, and markets grow. OFDI flow and market size are associated positively (Buckley et al., 2007). When referring to China, the level of economic development, which is proxied by GNP per capita plus refinements, is still the main factor explaining China’s rate of OFDI (Liu et al., 2005). Dunning et al. (2001) present a modern refinement of the IDP



Annual OFDI outflows from China during 1987–2009.

44


Hypothesis 2: The higher the income level of China, the bigger the amount of its OFDI. Exchange rate In international trade, exchange rates, which are the most important financial tool to adjust imports and exports, also affect OFDI. Aliber (1970) argues that firms from countries with strong currencies can support financial investments more successfully than firms from countries with weak currencies. A low or undervalued exchange rate encourages exports but discourages imports and OFDI (Kohlhagen, 1977; Stevens, 1993). The real effective exchange rate of the home country is the proposed approximation of the same currency’s external value. The appreciation of the home country currency reduces the capital requirement for foreign investments in home country currency terms (Pantelidis & Kyrkilis, 2005). As the home country exchange rate appreciates, more profitable opportunities for OFDI occur as foreign-currency-denominated assets become cheaper. It is possible that a rapid appreciation of the exchange rate, from a low or undervalued position, will more than proportionately increase OFDI (Buckley et al., 2007). Further, the appreciation of home country currency will motivate the home country and companies to invest abroad with lower transaction costs. However, the economic reality of the Chinese government’s regulation of foreign exchange means that China should neither continue its existing currency regime nor opt for a freely floating RMB and thus completely open capital markets. Instead, China has undertaken a ‘two-step’ currency reform. In 1994, it reformed its double-track exchange rate system and introduced the unification of exchange rates. China next instituted a managed floating exchange rate regime based on market supply and demand. Before 1997, RMB exchange rates were stable with a slight rise. After China became a member of the World Trade Organization in 2001, liberalizing the exchange rate system and basing it on market supply and demand have become the most urgent tasks for the Chinese government. Looking back on the development of China’s economy over the last three decades, RMB is evolving as a high credit currency and a hard one at present. This stimulated the globalization of Chinese companies. We therefore derive the third hypothesis:



hypothesis: based on types of product and industry, mainly measured by GNP per capita, they analyze the effect of inward and outward FDI in four stages. Kyrkilis and Pantelidis’ empirical study of macroeconomic determinants of OFDI finds that the income level of a country is associated with outward FDI. In our research, we use real GNP as the variable to reflect the income of the country. A higher-income level (GNP) allows a country to invest abroad. We therefore derive the second hypothesis:


Hypothesis 3: The lower the US dollar exchange rate against the RMB (e.g., if the RMB appreciates), the bigger the amount of Chinese OFDI.

The liberalization of a country’s international trade is expected to positively influence OFDI (Kyrkilis & Pantelidis, 2003), since the more a country is open to foreign economic transactions, the easier it is for domestic firms to invest abroad. Policies on international capital transfer are more likely to influence patterns and trends in Chinese OFDI (Buckley et al., 2007). Exports and imports are tightly connected with the government’s open policy, including FDI. Exporting has been a particular priority of government policy in China, which has urged foreign partners in joint ventures to build commitments into their agreements to maximize exports and local sourcing (Buckley et al., 2007). These variables reflect the economic explanation for China’s OFDI activity. We use total trade (exports plus imports) to reflect the degree of openness of Chinese economy and add trade surplus as a variable to examine the nature of substitution of FDI to international trade surplus. We can derive the fourth and fifth hypothesis as: Hypothesis 4: Total trade positively correlates with OFDI. Hypothesis 5: A trade surplus negatively correlates with OFDI. Interest rate Interest rates are a sensitive factor influencing the flow of capital. Capital abundance is associated with low interest rates, which in turn decrease the opportunity cost of capital domestically and make investments abroad profitable (Prugel, 1981; Clegg, 1987; Grubaugh, 1987). The lower the cost of borrowing, the higher the leverage exposure a firm may consider acceptable, and, consequently, the greater the investment rate the firm may pursue. If the same reasoning is applied to OFDI, as the opportunity cost of capital becomes lower at home, the equity or debt financing of a foreign investment becomes easier (Pantelidis & Kyrkilis, 2005). In general, the marginal productivity of capital is associated with interest rates. Low interest rates declare low marginal productivity of capital, and vice versa (Pantelidis & Kyrkilis, 2005). The interest rate of the country is proposed as an approximation of the margin efficiency of capital and denominates the evaluation of the cost of capital in the home country. If interest rates in the home country decrease, the capital will be invested abroad to earn more profit, and the OFDI will consequently increase. Here, we derive the sixth hypothesis: Hypothesis 6: The lower the interest rate, the higher the amount of the OFDI.



The openness of the economy

46


We know that foreign currency reserves correlate with national strength. Chinese companies are going global to invest in the next generation of global business and the government supports international relations and policy and financial loans based on its huge foreign currency reserves. China’s high savings rates and abundant foreign reserves lead Chinese banks to encourage OFDI. There were foreign currency reserves worth US$2.5 trillion in China by mid-2010 which needed to be invested. OFDI is a logical choice for the Chinese government since it owns most of the banks in China. Chinese banks form a conglomerate supporting global outreach and expansion. We thus introduce this variable for analysis and to measure the degree of Chinese government intervention in OFDI. Wu (2008) states that the increase in the foreign currency reserve is the reason for the increase in China’s OFDI. We therefore derive the seventh hypothesis as follows: Hypothesis 7: Foreign currency reserves are positively related to Chinese OFDI.

3. Methodology and data We conduct multiple linear regressions. We first try the full model: LnOFDI = a + β1∗ LnPATENTS + β2∗ LnGNP + β3∗ LnEXRATE + β4∗ LnTRADE + β5∗ LnSURPLUS + β6∗ LnINTERATE + β7∗ LnFR where: a = constant or intercept OFDI = Outward FDI from China annually PATENTS = the annual number of patents registered in China GNP = Chinese annual GNP EXRATE = US dollar annual exchange rate against RMB TRADE = the annual total import and export amount SURPLUS = the annual international trade surplus INTERATE = Chinese annual interest rate FR = Year-end foreign currency reserves in China. We selected our data from 1987 to 2009 based on the annual statistical book and statistics data published by NBS (National Bureau of Statistics of China). The figures of Chinese OFDI between 1987 and 2001 come from official Chinese data in MOFCOM (Ministry of Commerce), and the data from 2002 to 2009 come from NBS. The sources of interest rates and foreign



Foreign currency reserves


LnOFDI = a + β1∗ LnPATENTS + β3∗ LnEXRATE + β5∗ LnSURPLUS + β6∗ LnINTERATE + β7∗ LnFR

4. Discussion on results and concluding remarks In Table 2.1, on regression results, the second row of the model summary suggests that there is no significant advantage to adopting the full model over the selected. For simplicity, we prefer the selected sub-model. R2 is generally used in explaining the variance in FDI stock and inflows, which is accounted for by the explanatory variables. The values of the R2 and adjusted R2 are 0.9516 and 0.9344 respectively for the selected model, suggesting that the overall explanatory power of the model is very strong. Despite shortcomings due to the short time span of available data, this pioneer study gives a first insight into Chinese OFDI determinants in home country macroeconomic variables. The regression results show that foreign Table 2.1 Regression results Predictors

Full model β

(Constants) LPATENTS LGNP LEXRATE LTRADE LSURPLUS LINTERATE LFR Model Selected Full

36.842 −1.207∗∗ −1.371 −5.553∗∗∗ 1.055 −3.544 −0.973∗ 2.085∗∗ R2 0.9516 0.9577

t 3.267 −2.737 −1.208 −3.255 0.903 −1.762 −2.072 2.219

Selected model VIF

19.366 50.553 27.428 107.788 5.530 7.272 274.573

Adjusted R2 0.9344 0.9330

df1 5 2

β

t

VIF

33.521 −1.2342∗∗

7.138 −2.831

19.318

−5.8975∗∗∗

−5.884

9.666

−3.7820∗∗ −0.7992∗ 2.2570∗∗∗

−2.718 −1.851 6.413

2.703 6.277 39.309

df2

F-Stat

p-Value

14 12

55.09 0.856

0.000 0.449

Notes: ∗ Significant at the 10 percent level; ∗∗ significant at the 5 percent level; ∗∗∗ significant at the 1 percent level.



currency reserves are from SAFE (State Administration of Foreign Exchange). The patents variable comes from MOST (The Ministry of Science and Technology of the People’s Republic of China). Exchange rates, annual GNP, exports and imports come from NBS’s year-end statistical books. For better efficiency and interpretation, we select a subset of predictors based on well-known Akaike Information Criterion (AIC), which leads to the selected model:


reserves are positive and highly statistically significant at the 1 percent level. Exchange rates (US dollar exchange rates against RMB) are negatively related and statistically significant at the 1 percent level. Patents and trade surplus are negative and significant at 5 percent. Interest rates are negatively related and significant at 10 percent. Patents and surplus variables are negative and significant (at 5 percent), indicating that Chinese firms with ownership advantage mainly focus on serving domestic markets as well as promoting international trade. Overseas, the motives of those firms include asset- and technology-seeking. Liu et al. (2005) find that per capita GDP, exchange rates, and inward FDI together affect the magnitude of Chinese OFDI in the long run. Institutions, location, and networks have an indirect impact on OFDI through per capita GDP. According to Dunning’s IDP hypothesis, GDP per capita is an important determinant of OFDI and a high level of OFDI results from IDP stage 3. However, GNP represents the national income level of a country and may not influence OFDI directly, since the larger the GNP, the greater the opportunity for firms in the domestic market, thus decreasing their motivation for investing abroad. In our research, we did not find GNP and trade variables to significant determinants of Chinese OFDI. Interest rates are negative and significant at 10 percent in determining China’s OFDI in our research. Interest rates can increase capital inflow and outflow internationally, but China’s capital market has strict control over the flow of foreign currency in order to ensure the safety of the capital markets. Government interference plays an important role in OFDI. Our result disclosed that interest rates have a negative correlation with Chinese OFDI. When referring to OFDI, if the capital source comes from domestic borrowing, interest rates will be negative with the outward investment, and if the capital source comes from outward borrowing, the result is the opposite. The negative coefficient means that the capital sources of China’s OFDI are largely domestic. The trillion foreign currency reserves are the key point. Pantelidis and Kyrkilis (2005) state that interest rates are significant determinants for the OFDI in the case of Italy, the Netherlands, and Korea. The capital markets in those countries are more mature than China’s and have less government interference. The correlation between interest rates and OFDI and the maturity or openness of the capital markets is a topic for future research. In our study, the coefficient of the exchange rate is negative and significant (at 1 percent), confirming Aliber’s capitalization theory. Pantelidis and Kyrkilis (2005) point out that the statistical significance of the exchange rate variable implies that OFDI offers an effective solution to the strong currency in the home country. Although exchange rate is not based purely on market supply and demand, it still influences imports and exports significantly. The appreciation of the RMB motivates Chinese state-owned enterprises (SOEs) and private companies to invest abroad. The shift to an ‘exchange rate basket’ management system may lead to a gradual appreciation of the RMB



48

in the long run, which will increase the purchasing power of Chinese currency, making the acquisition of overseas assets more attractive to Chinese firms. Foreign currency reserves are a significant determinant factor for China’s OFDI (at 1 percent). To explain this variable, we need only consider the Chinese government’s ‘going global’ policy and the special status of SOEs. Only SOEs and local-government-owned enterprises were allowed to invest overseas before 1985. Although private enterprises were permitted to apply for OFDI projects, the government gave only SOEs strong support in international relations, policy, and financial loans (such as the relaxation of foreign currency control in 2003 by the State Administration of Foreign Exchange), direct and indirect subsidies, and offering favorable financing in the form of credit lines and low interest loans from state-owned financial institutions. Cheng and Ma (2007) argue that the bulk of China’s OFDI comes from SOEs, especially large multinationals administered directly by the central government’s ministries and agencies. The share of FDI outflows by these SOEs was 73.5 percent in 2003, 82.3 percent in 2004, and 83.2 percent in 2005. Their share of OFDI stocks by the end of 2004 and 2005 were 85.5 percent and 83.7 percent, respectively. Deng (2004) observes that the Chinese government played a crucial role in shaping the structure of approved outward investment. Child and Rodrigues (2005) find that the Chinese government gave encouragement and support to key firms to globalize within the rationale of their own needs and policies, particularly in the context of dramatic increase of foreign currency reserves. The literature analyzes the background and motives for Chinese OFDI with a focus on government initiatives. Conventional wisdom suggests that there are three principal reasons for Chinese companies to expand abroad. One is to secure natural resources to meet China’s high demand for raw materials and energy as illustrated by the global expansion of CNOOC or Sinopec. Second is to identify and secure foreign technology and know-how, illustrated by Haier and its use of overseas messaging centers and overseas design centers or Huawei’s globally dispersed research and development laboratories. Third is the desire to escape home market saturation and ruthless price wars, as illustrated by Ningbo Bird and Galanz. Our chapter reveals that macroeconomic variables such as patents, interest rates, exchange rates, the trade surplus, and foreign reserves are important determinants of Chinese outward FDI. Child and Rodrigues (2005) argue that the specific characteristics of Chinese internationalization (mainly the active role of the government and its support to companies, and the Chinese culture) require a different perspective for analysis. Chinese government policies influence some variables such as exchange rates, interest rates, and the openness of the economy. First, the government has, to a great extent, played a crucial role in shaping China’s approved outward investment.





Second, OFDI by Chinese multinationals, in contrast, has been triggered primarily by ‘pull’ factors, such as the desire to secure natural resources, raise foreign exchange income, circumvent host country trade barriers, penetrate new markets, acquire advanced technology and management expertise, and seek strategic assets. Third, in contrast to most other MNCs in the world, Chinese MNCs do not seek efficiency in terms of cost minimization in OFDI. The crucial role the Chinese government plays in OFDI reflects the country’s current political and economic systems. According to a survey conducted by the Asia Pacific Foundation of Canada (2005), government policy is one of the most important driving forces of Chinese OFDI. The Chinese Communist Party and the state still play a central role in the country’s economy and exert close control on Chinese companies and MNEs doing business in the country. Some state-dominated companies have been granted monopoly positions in China’s economy and have become very profitable. These companies are concentrated in energy, resources, infrastructure, telecommunications, and finance industries. The State-Owned Assets Supervision and Administration Commission’s goal is to better manage and promote companies in the ‘strategic and heavyweight’ industries. During the past three decades, there has been a dramatic change in China’s role in the global economy, including the evolution of Chinese businesses from isolation to internationalization, and even global integration. Although there have been major shifts in corporate strategy, technology management, and human resource and talent management practices, especially among a small set of globally competitive, leading-edge Chinese firms, the macroeconomic conditions of China will still play an important role in Chinese OFDI.

Note An earlier version was published as William Wei and Ilan Alon (2010), “Chinese Outward Direct Investment: A Study on Macroeconomic Determinants,” International Journal of Business and Emerging Markets, 2(4): 352–369.

References Akoorie, M. & Enderwick, P. 1992. The international operations of New Zealand companies. Asia Pacific of Journal of Management, 9: 51–69. Aliber, R.Z. 1970. A Theory of Foreign Direct Investment. Cambridge, MA: The International Corporation, MIT Press. Alon, I. & Mclntyre, J.R. 2008. Globalization of Chinese Enterprises. London: Palgrave Macmillan. Autio, E., Sapienza, H.J. & Almeida, J.G. 2000. Effects of age at entry, knowledge intensity, and imitability on international growth. Academy of Management Journal, 43: 909–924.



50

Barney, J.B. 1991. Firm resources and sustained competitive advantage. Journal of Management, 17: 99–120. Bartlett, C.A. and Ghoshal, S. 1988. Creation, adoption, and diffusion of innovations by subsidiaries of multinational corporations. Journal of International Business Studies, 19(3): 365–388. Bloodgood, J.M., Sapienza, H.J. & Almeida, J.G. 1996. The internationalization of new high-potential US ventures: Antecedents and outcomes. Entrepreneurship: Theory and Practice, 20: 61–76. Boisot, M.H. & Meyer, M.W. 2008. Which way through the open door? Reflections on the Internationalization of Chinese Firms. Management and Organization Review, 4(3): 349–365. Buckley, P.J. & Ghauri, P.N. 1999. The Internationalization of the Firm. London: International Thomson Business Press. Buckley, P.J., Clegg, L.J., Cross, A.R., Liu, X., Voss, H. & Zheng, P. 2007. The determinants of Chinese outward foreign direct investment. Journal of International Business Studies, 38: 499–518. Cantwell, J. 1981. Technological Advantage as a Determinant of the International Economic Activity of Firms, Discussion Papers in International Investment and Business Studies, No. 105, University of Reading, Reading. Caves, R.E. 1993. International corporations: The industrial economics of foreign investment. Economica, 38: 1–27. Chang, T. & Grubb, P.D. 1992. Competitive strategies of Taiwanese PC firms and their internationalization process. Journal of Global Marketing, 6: 5–27. Cheng, L. & Ma, Z. 2007. China’s Outward FDI: Past and Future, Hong Kong University of Science and Technology, mineo. Chetty, S.K. & Hamilton, R.T. 1993. Firm-level determinants of export performance: A meta analysis. International Marketing Review, 10: 26–34. Cheung, Y. & Qian, X. 2008. The Empirics of China’s Outward Direct Investment, Working Paper, University of California, Santa Cruz. Child, J. & Rodrigues, S. 2005. The internationalization of Chinese firms: A case for theoretical extension. Management and Organization Review, 1(3): 381–410. Clegg, J. 1987. Multinational Enterprises and World Competition, Working Paper, Macmillan, London. Cui, L. & Jiang, F. 2009a. FDI entry mode choice of Chinese firms: A strategic behavior perspective. Journal of World Business, 44(4): 434–444. Cui, L. & Jiang, F. 2009b. Ownership decisions in Chinese outward FDI: An integrated conceptual framework and research agenda. Asian Business & Management, 8(3): 301–324. Cui, L. & Jiang, F. 2009c. Behind ownership decision of Chinese outward FDI: Resources and institutions. Asia Pacific Journal of Management (Published online: 5 March 2009). Deng, P. 2004. Outward investment by Chinese MNCs: Motivations and implications. Business Horizons, 47(3): 8–16. Deng, P. 2007. Investing for strategic resources and its rationale: The case of outward FDI from Chinese companies. Business Horizons, 50: 71–81. Deng, P. 2009. Why do Chinese firms tend to acquire strategic assets in international expansion. Journal of World Business, 44: 4–84. Dunning, J.H. 1981. International Production and the Multinational Enterprise. George Allen & Unwin: London. Dunning, J.H. 1988. Explaining International Production. London: Unwin Hyman.





Dunning, J.H. 1993. Multinational Enterprises and the Global Economy. Wokingham: Addison-Wesley. Dunning, J.H. 1998. Location and the multinational enterprise: A neglected factor? Journal of International Business Studies, 29(1): 45–86. Dunning, J.H. 2001. The eclectic (OLI) paradigm of international production: Past, present and future. International Journal of the Economics of Business, 8(2): 173–190. Dunning, J.H. 2006. Comment on dragon multinationals: New players in 21st century globalization. Asia Pacific Journal of Management, 23: 139–141. Dunning, J.H., Kim, C. & Lin, J.D. 2001. Incorporating trade into the investment development path: A case study of Korean and Taiwan. Oxford Development Studies, 29(2): 145–154. Evangelista, F.U. 1994. Export performance and its determinants: Some empirical evidence from Australian manufacturing firms. In S.T. Cavusgil and C.T. Axmin (eds), Advances in International Marketing, Greenwich, CT: JAI Press, pp. 207–229. Grubaugh, S.J. 1987. Determinants of direct foreign investment. Review of Economics and Statistics, 69(1): 149–152. Hong, E. & Sun, L.X. 2004. Go Overseas via Direct Investment, Department of Financial and Management Studies, University of London. Available from URL: http://www. cefims.ac.uk/documents/research-28.pdf. Kohlhagen, S.W. 1977. The effects of exchange-rate adjustments on international investment. In P.B. Clark, D.E. Logue & R. Sweeney (eds), The Effects of Exchange Rate Adjustments, Washington, DC: US Government Printing Office, pp. 194–197. Kyrkilis, D. & Pantelidis, P. 2003. Macroeconomic determinants of outward foreign direct investment. International Journal of Social Economics, 30(7–8): 827–836. Leonidou, L.C. 1998. Organizational determinants of exporting: Conceptual, methodological, and empirical insights. Management International Review, 38: 7–52. Liu, L. & Tian, Y. 2008. The internationalizations of Chinese enterprises: The analysis of the UK case. International Journal of Technology and Globalization, 4(1): 87–102. Liu, X., Buck, T. & Shu, C. 2005. Chinese economic development, the next stage: Outward FDI? International Business Review, 14(1): 97–115. Luo, Y. 2000. Dynamic capabilities in international expansion. Journal of World Business, 35(4): 355–378. Madhok, A. 1997. Cost, value and foreign market entry mode: The transaction and the firm. Strategic Management Journal, 18(1): 39–61. Makino, S., Lau, C.M. & Yeh, R.S. 2002. Asset-exploitation versus asset-seeking: Implications for location choice of foreign direct investment from newly industrialized economies. Journal of International Business Studies, 33(3): 403–421. Mathews, J.A. 2002. Competitive advantage of the latecomer firm: A resource-based account of industrial catch-up strategies. Asia Pacific Journal of Management, 19(4): 467–488. Mathews, J.A. 2006. Dragon multinationals: New players in 21st century globalization. Asia Pacific Journal of Management, 23(1): 5–27. MOFCOM. 2010. 2009 statistical bulletin of China’s outward foreign direct investment. Available from URL: http://english.mofcom.gov.cn/ Pantelidis, P. & Kyrkilis, D. 2005. A cross analysis of outward foreign direct investment patterns. International Journal of Social Economics, 32(6): 510. Pearce, R.D. 1989. The Internationalization of Sales by Leading Enterprises: Some Firm, Industry and Country Determinants, Discussion Papers in International Investment and Business Studies, Series B, No. 135, University of Reading, Reading.



52

Peng, M.W. 2001. The resource-based view and international business. Journal of Management, 27: 803–829. Prugel, T.A. 1981. The determinants of foreign direct investment: An analysis of US manufacturing industries. Managerial and Decisions Economics, 2: 220–228. Rui, H.C. & Yip, G.S. 2008. Foreign acquisitions by Chinese firms: A strategic intent perspective. Journal of World Business, 43: 213–226. Södermana, S., Jakobsson, A. & Soler, L. 2008. A quest for repositioning: The emerging internationalization of Chinese companies. Asian Business and Management, 7: 115–142. Stevens, G.V.G. 1993. Exchange Rates and Foreign Direct Investment: A Note, International Finance Discussion Papers, April, No. 444, Board of Governors of the Federal Reserve System, Washington, DC. Taylor, R. 2002. Globalization strategies of Chinese companies: Current development and future prospects. Asian Business and Management, 1: 209–225. UNCTAD. 2010. World Investment Report 2010, New York and Geneva: United Nations. Voss, H., Buckley, P.J. & Cross, A.R. 2008. An assessment of the effects of institutional change on Chinese outward direct investment activity, The Globalization of Chinese Enterprises: Transformational Politics, Business Strategies, and Future Paths, 9–10 October, Harvard University, Cambridge, USA. Wang, M.Y. 2002. The motivations behind China’s Government-initiated industrial investments overseas. Pacific Affairs, 75(2): 187–206. Warner, M., Ng, S.H. & Xu, X. 2004. Late development experience and the evolution of transnational firms in the People’s Republic of China. Asia Pacific Business Review, 10: 324–345. Westhead, P., Wright, M. & Ucbasaran, D. 2001. The internationalization of new and small firms: A resource-based view. Journal of Business Venturing, 16: 333–358. Wu, F. 2005. The globalization of corporate China, NBR Analysis Series, The National Bureau of Asian Research, 16(3): 1–29. Wu, H. 2008. An empirical study on the macro performance of Chinese FDI – based on the foreign currency reserve. Science and Technology Progress and Policy, 25(12): 161–163 Zahra, S.A., Ireland, R.D. & Hitt, M.A. 2000. International expansion by new venture firms: International diversity, mode of market entry, technological learning, and performance. Academy of Management Journal, 43: 925–950. Zhan, J. 1995. Transnationalisation and outward investment: The case of Chinese firms. Transnational Corporations, 4(3): 67–100. Zhao, H. & Wang, Y. 2008. Advantage exploitation and disadvantage avoidance: An empirical analysis of outward internationalization propensity of Chinese private firms. The Globalization of Chinese Enterprises: Transformational Politics, Business Strategies, and Future Paths, 9–10 October, Harvard University, Cambridge, USA. Zhao, H. & Zou, S. 2002. The impact of industry concentration and firm location on export propensity and intensity: An empirical analysis of Chinese manufacturing firms. Journal of International Marketing, 10: 52–71. Zucchella, A., Palamara, G. & Denicolai, S. 2007. The drivers of the early internationalization of the firm. Journal of World Business, 42: 268–280.




3 Paz Estrella Tolentino

China is currently the fourth largest home country of multinational corporations (MNCs) among developing economies, after Hong Kong, Singapore, and Taiwan. Its outward foreign direct investment (OFDI) stock accounted for around 3 percent of the OFDI stock of developing economies in 1990 and 2000, increasing to over 8 percent by 2009, when it reached almost US$230 billion (UNCTAD, 2010). The rapid growth, as well as the distinguishing features of new MNCs from China in recent years, set against a backdrop of the country’s strong economic performance, has intrigued the international business community. The roles of country, industry, and firm on the ownership and internalization advantages of firms and location advantages of home and host countries have been analyzed extensively in the international business literature (see Dunning, 1982; Gray, 1982). At the core of a firm’s competitive advantages and performance are internal influences associated with internal assets and competencies (Hawawini, Subramanian, & Verdin, 2004). External or environmental factors associated with a firm’s country of origin play a critical, albeit partial, role in the development of a firm’s competitive advantages and international expansion (Kumar & Kim, 1984; Porter, 1990; Nachum & Rolle, 1999; Nachum, 2001). Accordingly, the current research examines the relationships among macroeconomic factors specific to China, including openness of the economy to international trade, national technological capability, domestic interest and exchange rates, and the level of China’s OFDI flows using multiple time-series data from 1982 to 2008. These real and financial factors define some of the home country determinants and effects of the competitiveness of all MNCs in a country, but have remained unexplored in analyzing Chinese MNCs. This study adopts a vector autoregressive (VAR) model to assess the causal relationships of the endogenous variables through exogeneity and Granger causality analyses. We study the contribution of changes in each variable in the system of equations to the variance in each variable through innovation accounting, and 54



The Role of Country of Origin and Chinese OFDI

55

we investigate the dynamic impact of the changes in one variable on the other system variables through impulse response functions (IRFs) analysis. The chapter begins with a literature review and presents the conceptual basis for selecting the variables included in the estimated VAR model. We introduce the empirical model, describe the data, and present the results of the integration tests on the variables. The exogeneity and dynamic analysis follow and we conclude by reflecting on the contribution of the research and its implications.

1. Literature review Over the last 15 years or so, scholars have explored the emergence and growth of Chinese MNCs, including their defining characteristics, motivations, and future prospects (see, for example, Young, Huang, & McDermott, 1996; Cai, 1999; Wu & Yeo, 2002; Deng, 2004; Fung, Liu, & Kao, 2007). Among case studies on Chinese MNCs (Liu & Li, 2002; Warner, Ng, & Xu, 2004), limited academic literature exists on the determinants of Chinese MNCs and home country, host country, and firm factors (Cai, 1999; Hong & Sun, 2006; Rugman & Li, 2007; Boateng, Qian, & Tianle, 2008; Morck, Yeung, & Zhoa, 2008). Some studies either reformulate existing conventional theories or advance emerging perspectives to explain either Chinese MNCs (Low & Hongbin, 2006; Li, 2007; Rui & Yip, 2008) or Chinese OFDI (Liu, Buck, & Chang, 2005; Yang, 2005; Buckley, Clegg, Cross, Xin, Voss, & Ping, 2007). The review of the determinants of Chinese MNCs and Chinese OFDI focuses attention again on the debate over how much country and industry factors in the ‘location-bound’ approach predominate over firm-specific factors in the ‘universalist’ approach in elucidating the nature of MNCs from developing economies (see Tolentino, 2006, 2008). The first of these emphasizes the interaction between the emergence and evolution of the Chinese MNC and the environment or location-specific (national) context (the location-bound approach). The second strand reflects the intellectual endeavors in search of universal aspects of the determinants of Chinese MNCs that apply equally across different national contexts (the universalist approach). The location-bound approach clearly predominates over the universalist approach in the current academic literature on the determinants of Chinese MNCs. This is not surprising, given their recent emergence, early stage of development, and wide scope for further growth. Studies that emphasize the role of home country-specific factors include the rapid pace of China’s economic growth, industrial restructuring, savings rates, and corporate ownership structures and capital allocation, along with other institutional factors in explaining the distinctive features of Chinese MNCs as well as the rapid growth of Chinese OFDI. The current study aims to expand the boundaries of empirical research in analyzing



Paz Estrella Tolentino


the relationship between a range of previously unexplored home countryspecific macroeconomic factors and the level of China’s OFDI flows. The use of VAR modeling helps to enhance the current study’s novel contribution from an empirical perspective, since it is rarely used as a methodological and analytical tool in previous studies on the determinants of FDI. The current research examines the relationships between a range of macroeconomic factors specific to China, including openness of the economy to international trade, national technological capability, domestic interest and exchange rates, and the level of China’s OFDI flows using multiple time-series data from 1982 to 2008. The length of the available time series restricted the number of variables we could select for analysis. The academic literature, which identifies the selected factors as some of the key macroeconomic determinants of FDI, provides the theoretical justification for the specific variable selection in the estimated VAR model. Tables 3.1 and 3.2 summarize the results of some of the empirical studies on the macroeconomic determinants of inward and outward FDI. In analyzing the

Table 3.1 Some empirical evidence on the macroeconomic determinants of inward FDI Potential macroeconomic determinants of inward FDI

Observed effect on inward FDI in different studies Positive

Negative

Insignificant

Schmitz and Bieri (1972) Wheeler and Mody (1992)

Openness of the economy to international trade

Kravis and Lipsey (1982) Culem (1988) Edwards (1990) Pistoresi (2000)

Interest rate

Billington (1999) Yang, Groenewold, and Tcha (2000) Jeon and Rhee (2008)

Hong and Kim (2003)

Exchange rate

Edwards (1990) Blonigen (1997) Georgopoulos (2008)

Caves (1988) Froot and Stein (1991) Klein and Rosengren (1994) Blonigen (1995) Guo and Trivedi (2002) Jeon and Rhee (2008)

Calderon-Rossell (1985) Sader (1993) Tuman and Emmert (1999) Yang, Groenewold, and Tcha (2000) Chowdhury and Wheeler (2008)



56

Paz Estrella Tolentino Some empirical evidence on the macroeconomic determinants of OFDI

Potential macroeconomic determinants of OFDI

Observed effect on OFDI in different studies Positive

Openness of the economy to international trade

Pantelidis and Kyrkilis (2005)

Technological capability

Dunning and Buckley (1977) Wolf (1977) Pugel (1978, 1981) Bergsten, Horst, and Moran (1978) Swedenborg (1979) Lall (1980) Cantwell (1987) Clegg (1987) Grubaugh (1987) Pearce (1989) Kogut and Chang (1991) Kyrkilis and Pantelidis (2003) Pantelidis and Kyrkilis (2005)

Interest rate

Barrell and Pain (1996)

Exchange rate

Barrell and Pain (1996) Gopinath, Pick, and Vasavada (1998) Kyrkilis and Pantelidis (2003) Pantelidis and Kyrkilis (2005) Bolling, Shane, and Roe (2007) Choi and Jeon (2007) Georgopoulos (2008)

Negative

Insignificant

Chiou Wei and Zhu (2007)

Clegg (1987)

Clegg (1987) Pearce (1989)

controversial studies on the macroeconomic determinants of inward FDI, Chakrabarti (2001) notes: The lack of a consensus over the conclusions reached by the wide range of empirical studies as to the relative importance and the direction of impact of the potential determinants of FDI can be explained, to some extent, in terms of the wide differences in perspectives, methodologies, sample-selection and analytical tools. (pp. 89–90)



Table 3.2

57


To these may be added differences in the size of investing firms, the time periods, proxies and indicators, and the level of analysis, among others. In contrast, the results of empirical studies on the macroeconomic determinants of OFDI are more consistent, as indicated in Table 3.2. The majority of studies show a positive effect on OFDI of the selected home countryspecific macroeconomic factors. But other studies focus on the reverse causality. For example, some examine the impact of OFDI on trade creation (see Barrell & Pain, 1999; Blonigen, 2001; Pantulu & Poon, 2003; Farrell, Gaston, & Sturm, 2004). Accordingly, recent studies analyze the relative importance of the direction of causality in evaluating FDI determinants (Aizenman & Noy, 2006; Ghosh, 2007). It would be necessary to consider this in the specification of the empirical model.

2. The empirical model specification and data description A multiple time series for China from 1982 to 2008 forms the basis of the current study, with the period determined by the availability of data to construct consistent measures of the selected variables over time. The data come from a number of international sources. The use of relevant price indices enabled the conversion of all nominal data series to real data series. The Data Appendix provides detailed descriptions of the variables and information on data sources. Given the presence of multiple variables, either the simultaneous or structural equation (SEQ) model or the VAR model is appropriate. Three main criticisms of SEQ modeling led Sims (1980) to pioneer the VAR methodology: the zero-order identification restrictions on SEQ parameters; the tenuous assumptions concerning the exogeneity and endogeneity of the variables; and additional identification problems arising from temporal restrictions when variables are themselves policy projections. ‘The main difference in the VAR approach is that it is built on creating a complete dynamic specification of the series in a system of equations’ (Brandt & Williams, 2007, pp. 9–10). A VAR model is an extension of an autoregressive model when there is more than one variable. Such models have more than one dependent variable and thus have more than one equation. Each equation in the multiple equation model uses as its explanatory variables lags of all the variables under study (and possibly a deterministic trend). The term autoregressive refers to the inclusion of the lagged value of the dependent variable on the right-hand side of the equation, and the term vector refers to the existence of a vector of two (or more) variables. The current study adopts a VAR model because it provides a robust methodological tool for assessing the causal relationships of the endogenous variables through exogeneity and Granger causality analyses. It allows us to study the contribution of changes in each variable in the system of equations



58

59

to the variance in each variable through innovation accounting. Further, we can investigate the dynamic impact of the changes in one variable to the other system variables through IRFs analysis. The strength of the VAR modeling is particularly useful where common sense, theory, or empirical evidence do not provide clarity on the exact direction of causality. The VAR model simply assumes that the current value of a dependent variable in a VAR can be explained by past values of a range of variables. It therefore considers that the past might influence the present, but not vice versa. There are other advantages in VAR modeling. It does not draw heavily on existing conceptual models or theories, but the results can have implications for models or theories. The results may contribute to advancing empirical debates about multiple time-series data. Regarded as ‘atheoretical’ (Koop, 2000), the use of theory in VAR modeling is limited to the selection of the variables. In the current research, the simply stated VAR model is as follows: the OFDI flows of China and a range of factors specific to China as a home country are related. The study models the relationship as implying only that each variable depends on lags of itself and all other variables. The aim is to focus on the underlying correlation and dynamic structure of the multiple time series. The test statistics of the parameters of the VAR model parameters will have a non-standard distribution in the presence of a unit root in one of more of the variables (Sims, Stock, & Watson, 1990), which will seriously compromise the assessment of Granger causality. Accordingly, Table 3.3 presents the autocorrelation coefficients on all the variables as follows: • LFDI = Natural logarithm of real FDI outflows from China, US$ million (2005 = 100), 1982–2008. • LO = Openness of the Chinese economy to international trade variable as measured by the natural logarithm of the annual sum of real exports and imports of China, US$ million (2005 = 100), 1982–2008. • LTE = Technology innovation variable as measured by the natural logarithm of the annual number of patent applications by China to the United States Patent Office, 1982–2008. • LI = Home country interest rate variable as measured by the natural logarithm of the annual real lending rate of China (2005 = 100), percent per annum, 1982–2008. • LER = Home country exchange rate variable as measured by the natural logarithm of the annual real effective exchange rate index of China based on relative consumer prices (2005 = 100), 1982–2008. There seems to be short-term correlation in the LO, LTE, and LI series, while LFDI and LER are random series. Table 3.4 shows the results of




60 Table 3.3 to 2008)

Autocorrelation coefficients of the variables (sample period from 1982

Order Autocorrelation Standard error Box-Pierce statistic Ljung-Box statistic coefficient

1 2 3 4 5 6 7 8 9

0.27104 −0.070971 −0.048542 −0.10365 −0.23698 −0.0010109 0.024766 −0.031767 −0.022462

0.19245 0.20610 0.20701 0.20743 0.20934 0.21905 0.21905 0.21915 0.21932

1.9835 [0.159] 2.1195 [0.347] 2.1831 [0.535] 2.4732 [0.649] 3.9895 [0.551] 3.9896 [0.678] 4.0061 [0.779] 4.0334 [0.854] 4.0470 [0.908]

2.2124 [0.137] 2.3701 [0.306] 2.4470 [0.485] 2.8128 [0.590] 4.8116 [0.439] 4.8116 [0.568] 4.8356 [0.680] 4.8772 [0.771] 4.8992 [0.843]

0.87491 0.74371 0.62080 0.50993 0.39937 0.30063 0.22227 0.14832 0.066506

0.19245 0.30617 0.36703 0.40405 0.42722 0.44083 0.44836 0.45242 0.45422

20.6677 [0.000] 35.6013 [0.000] 46.0069 [0.000] 53.0278 [0.000] 57.3342 [0.000] 59.7744 [0.000] 61.1083 [0.000] 61.7023 [0.000] 61.8217 [0.000]

23.0524 [0.000] 40.3754 [0.000] 52.9489 [0.000] 61.8012 [0.000] 67.4779 [0.000] 70.8477 [0.000] 72.7818 [0.000] 73.6884 [0.000] 73.8808 [0.000]

0.82164 0.67157 0.51176 0.36169 0.28668 0.20054 0.13347 0.066152 0.011521

0.19245 0.29503 0.34706 0.37397 0.38671 0.39450 0.39826 0.39991 0.40032

18.2275 [0.000] 30.4046 [0.000] 37.4758 [0.000] 41.0080 [0.000] 43.2270 [0.000] 44.3129 [0.000] 44.7939 [0.000] 44.9121 [0.000] 44.9156 [0.000]

20.3307 [0.000] 34.4562 [0.000] 43.0004 [0.000] 47.4541 [0.000] 50.3792 [0.000] 51.8788 [0.000] 52.5762 [0.000] 52.7565 [0.000] 52.7623 [0.000]

0.89694 0.82771 0.73865 0.63727 0.52620 0.41550 0.28917

0.19245 0.31085 0.38390 0.43335 0.46677 0.48825 0.50117

21.7216 [0.000] 40.2193 [0.000] 54.9505 [0.000] 65.9155 [0.000] 73.3915 [0.000] 78.0529 [0.000] 80.3106 [0.000]

24.2279 [0.000] 45.6853 [0.000] 63.4854 [0.000] 77.3109 [0.000] 87.1657 [0.000] 93.6029 [0.000] 96.8765 [0.000]

2. LO 1 2 3 4 5 6 7 8 9 3. LTE 1 2 3 4 5 6 7 8 9 4. LI 1 2 3 4 5 6 7



1. LFDI

Paz Estrella Tolentino 8 9

61

0.15334 0.030755

0.50731 0.50903

80.9455 [0.000] 80.9711 [0.000]

97.8455 [0.000] 97.8867 [0.000]

0.80021 0.56556 0.37430 0.24038 0.15137 0.10324 0.028689 −0.097140 −0.15621

0.19245 0.29064 0.32888 0.34430 0.35046 0.35287 0.35399 0.35407 0.35506

17.2892 [0.000] 25.9253 [0.000] 29.7081 [0.000] 31.2682 [0.000] 31.8868 [0.000] 32.1746 [0.000] 32.1968 [0.000] 32.4516 [0.000] 33.1104 [0.000]

19.2841 [0.000] 29.3019 [0.000] 33.8728 [0.000] 35.8400 [0.000] 36.6554 [0.000] 37.0528 [0.000] 37.0851 [0.000] 37.4739 [0.000] 38.5354 [0.000]

1 2 3 4 5 6 7 8 9

testing for stationarity and integration order using the Kwiatkowski– Phillips–Schmidt–Shin (KPSS) test. Tables 3.4a and 3.4b report the KPSS test results for stationarity around a level and stationarity around a trend, respectively. It is evident that the integration order of the variables is sensitive to the deterministic trend. When analyzing the residuals of alternative empirical models that include or exclude a deterministic trend, the results favor the empirical model that includes a deterministic trend at the margin. The results of the testing for stationarity and integration order imply the need to be conservative in interpreting the VAR test statistics and in considering a co-integrating relationship in the data. Table 3.4a

Tests for stationarity around a level using the KPSS testa

Truncation lags

0

1

2

3

4

0.0000 0.0000 0.0000 0.0000 0.0000

1.3944 0.8167 1.3911 1.2754 0.2618

0.9627 0.6016 0.9797 0.9135 0.2532

0.7467 0.4979 0.7748 0.7352 0.2538

0.6189 0.4383 0.6532 0.6323 0.2624

0.0000 0.0000 0.0000 0.0000

0.1705 0.3833 0.1534 0.4460

0.1869 0.4005 0.1733 0.3830

0.2051 0.4310 0.1636 0.3162

0.2090 0.4016 0.1601 0.2961

Ho: I(0), H(1): I(d) LI LER LO LTE LFDIb Ho: I(1), H(1): I(d) LIb LERb LOb LTEb

a The critical values are 0.347, 0.463, and 0.739 at the 10 percent, 5 percent, and 1 percent significance levels, respectively. b The variable is therefore I(0), and testing for higher integration is unnecessary.



5. LER

62


Table 3.4b

Tests for stationarity around a trend using the KPSS testa

Truncation lags

0

1

2

3

4

0.0000 0.0000 0.0000 0.0000 0.0000

0.1460 0.2648 0.2457 0.1986 0.0823

0.1135 0.2068 0.1824 0.1467 0.0834

0.0990 0.1798 0.1530 0.1242 0.0851

0.0917 0.1628 0.1390 0.1125 0.0887

0.0000 0.0000

0.0483 0.0719

0.0617 0.0845

0.0877 0.0832

0.0908 0.0850

LIb LER LO LTEb LFDIb Ho: I(1), H(1): I(d) LER LO

a The critical values are 0.119, 0.146, and 0.216 at the 10 percent, 5 percent, and 1 percent significance levels, respectively. b The variable is therefore I(0), and testing for higher integration is unnecessary.

The study does not use the vector error correction model for two reasons. First, the co-integration relationship is not the central focus of the current research but the analyses of exogeneity and short-term dynamics, of which inferences will be robust. Second, the resulting VAR system will be stationary and any test statistics asymptotically valid if there is co-integration among the variables containing a unit root. A combination of fit statistics and formal statistics for lag length usually determines the appropriate VAR order. The Akaike Information Criterion, Hannan-Quinn Criterion, and Scharwz Criterion unanimously select the order 3. In light of these, the VAR (3) model is chosen for estimation in the current study.1 Moreover, since the current research involves five variables, the unrestricted VAR will estimate five equations which depend on p = 3 lag of the dependent variable and q = 3 lag of each of the four other variables. Therefore the lag length is set such that p = q. The estimated VAR (3) model is as follows: LIt = α1 + δ1 t + φ11 LIt−1 + φ12 LIt−2 + φ13 LIt−3 + β11 LERt−1 + β12 LERt−2 + β13 LERt−3 + β14 LOt−1 + β15 LOt−2 + β16 LOt−3 + β17 LTEt−1 + β18 LTEt−2 + β19 LTEt−3 + β20 LFDIt−1 + β21 LFDIt−2 + β22 LFDIt−3 + e1t LERt = α2 + δ2 t + φ21 LI t−1 + φ22 LI t−2 + φ23 LI t−3 + β21 LERt−1 + β22 LERt−2 + β23 LERt−3 + β24 LOt−1 + β25 LOt−2 +β26 LOt−3 + β27 LTEt−1 + β28 LTEt−2 + β29 LTEt−3 + β30 LFDI t−1 + β31 LFDI t−2 + β32 LFDI t−3 + e2t



Ho: I(0), H(1): I(d)


63

LOt = α3 + δ3 t + φ31 LI t−1 + φ32 LI t−2 + φ33 LI t−3 + β31 LERt−1 + β32 LERt−2 + β33 LERt−3 + β34 LOt−1 + β35 LOt−2 + β36 LOt−3 + β37 LTEt−1 + β38 LTEt−2 + β39 LTEt−3 + β40 LFDI t−1 + β41 LFDI t−2 + β42 LFDI t−3 + e3t LTEt = α4 + δ4 t + φ41 LI t−1 + φ42 LI t−2 + φ43 LI t−3 + β41 LERt−1 + β42 LERt−2 + β49 LTEt−3 + β50 LFDI t−1 + β51 LFDI t−2 + β52 LFDI t−3 + e4t LFDI t = α5 + δ5 t + φ51 LI t−1 + φ52 LI t−2 + φ53 LI t−3 + β51 LERt−1 + β52 LERt−2 + β53 LERt−3 + β54 LOt−1 + β55 LOt−2 + β56 LOt−3 + β57 LTEt−1 + β58 LTEt−2 + β59 LTEt−3 + β60 LFDI t−1 +β61 LFDI t−2 +β62 LFDI t−3 + e5t where: α = constant or intercept; t = deterministic trend; e = the stochastic error term, or innovation or shock in the VAR.

3. Tests for exogeneity Table 3.5 shows the OLS estimation of the unrestricted 5-equation VAR (3) model for China. A series of univariate and multivariate diagnostic tests of the residuals establish the robustness of the results. The absence of residual serial correlation confirms the correct lag specification of the VAR model. There is also evidence of normality in the multivariate distribution of the residuals in the model as a whole. However, there seems to be residual serial correlation in the LFDI equation. A close examination of the residuals suggests considerable volatility of China’s LFDI over the period of analysis. Therefore, it is likely that the remaining serial correlation in the residuals of the LFDI equation may be due to a confluence of factors affecting China’s OFDI flows. A test of block Granger causality in the VAR results in the acceptance of the null hypothesis that the coefficients of the lagged values of LI, LER, LO, and LTE are zero in the equation explaining the variable LFDI at the 5 percent significance level. A further test shows no instantaneous causality between LI, LER, LO, LTE, and LFDI. To begin to assess the specific Granger causal relationships between the endogenous variables, we conduct exogeneity tests based on a series of bivariate VAR models between LFDI and LI, LER, LO, or LTE. Since there is a bias against the null hypothesis when there is a possible unit root (Hamilton, 1994), it would be necessary to use levels and differences and compare the test results at different lag lengths. The



+ β43 LERt−3 + β44 LOt−1 + β45 LOt−2 + β46 LOt−3 + β47 LTEt−1 + β48 LTEt−2

Dependent variable LI

LI (–1) LI (–2) LI (–3) LER (–1) LER (–2) LER (–3) LO (–1) LO (–2) LO (–3) LTE (–1) LTE (–2) LTE (–3) LFDI (–1) LFDI (–2) LFDI (–3)

Dependent variable LER

Dependent variable LO

Dependent variable LTE

Dependent variable LFDI

Coefficient

p-Value

Coefficient

p-Value

Coefficient

p-Value

Coefficient

p-Value

Coefficient

p-Value

−0.149 −0.017 0.034 −0.259 0.214 −0.470 1.084 −0.818 0.038 0.159 0.055 0.015 0.017 0.012 −0.011

0.805 0.979 0.951 0.534 0.664 0.310 0.071 0.251 0.946 0.339 0.648 0.920 0.454 0.602 0.637

−0.615 0.350 −0.504 0.749 −0.569 0.062 0.461 −0.504 0.842 0.025 0.000 −0.020 0.001 −0.004 0.014

0.248 0.540 0.304 0.042 0.192 0.879 0.386 0.425 0.092 0.864 0.998 0.881 0.975 0.850 0.503

0.018 0.158 0.114 −0.170 0.301 −0.050 1.164 −0.692 0.174 0.068 0.097 −0.126 −0.004 −0.001 −0.012

0.974 0.790 0.823 0.655 0.506 0.906 0.035 0.291 0.736 0.654 0.378 0.358 0.849 0.970 0.584

−0.772 −2.407 0.087 −1.065 0.979 1.227 −0.205 2.742 −1.359 −0.407 0.529 0.675 0.031 0.036 0.003

0.570 0.099 0.945 0.257 0.379 0.241 0.879 0.088 0.286 0.276 0.050 0.045 0.554 0.474 0.953

3.856 −5.563 4.770 −2.636 1.594 0.067 0.989 5.299 −0.890 −0.434 0.229 −0.409 0.042 −0.288 −0.010

0.730 0.643 0.643 0.738 0.862 0.994 0.929 0.690 0.932 0.888 0.918 0.883 0.922 0.486 0.982



64

Table 3.5 The vector autoregressive model of China

2.913 −0.197

0.273 0.047

−1.775 −0.178

0.451 0.042

2.206 0.071

0.366 0.431

−6.219 −0.334

0.300 0.134

−53.089 −0.317

0.283 0.863

Residual analysis Portmanteau test of residual serial correlation

Test statistic: 302.8307 (p-value: 0.8062) Adjusted test statistic: 464.5378 (p-value: 0.0000)

Tests for non-normality

Doornik and Hansen Joint test statistic: 47.8133 (p-value: 0.0000) Degrees of freedom: 10.0000 Skewness only: 15.6429 (p-value: 0.0079) Kurtosis only: 32.1704 (p-value: 0.0000) Lütkepohl Joint test statistic: 8.1305 (p-value: 0.6161) Degrees of freedom: 10.0000 Skewness only: 5.7923 (p-value: 0.3270) Kurtosis only: 2.3382 (p-value: 0.8006)

Jarque-Bera test of normality

Chi2 = 0. 8284 (p-value: 0.6609)

Chi2 = 0. 1840 (p-value: 0.9121)

Chi2 = 5. 3760 (p-value: 0.0680)

Chi2 = 0. 0129 (p-value: 0.9936)

Chi2 = 34. 7777 (p-value: 0.0000)

65



Constant Trend


Table 3.6

Exogeneity tests for FDI and other system variables

Hypothesized Block of coefficients exogenous restricted variable

LFDI LFDI LFDI LFDI LO LTE LI LER DLFDI DLFDI DLFDI DLFDI DLO DLTE DLI DLER

LO LTE LI LER LFDI LFDI LFDI LFDI DLO DLTE DLI DLER DLFDI DLFDI DLFDI DLFDI

Three lags Test statistic 1.5633 0.2861 1.4183 0.2505 0.6726 1.0970 0.5368 0.0514 0.9394 0.0387 0.4224 0.3251 0.3900 0.0975 0.4766 0.0592

Two lags

One lag

p-Value Test statistic

p-Value Test statistic

0.2174 0.8351 0.2555 0.8603 0.5752 0.3646 0.6604 0.9843 0.4339 0.9896 0.7383 0.8072 0.7610 0.9608 0.7009 0.9807

0.1105 0.5317 0.1382 0.8387 0.6380 0.4292 0.9193 0.9719 0.2709 0.8734 0.6652 0.6851 0.9254 0.9837 0.6990 0.9833

2.3352 0.6423 2.0858 0.1767 0.4548 0.8648 0.0843 0.0286 1.3546 0.1359 0.4123 0.3822 0.0777 0.0164 0.3616 0.0169

p-Value

4.7694 0.9305 3.1810 0.2589 1.3673 0.5101 0.1330 0.0223 1.1647 0.0231 0.6703 0.0934 0.4574 0.0188 0.0138 0.0020

0.0343 0.3400 0.0814 0.6134 0.2486 0.4789 0.7170 0.8819 0.2867 0.8799 0.4176 0.7614 0.5025 0.8915 0.9071 0.9645

Note: Results based on bivariate VAR models.

exogeneity tests’ results indicate that LO or LI plays a role in the endogenous determination of LFDI, but not LTE or LER. In turn, LFDI or DLFDI does not endogenously determine the other system variables (Table 3.6).

4. Dynamic analysis: Forecast error variance decomposition and impulse response analysis To examine the impact on system variables of typical shocks, the study considers forecast error variance decomposition and IRFs. Decomposition analysis estimates the percentage of the error variance in forecasting each variable in the system of equations at a given horizon due to an unexpected or unpredictable change in one of the VAR equations. More technically, the variance decomposition of the k-step-ahead forecast is the proportion of the total forecast variance of one variable caused by a shock to the moving average representation of another variable. The analysis of IRFs complements decomposition analysis by determining, over a forecast horizon, the direction of the expected responses of current and future values of each system variable to a specific innovation shock in a system equation. We focus the investigation on the path taken by OFDI flows in responding to a shock to



66


LI LER LO LTE LFDI

Estimated system covariance matrix of errors LI

LER

LO

LTE

LFDI

1.3817 e–02 1.4187 e–03 7.4330 e–03 –4.4532 e–03 4.7911 e–02

1.4187 e–03 1.0853 e–02 –5.1730 e–05 –3.5143 e–03 8.0913 e–02

7.4330 e–03 –5.1730 e–05 1.1647 e–02 –1.7789 e–02 –5.9085 e–02

–4.4532 e–03 –3.5143 e–03 –1.7789 e–02 7.0463 e–02 –2.1214 e–02

4.7911 e–02 8.0913 e–02 –5.9085 e–02 –2.1214 e–02 4.7855

each system equation, as well as the path taken by each system equation in responding to an OFDI equation shock. The estimated system covariance matrix of the errors reveals a diagonal matrix, which implies the absence of contemporaneous correlation of the stochastic error terms (e1t, e2t, e3t, e4t, e5t ) or innovations in the VAR (Table 3.7). It would therefore be possible to consider the effect of a shock to one system equation in isolation of other system equations. The orthogonalized and generalized impulse responses (and the associated forecast error variance decomposition) would not be very different. Accordingly, the current study chooses to impose a standard VAR model with a recursive unidirectional causal structure from the higher order variables to the lower order variables: LI, LER, LO, LTE, LFDI. Consistent with the primary focus of the current study, LFDI is last on the ordering to allow shocks to all system variables to have a contemporaneous impact on LFDI, but not vice versa. The financial variables LER and LI occupy higher orders in relation to the real variables LO and LTE to allow the real variables to respond contemporaneously to changes in the financial variables. LI occupies a higher order relative to LER, which allows LER to respond contemporaneously to changes in LI. LO occupies a higher order relative to LTE, which allows LTE to respond contemporaneously to changes in LO. Table 3.8 presents the orthogonalized forecast error variance decomposition for the standard VAR (3) model over a four-year forecast horizon.2 We can draw two main conclusions from the decomposition analysis with respect to the role of home country macroeconomic factors as a cause and effect of China’s OFDI flows. First, shocks to LFDI itself account for at least 40 percent of the forecast error variation in LFDI after four years, while shocks to the other system variables collectively explain at most 60 percent of the forecast error variance of the LFDI sequence. At the four-year horizon, the most important home country-specific determinants of Chinese FDI other than LFDI are in declining order: LO (24%), LTE (13%), LI (13%), and LER (11%). Clearly, a shock to each of the real and financial variables considered in this study leads to a change in the level of China’s outward FDI flows. Secondly, unexpected changes in LFDI affect LFDI the most, of all the system



Table 3.7

67


Table 3.8

Decomposition of the orthogonalized forecast error variance

Forecast error variation in

LI

LER

LO

LTE

LFDI

Horizon

0 1 2 3 4 0 1 2 3 4 0 1 2 3 4 0 1 2 3 4 0 1 2 3 4

Explained by innovations in LI

LER

LO

LTE

LFDI

1.00 0.79 0.75 0.65 0.63 0.01 0.07 0.10 0.10 0.15 0.34 0.33 0.37 0.37 0.35 0.02 0.10 0.12 0.12 0.17 0.03 0.08 0.07 0.12 0.13

0.00 0.04 0.07 0.11 0.12 0.99 0.86 0.81 0.78 0.52 0.01 0.04 0.05 0.05 0.06 0.01 0.07 0.09 0.17 0.22 0.11 0.12 0.12 0.11 0.11

0.00 0.12 0.11 0.10 0.10 0.00 0.07 0.06 0.09 0.27 0.65 0.61 0.54 0.54 0.53 0.46 0.34 0.29 0.25 0.23 0.17 0.16 0.25 0.25 0.24

0.00 0.01 0.01 0.09 0.09 0.00 0.00 0.00 0.00 0.04 0.00 0.01 0.04 0.04 0.05 0.51 0.47 0.48 0.41 0.35 0.13 0.12 0.12 0.11 0.13

0.00 0.04 0.05 0.05 0.06 0.00 0.00 0.03 0.03 0.03 0.00 0.00 0.00 0.00 0.01 0.00 0.03 0.03 0.04 0.04 0.55 0.52 0.44 0.41 0.40

variables. In all other system variables, unexpected changes in LFDI have a small effect, accounting for no more than 6 percent of their variance at the four-year forecast horizon. Thus, LFDI is essentially an exogenous variable in explaining all system variables other than itself. These findings based on Granger causal analysis (which depend on the dynamics of the system variables in a multivariate VAR) complement the exogeneity analysis (which depend on a series of bivariate VAR models) in assessing the role of these macroeconomic factors as determinants and effects of China’s OFDI flows.3 On the one hand, although China’s OFDI is exogenous to all system variables other than LO or LI, Granger causal analysis deduced from the innovation accounting tests indicates that a shock to LO, LTE, LER, and LI explains a considerable proportion of the variance in LFDI. On the other hand, Granger causal analysis confirms the exogeneity analysis that all system variables are exogenous to LFDI other than LFDI itself.



68

69

The orthogonalized IRFs in Figure 3.1 establish the direction of the current and future impact on China’s LFDI of one standard error (SE) shock to each system variable’s equation. The figure presents the IRFs alongside their 95 percent Hall confidence intervals derived with the use of 2000 bootstrapping replications. The ordering of the variables follows that in forecast error decomposition. An LER shock leads to a one-off statistically significant contemporaneous increase in LFDI of around 0.7 percent. A shock to LI will also lead to a statistically significant increase in LFDI of around 0.5 percent in the first and third years, and so will an unexpected change in LO which causes a statistically significant increase in LFDI of about 0.9 percent around the second year of the forecast horizon.

1.8

l_log –> TFDI_log

1.4 1.0 0.6 0.2 –0.2 –0.6 –1.0 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 2.0

ER_log –> TFDI_log

1.6 1.2 0.8 0.4 –0.0 –0.4 –0.8 –1.2 –1.6 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 Figure 3.1 Orthogonalized impulse responses of FDI to one standard error shock in each system variable equation Note: The dashed lines show 95 percent Hall percentile confidence intervals derived by bootstrapping with 2000 replications.




70

0_log –> TFDI_log 2.0 1.5 1.0 0.5

–1.0 –1.5 –2.0 –2.5 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 1.2

TE_log –> TFDI_log

0.8 0.4 –0.0 –0.4 –0.8 –1.2 –1.6 –2.0 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 3.5

TFDI_log –> TFDI_log

3.0 2.5 2.0 1.5 1.0 0.5 0.0 –0.5 –1.0 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 Figure 3.1

(Continued)



0.0 –0.5

71

By comparison, an unexpected change in LFDI results in about a 0.4 percent decline in LFDI around the second year of the forecast horizon. Finally, a shock to LTE elicits a shifting LFDI response from a negative one in the first 10 months in the region of 0.8 percent at most, to a statistically significant positive one in the second and fourth years of 0.4 percent.4 The orthogonalized IRFs in Figure 3.2 ascertain the reverse effect: the direction of the current and future impact on each system variable of one SE shock in the LFDI equation. There is no contemporaneous response in any of the other system variables following an LFDI shock. In fact, LO does not have a statistically significant response to an LFDI shock, given that its 95 percent confidence interval includes zero throughout the forecast horizon. However, LI will eventually increase by around 0.02 percent in the first two years of the forecast horizon, and so will LTE of around

0.08

TFDI_log –> I_log

0.06 0.04 0.02 0.00 –0.02 –0.04 –0.06 –0.08 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 TFDI_log –> ER_log 0.06 0.04 0.02 0.00 –0.02 –0.04 –0.06 –0.08 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0

Figure 3.2 Orthogonalized impulse responses of each system variable to one standard error shock in the FDI equation Note: The dashed lines show 95 percent Hall percentile confidence intervals derived by bootstrapping with 2000 replications.




72

Macro-Environmental Determinants of Chinese FDI TFDI_log –> 0_log 0.02 0.01 0.00

–0.02 –0.03 –0.04 –0.05 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 TFDI_log –> TE_log 0.16 0.12 0.08 0.04 0.00 –0.04 –0.08 –0.12 –0.16 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0

Figure 3.2

(Continued)

0.04 percent in the first 1.4 years of the forecast horizon, but this reverses rapidly in both cases. LI and LTE eventually decline after three years, and between 2.8 and 3.4 years in the forecast horizon, respectively. By contrast, there will be a statistically significant decrease of about 0.02 percent in LER around two years in the forecast horizon, given an LFDI shock. Thus, although all system variables are largely exogenous to LFDI other than LFDI itself based on innovation accounting, a shock to LFDI elicits a statistically significant response in all the system variables other than LO, however small.

5. Conclusions and implications Given the rapid growth of Chinese MNCs, conventional wisdom assumes the causal relationships between the level of OFDI flows and a range of



–0.01

73

macroeconomic factors specific to China as a home country such as the openness of the Chinese economy to international trade, domestic technological innovation, and domestic interest rates and exchange rates. However, the short history of these MNCs does not allow us to confirm or deny these causal relationships based on empirical research. In the current study, a recursive causal VAR (3) model provides the framework for testing the relationships among the endogenous variables over a 27-year period between 1982 and 2008. The VAR modeling enables the inference of Granger causal relationships among the system variables, and the determination of the endogenous structure and dynamics of the multiple time series. The examination reveals that the most important home country determinants of the level of Chinese OFDI flows consist of real variables (openness of the national economy to international trade and national technological capability) and financial variables (domestic interest rates and exchange rates). These account collectively for at least 45 percent of the forecast error variance of China’s OFDI flows sequence over a four-year horizon. Chinese OFDI flows increase contemporaneously following a national exchange rate shock, and they also increase given a shock to either domestic interest rates or the openness of the national economy to international trade anywhere within the first three years of the forecast horizon. On the other hand, China’s OFDI flows decline in the first 10 months, and then increase after a delay of two and four years, given a national technological capability shock. Since the shock happens before the OFDI response, the shock to each of these variables is Granger causing the OFDI response. Alternatively, these variables have ‘predictive causality’ (Diebold, 2007) which contains useful information for predicting OFDI (in the linear least squares sense) over and above the history of OFDI itself. In turn, unexpected changes in OFDI flows affect it the most, of all the system variables. In all other system variables, unexpected changes in outward FDI flows have a small effect, accounting for no more than 6 percent of their variance at the four-year forecast horizon. However, although all system variables are essentially exogenous to OFDI flows other than OFDI flows itself, an OFDI flows shock causes a small statistically significant response over the forecast horizon in all system variables other than the openness of the national economy to international trade. There is therefore evidence of dual causality between national technological capability, domestic interest or exchange rates, and China’s OFDI flows. A shock to OFDI flows will generate small increases in domestic interest rates and national technological capability within the first two years of the forecast horizon. However, this reverses rapidly to small declines in both variables within the second half of the forecast horizon. By comparison, there will be a small depreciation of the exchange rate around two years out in the forecast horizon following a shock to OFDI flows. These results are not surprising, considering the still relatively modest level of China’s OFDI.





The findings of the current research could change with a longer time series. This might allow the estimation of a revised VAR model to better explain the volatility in the OFDI sequence. A revised model might assess any structural change in the relationship between the variables or both. How these relationships will evolve with the further growth of Chinese MNCs would be a fascinating proposal for future research. We believe the results of the current research are valuable to international business scholars and practitioners as well as policymakers. There are at least four main implications of the research results. First, the determination of the endogenous structure and Granger causal relationships is particularly helpful in better understanding the relevance of a combination of home country-specific real and financial factors in explaining and predicting China’s OFDI flows. We can attribute the divergent results of the current research in relation to other empirical studies on MNCs based in other home countries employing the same methodology and analytical tool as well as similar periods (Tolentino, 2010a, 2010b) to sample selection. The current study modifies Franko’s idea (1976) by suggesting that the uniqueness of MNCs arises partly from the influence of specific macroeconomic factors of their country of origin in determining the level of their OFDI flows. Equally, the uniqueness of MNCs arises partly from the influence of their international expansion, including the level of their OFDI flows, in determining specific macroeconomic factors of their country of origin. This will become more important over time. The results support those of other studies that acknowledge the role of contingent factors which vary by home country in explaining the process of international expansion of MNCs, to include modes of market entry, investment patterns, and decision-making. Domestic firms and MNCs build on a platform of home country advantages (or disadvantages) broadly defined to generate enduring firm-specific advantages within and across a value chain. Collectively, these studies underscore the importance of recognizing context and examining firms and their development patterns in situ (Beamish, Hitt, Jackson, & Mathieu, 2005; Redding, 2005). Second, the national openness of the Chinese economy to international trade as the most important determinant of the level of China’s OFDI flows strengthens the claims of previous studies establishing an association between this factor and the growth and expansion of Chinese MNCs (Wu & Yeo, 2002; Hong & Sun, 2006). Third, the findings enable a re-evaluation of current views and perceptions on the role of advanced technological advantages in examining Chinese MNCs. The progression of technology creation of the Chinese economy in research and patenting activity increases the relevance of innovation in the growth and development of Chinese MNCs. This makes the theory of technological accumulation, extended by Cantwell and Tolentino (1990) to the analysis of third-world MNCs, highly relevant to the study of Chinese



74

75

MNCs. Chinese MNCs will increasingly develop the capacity to build on home country advantages in innovation to generate more firm-specific advantages in R&D. Fourth, macroeconomic policies which affect the openness of the Chinese economy, national technological capability, domestic interest, or exchange rates can influence the level of Chinese OFDI flows positively or negatively. These changes in the level of OFDI flows in turn can have domestic macroeconomic repercussions as Chinese MNCs grow in importance. Rising levels of OFDI flows neutralize any changes in the exchange rates, and lead to short-run increases in domestic interest rates and national technological capability, all of which deserve further attention from a policy standpoint. The VAR models estimated in the current study have far wider implications for the analysis of the relationships of macroeconomic variables and economic theory.

Appendix: Measurement and data sources

Variables

Measurement

Data sources

FDI

Real FDI outflows from China, US$ million (2005 = 100) Nominal FDI outflows from China

Calculated

Chinese GDP deflator (2005 = 100) O

Sum of real exports and imports of China, US$ million (2005 = 100) Nominal sum of exports and imports of China, US$ million USA GDP deflator (2005 = 100)

IMF, International Financial Statistics IMF, International Financial Statistics Calculated IMF, International Financial Statistics IMF, International Financial Statistics

TE

Number of patent applications to the United States Patent Office

OECD, Main Science and Technology Indicators

I

Real lending rate of China, 2005 = 100 (% per annum) Nominal lending rate of China

Calculated

Chinese GDP deflator (2005 = 100) ER

Real effective exchange rate index based on relative consumer prices (2005 = 100)

IMF, International Financial Statistics IMF, International Financial Statistics IMF, International Financial Statistics




76


1. To ensure the standard asymptotic distribution of the test statistics, the current study considered the procedure developed by Toda and Yamamoto (1995) which uses a modified Wald test when a VAR (k + dmax) is estimated (where k is the lag length and dmax is the maximal integration order suspected to occur in the system). Adopting this procedure would mean estimating a VAR (4), which on testing resulted in a large relative inefficiency given the small sample properties of the data. 2. VAR models at long horizons produce inconsistent impulse response functions and sub-optimal predictions in the presence of unit roots and co-integration. 3. In two-variable VARs, incorrect or spurious findings of causality are likely when testing causality versus exogeneity. 4. It may be necessary to adjust the bootstrap confidence intervals to prevent the computed bands from failing to include the estimated IRF.

References Aizenman, J. & Noy, I. 2006. FDI and trade – Two-way linkages? Quarterly Review of Economics and Finance, 46(3): 317–337. Barrell, R. & Pain, N. 1996. An econometric analysis of U.S. foreign direct investment. Review of Economics & Statistics, 78(2): 200–207. Barrell, R. & Pain, N. 1999. Trade restraints and Japanese direct investment flows. European Economic Review, 43(1): 29–45. Beamish, P., Hitt, M., Jackson, S. & Mathieu, J. 2005. Call for papers: Special research forum – Building bridges across levels. Academy of Management Journal, 48(2): 364–366. Bergsten, C., Horst, F., & Moran, T. 1978. American Multinationals and American Interests. Washington, DC: The Brookings Institution. Billington, N. 1999. The location of foreign direct investment: An empirical analysis. Applied Economics, 31(1): 65–76. Blonigen, B.A. 1995. Explaining Japanese Foreign Direct Investment in the United States. Unpublished PhD Dissertation, University of California, Davis, Davis, CA. Blonigen, B.A. 1997. Firm-specific assets and the link between exchange rates and foreign direct investment. American Economic Review, 87(3): 447–465. Blonigen, B.A. 2001. In search of substitution between foreign production and exports. Journal of International Economics, 53(1): 81–104. Boateng, A., Qian, W. & Tianle, Y. 2008. Cross-border M&As by Chinese firms: An analysis of strategic motives and performance. Thunderbird International Business Review, 50(4): 259–270. Bolling, C., Shane, M. & Roe, T. 2007. Exchange rates and U.S. foreign direct investment in the global processed food industry. Agricultural and Resource Economics Review, 36(2): 230–238. Brandt, P.T. & Williams, J.T. 2007. Multiple Time Series Models. Series on Quantitative Applications in the Social Sciences (number 07–148). Thousand Oaks, CA: Sage. Buckley, P.J., Clegg, L.J., Cross, A.R., Xin, L., Voss, H. & Ping, Z. 2007. The determinants of Chinese outward foreign direct investment. Journal of International Business Studies, 38(4): 499–518. Cai, K.G. 1999. Outward foreign direct investment: A novel dimension of China’s integration into the regional and global economy. China Quarterly, 160: 856–880.



Notes

77

Calderon-Rossell, J.R. 1985. Towards the theory of foreign direct investment. Oxford Economic Papers, 37(2): 282–291. Cantwell, J. 1987. The reorganization of European industries after integration: Selected evidence on the role of multinational enterprise activities. Journal of Common Market Studies, 26(2): 127–151. Cantwell, J. & Tolentino, P.E. 1990. Technological Accumulation and Third World Multinationals. University of Reading Discussion Paper in International Investment and Business Studies, No. 139. Reading, UK: University of Reading Department of Economics. Caves, R.E. 1988. Trade exposure and changing structures of U.S. manufacturing industries. In A.M. Spence & H.A. Hazard (eds), International Competitiveness. Cambridge, MA: Harper and Row, Ballinger, pp. 1–26. Chakrabarti, A. 2001. The determinants of foreign direct investment: Sensitivity analyses of cross-country regressions. Kyklos, 54(1): 89–114. Chiou Wei, S.Z. & Zhu, Z. 2007. A revisit to the outward FDI determinants: Further evidence from count panel data models with fixed effects. Applied Economics Letters, 14(1): 809–812. Choi, J.J. & Jeon, B.N. 2007. Financial factors in foreign direct investments: A dynamic analysis of international data. Research in International Business and Finance, 21(1): 1–18. Chowdhury, A.R. & Wheeler, M. 2008. Does real exchange rate volatility affect foreign direct investment? Evidence from four developed economies. International Trade Journal, 22(2): 218–245. Clegg, J. 1987. Multinational Enterprises and World Competition: A Comnewlineative Study of the USA, Japan, the UK, Sweden and West Germany. New York: St Martin’s Press. Culem, C.G. 1988. The locational determinants of direct investments among industrialized countries. European Economic Review, 32(4): 885–904. Deng, P. 2004. Outward investment by Chinese MNCs: Motivations and implications. Business Horizons, 47(3): 8–16. Diebold, F. 2007. Elements of Forecasting, 4th edition. Mason, OH: Thomson SouthWestern. Dunning, J.H. 1982. Explaining the international direct investment position of countries: Towards a dynamic or developmental approach. In J. Black & J.H. Dunning (eds), International Capital Movements. London: Palgrave Macmillan, pp. 84–121. Dunning, J.H. & Buckley, P.J. 1977. International production and alternative models of trade. Manchester School of Economic and Social Studies, 45(4): 392–403. Edwards, S. 1990. Capital flows, foreign direct investment, and debt-equity swaps in developing countries. National Bureau of Economic Research, Working Paper No. 3497. Cambridge, MA. Farrell, R., Gaston, N. & Sturm, J-E. 2004. Determinants of Japan’s foreign direct investment: An industry and country panel study, 1984–1998. Journal of the Japanese and International Economics, 18(2): 161–182. Franko, L.G. 1976. The European multinationals. A Renewed Challenge to American and British Big Business. London: Harper and Row. Froot, K.A. & Stein, J.C. 1991. Exchange rates and foreign direct investment: An imperfect capital markets approach. Quarterly Journal of Economics, 106(4): 1191–1217. Fung, H-G., Liu, Q.W. & Kao, E.H.C. 2007. China’s outward direct and portfolio investments. China and World Economy, 15(6): 53–68.





Georgopoulos, G.J. 2008. Cross-border mergers and acquisitions: Does the exchange rate matter? Some evidence for Canada. Canadian Journal of Economics, 41(2): 450–474. Ghosh, I. 2007. The relations between trade and FDI in developing countries – A panel data approach. Global Economy Journal, 7(3): 1–30. Gopinath, M., Pick, D. & Vasavada, U. 1998. Exchange rate effects on the relationship between FDI and trade in the U.S. food processing industry. American Journal of Agricultural Economics, 80(5): 1073–1079. Gray, H.P. 1982. Macroeconomic theories of foreign direct investment: An assessment. In A.M. Rugman (ed.), New Theories of the Multinational Enterprise. London: Croom Helm, pp. 172–195. Grubaugh, S.G. 1987. Determinants of direct foreign investment. Review of Economics & Statistics, 69(1): 149–152. Guo, J.Q. & Trivedi, P.K. 2002. Firm-specific assets and the link between exchange rates and Japanese foreign direct investment in the United States: A re-examination. Japanese Economic Review, 53(3): 337–349. Hamilton, J.D. 1994. Time Series Analysis. Princeton: Princeton University Press. Hawawini, G.V., Subramanian, V. & Verdin, P. 2004. The home country in the age of globalization: How much does it matter for firm performance? Journal of World Business, 39(2): 121–135. Hong, E. & Sun, L. 2006. Dynamics of internationalization and outward investment: Chinese corporations’ strategies. China Quarterly, 187: 610–634. Hong, S. & Kim, S. 2003. Locational determinants of Korean manufacturing investments in the European Union. Hitotsubashi Journal of Economics, 44(1): 91–103. Jeon, B.N. & Rhee, S.S. 2008. The determinants of Korea’s foreign direct investment from the United States, 1980–2001: An empirical investigation of firm-level data. Contemporary Economic Policy, 26(1): 118–131. Klein, M.W. & Rosengren, E. 1994. The real exchange rate and foreign direct investment in the United States. Journal of International Economics, 36(3/4): 373–389. Kogut, B. & Chang, S.J. 1991. Technological capabilities and Japanese foreign direct investment in the United States. Review of Economics & Statistics, 73(3): 401–413. Koop, G. 2000. Analysis of Economic Data. Chichester: John Wiley. Kravis, I.B. & Lipsey, R.E. 1982. The location of overseas production and production for export by U.S. multinational firms. Journal of International Economics, 12(3/4): 201–223. Kumar, K. & Kim, Y.K. 1984. The Korean manufacturing multinationals. Journal of International Business Studies, 15(1): 45–61. Kyrkilis, D. & Pantelidis, P. 2003. Macroeconomic determinants of outward foreign direct investment. International Journal of Social Economics, 30(7): 827–836. Lall, S. 1980. Monopolistic advantages and foreign involvement by US manufacturing industry. Oxford Economic Papers, 32(1): 102–122. Li, P.P. 2007. Toward an integrated theory of multinational evolution: The evidence of Chinese multinational enterprises as latecomers. Journal of International Management, 13(3): 296–318. Liu, H. & Li, K. 2002. Strategic implications of emerging Chinese multinationals: The Haier case study. European Management Journal, 20(6): 699–706. Liu, X., Buck, T. & Chang, S. 2005. Chinese economic development, the next stage: Outward FDI? International Business Review, 14(1): 97–115.



78

79

Low, S.P. & Hongbin, J. 2006. Analysing ownership, locational and internalization advantages of Chinese construction MNCs using rough sets analysis. Construction Management and Economics, 24(11): 1149–1165. Morck, R., Yeung, B. & Zhoa, M. 2008. Perspectives on China’s outward foreign direct investment. Journal of International Business Studies, 39(3): 337–350. Nachum, L. 2001. The impact of home countries on the competitiveness of advertising TNCs. Management International Review, 41(1): 77–98. Nachum, L. & Rolle, J.D. 1999. Home country and firm-specific ownership advantages: A study of US, UK and French advertising agencies. International Business Review, 8(5/6): 633–660. Pantelidis, P. & Kyrkilis, D. 2005. A cross country analysis of outward foreign direct investment patterns. International Journal of Social Economics, 32(6): 510–519. Pantulu, J. & Poon, J.P.H. 2003. Foreign direct investment and international trade: Evidence from the US and Japan. Journal of Economic Geography, 3(3): 241–259. Pearce, R.D. 1989. The Internationalisation of Sales by Leading Enterprises: Some Firm, Industry and Country Determinants. Discussion Papers in International Investment and Business Studies, Series B, No. 135, University of Reading: Reading, UK. Pistoresi, B. 2000. Investimenti diretti esteri e fattori di localizzazione: L’America Latine e il Sud Est Asiatico. Rivista di Politica Economica, 90: 27–44. Porter, M. 1990. The Competitive Advantage of Nations. New York: The Free Press. Pugel, T.A. 1978. International Market Linkages and U.S. Manufacturing: Prices, Profits, and Patterns. Cambridge, MA: Ballinger: Pugel, T.A. 1981. The determinants of foreign direct investment: An analysis of US manufacturing industries. Managerial & Decision Economics, 2(4): 220–228. Redding, G. 2005. The thick description and comparison of societal systems of capitalism. Journal of International Business Studies, 36(2): 123–155. Rugman, A.M. & Li, J. 2007. Will China’s multinationals succeed globally or regionally? European Management Journal, 25(5): 333–343. Rui, H. & Yip, G.S. 2008. Foreign acquisitions by Chinese firms: A strategic intent perspective. Journal of World Business, 43(2): 213–226. Sader. F. 1993. Privatization and Foreign Investment in the Developing World. World Bank Working Paper No. 1202, Washington, DC. Schmitz, A. & Bieri, J. 1972. EEC tariffs and U.S. direct investment. European Economic Review, 3(3): 259–270. Sims, C.A. 1980. Macroeconomics and reality. Econometrica, 48(1): 1–48. Sims, C.A., Stock, J.H. & Watson, M.W. 1990. Inference in linear time series models with some unit roots. Econometrica, 58(1): 113–144. Swedenborg, B. 1979. The Multinational Operations of Swedish Firms: An Analysis of Determinants and Effects. Stockholm: Industriens Utredningsinstitut. Toda, H.Y. & Yamamoto, T. 1995. Statistical inference in vector autoregressions with possibly integrated processes. Journal of Econometrics, 66 (1–2): 225–250. Tolentino, P.E. 2006. Explaining multinational companies from the developing economies of East and Southeast Asia. In H.W-C. Yeung (ed.), Handbook of Research on Asian Business. Cheltenham, UK: Edward Elgar, pp. 409–427. Tolentino, P.E. 2008. Explaining the competitiveness of multinational companies from developing economies: A critical review of the academic literature. International Journal of Technology and Globalisation, 4(1): 23–38. Tolentino, P.E. 2010a. Home country macroeconomic factors and outward FDI of China and India. Journal of International Management, 16(2): 102–120.





Tolentino, P.E. 2010b. South Korea’s Outward FDI: Determinants and Impact. Unpublished research paper. Tuman, J.P. & Emmert, C.F. 1999. Explaining Japanese foreign direct investment in Latin America, 1979–1992. Social Science Quarterly, 80(3): 539–555. UNCTAD. 2010. World Investment Report 2010: Investing in a Low-Carbon Economy. Geneva: United Nations. Warner, M., Ng, S.H. & Xu, X. 2004. ‘Late development’ experience and the evolution of transnational firms in the People’s Republic of China. Asia Pacific Business Review, 10(3/4): 324–345. Wheeler, D. & Mody, A. 1992. International investment location decisions: The case of U.S. firms. Journal of International Economics, 33(1–2): 57–76. Wolf, B.M. 1977. Industrial diversification and internationalization: Some empirical evidence. Journal of Industrial Economics, 26(2): 177–191. Wu, F. & Yeo, H.S. 2002. China’s rising investment in Southeast Asia: Trends and outlook. Journal of Asian Business, 18(2): 41–61. Yang, D. 2005. China’s Offshore Investments: A Network Approach. Cheltenham: Edward Elgar. Yang, J.Y.Y., Groenewold, N. & Tcha, M. 2000. The determinants of foreign direct investment in Australia. Economic Record, 76(232): 45–54. Young, S., Huang, C.-H. & McDermott, M. 1996. Internationalization and competitive catch-up processes: Case study evidence on Chinese multinational enterprises. Management International Review (MIR), 36(4): 295–314.



80

Chinese SWFs: At the Crossroad between the Visible and the Invisible Hand Michael Keller and Laura Vanoli

China is one of the largest foreign direct investment (FDI) recipients in the world. Since the early 2000s, however, a new development has intensified and attracted considerable attention among politicians as well as academics: China’s outward FDI (OFDI). Statistics from UNCTAD confirm this trend. In 2003, Chinese OFDI accounted for only 0.5 percent of the world’s total FDI and China ranked 25th among OFDI countries. But, by 2008, China accounted for 2.8 percent of OFDI and ranked 13th (UNCTAD, 2009, p. 53). Although China’s OFDI is still marginal compared to total FDI, the growth path is impressive. China’s OFDI has increased more than 18-fold, from US$2854.65 billion in 2003 to US$52,150 billion in 2008 (UNCTAD, 2009, p. 53). Chinese FDIs are usually made by large state-owned companies and, more recently, by private firms. Besides these two categories of investors, the government created the China Investment Corporation (CIC) in 2007, which is its sovereign wealth fund (SWF). The goal was to diversify China’s foreign exchange reserves. Due to the rapid accumulation of reserves, CIC, like other SWFs, began to expand abroad (UNCTAD, 2008, p. 20) through OFDIs and portfolio investments (Keller, 2012). Domestically, CIC competes with another large institutional investor, the State Administration of Foreign Exchange (SAFE) Investment Company, whose role consists of supervising and managing the foreign exchange market. The presumed Chinese government influence on these funds raises concerns about its underlying intentions. The purpose of our research is to analyze the geographical and sectoral distributions of Chinese SWF investments to assess the investment strategy and motivations. This systematic analysis supports the hypothesis that the Chinese government is highly involved in SWF investment decisions. We also highlight the main concerns about SWFs in terms of transparency and governance (Altbach & Cognato, 2008; Gugler & Chaisse, 2009). 81



4

82


1. SWFs: Their main features

As confirmed by UNCTAD (2008, p. 20), ‘there is no universally agreed-upon definition of such funds, but their original objective was wealth preservation.’ Their objectives may be different from one fund to the other. However, their investment strategies are different from those of private equity funds and multinational enterprises (MNEs) (UNCTAD, 2008, p. 20). Miracky and colleagues (2008, p. 11) consider SWFs a government vehicle that meets three criteria: ‘It is owned by a sovereign government, managed separately from funds administered by the sovereign government’s central bank, ministry of finance, or treasury, and it invests in a portfolio of financial assets of different classes and risk profiles, including bonds, stocks, property, and alternative instruments.’ SWFs usually have higher expected returns on investment as well as a higher risk tolerance than traditional financial instruments managed by the monetary governmental institutions (UNCTAD, 2008, p. 22). Sovereign wealth funds may be considered ‘part of a continuum of sovereign government investment vehicles that runs along a spectrum of financial risk from Central Banks as the most conservative and risk-averse, to traditional pension funds, to special government funds, to SWFs, and finally to state-owned enterprises, which are the least liquid and highest-risk investments’ (Miracky et al., 2008, p. 14) (Figure 4.1). 1.2. Types of SWFs Sovereign wealth funds can be classified according to criteria such as the nature of the fund, dominant objectives, and the type of investments. With respect to the nature of the fund, there are two types of orientation for SWFs. Some act purely as fund managers that do not own the funds they manage, ‘but manage them on behalf of clients’ (a government, for example) (Zhang & He, 2009, p. 8). According to Zhang and He (2009), SWFs of this type neither hold the fund as capital nor as debt.

State-owned enterprises

Central bank

Development bank

Pension fund

Figure 4.1

State

FDI

SWF

Other public entities

Portfolio

Sovereign wealth funds and government activities

Source: Adaption based on Steffen Kern (2008), SWFs, and foreign investment policies – an update, Deutsche Bank Research, p. 2.



1.1. Definition

83

The second type of SWF can be an investment fund, accumulating revenue on its own (taxes on oil mining and export duties, for example). In this case, the fund is the capital of the SWF (Zhang & He, 2009). With respect to the objectives of the funds, Zhang and He (2009) distinguish two kinds of institutional investors: Financial investors, who want to maximize investment income, typically have no interest in controlling the targeted company. Strategic investors, on the other hand, want to influence the management of the targeted company through seats on the boards of directors, for example (Zhang & He, 2009). The IMF (2007, p. 46) distinguishes five types of funds based on their dominant objectives: Stabilization funds are set up by countries rich in natural resources to insulate the budget and economy from volatile commodity prices (usually oil). The funds build up assets during years of ample fiscal revenues to prepare for leaner years. Savings funds are intended to share wealth across generations. For countries rich in natural resources, savings funds transfer non-renewable assets into a diversified portfolio of international financial assets to provide for future generations. Reserve investment corporations are established as separate entities, either to reduce the negative cost-of-carry of holding reserves or to pursue investment policies with higher returns. Development funds allocate resources for funding priority socioeconomic projects, such as infrastructure. Pension reserve funds hold identified pension and/or contingent-type liabilities on the government’s balance sheet. Finally, SWFs may be divided into two categories based on investment type: FDI and portfolio investments. Most SWF investments do not enter within the definition of FDIs. In 2007 FDI by SWFs was US$10 billion, accounting for around 0.2 percent of their total assets and only 0.6 percent of total FDI flows. In the same year private equity funds invested more than US$460 billion in FDI, despite being much smaller in size (UNCTAD, 2008, pp. 20–21). However, FDIs by SWFs are growing continually. As highlighted by UNCTAD (2009, p. 27), ‘Since 2005, SWFs have embarked on a conspicuous quest to participate in OFDI or cross-border M&A. [ . . . ] Cumulative cross-border M&A investments by SWFs over the past two decades totalled US$65 billion by the end of 2008, of which US$57 billion was invested just in the past four years.’ Most SWF investment is in portfolios with professional management to generate a sustainable income stream. Portfolio investments include financial instruments such as equities, bonds, and other asset classes (UNCTAD, 2008). Since 2007, SWFs have invested heavily in financial services in developed economies, in particular in Europe and the United States where banks were lacking liquidity as a result of the financial crisis. For example, the



Michael Keller and Laura Vanoli

84


Government of Singapore Investment Corporation acquired a US$9.8 billion stake in the Swiss bank UBS (UNCTAD, 2008, pp. 23–24).

Increased integration among the world’s main regions has advanced the rise of emerging countries in the past decade. As indicated by Subacchi (2007, p. 2), ‘SWFs are not new, especially in countries rich in natural resources, but they have recently gained prominence in several emerging market countries, reflecting those countries’ large balance of payment surpluses.’ The major wave, starting in 2007, has led to the creation of around 20 SWFs, most of them funded by capital incomes based on high energy prices (in the Middle East) or on large trade surpluses (in China) ( Miracky et al. (2008, p. 16). In October 2008, assets managed by Asian SWFs accounted for around US$1 trillion, representing 30 percent of worldwide sovereign assets. This makes Asia the second most important region in SWF assets, following the Middle East, which was estimated to control almost half of SWF assets in October 2008. Europe follows far behind, with 16 percent of total sovereign assets, driven by SWFs from Russia and Norway (Kern, 2008). The volume of assets as such provides a somewhat static picture of the importance of SWF investments. To capture the degree of activity of SWFs in recent years it is far more interesting to look at actual investments by SWFs. Asian SWFs seem to be the most active sovereign investors in the world. According to Kern (2008, p. 7), they contributed 66 percent of total global SWF investments (value) between 1995 and 2008, whereas Middle Eastern SWFs only contributed 34 percent. This is in line with Miracky and colleagues’s estimate (2008) for the period 2000–2008, assuming that Asian SWFs invested US$150 billion worldwide over this period, while funds based in the Middle East and North Africa (MENA) invested some US$100 billion. However, there is a striking difference between Asian SWFs and funds from the Middle East with respect to the targets of their sovereign investment. Asian SWFs invested heavily in their home region from 2000 to the first quarter of 2008. US$75 billion, representing half of total investment by value, took place in Asia. Most of the remaining Asian investment, $74 billion, went to Europe and the US. Middle Eastern SWFs, on the other hand, only invested $19 billion inside their home region, while almost three quarters, US$72 billion, went to Europe and North America (Miracky et al., 2008, pp. 37–38). A study of publicly reported investments by SWFs within the European Union by the Center for Competitiveness of the University of Fribourg (Keller, 2012) finds that 23 percent of these transactions for the period January 2007 to December 2009 involved investments by Asian SWFs. Kern (2008) estimates the share of Asian SWF investments in Europe between 1995 and 2008 at around 50 percent. According to Keller (2012), Chinese SWFs accounted for almost 50 percent of all SWF transactions in Europe



1.3. Global trends


85

between 2007 and 2009, in line with data from UNCTAD on the general rise of Chinese OFDI.

2. Chinese SWFs

‘Sovereign wealth funds are state-owned investment funds created to invest excess foreign exchange reserves or natural resource export surplus’ (SWF Institute, 2010). China’s foreign exchange reserves have tremendously increased since 2001, from US$215 billion to US$1500 billion in 2007, and they continue to grow, reaching nearly US$2400 billion in 2009 (Figure 4.2). This accumulation of foreign reserves poses great challenges for China. First, the opportunity cost of holding such large amounts is very high. Most of China’s reserves are invested safely with a relatively low rate of return on investment, mainly in US Treasury and agency (Altbach & Cognato, 2008; Zhang & He, 2009). Second, the gradual exchange rate appreciation of the RMB against the US dollar can result in a significant disadvantage for the purchasing power of China’s foreign reserves. Third, the accumulation of foreign reserves has resulted in RMB inflation. To counteract it, the People’s Bank of China (PBOC), the Chinese central bank, issued central bank bills (Zhang & He, 2009). To sustain China’s monetary policy, the PBOC has to run a loss, because of the increasing path of the interest rate for central bank bills. To protect the value of China’s reserves, the government can follow two approaches. The first consists of limiting the accumulation of foreign 3000 2500 2000 1500 1000 500

87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 20 09

85

19

83

19

19

19

81

0

Foreign exchange reserves (in billions USD) Figure 4.2

The accumulation of Chinese foreign exchange reserves (1981–2009)

Source: State Administration of Foreign Exchange (July 2010).



2.1. Reasons for the creation of a Chinese SWF


exchange reserves, which requires more flexibility and further appreciation of the RMB. The second approach is to consider more active ways to manage China’s foreign exchange reserves in order to obtain higher investment income. This requires the establishment of a special entity, whose function consists of actively managing Chinese foreign exchange reserves, as, for instance, an SWF. The success of Temasek and GIC, two investment companies owned by the government of Singapore, in managing the foreign reserves of Singapore encouraged China to establish its own SWF in 2007, the China Investment Corporation (CIC) (Altbach & Cognato, 2008; Zhang & He, 2009). China may also have established an SWF as an intergenerational transfer of wealth. China is saving today to consume in the future, which seems puzzling. In fact, China is a relatively poor country that would be better off with a higher consumption rate today to improve economic development, and a higher savings rate in the future when it will be richer (Gugler & Boie, 2008). It follows that the underlying reason for the establishment of a Chinese SWF seems to be more strategic than it appears. Some Chinese economists argue that economic development can be sustained by these savings since China will use them to acquire international technologies, brands and resources. Hence, China will upgrade its technologies and improve its competitiveness.

2.2. Characteristics of the Chinese SWFs Before the creation of the CIC in 2007, Chinese foreign exchange reserves were only managed by the SAFE Investment Company, a wholly owned subsidiary of the State of Administration of Foreign Exchange (SAFE). After the establishment of the CIC, SAFE Investment Company continued to manage part of the Chinese foreign exchange reserves, although its investments became less significant than CIC’s. Its major functions are supervising and managing the foreign exchange market of the State and operating foreign exchange reserves, gold reserves, and other foreign exchange assets (SWF Institute, 2010). However, although SAFE acts as an SWF, it cannot be considered one under the definition proposed by Miracky and colleagues (2008) since it is not managed independently of other state financial institutions. Nevertheless, we do not exclude it because our objective in this study is to compare CIC and SAFE in terms of investment strategies. CIC is a wholly state-owned company headquartered in Beijing created as a way to diversify China’s foreign exchange reserves, hold less in US currency, and increase risk-adjusted returns. The capital of CIC is funded through government bonds issued by the Ministry of Finance (MOF). These government bonds are used to purchase the US$200 billion foreign reserves from People’s Bank of China, which are subsequently injected into CIC (SWF Institute, 2010). CIC is debt-based, which introduces additional constraints on its returns. As Rozanov (2008, p. 1) noted, ‘The cost of local debt and the expected appreciation of the local currency become the “hurdle rate” which the



86

87

fund must beat in order to be economically viable over the long-term.’ This financial constraint affects the asset allocation, the strategic investments, and the level of transparency. CIC’s orientation to the different types of funds defined in the previous section is vague since it is neither a fund manager nor an investment fund (Zhang & He, 2009). CIC’s internal structure has two distinct and separate entities: (1) the global investment management operation (CIC) and (2) Central Huijin Investment Ltd., previously a state-owned investment company, which CIC purchased after its creation and which ‘invests exclusively in domestic state-owned financial institutions on behalf of the state in order to improve governance and preserve and enhance the value of state-owned financial assets’ (CIC Annual Report, 2008, pp. 4–5). Central Huijin Investment Company and its subsidiary, China Jianyin Investment Company, invest in the most important financial institutions in China, which reflects their strategic, perhaps political, interest in acquiring these shares. Although CIC and Central Huijin operate separately, strategic and political interference in CIC global investment decisions by the government is a concern. Another consideration highlights the potential political influence on CIC investment decisions. The governance structure of CIC is composed of three governing bodies: the board of directors, the board of supervisors, and the executive committee. Based on the objectives and broad policy set by the only shareholder, the State Council, the board of directors decides how to implement the investment strategy. Analyzing the composition of the CIC board of directors, one notes that the top management team includes mainly people who work or have worked for the Chinese government, which supports the hypothesis of the government’s involvement in CIC investment decisions (Altbach & Cognato, 2008; Martin, 2008; CIC Annual Report, 2009). In fact, the chairman of the board of CIC, Lou Jiwei, served as Deputy Secretary General of the State Council. The board of directors also has ministry and vice ministry-level officials from the State Council, the National Council for the Social Security Fund, the MOF, the National Development and Reform Commission, the Ministry of Commerce, the People’s Bank of China, and the SAFE as members (CIC Annual Report, 2009; Zhang & He, 2009). The executive committee is responsible for translating the board’s decisions into effective operational activities. Finally, the board of supervisors monitors the ethical behavior of directors and executives and recommends more efficient investment management processes (CIC Annual Report, 2009; Zhang & He, 2009). 2.3. Investment strategy CIC and SAFE Investment Company have essentially the same objective: to manage the excess of Chinese foreign reserves. However, the investment approach and strategy can differ between the two entities. According to





CIC’s Annual Report (2009, p. 28), its investment approach and strategy are fourfold: ‘(1) to maximize long-term, sustainable, risk-adjusted returns for its shareholder, the State Council of People’s Republic of China; (2) not to control firms or sectors in which it invests or attempt to influence their operations; (3) to abide by local laws and regulations in jurisdictions where it invests and to take corporate social responsibility seriously; (4) to make research- and allocation-driven investments for sound investment decisions with a disciplined approach to investing’. SAFE does not report its investment strategy and approach, which reflects the ambiguous position of the SWF in terms of investments. To study their investment strategy in depth, it is necessary to analyze their investment deals. Based on our own database of publicly reported investments by Chinese SWFs worldwide from January 2007 through August 2010, we can identify and compare their investment strategy in terms of the number of transactions. The data come from different sources such as the Financial Times, the SWF Institute, and the CIC website. The database contains 34 effective investments or deals in negotiation for CIC, and 14 for SAFE.1 The data analysis helps our understanding of the geographical and sectoral distribution of Chinese SWF investments and indicates their investment orientation. The geographical distribution (Figure 4.3) indicates that CIC invests predominantly in North America (38%) – 29 percent in the United States and 9 percent in Canada – and in Asia (35%) – 23 percent in China and 12 percent in Hong Kong. Compared to CIC, SAFE invests mainly in Europe (72%) – 58 percent in the United Kingdom, 7 percent in France and 7 percent in the Netherlands. The capital that CIC and SAFE manage is primarily invested in developed regions such as North America and Europe, and an important part is directly invested in China, especially in the financial sector. CIC 9%

SAFE 7%

6%

22%

38%

12%

71% 35% North America Oceania Figure 4.3

Asia

Europe

Europe

Oceania

North America

Eurais

Targeted regions of Chinese sovereign wealth funds (2007–2010)

Source: Elaboration based on the database of the Center of Competitiveness, University of Fribourg.



88


CIC

89

Safe

6% 9%

14% 44% 50%

Financials Commodities & energy Infrastructure, industrial, and engineering Real estate Insurance Technology Figure 4.4

Commodities & energy Services & retail

Financials

Targeted sectors of Chinese sovereign wealth funds (2007–2010)


This inflow of capital from foreign government-controlled institutions raises some concerns in developed host countries. The sectoral distribution (Figure 4.4) suggests that the preferred targets for CIC and SAFE are the financial sector and the commodities and energy sectors. According to Lyons (2008), these are key sectors that governments from developing countries target to secure access to natural resources and to transfer financial skills back home to help develop and improve domestic financial markets. The objectives behind these investments include a strategic dimension. Figures 4.5 and 4.6 combine the geographical and sectoral dimensions to compare the targeted sectors in different regions. For CIC, North American investments are primarily in the financial sector and in the commodities and energy sectors, whereas Chinese investments are mainly focused on the financial sector. SAFE invests in Europe mainly in the commodities and energy sector. To deepen the analysis, some characteristics of the targeted firms are reported in Tables 4.1–4.3, which reflect the market position of the targeted firms as well as the percent of CIC ownership determining the level of control in a specific firm. According to the IMF and OECD, 10 percent ownership is considered the threshold percentage for significant control (IMF, 1993, pp. 86–87; OECD, 1996, p. 8). However, this threshold is defined arbitrarily and it does not mean that 10 percent ownership always carries significant influence or, conversely, that less than 10 percent ownership implies no control in the invested firm (IMF, 1993, pp. 86–87; OECD, 1996, p. 8). Table 4.1 reports CIC’s foreign investments. Nearly all the targeted firms are well-positioned and relatively large and important in the sector where



35%

36%

90


Europe Eurasia

Asia North America 0

2

4

Technology

6

Real estate

8

Insurance

Infrastrucure, industrial and engineering Financials Commodities & energy Figure 4.5

Number of deals by targeted regions and sectors, CIC (2007–2010)


Europe Oceania North America 0

1

2

Services & retail Figure 4.6

3

4 Financials

5

6

7

8

Commodities & energy

Number of deals by targeted regions and sectors, SAFE (2007–2010)


they operate. Further, CIC ownership is higher or equal to 10 percent for 62 percent of the targeted firms (including 9.9% in Blackstone and 9.9% in Morgan Stanley), less than 10 percent for 8 percent of the targeted firms, and undisclosed for the remaining 30 percent. It follows that CIC has an important ownership in the majority of the invested firms. Does it mean that CIC has an impact on the management of the invested firms? Difficult to say. Table 4.2 reports CIC’s domestic investments. Since absorbing Central Huijin, CIC owns shares in a majority of China’s largest banks and financial institutions, such as the Bank of China, the China Construction Bank, the



Oceania

91 CIC’s foreign investments (2007–2010)

Target company

Headquarter

Sector

Market position

% CIC ownership

AES Wind Generation

USA

Commodities

Global firm active in renewable energy

15

Apax

UK

Financials

Equity firm – majority and minority stakes in large companies that have strong and established market positions and the potential to expand

2.3

Areva T&D

France

Commodities

World leader

15

Black Rock

USA

Financials

Leading management firm

Complete acquisition of Barclays Global Investors (UK)

Blackstone Group

USA

Financials

Global investment and advisory firm – invest locally

9.9

Chesapeake Energy

USA

Commodities

One of the largest natural gas suppliers in the USA

Undisclosed

Citic Capital Holdings Ltd.

Hong Kong

Financials

Alternative investment management and advisory company

40

Diageo

UK

Beverage

One of the world’s largest producers of alcoholic drinks and among the top 15 largest publicly quoted companies in the UK

1.1

Fortescue Metals Group

Australia

Commodities

World leading producer of iron ore

Undisclosed+ agreement with Baosteel



Table 4.1

92 (Continued)

Target company

Headquarter

Sector

Market position

% CIC ownership

GCL-Poly Energy Holdings Ltd.

Hong Kong

Commodities

One of the leading polysilicon suppliers for solar industry in the world, as well as a top green energy supplier in China

20

Goodman Group

Australia

Real Estate

Vertically integrated property group

Undisclosed

Intel Capital

USA

Technology

Subsidiary of Intel – invests in promising technology companies worldwide (especially in energy and communication technologies)

Collaboration agreement

International Lease Finance Corporation

USA

Aircrafts

Active on the five continents

100

JC Flowers PE Fund

USA

Financials

Private equity investment firm focusing on buyouts in financial service industries

80

JSC KazMunaiGas Exploration Production

Kazakhstan

Commodities

Second largest Kazakh oil company

11

Lung Ming

Hong Kong

Commodities

Operations in iron ore business in Inner Mongolia

Undisclosed

Morgan Stanley

USA

Financials

Ranked 111 in 2010 Forbes 2000

9.9



Table 4.1

Nobel Oil Group

UK

Commodities Vertically integrated oil and gas company with a Branch office located in Azerbaijan

45

Oaktree Capital Management

USA

Financials

Undisclosed

Penn West Energy Canada

Canada

Commodities Largest producer of light and medium oil in western Canada

45

PT Bumi Resources Tbk

Indonesia

Commodities Operations in Indonesia, UK, Japan and Australia

Undisclosed

Songbird Estates

UK

Real estates

Manage Canary Wharf – a large office and shopping development in East London and surrounding areas

19

South Gobi Energy Resources

Canada

Commodities Coal exploitation in Mongolia

13

Teck Resources Limited

Canada

Commodities Canada’s largest company engaged in mining, mineral processing, and metallurgical activities

17.2

The Noble Group

Hong Kong

Commodities Leading supply chain manager of agricultural, industrial, and energy products

14.9

Visa Inc.

USA

Financials

Undisclosed

Investment management company – investing in emerging markets and Japan

World’s largest firm active in transaction processing services

Source: Elaboration based on the database of the Center of Competitiveness, University of Fribourg, and firms’ respective websites, as well as Datamonitor – Company profiles from Ebsco: Business Source Premier



93


Table 4.2

CIC’s domestic investments (2007–2010)

Target company

Headquarter

Sector

Market position

% CIC ownership

Agricultural Bank of China

China

Financials

One of the four big Chinese state-owned commercial banks

50

Bank of China

China

Financials

One of the largest Chinese state-owned commercial banks

67.5

China Construction Bank

China

Financials


57

China Development Bank

China

Financials

Commercial bank controlled by the State Council

48.7

China Everbright Bank

China

Financials

Aims to become an excellent listed bank in China

71

China Railway Hong Kong

China

Infrastructures

In 2009: ranked 13 in China’s Top 500 enterprises

4

China Reinsurance

China

Insurance

China’s largest reinsurer

85.5

Industrial and Commercial Bank of China

China

Financials


35.4

Source: Elaboration based on the database of the Center of Competitiveness, University of Fribourg, and firms’ respective websites, as well as Datamonitor – Company profiles from Ebsco: Business Source Premier.

Industrial and Commercial Bank of China, and the China Everbright Bank. Further, CIC restructured two banks – the China Development Bank and the Agricultural Bank of China – through cash injections. Overall, banks controlled by CIC represent 58 percent of all bank assets and 59 percent of all loans (Altbach & Cognato, 2008). CIC also invests in China’s largest insurer with an ownership of 85.5 percent. CIC’s domestic investments receive more attention, since CIC can indirectly influence the banking sector as well as the whole economic system, especially in terms of FDI orientation.



94

95 SAFE’s foreign investments (2007–2010)

Target company

Headquarter

Sector

Market position

% SAFE ownership

Australia and New Zealand Bank

Australia

Financials

One of the largest banking groups in Australia and number one bank in New Zealand

Less than 1

Aviva

UK

Insurance

World’s fifth largest insurance group – leading position in the UK (FTSE 100)

0.97

BG Group

UK

Commodities

Ranked in the FTSE 100

0.7

BP Plc

UK

Commodities

One of the largest vertically integrated oil and gas companies in the world (in FTSE 100)

1

Cadbury

UK

Services and retail

Market leader in global confectionery sector

Less than 1

Commonwealth Bank of Australia

Australia

Financials

One of the Australian leading firms in financial and insurance services

Less than 1

Drax Group Plc

UK

Commodities

Operates primarily in the UK

Less than 1

National Australia Bank

Australia

Financials

0.33

Rio Tinto

UK

Commodities

Operates primarily in Australia Ranked in the FTSE 100 and 68 in the 2010 Forbes Global 2000

Less than 1



Table 4.3


Table 4.3

(Continued)

Target company

Headquarter

Sector

Market position

% SAFE ownership

Royal Dutch Shell

UK

Commodities

One of the largest oil companies in the world

0.9

Severn Trent Plc

UK

Commodities

One of the world’s leading suppliers of water and the second largest water company in the FTSE 100

Less than 1

Tate & Lyle

UK

Services and retail

Produces renewable food and industrial ingredients

Less than 1

Total SA

France

Commodities

One of the leading oil companies in the world

1.3

TPG Fund

USA

Financials

Leading investment firm

Undisclosed

Source: Elaboration based on the database of the Center of Competitiveness, University of Fribourg, and firms’ respective websites, as well as Datamonitor – Company profiles from Ebsco: Business Source Premier.

According to the SWF Institute (2010), SAFE Investment Company makes significant investments in the UK equity market. In fact, it reports a total amount of US$6 billion invested in the FSTE 100, an index including the 100 leading companies traded on the London Stock Exchange. Table 4.3 indicates that 58 percent of the invested firms are in the United Kingdom, of which 62 percent are listed on the FTSE 100 (London Stock Exchange), proving the importance of the firms on the UK market. The sector-based analysis suggests that 50 percent of the targeted firms are active in commodities and energy, of which 57 percent are in oil and gas. This reflects China’s need to access natural resources since China is comparatively poor in the latter. In fact, China’s tremendous economic development requires a steady supply of natural resources (Zhan, 1995, p. 88). Hence, SAFE focuses on resource-seeking investments. The ownership percentage in the targeted firms is around 1 percent for each deal.



96


97

Previous studies and our analysis of SWF investment activities suggest that Chinese SWFs mix private (commercial) and government objectives in their investment approach. To test whether the government influences Chinese SWF investment decisions, we analyze the government’s policy toward Chinese FDI (Sub-section 3.1) and compare this strategy with the investments by CIC and SAFE (Sub-section 3.2). The last sub-section (3.3) addresses the main concerns raised by possible government involvement in Chinese SWF investments, especially for developed countries. 3.1. Government policy behind Chinese FDI The internationalization of Chinese firms began slowly in 1979 after the implementation of the ‘open-door’ policy by the Chinese Government, which considered outward investment a way to integrate China into the world economy and invest overseas. However, in the 1980s, the institutional environment was very restrictive, leading to a number of approval requirements that only a few firms were able to fulfil. Over time, the government relaxed the approval procedure and the number of Chinese outward investments increased substantially. Even if the requirements for investing abroad seem to be less restrictive, the Chinese government still influences the sectoral and geographical orientation of outward investments through the approval procedure. In fact, the approval procedure governing OFDI involves different levels of the government, depending upon the type, the scale, and the location of investments (Zhan, 1995). To analyze the evolution of the institutional framework surrounding Chinese outward investments, some researchers (Wong & Chan, 2003; Hong & Sun, 2006; Deng, 2007; Poncet, 2007; Buckley et al., 2008) suggest dividing the period from 1979 until now into four sub-periods, described below. During the first stage (1979–1985), the main objective of the government was to ensure access to natural resources for the domestic economy and improve national economic development. To attain these objectives, the government adopted a cautious approach toward outward investments for several reasons. First, it considered OFDI a substitute for domestic investments affecting economic development. Second, overseas investments were difficult to monitor and could result in a loss of control of state property. Third, the government feared the inexperience of Chinese firms at competing internationally (Zhan, 1995; Buckley et al., 2008). As a result, only state-owned and local companies regulated by the State Economic and Trade Commission were allowed to invest abroad, mainly in natural resources (Wong & Chan, 2003; Poncet, 2007). During the second phase (1986–1991), the approval process was gradually liberalized and more firms (including non-state firms) were allowed to establish foreign affiliates. However, the government limited Chinese



3. Private and government strategy behind Chinese SWFs


OFDI to firms meeting the following conditions: having enough capital, basic technical and operational know-how, and an adequate foreign partner (Buckley et al., 2008). In addition to these administrative requirements, firms seeking to invest abroad had to meet specific objectives defined by the government, such as ‘ensuring a stable supply of natural resources that are scarce in China, acquiring advanced technology and equipment and channelling these back to China, or contributing to stronger economic relations with neighboring countries’ (Zhan, 1995, p. 69). The third stage (1992–1998) was characterized by an expansion of outward investments, by local and provincial enterprises, and by the Asian crisis in 1997, whose consequences were disastrous for the real estate sector. In addressing this situation, the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) adopted a stricter screening and monitoring process (Wong & Chan, 2003; Poncet, 2007). The fourth and last stage (1999–2010) is the most relevant in terms of OFDI, since the government adopted and implemented a policy called ‘Go Global’. The strategy aims to encourage and promote the internationalization of capable Chinese firms through different preferential measures (such as easing access to foreign exchange or preferential loans) in order to enhance their international competitiveness (Poncet, 2007; Buckley et al., 2008). In 2004, the Ministry of Commerce (MOFCOM) and the Ministry of Foreign Affairs (MoFA) created an overseas investment guidance catalog that orients OFDI toward specific countries and industries. Schüler-Zhou and colleagues (2010) highlight the main requirements defined by the government with the introduction of the catalog, which should ensure that Chinese OFDI benefits the China’s economy by ‘securing access to natural resources, enhancing companies’ technological capacity, and acquiring international brands’(Schüler-Zhou et al., 2010, p. 4). Host countries have to fulfil several requirements: ‘(1) a close relationship with China, (2) be complementary to the Chinese economy, (3) be important trading partners of China, (4) sign investment and taxation agreements, and (5) be part of an important economic region in the global economy’ (Schüler-Zhou et al. 2010, p. 4). The analysis of the institutional evolution highlights the strong government involvement in Chinese OFDI by state-owned firms, as well as by privately owned companies, through the approval procedure and the introduction of the ‘Countries and Industries Overseas Investment Guidance Catalog’. The next section investigates whether Chinese SWF investments are driven by the ‘Go Global’ policy according to the government’s strategic objectives, or by the pure financial maximization of the return on investment.

3.2. Private and government’s strategy Combining the results found in analyzing the investment strategy of CIC and SAFE with the objectives defined in the ‘Go Global’ policy by



98

99

the Chinese Ministry of Commerce, we can assess whether the Chinese government plays an important role in shaping their investment strategy. Since SAFE is not considered an SWF, it is obvious that the Chinese government influences its investment decision process. The analysis of its investment activities suggests that it primarily invests in commodities and energy, in line with the ‘Go Global’ strategy. The main objective is to secure access to natural resources (Zhan, 1995). More interesting is the case of CIC which is run independently and considers itself a financial investor, maximizing investment return and having little interest in influencing the management of the invested firm (CIC Annual Report, 2008). On an international scale, CIC invests primarily in the financial sector and in the commodities and energy sectors, which corresponds to the sectors in which the government encourages FDI. Domestically, CIC, by acquiring Central Huijin, became the major shareholder of the biggest Chinese banks. Hence, the strategic and political investments of these banks are indistinguishable from CIC’s. Chinese banks have preferred sectors (defined by the government) to which they give preferential loans and support the international expansion of Chinese firms operating in sectors such as commodities to achieve a strategic and political objective. To conclude, the fund is ambiguous. On one side, CIC follows economic and financial objectives to maximize the return on investment; on the other side, the Chinese government exerts an indirect but significant influence on CIC investment decisions.

3.3. Concerns The surge of the Chinese SWF raises concerns due to the large amount of capital invested in US and Western companies in recent years. Two main concerns have been highlighted by US policymakers and international organizations. The first one pertains to governance and transparency issues about SWF investments. The second, defined as ‘state capitalism’ by some analysts, refers to ‘the potential use of governmentcontrolled investment vehicles to attain global strategic and political goals’ (Weiss, 2008, p. 2), especially in the financial, energy, information technology, telecommunications, and transportation sectors of the economy (Hemphill, 2009). As illustrated in Figure 4.7, CIC has minimal transparency and its investment approach seems to be rather strategic. This reinforces the protectionist sentiment in the West toward the Chinese SWF (Lyons, 2008). The governance issue is related to the fact that CIC is an independent entity of the State, but its board of directors consists of people working or having worked for the Chinese Government (CIC Annual Report, 2009). The level of independence in CIC’s decision process is not clear, leading




100


Top sovereign wealth funds By investment approach and transparency Non-commodity fund UAE (Dubai) - DIC

Qatar

Malaysia

UAE (Dubai) - Istithmar

China

Singapore-Temesek Singapore-GIC S Korea

UAE (Abu Dhabi) - ADIA Brunei Ornan Kuwait Taiwan Venezuela Kazakhstan Chile Russia

Norway US (Alaska) Canada (Alberta)

Low

High Level of transparency

Figure 4.7

Sovereign wealth funds: strategy and transparency

Source: Standard Chartered (2008).

to a mix of economic and political objectives. As far as SWF transparency is concerned, different approaches have been adopted to measure it. ‘The Linaburg-Maduell Transparency Index developed at the Sovereign Wealth Fund Institute by Carl Linaburg and Michael Maduell is based on ten essential principles, each adding one point of transparency to the index rating’ (SWF Institute, 2010). The scale goes from 1 (lowest transparency) to 10 (highest transparency).2 According to this scale, CIC has a Transparency Index of 7, while SAFE has a score of 2 in the first quarter of 2010 (SWF Institute, 2010). Both fail to meet the recommended minimum transparency rating of 8. Truman (2007, 2008), in another measurement, constructed a scoreboard for 44 SWFs – 34 non-pension funds and 10 representative pension funds – to evaluate the structure, governance, accountability, transparency, and behavior of SWFs. In the non-pension fund category, CIC ranks 21st with a score of 29. The average score of the non-pension fund category is around 46, which clearly indicates that CIC scores below the average level. CIC also performs poorly in accountability, transparency, and behavior. The accountability and transparency category focuses mainly on the investment strategy implementation, investment activities, the publication of annual reports, and the audit process. The behavior category is more concentrated on aspects of risk management. CIC fails to meet requirements in these categories (Truman, 2008). To sum up, these studies highlight CIC’s weakness in governance



Investment approach Conventional Strategic

Commodity fund

101

and transparency and reinforce the geopolitical dimension of its investment activities. The second big concern related to governance and transparency issues reflects the possible non-commercial motivations behind SWF investment decisions. According to Weiss (2008, p. 15), the two primary SWF strategic objectives are (1) to secure access to natural resources and (2) to develop domestic financial markets. CIC’s recent deals suggest that the fund tends to act strategically, even if it claims that it has no intention to invest in strategic sectors. Therefore, CIC is criticized, over-regulated, and sometimes rejected by developed countries who believe it threatens their national security. These concerns require the adoption of a common approach and standards toward SWFs at an international level, such as the Santiago Principles defined by IMF (Hemphill, 2009).

4. Conclusion SWF trends impressively reflect the key changes of the global economic map. The analysis suggests an emergence of developing countries as dominant investors, notably including China from the list of the candidates to become the main global economic pole. The particular role of Chinese SWF investments is reflected in the special concerns they raise with respect to their potential geopolitical objectives. This chapter explores the role of the government in Chinese SWF investment decisions and discusses the main concerns of developed countries about Chinese government involvement. To determine the investment strategy of the Chinese SWFs, we have used our own database of publicly reported Chinese SWF investments worldwide for the period January 2007–August 2010. Comparing the targeted sectors with the government objectives, we can conclude that government influences significantly SWFs’ decisions, reinforcing the assumed strategic behavior of the SWFs. In fact, the access to natural resources, scarce in China, represents the main motivation for outward investments supported by the government (Zhan, 1995). But at the same time, Chinese SWFs make pure financial investments. Moreover the Chinese government has revealed a focus shift from the export-led sectors to increasing domestic consumer demand in its 12th Five-Year Plan (March 2011). This shift might indicate a change of priorities in the use of foreign exchange reserves in the future, with less scope for strategic considerations. Due to the lack of transparency, it is difficult to classify the funds either as financial investors or strategic investors. This raises some concerns, especially for recipient countries, and leads to the establishment of an SWF legal and regulatory framework.




102


Notes

References Altbach, E. G., & Cognato, M. H. 2008. NBR Analysis: Understanding China’s New Sovereign Wealth Fund. NBR The National Bureau of Asian Research, 19(1): 1–36. Blundell-Wignall, A., Hu, Y., & Yermo, J. 2008. Sovereign Wealth and Pension Fund Issues. OECD Working Paper on Insurance and Private Pensions No. 14. France: OECD Publishing, doi: 10.1787/243287223503. Buckley, P. J., Cross, A. R., Tan, H., Liu, X., & Voss, H. 2008. Historic and Emergent Trends in Chinese Outward Direct Investment. Management International Review, 48(6): 715–748. China Investment Corporation. 2008. CIC Annual Report 2008. Retrieved from http:// www.china-inv.cn/cicen/include/resources/CIC_2008_annualreport_en.pdf. China Investment Corporation. 2009. CIC Annual Report 2009. Retrieved from http: //www.china-inv.cn/cicen/include/resources/CIC_2009_annualreport_en.pdf. Deng, P. 2007. Investing for strategic resources and its rationale: The case of outward FDI from Chinese companies. Business Horizons, 50(1): 71–81, doi: 10.1016/j.bushor.2006.07.001. Gugler, P., & Boie, B. 2008. The Chinese International Investments: Corporate and Government Strategies. NCCR Trade Regulation, Working Paper 2008/25. Bern. Gugler, P., & Chaisse, J. 2009. Sovereign Wealth Funds in the European Union – General trust despite concerns. NCCR Trade Regulation, Working Paper 2009/4. Bern. Hemphill, T. A. 2009. Sovereign Wealth Funds: National Security Risks in a Global Free Trade Environment. Thunderbird International Business Review, 51(6): 551–566. Hong, E., & Sun, L. 2006. Dynamics of Internationalization and Outward Investment: Chinese Corporations’ Strategies. The China Quarterly, 187(2): 610–634, doi: 10.1017/S0305741006000403. IMF. 1993. Balance of Payments Manual. IMF (5th ed.). Washington, DC. IMF. 2007. Global Financial Stability Report: Chapter 1 – Annex 1.2: Sovereign Wealth Funds. Washington DC: International Monetary Fund, pp. 45–51. Keller, M. 2012. The Role of SWFs in Shaping the Neopolar World: The Asia Europe Perspective. In: Oxelheim, Lars (ed) (2012), EU/Asia and the re-polarization of the global economic arena, World Scientific Press (London), Forthcoming. Kern, S. 2008. SWFs and Foreign Investment Policies – An Update. Frankfurt am Main, Germany: Deutsche Bank Research, pp. 1–38. Lyons, G. 2008. State Capitalism: The Rise of Sovereign Wealth Funds. Law and Business Review of the Americas, 14. 202–238.Martin, M. F. 2008. China’s Sovereign Wealth Fund. CRS Report for Congress RL34337. Miracky, W. et al. 2008. Assessing the Risks: The Behaviours of Sovereign Wealth Funds in the Global Economy. New York: Monitor Group. OECD. 1996. OECD Benchmark Definition of Foreign Direct Investment (3rd ed.). Paris. Poncet, S. 2007. Inward and Outward FDI in China. Panthéon-Sorbonne-Economie, Université Paris 1 CNRS and CEPII, Working Paper, 1–26.



1. A survey of publicly available sources can never be exhaustive. Thus, the results and their interpretation should be treated with caution, and can only be indicative. 2. According to the SWF Institute, the minimum rating for adequate transparency is 8.

103

Rozanov, A. 2008. Will China Follow the Norwegian Model? The Sovereign Wealth Funds Debate. Retrieved from State Street Global Advisors, Ofiicial Institutions Group. http://www.ssga.com/library/esps/The_SWF_Debate_Andrew_Rozanof_1.8.08CCRI 1200431495.pdf (August 2010). Schüler-Zhou, Y., Brod, M., & Schüller, M. 2010. Heading for Europe? Push and Pull Factors for Chinese FDI in EU. Paper Submitted for the Book ‘Chinese International Investments’ by Ilan Alon, Marc Fetscherin and Philippe Gugler. Subacchi, P. 2007. Asian SWFs in Europe: Much Ado About Nothing? London: Chatham House, pp. 1–26. SWF Institute. 2010. SWF Institute Website. Retrieved from http://www.swfinstitute. org/what-is-a-swf/. Truman, E. M. 2007. The Management of China’s International Reserves: China and a Sovereign Wealth Fund Scoreboard. Washington, DC: Peterson Institute for International Economics, pp. 169–218. Truman, E. M. 2008. A Blueprint for Sovereign Wealth Fund Best Practices. Washington, DC: Peterson Institute for International Economics, Policy Bri. UNCTAD. 2008. World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge. New York and Geneva. UNCTAD. 2009. World Investment Report 2009: Transnational Corporations, Agricultural Production and Development. New York and Geneva. Weiss, M. A. 2008. Sovereign Wealth Funds: Background and Policy Issues for Congress. CRS Report for Congress RL34336, pp. 1–21. Wong, J. & Chan, S. 2003. China’s Outward Direct Investment: Expanding Worldwide. China: An International Journal, 1(2): 273–301. Zhan, J. X. 1995. Transnationalization and Outward Investment: The Case of Chinese Firms. Transnational Corporations, 4: 67–100. Zhang, M. & He, F. 2009. China’s Sovereign Wealth Fund: Weakness and Challenges. China & World Economy, 17(1): 101–116.







Part II


Micro-Environmental Determinants of Chinese FDI





Motives and Patterns of Reverse FDI by Chinese Manufacturing Firms Xiaobo Wu, Wanling Ding, and Yongjiang Shi

China’s outward foreign direct investment (OFDI) has increased rapidly and continuously since 2003. According to United Nations Conference on Trade and Development (UNCTAD), China’s OFDI flows exceeded US$10 billion for the first time in 2005, US$20 billion in 2006, and US$50 billion in 2008. China’s OFDI reached US$56.53 billion in 2009, according to the Ministry of Commerce (MOC) of China. China’s OFDI flows now stand first among developing countries and fifth among all economies. From 2002 to 2009, China’s OFDI grew by 54 percent annually. By the end of 2009, nearly 12,000 domestic investing entities had established about 13,000 overseas enterprises in 177 countries (regions). Though China’s investment in the developed countries represents a small percentage of overall OFDI, it has risen dramatically recently. China’s investment in Europe reached US$3.35 billion in 2009, an increase of 280 percent year-on-year. And China’s investment in North America was US$1.52 in 2009, 320 percent more than in 2008. Recently, Chinese manufacturing firms have become more active in buyout activities in developed countries. Although Sichuan Tengzhong Heavy Industrial Machinery Co Ltd (Tengzhong) failed to acquire Hummer from General Motors (GM) in 2010, Geely Holding Group (Geely) successfully acquired Volvo from Ford, though many observers doubt the success of this acquisition in the future. Meanwhile, many Chinese manufacturing firms are flocking to developed countries to build plants. In November 2009, Suntec Power Holding, China’s leader in the design and manufacture of solar products, decided to build a solar panel assembly plant in Arizona. In April 2010, BYD Auto set up its North American headquarters in Los Angeles, further reflecting the accelerated pace of Chinese investment in developed countries. Why are Chinese manufacturing firm investments in developed countries increasing rapidly? How are Chinese manufacturing firms invested in developed countries? We answer the two questions by first proposing an 107



5

108


analytical framework based on a literature review. Second, we choose three Chinese manufacturing firms for single-case analysis. Third, we summarize the findings based on cross-case analysis.

1. Theoretical foundation

FDI theories emerged when firms from developed countries started to invest overseas in the 1960s. Researchers such as Hymer (1960), Vernon (1966), Dunning (1977), Johanson (Johanson & Wiedersheim-Paul, 1975; Johanson & Vahlne, 1977), and Buckley and Casson (1976) contributed to the development of FDI theories. The main research topics include the nature of multinational enterprises (MNEs), the relationship between exports and FDI, the motives and determinants of FDI, foreign market entry modes, and the impacts of FDI on host country productivity. Until now the most widely accepted theoretical approach of FDI was developed by Dunning (1977; Dunning & Narula, 1996): the ownershiplocation-internalization (OLI) theory, investment development path (IDP), and categories of FDI motives. OLI theory argues that the international production activities of multinational corporations (MNCs) are motivated by ownership, location, and internalization advantages. Investment development path (IDP) theory offers an explanation of which countries engage in FDI and how the level and nature of these activities might be related to the economic development of its home country (Dunning & Narula, 1996). Dunning (1998) classifies four kinds of FDI motives: resource-seeking, market-seeking, efficiency-seeking, and strategic asset-seeking. From a process perspective, Johanson and Wiedersheim-Paul (1975) define four steps in the internationalization process based on a case analysis of four large Swedish multinationals. They maintain that internationalization is an incremental process in which firms can proceed with gradual acquisition and use of information from foreign operations (Johanson & Vahlne, 1977). In addition, they argue that internationalization is a learning process through the development of experiential knowledge about foreign markets which causes the reduction of ‘psychic distance’ (Johanson & Vahlne, 1977). 1.2. Theoretical extension based on FDI from developing countries Some scholars criticize the limitations of traditional theories and extend FDI theories by focusing on developing countries. Wells (1983), Lall (Lall & Chen, 1983), and Cantwell and Tolentino (1990) make valuable contributions to the research on multinationals from developing countries whose OFDI is classified into different waves. In the first wave, MNEs from developing countries were pushed to internationalize by the difficulties encountered at home, such as market restrictions and export difficulties. In the second wave, MNEs from developing countries were less driven by cost factors but



1.1. Traditional theories based on FDI from developed countries

by searching for markets and technological innovations to compete in the global economy (Yeung, 1999). In Dunning’s (1998) explanation, the first wave of investors from developing countries mainly invested in neighbor countries or other developing countries for resource-seeking and market-seeking. The ownership advantages of these investors are more specific to country of origin, as, for example, ‘ethnic’ advantages, technology, and management adapted to other developing countries. There has been a shift in both the character and motives of FDI from certain developing countries since the 1980s. MNEs started to invest in developing countries for resource- and market-seeking and in developed countries for asset- and market-seeking. Ownership advantages were not only country-of-origin-specific but also firm-specific, such as limited marketing skills, product differentiation, and vertical control over factor/product markets (Dunning 1998). 1.3. Theoretical perspectives on China’s OFDI The phenomenon of China’s increasing OFDI has drawn attention from researchers to investigate Chinese firms’ overseas expansion (Alon & McIntyre, 2008; Alon et al., 2009). One of the key issues discussed in studies about China’s OFDI is what motivates Chinese firms. Buckley, Clegg, and Cross (2007) test the extent to which mainstream theories based on industrialized country FDI applies to emerging countries. They argue that capital market imperfections, the special ownership advantages of Chinese MNEs, and institutional factors may be the special theoretical dimension nested within the mainstream theory. As Child and Rodrigues (2005) point out: ‘While mainstream theory tends to assume that firms internationalize to exploit competitive advantages, Chinese firms are generally making such investments in order to address competitive disadvantages.’ That is because most Chinese firms have only limited ownership advantages to exploit and many internationalization activities of Chinese firms reflect attempts to acquire strategic assets (Ping, 2007; Rui & Yip, 2008; Xiaobo & Wanling, 2009) such as technologies, brands, and distribution networks. Mathews (2006) develops the LLL model (linkage, leverage, and learning) to emphasize that ‘latecomer firms’ will use their global linkages to leverage the low-cost advantage and learn for new competitive advantages. While some attention has been devoted to the motives of Chinese firms’ OFDI, other researchers investigate how Chinese firms choose OFDI entry modes, especially the choice between joint ventures and wholly owned subsidiaries (Cui & Jiang, 2009). These studies emphasize the extent of control in different entry modes but ignore other dimensions. Meyer, Wright, and Pruthi (Meyer et al., 2009) introduce a new categorization of entry modes based on their potential to augment the resources of an entrant. They discuss entry modes from a resource-based perspective and argue that ‘foreign entry is a means to augment a firm’s resource base by (internal) exploration



Xiaobo Wu et al. 109

110


2. Method In this study, we adopt an exploratory case study method and conduct case analyses of three Chinese firms: Sany Group, Wanxiang Group, and Geely Holding Group. Based on the above theoretical foundation, we propose the conceptual dimensions for a single-case analysis. We analyze investment motives according to Dunnings’ classification: resource-seeking, market-seeking, efficiency-seeking, and strategic asset-seeking. We adopt the two dimensions that Meyer (2009) suggests to analyze investment patterns: degree of resource augmentation and degree of control. Then the similarities and differences between three cases are discussed in Section 4. We considered several factors in selecting the cases. First, we limited our study to manufacturing firms to minimize extraneous variations (Eisenhardt, 1989) that might arise from differences between the service and manufacturing sectors. Second, the three firms are representative of Chinese firms that conducted OFDI after 2000. A third factor considered is the feasibility of interviews with managers from the firms. We collected data for this study from both interviews and archives. We conducted face-to-face and telephone interviews with managers from the firms. Most of our informants had positions in top management or departments of overseas expansion. In addition to interviews, numerous archival data were collected for each case study, including annual reports, published case descriptions, and newspaper and magazine reports.

3. Single-case analysis 3.1. Case A: Sany Group’s greenfield investment in Germany Company overview Sany Group (Sany), the largest concrete machinery manufacturer in the world, and also one of the Global Top 50 Construction Machinery Manufacturers, was established in 1989 in Changsha, China. Sany mainly engages in the research and development (R&D), manufacture and sale of construction machinery. At present, Sany Group has over 35,000 employees in more than 120 countries. In 2009, sales revenue was RMB 30.6 billion, an increase of 46.4 percent over 2008.



of existing knowledge through organizational learning, and (external) access to complementary knowledge’ (Meyer et al., 2009). Therefore, the mode of acquisition has a higher degree of resource augmentation than greenfield investment. The dimension of resource augmentation just fits above arguments that Chinese firms invest overseas for asset exploration and to address competitive disadvantages.

Sany Heavy Industry Co., Ltd. (Sany Heavy), founded by Sany Group in 1994, includes over 120 product types in 25 series, such as concrete pumps, truck-mounted concrete pumps, concrete batching plants, asphalt batching plants, rollers, asphalt pavers, motor graders, truck cranes, and crawler cranes. Sany Heavy went public and was listed on the Shanghai Stock Exchange on July 3, 2003. In 2009 the sales revenue of Sany Heavy was RMB 16.5 billion, an increase of 20.01 over 2008. At present, Sany Heavy’s market shares of truck-mounted concrete pumps, concrete pumps, and full hydraulic rollers is number one in the domestic market. The output of pump trucks is number one in the world. Sany Heavy is the largest manufacturer of pump trucks with long booms and large displacement. Overseas investments Sany Group owns 30 foreign subsidiaries with more than 1300 employees working in overseas marketing and service departments. Among them, nearly 300 are foreign employees. In the past, export was the main path of Sany’s internationalization. Sany’s total exports now exceed US$1 billion. In recent years, establishing overseas plants has been another internationalization path. Sany Group has established R&D and manufacturing bases in the United States, India, Germany, and Brazil. On January 28, 2010, four concrete mixers made in Sany’s India plant were delivered from the factory in Pune, India, and exported to Sri Lanka. This was the first concrete mixer made by the Sany India plant and exported. We focus on Sany’s investments in Germany and analyze the motives and characteristics in the following section (Table 5.1). Motives for investment in Germany Market-seeking. Sany’s concrete piling crawler crane and road header machinery are the best-known products in China. Sany’s market share for truck-mounted concrete pumps is as high as 57 percent, the highest in the domestic market. But the domestic construction machinery market Table 5.1 Sany Group’s OFDI projects Year

Host country

Investment projects

2006 2007

India USA

2009

Germany

2010

Brazil

Invested $60 million to set up a manufacturing base Invested $60 million to set up an R&D and manufacturing base Invested ¤100 million to set up an R&D and manufacturing base Invested $200 million to set up a manufacturing base

Source: Annual Report of Sany Heavy Industry Co., Ltd. (2006–2009) and notes from interviews.





just accounts for about 15 percent of the global market. Huge overseas markets are attractive to Sany since it has become a leading company in China. In 2007, Sany’s revenues reached 13.5 billion RMB while its profit reached 4 billion RMB. Overseas sales increased from $60 million in 2006 to $220 million in 2007. Though domestic markets still play a dominant role for Sany, overseas markets represent an important expansion opportunity. The R&D and manufacture base Sany invested in Germany was intended to expand its market share in Europe. Strategic asset-seeking. Sany ranked number three to produce concrete pumping equipment in the industry, after two German enterprises, Putzmeister (number one) and Schwing (number two). Germany is one of the leading countries in machinery manufacturing, with products wellknown for high precision, excellent quality, and good performance. There is a clear gap in technological capability between Sany and Germany’s leading companies. Sany wanted to gain more technological talent and technology know-how through operations in Germany. Therefore, Sany Group’s decision to invest in Germany demonstrated strategic asset-seeking. Efficiency-seeking. In the past Sany needed to purchase automotive chassis, oil pumps, engines, and other components from Europe, nearly half of them from Germany. The final products had to be shipped to Europe after being assembled in China, with huge transportation costs for Sany. The R&D and manufacture base established by Sany in Germany would cover the entire European market and Sany would have local R&D, purchasing, production, sales, and service. Transportation costs, especially, would be reduced. Degree of resource augmentation and control Technological talents and technology know-how are the strategic assets that Sany wanted to gain through operations in Germany. These assets are all knowledge-based and have the nature of externality. Sany could access these assets from local knowledge spillovers. For example, Sany could recruit local professionals, work with local experts, and develop networks of contacts through personal ties of expatriate managers. Compared with exports and M&As, Sany’s greenfield investment provided a medium degree of learning about the local environment and a medium degree of resource augmentation. On the other hand, a 100 percent greenfield investment was a safer way to invest overseas for Sany. First, Sany could control the scale and schedule of investment projects to reduce investment risk. Second, Sany could establish a new plant to increase local employment and pay government tax revenue to reduce cultural and social conflict. Unpredictable risk, and cultural and social conflict caused by cross-border M&As, constituted



112


higher investment costs for Sany, which chose the greenfield investment and a high degree of control. 3.2. Case B: Wanxiang Group’s cross-border M&As in the USA Wanxiang Group (Wanxiang) was founded as a farm tool repair plant in Xiaoshan, China, in 1969. It provides universal joints, bearings and constant-velocity joints to customers in more than 40 countries. In addition to the auto parts industry, Wanxiang Group also engages in large-scale agriculture, aquaculture, real estate development, and infrastructure development. With 40,000 employees and $4.2 billion in annual revenue, Wanxiang Group is the largest auto parts maker in China and one of the Top 500 Chinese enterprises. Wanxiang America Corporation (Wanxiang America), located in Chicago, was formally established by Wanxiang Group in 1994 as the first wholly owned overseas subsidiary of Wanxiang Group. It helped the company build a global sales network covering both European and American markets and has 18 overseas sales subsidiaries in more than 50 countries. It is the largest Chinese-based company in the American Midwest. Overseas investment Wanxiang was far ahead of other Chinese companies in its efforts toward internationalization, which had three stages: exports, building overseas sales subsidiaries, and cross-border M&As. In the first stage, Wanxiang grew through exporting universal joints. In the second stage, Wanxiang established subsidiaries in America, Europe, and South America for expanding overseas sales. Since 1997, Wanxiang has made a series of cross-border M&As. Most of the target companies acquired by Wanxiang are American and nearly all are auto parts enterprises (see Table 5.2). Wanxiang has become the largest shareholder of the target company in most deals, including LT, UAI, and Table 5.2 Wanxiang Group’s OFDI projects Year

Host country

Investment projects

1997 2000 2000 2001 2003 2005 2007

UK USA USA USA USA USA USA

Acquired 60% stake in AS Company Acquired 100% stake in Zeller Corporation Acquired 35% stake in LT Company Acquired 21% stake in UAI Acquired 33.5% stake in Rockford Acquired 60% stake in PS Corporation Acquired 30% stake in ACH

Source: Notes from interviews, newspaper, and magazine reports.



Company overview

114


Rockford. We analyze the common characteristics of Wanxiang’s US projects below.

Market-seeking. Unlike Sany Group, Wanxiang’s growth has depended on overseas markets from the very beginning. When it entered China’s auto parts industry at the end of the 1970s, Wanxiang was not in the country’s central economic plan. Only state-owned enterprises that were in the central economic plan could supply products to automobile enterprises in China. Wanxiang had to export products to survive. The export of universal joints began in 1984 when Wanxiang got the first order from American auto parts manufacturer Zeller Corporation. Later Wanxiang became an important OEM (original equipment manufacturer) enterprise for the American auto parts industry. To extend its market share in America, Wanxiang broadened product categories and production scale by acquiring local auto parts enterprises. Strategic asset-seeking. Started as a farm tool repair plant 40 years ago, Wanxiang did not have a long development history or sophisticated technology in the auto parts industry. Its target companies all had a long history in the auto parts industry and many technology patents. Wanxiang wanted to gain technological assets to improve its own technological capability. But as a China-based company, it was difficult for Wanxiang to enter the local market with the ‘Wanxiang’ brand in America. The target companies owned local sales networks and had a brand reputation. ‘The company with advantages on technology, local sales network, and brand reputation are the ones that attract us,’ said Ni Pin, the president of Wanxiang America. Degree of resource augmentation and control In most of its acquisitions, Wanxiang used the same post-merger integration strategy of keeping the target company’s sales network and brand. The acquisition agreements required the target company to purchase a certain number of products from Wanxiang and sell these products under the local brand. Wanxiang successfully gained access to local firms’ technology, sales networks, and brand reputation by the majority stake acquisition. These resources are organizationally embedded and also important strategic assets for Wanxiang, making its degree of resource augmentation with cross-border M&As very high. Not intervening in the daily operations of overseas subsidiaries is a general principle of Wanxiang. In America, the general managers, chief operating officer, and chief financial officer were all recruited locally. Only 15 employees among the 4000 employees in the United States were from China. Wanxiang built on the longevity of its acquired brands rather than



Motives for investment in the United States


promoting the Wanxiang name. It exercised control mainly by suggesting performance targets at the board meetings of US subsidiaries. Wanxiang chose a medium degree of control in these majority stake acquisition projects. 3.3. Case C: Geely Holding Group’s acquisition of Volvo Geely Holding Group (Geely) was founded as a refrigerator component maker in 1986 in Zhejiang province, China, launching its auto manufacturing business in 1997. Geely was the first private company qualified to produce automobiles in China. Geely Automobile Holdings Limited (Geely Auto) became listed on the Hong Kong Stock Exchange in 2005. Geely located its headquarters in Hangzhou and six assembly and powertrain manufacturing plants in Lanzhou, Linhai, Luqiao, Ningbo, Shanghai, and Xiangtan. These facilities enable Geely to have a production capacity of 400,000 cars, 400,000 engines, and 400,000 transmissions per year. Geely Auto was one of the fastest growing automobile enterprises in China. It sold a total of 326,710 vehicles in 2009, an increase of 60 percent over 2008. Total revenue increased by 228 percent to RMB 14.1 billion. Geely Auto’s net profit was increased 35 percent to RMB 1.18 billion in 2009. Geely Holding Group’s profit reached RMB 1.32 billion in 2009, an increase of 52 percent over 2008. Overseas investment Geely’s first overseas investment took place in October 2006 when it acquired a 23 percent stake in Manganese Bronze Holdings, the leading maker of London’s black taxis, and became its largest shareholder. In March 2007, Geely set up a new production joint venture called Shanghai LTI Automobile Components Company Limited with Manganese Bronze Holdings Plc to manufacture the iconic London taxies and other limousines and taxis. Also in 2007, Geely announced its strategic transformation. It began manufacturing and selling higher-end vehicles and made major investments to improve its technology competence and product branding. The goal was to transform Geely’s competitive advantages on low price on to technology and quality. Geely gradually expanded its international operations to become a leading supplier for the safest, the most environmental friendly, and the most energy-efficient vehicles. In March 2009 Geely acquired Australian auto parts maker Drivetrain Systems International (DSI) for AUS$54.6 million. DSI designs, develops, and manufactures automotive transmissions for top global players like Ford, Chrysler, and Ssangyong Motors. On March 29, 2010, Geely Group acquired Swedish luxury car brand Volvo from Ford for US$1.8 billion. Geely acquired 100 percent of Volvo and its assets, marking the largest acquisition of an overseas carmaker by a



Company overview


Table 5.3

Geely Holding Group’s OFDI projects

Year

Host country

Investment projects

2006 2007 2009

UK Australian Sweden

Acquired 23% stake in Manganese Bronze Holdings Acquired Drivetrain Systems International (DSI) Acquired 100% stake in Volvo

Source: Notes from interviews, newspaper, and magazine reports.

Chinese company. It is also China’s biggest foray into ownership of a big luxury brand, seen as a milestone in the development of China’s automobile industry. We analyze Geely’s motives in acquiring Volvo (Table 5.3). Motives for acquisition of Volvo Market-seeking. China overtook the United States as the world’s number one auto market in 2009. China’s auto market has become a safe haven for car makers battered by a steep global industry downturn. With the country’s fast economic development China’s luxury car market grew rapidly in recent years. Geely is expected to use the Volvo brand to compete with Audi, Mercedes-Benz, and BMW in China’s luxury car market. Strategic asset-seeking. Though Geely is one of the fastest growing automobile enterprises in China, its success has hinged on selling inexpensive sedans in China and other developing markets. Technology development, quality improvement, and brand building are the critical factors for Geely’s sustainable development. Li Shufu, the chairman of Geely Holding Group, had targeted Volvo for eight years before acquiring it in 2010. It was not until the global economic crisis that Ford decided to sell Volvo, which lost $2.6 billion during 2008 and 2009. Li Shufu thought that Volvo’s safety and green technology, which are embedded in its brand reputation, were still valuable for Geely. Volvo fits Geely’s new strategy to become a leading supplier of the safest, the most environmentally friendly, and the most energy-efficient vehicles. Degree of resource augmentation and control Geely’s acquisition of Volvo includes agreements on intellectual property rights as well as supply and research and development arrangements among Volvo, Geely, and Ford. Geely will improve its own product line and enhance its image in China with Volvo’s high-end models, cutting-edge technology, and luxury car brand image. Volvo as a top brand in the world has accumulated enormous technology know-how and is an important strategic resource for Geely. The degree of resource augmentation in Geely’s full acquisition of Volvo is very high.



116


4. Cross-case analysis 4.1. Motives behind Chinese manufacturing firms’ investments in developed countries Based on our single-case analysis, we find that market-seeking and strategic asset-seeking are the two most important motives. But there are several motives at work in any OFDI by a Chinese manufacturing firm. For example, Sany invested in Germany for market-seeking, strategic asset-seeking, and efficiency-seeking. Wanxiang and Geely both had market-seeking and strategic asset-seeking motives when they acquired foreign companies. There is no evidence of resource-seeking motives in our single-case analysis. Even if they have the same basic motives, Chinese manufacturing firms are different in how they act based on their motives (see Table 5.4). For example, Geely wants to expand its share in the domestic luxury car market through cross-border acquisition, while Wanxiang wants to expand its market share in the United States. Geely and Wanxiang want to use the Table 5.4 Summary of cross-case analysis: motives Resource- Market-seeking seeking

Efficiencyseeking

Strategic assets-seeking

Sany Group’s investment in Germany

–

To expand market share in Europe with Sany brand

To reduce transportation costs of purchasing parts from Germany

To gain technological talent and technology know-how

Wanxiang Group’s investment in USA

–

To be a first-tier auto parts supplier for top three car manufacturers in the USA

–

To gain advanced technology, local sales networks, and brand reputation

Geely Auto’s acquisition of Volvo

–

To enter China’s luxury car market

–

To gain Volvo’s safety and green technology, brand reputation

Source: Case data.



Geely chose a high degree of control in acquiring Volvo, buying a 100 percent stake, including all factories, cars and parts, R&D centers, production lines, and other assets. Geely has demonstrated a strong desire to utilize Volvo’s resources as much as possible to shorten its learning curve. Geely wants to compete with international brands not only in China’s auto market but in the global auto market in the not too distant future.

118


4.2. Patterns of Chinese manufacturing firms’ investments in developed countries

Medium

High

Wanxiang’s M&A in the US

Geely’s acquisition of Volvo Sany’s investment in Germany

Low

Resource augmentation

The two dimensions, resource augmentation and control, show the nature of overseas investment, which allows firms to own new resources (control) and have the resources for creating more value (resource augmentation). Investment patterns can be classified into nine categories based on the degree of resource augmentation (low, medium, high) and the degree of control (low, medium, high). Figure 5.1 shows our classifications and findings from the cross-case analysis. Wanxiang and Geely, who were motivated by strategic asset-seeking and chose cross-border acquisition as the entry mode, showed a high degree of resource augmentation. Geely and Sany, who have a 100 percent stake in overseas subsidiaries, showed a high degree of control. Wanxiang usually chose majority stake acquisition as the entry mode. Compared with Geely’s 100 percent stake acquisition, Wanxiang’s degree of control is medium. Sany chose to access advanced technology through local knowledge spillover. Compared with acquiring advanced technology by cross-border acquisition, the degree of resource augmentation in the case of Sany is medium.

Low

Medium

High

Control Figure 5.1

Summary of cross-case analysis: patterns



target company’s brand as a strategic asset, but Sany just wants to access local advanced technology as a strategic asset in Germany. These findings tell us that the domestic market may also be an important target market, even though Chinese manufacturing firms have invested overseas. Chinese manufacturing firms may expand overseas quietly, without a ‘Chinese brand’.

In Figure 5.1 we see that, in general, Chinese manufacturing firms’ investments in developed countries show a comparatively high degree of resource augmentation and control. Unlike their investment goals in developing countries, Chinese manufacturing firms usually want to gain resources, including advanced technology, brand reputation, and sales networks, when they invest in developed countries. Chinese manufacturing firms tend to choose investment patterns with a high degree of resource augmentation and control to integrate with their low-cost production advantages.

5. Conclusion We analyze the motives and patterns of three Chinese manufacturing firms’ investments in developed countries and find that market-seeking and strategic asset-seeking are the two most important motives. Europe and the United States are now attractive for Chinese manufacturing firms looking for investments, not only because Chinese manufacturing firms are interested in potential market demand, but because they wish to acquire local distribution networks, frontier technology, advanced manufacturing procedures, and highly skilled people. It is interesting to find one special motive along with conventional motives in the cases. Since Chinese customers take the internationalization of a firm as an indicator of a firm’s success, and since most competition in the domestic market comes from MNCs founded in developed countries, Chinese manufacturing firms want to enhance their brand reputation in the domestic market by investing in developed countries. We classified the patterns of investment into nine categories based on two dimensions: the degree of resource augmentation and the degree of control. Chinese manufacturing firm investments in developed countries show a comparatively high degree of both resource augmentation and control. The higher the financial stake, the higher the degree of control. While the mode of acquisition shows a higher degree of resource augmentation than greenfield, in most cases Chinese manufacturing firms want to integrate overseas advantages on advanced technology, brand reputation, and local sales network with China’s advantages on low-cost production.

6. Implications The theoretical implications and practical implications of this study are limited but important. This study employs the resource-based view to analyze the motives and patterns of Chinese firms’ investments in developed countries. It sheds light on the contribution of the resource-based view to explain the ‘asset exploration’ motive of OFDI from emerging economies and the ‘resource augmentation’ dimension of investment patterns. The findings of this study challenge the traditional ‘gradual’ perspective of





firms’ internationalization process by emphasizing the mixed motives in any single OFDI. This study may be valuable for managers in Chinese manufacturing firms planning to invest in developed countries. Managers should consider the degree of control when they choose the pattern of investment, but a high degree of control does not mean a high degree of resource augmentation in some investment patterns. A pattern of investment with a high degree of resource augmentation is more useful for a foreign subsidiary to access and gain strategic assets that are embedded in developed countries.

7. Limitations and future research This study has certain limitations. We focus on a comparatively specific phenomenon in its infant stage, which limits the generalizability of the study. The cases selected are pilots in the context of Chinese investment in developed countries. More cases need to be included under the framework in future studies. The following themes represent valuable streams of study to pursue: what factors determine a higher performance of resource augmentation of China-based firms in developed countries? In the context of Chinese investment in developed countries, what is the relationship between subsidiary capability and Chinese manufacturing firm competitiveness in domestic markets?

Acknowledgements The authors are grateful for research funding from the National Natural Science Foundation of China (Project Number: 70772047) and help from employees of Sany Group, Wanxiang Group, and Geely Auto. We are also grateful for the valuable suggestions given by our colleagues Bin Guo, Yongyi Shou, Jian Du, Kaimei Wang, Ying Chen, Suli Zheng, Dong Wu, and the reviewers’ comments.

References Alon, I. & McIntyre, J. R. 2008. Globalization of Chinese Enterprises. New York, NY: Palgrave Macmillan. Alon, I., Chang, J., Fetscherin, M., Lattemann, C., & McIntyre, J. R. 2009. China Rules: Globalization and Political Transformation. New York, NY: Palgrave Macmillan. Buckley, P. J., & Casson, M. 1976. The Future of the Multinational Enterprise. London: Palgrave Macmillan. Buckley, P. J., Clegg, L. J., & Cross, A. R. 2007. The Determinants of Chinese Outward Foreign Direct Investment. Journal of International Business Studies, 38: 499–518. Cantwell, J. & Tolentino, P. 1990. Technological Accumulation and Third World Multinationals. London: Routledge. Child J. & Rodrigues, S. B. 2005. The Internationalization of Chinese Firms: A Case for Theoretical Extension. Management and Organization Review, 1: 381–410.



120

Cui, L. & Jiang, F. 2009. FDI Entry Mode Choice of Chinese Firms: A Strategic Behavior Perspective. Journal of World Business, 44: 434–444. Dunning, J. H. 1977. Trade, Location of Economic Activity and the MNE: A Search for an Eclectic Approach. In B. Ohlin, P. O. Hesselborn & P. M. Wijkman (eds), The International Allocation of Economic Activity. London: Macmillan, pp. 395–418. Dunning, J. H. 1998. Location and the Multinational Enterprise: A Neglected Factor. Journal of International Business Studies, 29: 45–86. Dunning, J. H. & Narula, R. 1996. Foreign Direct Investment and Governments. London and New York: Routledge. Eisenhardt, K. M. 1989. Building Theories from Case Study Research. Academy of Management Review, 14: 532–550. Hymer, S. 1960. The International Operations of National Firms: A Study of Direct Foreign Investment’, PhD Dissertation. Johanson, J. & Vahlne, J. 1977. The Internationalization Process of the firm – A Model of Knowledge Development. Journal of International Business Studies, 8: 22–32. Johanson, J. & Wiedersheim-Paul, F. 1975. The Internationalization of the Firm: Four Swedish Cases. Journal of International Business Studies, 10: 305–322. Lall, S. & Chen, E. 1983. The New Multinationals: The Spread of Third World Enterprises. New York: Wiley. Mathews, J. 2006. Dragon Multinationals: New Players in 21st Century Globalization. Asia Pacific Journal of Management, 23: 5–27. Meyer, K. E., Wright, M., & Pruthi, S. 2009. Managing Knowledge in Foreign Entry Strategies: A Resource-Based Analysis. Strategic Management Journal, 30: 557–574. Ping, D. 2007. Investing for Strategic Resources and its Rational: The Case of Outward FDI from Chinese Companies. Business Horizons, 50: 71–81. Rui, H & Yip, G. S. 2008. Foreign Acquisition by Chinese Firms: A Strategic Intent Perspective. Journal of World Business, 43: 213–226. Vernon, R. 1966. International Investment and International Trade in the Product Cycle. The Quarterly Journal of Economics, 80: 190–207. Wells, L. 1983. Third World Multinationals: The Rise of Foreign Investments from Developing Countries. Cambridge, MA: MIT Press. Xiaobo, W. & Wanling, D. 2009. Chinese Firms Internationalization Paths By Strategic Asset-Seeking Outward Foreign Direct Investment. Proceedings of Portland International Conference on Management of Engineering and Technology. Portland, Oregon, USA. Yeung, H. W. 1999. The Globalization of Business Firms from Emerging Economies. Cheltenham, UK: Edward Elgar.




A Two-way Causal Link between Internationalization and CEO Equity Ownership in Chinese Firms Xiaohui Liu and Jiangyong Lu

Internationalization is a critical strategic decision for firms in both developed and emerging economies. Research generally focuses on the driving forces and outcomes of internationalization, especially the impact on CEO compensation. Since internationalization increases managerial complexity and risk premium, CEOs must be compensated accordingly. Their increased pay creates a convergence of interests between shareholders and managers. The relationship of internationalization with CEO compensation has been established in existing studies (Sanders & Carpenter, 1998; Oxelheim & Randøy, 2005) but they do not take into account the fact that CEO compensation is also an antecedent of international diversification. Studies that examine the role of CEO compensation in internationalization (Filatotchev, Stephan, & Jindra, 2008; Musteen, Datta, & Herrmann, 2008; Datta, Musteen, & Herrmann, 2009; Lu, Xu, & Liu, 2009) treat it as a growth strategy and an important channel for maximizing firm value and enhancing firm performance (Hitt, Hoskisson, & Ireland, 1994; Lu, Xu, & Liu, 2009). When corporate governance sets the optimal level of CEO compensation, it helps alleviate principal-agent conflicts and may encourage internationalization. However, most existing studies that focus on a one-way relationship between CEO compensation and internationalization implicitly assume that reverse causation from either internationalization or CEO compensation is negligible. Assuming one-way causation may lead to overestimating the effect of the two factors on each other. It is difficult to address the endogeneity between the two factors in studies based on cross-sectional data analysis (Goranova, Alessandri, Brandes, & Dharwadkar, 2007). Whether CEO compensation is an antecedent of internationalization or the reverse remains almost completely unexplored. The interrelatedness between these two issues and the research gap limit our understanding of the determinants and consequence of CEO compensation. Failure to take 122



6

123

reverse causation into account may not only affect the statistical validity of prior findings, but also lead to inappropriate theoretical propositions based on biased empirical evidence. This paper takes a first step towards investigating a two-way causation between internationalization and CEO compensation by conducting Granger causality tests based on a sample of Chinese listed firms. It aims to establish the direction of causation between these two factors. Our study contributes to existing literature in several ways. First, the paper is one of the first to systematically investigate the bi-directional relationship between internationalization and CEO compensation, using panel data analysis to address the endogeneity between the two variables. The study findings will help to fill an important gap in the existing literature regarding the mutual reinforcement between internationalization and CEO compensation. Our research also challenges existing studies which have neglected the reverse causation between internationalization and CEO compensation. Second, by conducting Granger causality tests, we empirically isolate the effect of CEO compensation → internationalization from the effect of internationalization → CEO compensation, based on agency theory. The findings provide evidence on the mutual effect between these two factors. Finally, we extend prior studies on the internationalization of firms in emerging economies by using different measures for internationalization, such as its degree and scope. Hence, we do not rely on one uni-dimensional variable for measuring internationalization. We believe that our measurements reflect the dynamic process of internationalization of firms in emerging economies.

1. Theoretical framework and hypotheses International diversification creates value and benefits firms, according to many studies (Kim, Hwang, & Burgers, 1993; Hitt, Hoskisson, & Ireland, 1994; Liu & Buck, 2009). The advantages of internationalization are documented in the literature in terms of motives for internationalization (Dunning, 1988), such as market-seeking, asset-seeking, and efficiencyseeking foreign direct investment (FDI). Some empirical findings indicate that internationally diversified firms perform better and have higher returns than domestically focused firms (Kim, Hwang, & Burgers, 1993; Hitt, Hoskisson, & Ireland, 1994). Internationalization gives firms the opportunity to exploit and explore, especially when they face increasing global competition at home (Wiersema & Bowen, 2008). In addition, firms from emerging economies consider internationalization an effective way of obtaining advanced knowledge and catching up with multinational enterprises (MNEs) in developed countries (Buckley, Clegg, Cross, Liu, Voss, & Zheng, 2007; Deng, 2009). Internationally diversified firms, however, face exposure that increases the level of uncertainty, which may result in strategic errors such as



Xiaohui Liu and Jiangyong Lu


misunderstanding consumer tastes, regulations, retaliation from local and multinational players, and problems in accessing distribution channels (Mitchell, Shaver, & Yeung, 1992). International diversification may also lead to higher monitoring costs due to increased size and complexity (Geringer, Beamish, & daCosta, 1989; Hitt, Hoskisson, & Kim, 1997). In examining the factors affecting international diversification (see a review by Hitt, Tihanyi, Miller, & Connelly, 2006), researchers identify corporate governance as one of the important determinants. While some studies show that ownership, the board of directors, and CEO compensation affect firm internationalization strategies (Filatotchev, Stephan, & Jindra, 2008; Lu, Xu, & Liu, 2009), other studies investigate how internationalization affects CEO compensation (Sanders & Carpenter, 1998; Miller, Wiseman, & Gomez-Mejia, 2002). One neglected aspect in existing studies, however, is assuming that the relationship between firm internationalization and CEO compensation is uni-directional, either running from internationalization to CEO compensation or the reverse. Existing studies thus do not consider reverse causation explicitly, which may flaw the validity of empirical findings from prior studies and lead to inappropriate theoretical propositions, thus representing an important research gap. To analyze the underexplored two-way relationship between CEO compensation and internationalization, we adopt agency theory as our main theoretical framework. Agency theory has been widely applied to examine the relationship among firm performance, CEO compensation, and strategic choices, such as diversification (Brush, Bromiley, & Hendrickx, 2000; GomezMejia, Wiseman, & Dykes, 2005; Datta, Musteen, & Herrmann, 2009), based on the assumption that there may be a divergence in interests between agents and principals, and agents may behave according to self-interest (Gomez-Mejia & Wiseman, 1997; Gomez-Mejia, Wiseman, & Dykes, 2005). Agency theory argues that executive pay is a means of aligning the interests of executives with those of shareholders (Fama & Jensen, 1983). Executives receive incentives to perform well on behalf of shareholders. By providing incentives, the risk of deviation from the interests of the principal transfer back to the agent. The optimal CEO pay package would minimize agency cost as a trade-off between the costs of monitoring and incentives (GomezMejia & Wiseman, 1997). This approach can be used to examine the two-way relationship between CEO compensation and internationalization, theoretically underpinning the two dimensions of incentive pay. On the one hand, CEO pay in the form of long-term incentives, such as equity ownership, is a motivational tool, since it encourages managers to exhibit desirable behaviors to maximise firm values through pursuing feasible growth strategies, such as internationalization. International diversification is thus a function of CEO compensation. On the other hand, CEO equity ownership helps owners reduce monitoring costs and divergence in the interests of



124

125

agents and principals. Increased complexity associated with the degree and scope of internationalization makes it difficult to monitor senior executives. Long-term incentives minimize monitoring cost by aligning CEO interests with those of shareholders. CEO equity ownership thus becomes a reward which links pay to share price performance. This type of equity reward is expected to increase with the level of internationalization and the complex tasks it entails. Building on these theoretical perspectives, we develop two interrelated and testable hypotheses. 1.1. Internationalization → CEO compensation International diversification is more uncertain and risky than domestic business, as many studies document (Nelson, 2000). When a firm expands beyond the domestic market, it faces new cultures, customers, competitors, and regulations in foreign markets (Sanders & Carpenter, 1998). CEOs have more complex and demanding tasks within international firms than in domestic firms, which demand more information-processing for the top management team and information asymmetry between managers and shareholders. An increase in information asymmetry increases the cost and difficulty of monitoring CEOs. Equity pay, as an incentive alignment component of CEO compensation, is often referred to as a substitute for monitoring, especially since monitoring CEOs is difficult and costly in international firms. Equity pay should increase in such cases, with firms using long-term incentives to compensate or reward managers for undertaking complex internationalization strategies. CEO equity ownership represents reward through which CEOs are compensated for managing international diversification. In addition, international firms may be forced to pay their senior executives more if competitors do so. Long-term incentives such as equity pay are widely adopted in the United States and the United Kingdom (Buck, Liu, & Skovoroda, 2008). Other forms of remuneration cannot substitute for equity pay, which becomes essential to attract and retain chief executives. A competitive labor market requires international firms to offer their CEOs compensation packages with long-term incentives. We therefore predict that CEOs in Chinese listed firms with international diversification are more likely to receive equity pay: H1: There will be a positive association between the level of the international diversification of a firm and subsequent CEO equity ownership, running from internationalization to CEO equity ownership. 1.2. Internationalization ← CEO compensation International diversification allows firms to augment their core competences, gain valuable knowledge and exploit potential growth opportunities in foreign countries (Hitt, Tihanyi, Miller, & Connelly, 2006). It also helps to maximize firm value and enhance performance since it enables firms to





access foreign shareholders, resources, and institutions (Hitt, Hoskisson, & Ireland, 1994). Several recent studies on outward foreign direct investment (FDI) propose that firms from emerging economies tend to use outward FDI as a springboard to acquire advanced technology and widely recognised brands to catch up with technological leaders in the West (Makino, Lau, & Yeh, 2002; Mathews, 2006; Luo & Tung, 2007). Among the factors affecting international diversification strategies, CEOs have an important role in strategic decision-making, and their pay structure may influence strategic decisions. Agency theory argues that the design of an agent’s compensation structure reduces agency problems and associated costs by ensuring proper alignment of the interests of managers with those of owners. CEO compensation thus acts as a mechanism to converge interests between the agent and principal. An incentive system that encourages CEOs to take a long-term view is likely to result in different choices than a system with a short-term focus (DeFusco, Zorn, & Johnson, 1991). CEOs may take greater risks in pursuing growth via international diversification when their rewards are more closely linked to long-term performance (Musteen, Datta, & Herrmann, 2008). CEOs receiving long-term incentives may devote more attention to internationalization as an effective means of improving firm performance and avoiding risks associated with a limited domestic market. CEO equity ownership is a motivational tool in aligning the interests of managers and owner (Sanders & Hambrick, 2007). First, it helps overcome the problem of short-sightedness since CEOs would remain eligible for future gains in company share price even if their tenure ends. Equity pay helps foster a long-term orientation because executives retain a financial interest in the company even after they leave (Wong, 2010). Second, CEO equity ownership linking pay with share value encourages CEOs to choose appropriate growth strategies to maximise share value. It is in CEOs’ own interests to pursue value-enhancing strategies such as internationalization (Rajgopal & Shevlin, 2002; Sanders & Hambrick, 2007) and increased firm size through international diversification (Jensen & Murphy, 1990). Some studies find that equity ownership imposes market discipline on managers and motivates them to pursue more aggressively value maximization and improve firm performance (Pennings, 1980; Stearns & Mizruchi, 1993; Palmer & Wiseman, 1999). A positive relationship between managerial incentives and wealth-enhancing corporate strategies has been observed (Bethel & Liebeskind, 1993). Managers with equity ownership are more likely to pursue internationalization strategies with the potential for higher longterm returns. In contrast, when equity ownership in the firm is unavailable or is limited, CEOs have little incentive to pursue strategic options with long-term gain such as internationalization. Therefore, we propose.



126


127

H2: There will be a positive association between CEO equity ownership and subsequent international diversification, running from CEO equity ownership to internationalization.

2. Data and methodology

The sample firms were drawn from publicly-listed Chinese firms on the Shanghai and Shenzhen Stock Exchanges. We collected information on overseas subsidiaries from listed firms’ annual reports for 2002–2007, choosing 2002 as the starting year for two reasons: first, outward foreign direct investment (OFDI) by Chinese firms surged after China’s access to the World Trade Organization (WTO) at the end of 2001, and, second, annual reports for years before 2002 contain less detailed information on subsidiaries. We focused on firms that have invested overseas in all six years, from 2002 through 2007, and whose annual reports can be obtained from Shanghai and Shenzhen Stock Exchanges, the website of the China Security Regulation Committee (CSRC), and the websites of listed firms. There were 191 firms that established overseas subsidiaries in the sample period, the majority in the manufacturing sector. 2.2. Variables We use China’s OFDI to proxy the internationalization of Chinese listed firms because OFDI from emerging economies, China in particular, has recently grown substantially as part of an ongoing trend. Using an OFDI measure allows us to capture the internationalization trend in Chinese firms. We calculated two measures for China’s OFDI (Tihanyi, Johnson, Hoskisson, & Hitt, 2003). The first internationalization variable, Outward ∗ FDI (OFDI) Entropy, is defined as c Sc ln (1/Sc ) , where Sc is the share of investment in country c to total investment and ln(1/Sc ) is the logarithm of the inverse of the investment share. The measure considers both the number of countries where the firm operates and the relative importance of each region to the firm (Hitt, Hoskisson, & Kim, 1997). The second measure, Outward FDI (OFDI) Composition, combines both the FDI share in the total investment and the number of overseas subsidiaries, in which we adopt a factor analysis. The components were loaded on to one factor with the eigen value exceeding 1.0. The cumulative variance explained was 77.5 percent. We argue that these two measures represent an improvement in proxying internationalization as they capture the different dimensions of internationalization and allow us to estimate how internationalization and CEO equity pay affect each other. CEO equity ownership is measured as the percentage of total equity owned by the CEO.



2.1. Sample

128


We included state shareholding as the percentage of shares owned by the government and state-owned enterprises to control for the effects of state ownership. We followed the methodology of Delios, Wu, and Zhou (2006) to categorize ownership in Chinese listed firms according to the ultimate identity of shareholders. The impact of board characteristics on executive pay was considered. Outside director ratio was measured as the number of outside directors divided by the total number of board directors. Firm size was controlled for, as larger firms typically have more slack resources for internationalization, which was measured by the logarithm of firm total assets. Firm age was controlled for as a proxy of experience and resources. We controlled for a firm’s previous performance as measured by return on sales. We used industry dummies to control for industry effects in the manufacturing sector and the primary sector. We controlled for time effects by using year dummies. 2.4. Methodology To identify reverse causation from CEO equity ownership to internationalization, we conducted panel Granger causality tests, explained in detail in the Appendix. The dynamic interaction between CEO equity ownership and internationalization is our main focus since our sample period is relatively short, from 2002 to 2007. Based on the results of causality tests that denote two-way relationships between the equity ownership and performance variables, we go a step further to search for an appropriate model to estimate the strength of these relations. For example, if reverse causation from CEO equity ownership to internationalization exists, the impact of internationalization on CEO equity ownership would be overstated when estimating a single equation using ordinary least squares (OLS). Instead, panel system equations should be applied, using the generalized method of moments (GMM) in order to take reverse causation into account. This modeling strategy allows us to examine how CEO equity ownership and internationalization are interconnected and affect each other.

3. Empirical results Table 6.1 presents the correlation matrix with means and standard deviations. Most of the variables have the expected signs. A positive correlation exists between the variable for CEO equity ownership and the two measures of internationalization, which suggests that there is a positive relationship between CEO equity ownership and internationalization. However, correlations of this kind only measure contemporaneous relationships between variables without reflecting the time dimension. In addition, the correlation is symmetrical, with no evidence of the direction of causation. For these reasons, causality tests are needed. Examining the link running from equity



2.3. Control variables

Correlation matrix

1 CEO equity ownership 2 OFDI entropy 3 OFDI composition 4 Independent directors 5 Firm size 6 Firm age 7 Return on sales 8 State holdings

Mean

SD

0.001 0.141 1.474 3.240 12.188 14 0.029 11.998

0.005 0.196 2.015 1.107 1.459 4.744 0.076 18.550

1 1.000 0.081∗∗ 0.043∗ 0.022 −0.029 0.113∗∗ 0.065∗ 0.037

2

1.000 0.899∗∗∗ 0.004 0.066∗ −0.003 0.071∗ −0.060∗

3

1.000 0.025 0.065∗ −0.010 0.029 −0.081∗∗

4

1.000 0.076∗ 0.036 0.053∗ 0.084∗∗

5

1.000 0.060 0.341∗∗∗ −0.024

6

1.000 0.096∗∗ 0.147∗∗∗

7

8

1.000 0.003

1.000

Note: ***, ** and * represent significance at the 0.1%, 1% and 5% level.

129



Table 6.1


Table 6.2

Results from the panel causality test

Causality OFDI Entropy ⇒ CEO equity ownership CEO equity ownership ⇒ OFDI entropy OFDI composition ⇒ CEO equity ownership CEO equity ownership ⇒ OFDI composition Two-way causality

F test 3.08∗ 3.434∗ 3.131∗ 10.845∗∗∗

Inferences Yes Yes Yes Yes FDIENTROPY ⇔ CEOEO FAFDI ⇔ CEOEO

Note: ***, ** and * represent significance at the 0.1%, 1% and 5% level.

pay → internationalization enables us to differentiate the pay reward effect from the motivational effect, which previous studies neglect. The results from the causality tests summarised in Table 6.2 reveal the existence of significant two-way causality between executive pay and the two measures for internationalization, suggesting that executive equity ownership and internationalization mutually affect each other. The causation from internationalization to CEO equity ownership was established in prior studies (Sanders & Carpenter, 1998) but the reverse causation running from CEO equity ownership to internationalization, shown with two time periods, indicates that there is also feedback from CEO equity pay → internationalization, thus supporting H2. This interplay between executive equity ownership and internationalization represents a novel feature of our study and reveals that motivational effects, an important dimension of executive pay, should not be neglected. Previous studies on the relationship between internationalization and CEO equity ownership may have overestimated the reward effect of internationalization on CEO equity ownership without taking into account reverse causation via motivations. Our results show that CEO equity ownership is not simply a function of internationalization, but also has a reverse effect on internationalization. The results from the panel system equations presented in Table 6.3 show that the two measures for internationalization are statistically significant in CEO equity ownership (i.e. equity ownership is regressed on internationalization variables), suggesting that CEO equity ownership is positively affected by international diversification proxied by FDI entropy and FDI composition, thus supporting H1. This positive association between executive pay and internationalization again indicates that an increase in firm internationalization will result in a rise in executive equity ownership. The variable for state holdings has a negative impact on CEO equity ownership, while firm age has a positive effect on CEO pay. The variables for independent director, prior performance, and firm size are not statistically significant. In the internationalization equation (where internationalization is regressed on CEO equity ownership), the variable for CEO equity ownership



130

Xiaohui Liu and Jiangyong Lu Results from the panel system equations

CEO equity ownership equation

Dependent variable CEO equity ownership Coefficient (SE)

OFDI entropy

Independent directors Prior performance Firm age Firm size Constant

Coefficient (SE)

0.002 (0.001)∗∗

OFDI composition State holdings

Dependent variable CEO equity ownership

−0.0004 (0.0002)∗ 5.39E − 05 (0.0002) 0.002 (0.002) 7.19E − 05 (2.32E − 05)∗∗ −6.29E − 05 (6.14E − 05) −0.142 (0.046)∗∗

7.84E − 05 (4.87E − 05)∗ −0.0004 (0.0002)∗ 5.40E − 05 (0.0002) 0.002 (0.002) 7.24E − 05 (2.32E − 05)∗∗ −6.09E − 05 (6.09E − 05) −0.143 (0.046)∗∗∗

Internationalization equation

Dependent variable OFDI entropy

Dependent variable OFDI composition

CEO equity ownership

0.311 (0.099)∗∗∗ −0.003 (0.002) 0.002 (0.002) 0.021 (0.020) −0.001 (0.004)∗∗∗ 0.004 (0.001)∗∗∗ 2.707 (0.796)∗∗∗ 955 0.125

0.899 (0.081)∗∗∗ −0.041 0.026 0.001 0.024 0.246 0.202 −0.015 (0.004)∗∗∗ 0.049 (0.012)∗∗∗ 2.561 (8.543)∗∗∗ 955 0.173

State holdings Independent directors Prior performance Firm age Firm size Constant Observations Adjusted R-squared

Note: Standard errors (SE) are in parentheses; ***, ** and * represent significance at the 0.1%, 1% and 5% level.

positively affects the two internationalization measures, again supporting H2. The variable for firm size has a positive, significant association with the two internationalization variables, but the variable for firm age is negatively related to internationalization, showing that Chinese firms



Table 6.3

131

132


tend to internationalise at an early stage. The variables for state holdings, independent directors, and prior performance have little impact on internationalization.

This paper examines the two-way relationship between CEO equity ownership and international diversification based on a sample of Chinese listed firms. By conducting Granger causality tests, we find that CEO equity ownership is positively associated with international diversification. Corporate governance in Chinese listed firms plays an important role in internationalization strategies. CEO compensation motivates these executives to make strategic decisions on behalf of shareholders. CEO equity ownership is only a recent phenomenon in China but is an increasing trend even though ownership is relatively low by international standards. Our results on CEO equity ownership, which are quite similar to those in developed countries, shows how much marketization and corporate governance convergence between China and the West has taken place (Buck, Liu, & Skovoroda, 2008). It may reflect the fact that market-oriented CEO compensation has encouraged CEO loyalty and subsequent willingness to make risky longer-term decisions on issues such as internationalization (Kato & Long, 2006). We find that the scope and extent of internationalization also affect CEO equity ownership. Internationally diversified firms tend to use equity ownership to reward CEOs who take long-term views and manage complex and demanding tasks associated with internationalization. Hence, there is a feedback effect from internationalization to CEO equity ownership, consistent with previous studies that show internationalization as a function of CEO equity ownership. Our results clearly demonstrate that internationalization and CEO equity ownership go hand-in-hand and mutually reinforce each other. We also find that state ownership has a significant, negative impact on CEO equity ownership, indicating that the state still exercises significant control on CEO equity ownership through direct intervention. The state continues to influence enterprise structures and strategies, including the design of executive pay packages. CEO equity ownership in state-owned enterprises, to a larger extent, is not determined by market forces. Our findings indicate that previous studies may have overestimated the impact of the two variables on each other without taking reverse causation into account. CEO equity ownership and internationalization should be treated as interrelated issues and separate examination may produce biased results. Our study fills an important gap in existing research which has mainly focused on the Anglo-American aspect of CEO compensation. By examining how CEO compensation affects the internationalization strategies of



3.1. Discussion

133

Chinese firms, the study extends agency theory to a richer and more complex context beyond companies from developed countries where agency theory was originally derived. Unlike prior research that assumes straightforward causation between CEO compensation and internationalization, we adopt an appropriate empirical method to conduct panel data analysis by taking reverse causation into account and thus provide a better understanding of the complex relationship between OFDI and incentive systems. The results from our study show that previous empirical efforts to examine the link between CEO compensation and internationalization suffered from methodological problems due to failure to take reverse causation into account. This omission may limit our understanding of the complexity between internationalization and CEO equity ownership. Our study has some limitations. The sample only contains Chinese listed firms, which prevents us from investigating two-way causation between internationalization and CEO equity ownership in a wider context. Further research should be extended to other emerging economies where marketization and internationalization strategies exist, but variations in governance regimes suggest that there is scope for comparative international analysis. In addition, we did not examine in detail how internationalization occurs in organizations and how managers and boards of directors interact in deciding on significant international expansion due to data constraints and the empirical setting of Granger causality tests.

4. Conclusion Using panel data analysis, we test two-way causal links between internationalization and CEO equity ownership for a sample of Chinese listed firms. Differing from previous studies, our study considers reverse causation from internationalization to CEO equity ownership, an improvement over previous studies that consider only a one-way relationship between internationalization and CEO compensation. The results from Granger causality tests indicate a bi-directional relationship between internationalization and CEO equity ownership, thus suggesting that there are inter-relationships between CEO equity ownership and internationalization. Such complex relationships should be taken into account when examining how these two factors affect each other. Our study has policy implications. Corporate governance mechanisms, such as CEO equity ownership, can play a positive role in the internationalization decisions of firms in emerging economies. Existing studies find mixed results on the effectiveness of Western corporate governance mechanisms in emerging economies (Peng, 2004; Lau et al., 2007; Young et al., 2008). Our study suggests that designing an appropriate level and structure for CEO compensation, including CEO equity ownership, helps to mitigate the principal-agent conflicts in Chinese listed firms and facilitate their




134


international diversification. Thus, governments of emerging economies should encourage adopting long-term incentives as a major component of CEO compensation.

Appendix

Xit = ϕ0 +

n

ϕ1j Xit−j +

j=1

Yit = θ0 +

p j=1

n

ϕ2k Yit−k +

k=1

θ1j Yit−j +

p k=1

θ2k Xit−k +

n

ϕ3l Zit−l + uit ,

(1)

l=1 p

θ3l Zit−l + εit ,

(2)

l=1

where i = 1, . . . , N; t= 1, . . . , T, n and p are lag lengths. In equations (1) and (2), X and Y are the two variables (CEO equity ownership and international diversification in this case) proposed to have interacting relationships, given a set of control variables, Z. The null hypothesis ‘Y does not Granger cause X, given Z’ is tested via a standard F test on the joint significance of ϕ 2k in equation (1). Y is said to cause X in the Granger-sense if the ϕ 2k are jointly significant. Similarly, if the θ 2k are jointly significantly different from zero, the null hypothesis that X does not Granger-cause Y is rejected.

References Bethel, J. & Liebeskind, J.1993. The Effects of Ownership Structure on Corporate Restructuring. Strategic Management Journal, 14: 15–31. Brush, T., Bromiley, P., & Hendrickx, M. 2000. The Cash Flow Hypothesis for Sales Growth and Firm Performance. Strategic Management Journal, 21: 455–472. Buck, T., Liu, X., & Skovoroda, R. 2008. Top Executive Pay in China: A New Laboratory for Research? Journal of International Business Studies, 39: 833–850. Buckley, P.J., Clegg, J., Cross, A., Liu, X., Voss, H., & Zheng, P. 2007. The Determinants of Chinese Outward Foreign Direct Investment. Journal of International Business Studies, 38: 499–518. Datta, D., Musteen, M., & Herrmann, P. 2009. Board Characteristics, Managerial Incentives and the Choice between Foreign Acquisitions and International Joint Ventures. Journal of Management, 35(4): 928–953. DeFusco, R., Zorn, T., & Johnson, R. 1991. The Association between Executive Stock Option Plan Changes and Managerial Decision Making. Financial Management, 20: 36–43. Delios, A., Wu, J., & Zhou, N. 2006. A New Perspective on Ownership Identities in China’s Listed Companies. Management and Organization Review, 2: 319–343. Deng, P. 2009. Why Do Chinese Firms Tend to Acquire Strategic Assets in International Expansion? Journal of World Business, 44: 74–84. Dunning, J. 1988. The eclectic paradigm of international production: A restatement and some possible extensions. Journal of International Business Studies, 19: 1–31.



We conducted panel Granger causality tests using the following equations:

135

Fama, E. & Jensen, M. 1983. Separation of Ownership and Control. Journal of Law and Economics, 26: 301–325. Filatotchev, I., Stephan, J., & Jindra, B. 2008. Ownership Structure, Strategic Controls and Export Intensity of Foreign-Invested Firms in Transition Economies. Journal of International Business Studies, 39: 1133–1148. Geringer, J., Beamish, P., & daCosta, R. 1989. Diversification Strategy and Internationalization: Implications for MNE Performance. Strategic Management Journal, 10: 109–119. Gomez-Mejia, L. & Wiseman, R. 1997. Reframing Executive Compensation: An Assessment and Outlook. Journal of Management, 23: 291–374. Gomez-Mejia, L., Wiseman, R., & Dykes, B. 2005. Agency Problems in Diverse Contexts: A Global Perspective. Journal of Management Studies, 42: 1507–1517. Goranova, M., Alessandri, T., Brandes, P., & Dharwadkar, R. 2007. Managerial Ownership and Corporate Diversification: A Longitudinal View. Strategic Management Journal, 28: 211–225. Hitt, M., Hoskisson, R., & Ireland, R. 1994. A mid-range Theory of the Interactive Effects of International and Product Diversification on Innovation and Performance. Journal of Management, 20: 297–326. Hitt, M., Hoskisson, R., & Kim, H. 1997. International Diversification: Effects on Innovation and Firm Performance in Product-diversified Firms. Academy of Management Journal, 40: 767–798. Hitt, M., Tihanyi, L., Miller, T., & Connelly, B. 2006. International Diversification: Antecedents, Outcomes, and Moderators. Journal of Management, 32: 831–867. Jensen, M. & Murphy, K. 1990. Performance Pay and Top Management Incentives. Journal of Political Economy, 98: 225–264. Kato, T. & Long, C. 2006. Executive Compensation, Firm Performance and Corporate Governance in China: Evidence from Firms Listed in the Shanghai and Shenzhen Stock Exchanges. Economic Development and Cultural Change, 54(4): 945–983. Kim, W., Hwang, P., & Burgers, W. 1993. Multinationals’ Diversification and the RiskReturn Trade-off’. Strategic Management Journal, 14: 275–286. Lau, M., Fan, D., Young, M., & Wu, S. 2007. Corporate Governance Effectiveness during Institutional Transition. International Business Review, 16: 425–448. Liu, X. & Buck, T. 2009. The Internationalization of Chinese Firms: Two Case Studies from Lenovo and BOE. Journal of Chinese Economic and Business Studies, 7: 167–181. Lu, J., Xu, B., & Liu, X. 2009. The Effects of Corporate Governance and Institutional Environments on Export Behaviour in Emerging Economies: Evidence from China. Management International Review, 49: 455–478. Luo, Y. & Tung, R. 2007. International Expansion of Emerging Market Enterprises: A Springboard Perspective. Journal of International Business Studies, 38: 481–498. Makino, S., Lau, C., & Yeh, R. 2002. Asset-Exploitation Versus Asset-Seeking: Implications for Location Choice of Foreign Direct Investment from Newly Industrialized Economies. Journal of International Business Studies, 33: 403–421. Mathews, J. 2006. Dragon Multinationals: New Players in 21st Century Globalization. Asia Pacific Journal of Management, 23: 5–27. Miller, J., Wiseman, R., & Gomez-Mejia, L. 2002. The Fit between CEO Compensation Design and Firm Risk. Academy of Management Journal, 45: 745–757. Mitchell, W., Shaver, M., & Yeung, B. 1992. Getting There in a Global Industry: Impacts on Performance of Changing International Presence. Strategic Management Journal, 13: 410–432.





Musteen, M., Datta, D., & Herrmann, P. 2008. Ownership Structure and CEO Compensation: Implications for the Choice of Foreign Market Entry Modes. Journal of International Business Studies, 39: 1–18. Nelson, C. 2000. Import/Export: How to Get Started in International Trade. New York: McGraw-Hill. Oxelheim, L. & Randøy, T. 2005. The Anglo-American Financial Influence on CEO Compensation in non-Anglo-American Firms. Journal of International Business Studies, 36: 470–483. Palmer, T. & Wiseman, P. M. 1999. Decoupling Risk Taking from Income Stream Uncertainty: A Holistic Approach. Strategic Management Journal, 20: 1037–1062. Peng, M. 2004. Outside Directors and Firm Performance during Institutional Transitions. Strategic Management Journal, 25: 453–471. Pennings, M. 1980. Interlocking Directorates: Origins and Consequences of Connections amongst Organizations’ Boards of Directors. San Francisco, CA: Jossey-Bass. Rajgopal, S. & Shevlin, T. 2002. Empirical Evidence on the Relation between Stock Option Compensation and Risk Taking. Journal of Accounting and Economics, 33: 145–171. Sanders, W. & Carpenter, M. 1998. Internationalization and Firm Governance: The Roles of CEO Compensation, Top Team Composition, and Board Structure. Academy of Management Journal, 41: 158–178. Sanders, W. & Hambrick, D. 2007. Swing for the Fences: The Effects of CEO Stock Options on Company Risk Taking and Performance. Academy of Management Journal, 50: 1055–1078. Stearns, L. & Mizruchi, M. 1993. Board Composition and Corporate Financing: The Impact of Financial Institution Representation on Borrowing. Academy of Management Journal, 36: 603–618. Tihanyi, L., Johnson, R., Hoskisson, R., & Hitt, M. 2003. Institutional Ownership Differences and International Diversification: The Effects of Boards of Directors and Technological Opportunity. Academy of Management Journal, 46: 195–211. Wiersema, F, & Bowen, P. 2008. Corporate Diversification: The Impact of Foreign Competition, Industry Globalization, and Product Diversification. Strategic Management Journal, 29(2): 115–132. Wong, S. 2010. Uses and Limits of Conventional Corporate Governance Instruments: Analysis and Guidance for Reform, the Global Corporate Governance Forum of the World Bank Group at http://ssrn.com/abstract=1455166 (accessed on 15 May 2010). Young, M., Peng, M., Ahlstrom, D., Bruton, G., & Jiang, Y. 2008. Corporate Governance in Emerging Economies: A Review of the Principal-Principal Perspective. Journal of Management Studies, 45: 196–220.



136

Effects of Absorptive Capacity on International Acquisitions of Chinese Firms Ping Deng

Outward foreign direct investment (OFDI) by Chinese multinational corporations (MNCs) continues to grow, with international mergers and acquisition (M&A) the primary mode of entry for Chinese firms (Alon & McIntyre, 2008). In the first quarter of 2008, cross-border M&A volume from China jumped to $28.5 billion, four times the previous year’s amount (Xinhua, 2008; Fortune, 2009). Although various motivations underlie Chinese overseas acquisitions, strategy asset-seeking predominates (Child & Rodrigues, 2005; Deng, 2007). Chinese MNCs use cross-border M&As to acquire strategic assets or knowledge to improve their competitive advantage in the global marketplace. However, such strategic-asset-driven M&As do not guarantee superior business performance, especially in light of the tacit and proprietary nature of knowledge. For a number of Chinese MNCs, international acquisitions have proven to be highly problematic and valuedestroying (Economist.com, 2007). Given these M&A failures, and their frequency, we need to examine the strategic and performance dimensions of such M&As with a new rigor. By drawing on theories of absorptive capacity, we uncover some of the key firm-level factors and mechanisms that may contribute to outcomes. The absorptive capacity literature (Cohen & Levinthal, 1990; Zahra & George, 2002; Volberda, Foss, & Lyles, 2010) highlights the importance of taking in external knowledge, combining it with internal knowledge and absorbing it for commercial use. Firms with higher absorptive capacity tend to have a better foundation to create knowledge, assimilate and interpret opportunities, and develop and apply explicit knowledge more effectively. Building on the literature of absorptive capacity, we propose that Chinese firms’ ability to acquire strategic assets and improve competitive advantage depends on their absorptive capacity at various levels. Guided by this framework, we empirically analyze two M&As in leading Chinese companies (Lenovo and TCL). These M&As differ substantially in their ability to source 137



7


strategic assets and resulting performance outcomes. For TCL, its 2004 acquisition of Thomson’s TV (France) business proved highly problematic and is regarded as a typical example of a Chinese firm that ‘failed miserably in overseas expansion’ (Economist.com, 2007). For Lenovo, its acquisition of IBM’s PC unit in 2005 helped the company become one of the most internationally recognized Chinese brands (Fortune, 2009). As the first study that applies the arguments of absorptive capacity to resource-driven M&As by Chinese MNCs, we explain in detail why such M&A deals have different outcomes and we encourage business practitioners and academics to think about M&A strategy in innovative ways. By arguing that M&A represents a way for Chinese firms to acquire strategic assets within the constraints of their absorptive capacity, this study also draws lessons for other emerging markets that are closely watching Chinese firms’ international expansion strategy (Fortune, 2009).

1. Theoretical foundation and propositions Knowledge, especially tacit knowledge, is the most important strategic asset, according to the knowledge-based view (Kogut & Zander, 1992). Companies may use cross-border M&As to gain access to new knowledge and skills controlled by indigenous firms (Stahl & Voigt, 2008). Using M&As for resolving knowledge deficiencies, however, does not necessarily result in superior returns because strategic assets often are tacit, specific, and complex (Amit & Schoemaker, 1993). In addition, in the early stages of internationalization, firms tend to underestimate the complexities of foreign acquisitions and exaggerate the synergies from a combination of the merging firms’ strategic assets (Child, Falkner, & Pitkethly, 2001; King, Dalton, Daily, & Covin, 2004). To succeed in overseas acquisitions, firms need to develop the knowledge and routines to overcome these problems – that is, they need absorptive capacity (Kim, 1998). The literature on absorptive capacity generally agrees that absorptive capacity determines a firm’s ‘ability to recognize the value of new, external information, assimilate it and apply it to commercial ends’ (Cohen & Levinthal, 1990, p. 128; Volberda et al., 2010). It derives from stocks of knowledge within the firm and is a function of prior organizational problem-solving (Kogut & Zander, 1992). The absorptive capacity construct has emerged as an underlying theme in global strategy management to explain organizational phenomena such as strategic alliances, organizational learning, knowledge acquisition and transfer, and business performance (Lane et al., 2006). Absorptive capacity, which represents an organization’s dynamic capability, is a multidimensional construct, with each dimension playing a different but complementary role in influencing knowledge acquisition and business outcomes. For example, Zahra and George (2002) conceptualize it as a dynamic capability with a multidimensional construct



138

139

involving a firm’s ability to acquire, assimilate, transform, and exploit knowledge. Moreover, absorptive capacity itself is determined by a number of organizational antecedents with differing influences on different components of absorptive capacity (e.g., Jansen, Van den Bosch, & Volberda, 2005; Puranam, Singh, & Chauduri, 2009). This clarifies why certain firms are able to acquire and assimilate new external knowledge but are not able to transform and exploit it successfully. For instance, Kim (1998) considers the level of prior related knowledge the determinant of absorptive capacity. Van den Bosch and his colleagues (1999) demonstrate how organizational forms and combinative capacities influence the level of absorptive capacity. Other researchers (e.g., Volberda et al., 2010) show how multilevel antecedents influence future outcomes such as competitive advantage, innovation, and firm performance. In this paper, we propose an absorptive capacity model that highlights the main building blocks and outcomes. The model integrates the accumulated knowledge across different research efforts in the field, particularly cross-border M&As. Our framework consists of three key components that shape absorptive capacity, with each component determined by a number of organizational factors, as summarized in Figure 7.1. In the first dimension, antecedents of absorptive capacity, such as prior knowledge, are critical for the firm to recognize and understand the strategic assets to be acquired. The second dimension involves applying combinative capabilities to assimilate and combine newly acquired assets with the firm’s existing resources. The third dimension focuses on how the acquiring firms effectively transform and apply the acquired strategic assets. Below, we elaborate

Cross-border M&A by Chinese multinationals

Acquisition of strategic assets and valuable knowledge

Absorptive capacity Ability to recognize, integrate and assimilate knowledge • Prior related knowledge (P1) • Combinative capabilities (P2) Figure 7.1

Competitive advantage and superior performance

Absorptive capacity Ability to transform and apply knowledge into commercial ends • Strategy execution & effort (P3)

An absorptive capacity model of acquisition of strategic assets via M&A

Note: The solid arrows indicate the causal connections between the elements that constitute the focus of the current research, whereas the dashed arrows indicate the indirect and potential causal connections between the elements that are beyond the scope of the current study and may represent fruitful research opportunities in the future.



Ping Deng

140


on each of the three components, focusing on some of the key determinants, as shown in bold in the figure.

Recognizing and identifying the value of new external knowledge is the first step toward acquisition of strategic assets. Much of the literature identifies absorptive capacity as a knowledge base, especially prior knowledge in the firm (Lane, Salk, & Lyles, 2001). ‘Organizations need prior related knowledge to assimilate and use new knowledge’ (Cohen & Levinthal, 1990, p. 129) and to help understand the industry, products, and customers related to the knowledge held by the foreign firm. This facilitates knowledge absorption and development (Kim, 1998). Firms with a high level of absorptive capacity are likely to harness new knowledge from acquired firms to help their innovative activities because, without such capacity, it is hard for them to learn or transfer knowledge from one unit to another (Szulanski, 1996). Managers can help develop their firms’ absorptive capacity by building knowledge stocks through investment in internal R&D and carefully analyzing the potential target firm (Lei & Hitt, 1995). For firms in emerging markets, the intensity of effort is crucial for accumulation of prior related knowledge about the potential target firms (Kim, 1998). In sum, the extent of a firm’s prior related knowledge may determine the magnitude of the M&A effect on knowledge acquisition and serve as an important stepping stone for learning how to handle cross-border M&A activities (Shimizu, Hitt, Vaidyanath, & Pisano, 2004). The greater the prior related knowledge, the more likely the acquiring firm will acquire strategic assets. Based on the above discussions, we propose: Proposition 1. Whether and to what extent Chinese companies can acquire strategic assets via cross-border M&As will be contingent on their absorptive capacity, determined by the acquiring firms’ related knowledge of target firms. The greater the prior related knowledge, the more likely a firm will acquire strategic assets. 1.2. Ability to integrate strategic assets and its key determinant: Combinative capabilities Mere exposure to related external knowledge is not sufficient to ensure that a firm will internalize it successfully. Companies need to develop combinative capabilities to synthesize and acquire new knowledge (Zollo & Singh, 2004). Combinative capabilities involve coordination capabilities and socialization mechanisms for specific ways of dealing with different aspects of absorptive capacity (Van den Bosch et al., 1999). Coordination capabilities deepen knowledge flows across disciplinary boundaries and lines of authority and facilitate knowledge exchange by bringing together different



1.1. Ability to understand strategic assets and the key determinant: Prior related knowledge

141

sources of expertise and increasing interaction between areas of functional, or component, knowledge (Jansen et al., 2005; Puranam et al., 2009). Coordination capabilities also let employees combine sets of existing and newly acquired knowledge and generate commitment as well as decision-making (Kogut & Zander, 1992). Socialization mechanisms, on the other hand, may influence absorptive capacity by creating broad, tacitly understood rules for appropriate action under unspecified contingencies. They may contribute to effective communication and dominant values (Lane et al., 2001). The rationale underlying the above studies is that absorptive capacity in terms of combinative capabilities combines resources in new ways and serves as an effective governance mechanism, thereby contributing to assimilation and integration of the sought-after strategic assets. Therefore, we propose: Proposition 2. Whether and to what extent Chinese companies can acquire and integrate strategic assets via cross-border M&As will be contingent on their absorptive capacity, which depends on the acquiring firms’ combinative capabilities. The higher the combinative capabilities, the more likely it is that they will effectively integrate the acquired strategic assets. 1.3. Ability to apply strategic assets and its key determinant: Strategy execution and effort Acquisition of strategic assets does not automatically result in competitive advantage or high performance because ‘applying external knowledge involves the ability to diffuse knowledge within the organization, to integrate it with the organization’s activities, and to generate new knowledge from it’ (Lane et al., 2001, p. 1157). Research shows that an acquiring firm’s post-acquisition strategies and what it does after the acquisition can determine success or failure (Hitt, Harrison, & Ireland, 2001). Therefore, effectiveness of strategy execution by an acquirer may influence absorptive capacity and whether the acquirer can exploit the acquired new external knowledge or not. Knowledge matters, but the acquiring firm’s strategy execution matters more (Hitt et al., 2001; King et al., 2004). Accordingly, a concern for emerging market firms is how to manage acquired knowledge and improve business performance. Ineffective strategy execution is one of the primary reasons that acquisitions fail to create value for shareholders (Child et al., 2001; Capron & Mitchell, 2009). Daimler Benz’s acquisition of Chrysler, for example, failed because economies of scale were not realized due to ineffective strategic execution. Whether acquired knowledge can be deployed for competitive advantage depends on the acquiring firm’s strategy execution. Increased absorptive capacity would provide a basis for more effective management (Hayward, 2002; Bjorkman, Stahl, & Vaara, 2007). With subsequent increases in absorptive capacity there may be fewer errors, development of



Ping Deng

142


2. Method and data collection To test empirically the above theoretical model, we employed a case study research method. Case studies can provide valuable insights and richness of information, especially when the researcher’s focus is on ‘how and why’ questions (Yin, 2003). This study employs a comparative case study method of two high-profile Chinese cross-border M&A deals: TCL’s acquisition of Thomson’s TV business in 2004, and Lenovo’s acquisition of IBM’s PC unit in 2005. We focused on China because it is the largest emerging economy. OFDI from China, especially its M&As, is growing exponentially (Alon & McIntyre, 2008). Both companies had the same motivation for the M&A: acquisition of strategic assets to compensate for their competitive disadvantage in the global marketplace (Deng, 2009). However, the subsequent business performances are substantially different. Lenovo’s acquisition of IBM’s PC unit is a success story, while TCL’s acquisition of Thomson’s TV business was a disappointment (Economist.com, 2007; Fortune, 2009). These performance differences provide a unique opportunity to apply the absorptive capacity construct and understand differing M&A outcomes in the same strategic context. Our research relied on multiple sources of data. The primary data were collected through semi-structured interviews with senior executives from the two firms in October and November of 2007. Owing to the secrecy and delicacy of the M&A processes, the interviewees were promised anonymity. The secondary data are from internal and external documents, including memos by key managers, corporate newsletters and press releases, strategic reports, quarterly and annual reports, and media reports. The data were coded according to accepted content analysis procedures, with specific events identified as the unit of analysis (Yin, 2003). We identified themes in the data and compared them to relevant points in the absorptive capacity literature (Eisenhardt, 1989).

3. Absorptive capacity approach and cross-border M&As from China Among major M&As by Chinese MNCs, the 2004 merger of TCL with the TV division of France’s Thomson and the 2005 acquisition of IBM’s PC business



specialized and standardized routines, and increased execution effectiveness (Nadolska & Barkema, 2007). On this basis, we propose: Proposition 3. Whether and to what extent acquired strategic assets can enhance Chinese companies’ performance will be contingent on their absorptive capacity, which depends on the effectiveness of strategy execution. The more effective the execution, the more likely it is that the acquired strategic assets will improve business performance.

143

by Lenovo are the biggest and most high profile, as well as similar in many aspects. As two of the largest companies championed by the Chinese government, they are at the forefront of a new wave of Chinese MNCs (Morck, Yeung, & Zhao, 2008; Deng, 2009). Both Lenovo and TCL explicitly declare that their overseas M&A activities serve their goals of becoming first-class multinationals. Lenovo’s goal was to become a Fortune 500 company by 2010 (Morck et al., 2008). And TCL’s chief financial officer declared that the company aimed ‘to be the next Sony or the next Samsung’ (Deng, 2007). To achieve such ambitious goals, each company needed globally valued brands, leading-edge technologies, and genuinely innovative and admired business methods (Morck et al., 2008; Deng, 2009). In spite of the same strategic asset-seeking motivation, their performance outcomes are dramatically different. After acquiring Thomson’s TV business in 2004, TCL suffered huge losses (with a cumulative loss of over RMB 6 billion, or $680 million as of 2006) and sought bankruptcy protection for its European operations in May 2007. Conversely, for Lenovo, the IBM purchase emerged as the quickest and most efficient way to build up its global presence and international competitive position (Newman, 2007). Since the absorptive capacity construct explains why there are significant variations between the firms in their ability to evaluate and utilize outside knowledge (Capron & Mitchell, 2009; Volberda et al., 2010), this framework may provide new insights into their M&A performance differentials. In the following two sections, based on primary and secondary data, we illustrate the theoretical approach through a comparative case study of these two prominent cross-border M&A deals. 3.1. Lenovo’s acquisition of IBM’s PC unit – A success story Lenovo (originally known as Legend Group) is the largest computer company and the second largest electronics manufacturer in China. It began in 1984 as a spin-off from a new technology unit at the Chinese Academy of Sciences (CAS). With its $1.75 billion acquisition of IBM’s Personal Computing (PC) business in May 2005, Lenovo doubled its workforce and quadrupled its revenue, with former IBM operations accounting for about 70 percent of the combined firm’s revenue. High prior related knowledge of the target firm Initially, Lenovo achieved its competency in PC distribution through joint ventures with well-established MNCs like AST Computers, IBM, and HewlettPackard. Through these international joint ventures, Lenovo started manufacturing its own hardware products and developed its own PC brand. In 1997, seven years after it started making its own PCs, Lenovo became the best-selling PC in the country. Its prior related knowledge is reflected in its ongoing R&D (at least 1 percent of its annual revenue is spent on R&D).



Ping Deng


Lenovo uses its R&D resources in modification research, which is essential to succeed in new markets. In addition, every employee receives training in corporate strategy and related areas through Lenovo University. The management team is also hungry to learn what it takes to build a truly global business. This commitment to learn and absorb successful techniques is a potential strength as Lenovo ventures into other geographic regions and cultural clusters. In the IBM PC acquisition, Lenovo’s ability to identify and acquire strategic assets was preceded by a unique and intense effort before the deal. Lenovo’s top executives were aware of the challenges that they faced in combining two different cultures as well as managing highly complicated logistics and supply chains. Moreover, IBM’s PC business had a cumulative loss of $4 billion during the four years before it was sold to Lenovo. To fully recognize and acquire the strategic assets from the deal, Lenovo’s top management team, supported by McKinsey & Company and Goldman Sachs, analyzed potential challenges and risks by repeatedly asking: Are Lenovo’s executives capable of running a complex global business? Will the new Lenovo be accepted by IBM’s clients and the PC market? Can the two corporate cultures be successfully consolidated? Why was IBM’s PC business unprofitable? Based on this in-depth analysis and thorough knowledge of the target firm, Lenovo knew what it was buying. As one senior Lenovo manager commented: As discussions progressed, we gained confidence that many of the risks we feared could be distributed or controlled. For example, we worried about losing customers. So we worked out an agreement that would allow us to continue using the IBM brand, to keep the IBM salespeople, and even to keep the top IBM executive as CEO. Equipped with valuable strategic assets, including IBM’s ThinkPad brand and ThinkVantage technologies, the new company started from a good spot. Strong combinative capabilities In addition to thorough knowledge of the target firm, combinative capabilities were also important for Lenovo to integrate and assimilate new knowledge. Shortly after the IBM PC takeover, the board created a powerful strategy committee headed by Yang Yuanqing and supported by other strong managers, including company co-founder Liu Chuanzhi. In the first year of the combined company’s operation, the committee played a major role in setting strategy and recruiting key corporate executives. Lenovo also assembled an international management team, which boasted a combination of management savvy, technical expertise, and proven track record of diversity. One Lenovo executive commented, ‘These design steps are intended to



144

Ping Deng

145

A lot of IBM managers expressed a kind of glee at being out from under IBM. Compared with the plodding pace at Big Blue, we describe Lenovo as if it were a Silicon Valley start-up. It’s a young, international, ambitious company. It is also willing to change – a good base for cultural integration. Further, the new company actively looked for opportunities within a regional and geographic cluster by clarifying the accountability of key individuals and enforcing a common culture where needed. As one senior manager said: The benefits of regional clustering are numerous, including stronger integration of the relevant functions across countries, the avoidance of duplication and moving toward organization integration. The mechanism also helps us share best practices in formal and informal networks, rotate key people from one country to another, and create a corporate culture to develop common work patterns that facilitate cross-border cooperation. Effective strategy execution and effort In the post-acquisition stage, effective strategy execution is one of the key attributes for successful cross-border M&As (Child et al., 2001). With the increasing pressure for faster cost-cutting and more effective decisionmaking, William Amelio, Dell’s former senior vice president for Asia-Pacific and Japan, replaced Steve Ward as CEO of Lenovo. Amelio brought his extensive knowledge to Lenovo, whose top management possessed little experience on a global stage. Under the leadership of Amelio, Lenovo was relentless in cutting costs from its PCs, but did so through production efficiencies, not by cutting R&D or product features. In the meantime, Lenovo accelerated its business expansion, largely in emerging markets. In July 2007, Lenovo announced two new manufacturing plants and fulfillment operations centers in Monterrey, Mexico, and Baddi, India, at an investment cost of over $30 million. The new product range offered in the Indian market included notebooks such as the IdeaPad Y710, IdeaPad Y510 and Idea Pad U110, and the desktops, Idea Center K200 and Idea Center Q200. As of March 2008, Lenovo had service centers in 15 Indian cities. As its latest move in a string of global expansions, in December 2007, Lenovo announced its first European manufacturing site in Poland with a total investment of $20 million.



create the best organization for extracting cross-border synergies and, at the same time, protect IBM’s old value . . . Our cohesive team helped find ways to turn diversity into competitive advantage.’ In the meantime, the IBM-ers, instead of rejecting their new corporate parent, embraced Lenovo. One long-time IBM executive noted:

146


Part of the reason that our strategy execution has gone so well is that there is hardly any overlap between the Lenovo business and the old IBM PC division. With the IBM PC unit, more than 60 percent of our business was with notebooks. And when you look at Lenovo in China, 85 percent of it was in desktops. IBM focused a lot on the large-enterprise market and they were focused on consumers and small business. Note too that Lenovo and IBM are each other’s biggest customer. Such resource complementarity no doubt helps the combined firm successfully put the acquired knowledge and skills to commercial ends. Further, Lenovo knew how to accommodate vastly different needs of consumers and business customers in the newly competitive setting. The company developed two distinct sales models, and products rally around these models. The traditional Lenovo PC products are aimed at consumers (outside the United States) and sold through a high-volume ‘transaction’ model. The ThinkPad brand of business products are sold through a lowvolume ‘relationship’ model. This dual business model enabled Lenovo to quickly expand into the small-business and home-PC markets outside of China, which is becoming more lucrative. This innovative business method proved very successful in the United States, for example, where the old IBM had an exclusive focus on serving large corporations. In early 2006, Lenovo launched a new range of PCs targeted at small- and mid-sized entities (SMEs) in the United States. In January 2008, it launched a new line of Idea Pad notebooks and desktops, its first-ever consumer computers for the United States. By early 2008, Lenovo’s distribution networks in the United States had 2600 partners focusing on the SME market. As one Lenovo executive commented: Lenovo has a very successful business model in China. A lot of it applies to other markets, especially emerging markets; but not everything. So we intensively discuss what makes sense to replicate, and what doesn’t make sense. We want to extend the business model that was so successful in China across the world. Judged by several measures of absorptive capacity, Lenovo has acquired valuable strategic assets and, after two years, has begun to turn in superior business results. The company has successfully reassured existing ThinkPad customers of the brand’s high-quality reputation, and there has been minimal drop-off in loyalty. On November 2, 2007, Lenovo finally severed



Before the M&A, Lenovo’s executives knew about the problems HP faced after it acquired Compaq in 2002. But Lenovo–IBM had some advantages that HP–Compaq did not; their resources complemented each other neatly. This is well-summarized by a former IBM-er and now Lenovo’s top supply chain executive:

147

ties with the IBM brand name two years earlier than planned, in a sign that it was ready to stand on its own. For the three months ended September 30, 2007, Lenovo’s net profit nearly tripled to $105.3 million and surpassed the forecast of $72.3 million. This was Lenovo’s fourth consecutive quarter of dramatically increasing sales revenue and exceeding expectations. With 2007 global sales revenue of $16.8 billion, in July 2008 Lenovo became the first Chinese private company to join the elite Fortune 500 list, an ambitious strategic goal accomplished in just three years. 3.2. TCL and Thomson’s TV Business – An acquisition failure As China’s largest color TV and second largest mobile phone maker, TCL began to aggressively promote its brand internationally in 2000. Its global expansion culminated in January 2004 when it struck a $560 million deal to merge its TV and DVD operations with those of French consumer electronics giant Thomson. The resulting venture, TCL–Thomson Electronics Co. Ltd. (TTE), in which TCL held a 67 percent equity share, began formal operations in July 2004 and was totally acquired by TCL in 2006. When the TCL–Thomson deal was announced, one business observer called it ‘the latest and most dramatic example of China’s determination to put its own stamp on the global marketplace . . . There’s no company that has a better chance of becoming China’s first truly global corporation than TCL’ (Business China, 2004). The agreement was signed in the presence of the French prime minister and Chinese president, highlighting its significance. But the deal is now widely regarded as one more example that China ‘failed miserably in overseas expansion’ (Economist.com, 2007). Due to its highly problematic and value-destroying European operations, during 2005 and 2006, TCL cumulatively suffered a total loss of RBM 5.07 billion ($680 million). As a result, its stock was put on a ‘star’ and became ‘*ST TCL’, indicating that the stock was at risk of being delisted. In November 2007, TCL declared its European operation ‘insolvent’ and overhauled its TV manufacturing operations. TCL’s original goal in acquiring Thomson’s TV unit was to obtain its technology, distribution channels, brand and network assets. With the massive restructuring, TCL gave up Thomson’s original business model, distribution channel and even the Thomson brand. Since absorptive capacity is one of the major requirements for acquiring firms to obtain external knowledge, and since it has a direct impact upon business performance, our framework may provide insights into why this high-profile M&A failed. Lack of related knowledge of the target firm TCL had prior knowledge related to the global TV industry and had served other emerging markets similar to the home market before moving into developed markets. In Asia, for example, TCL products are sold under its own brand, claiming a 14 percent share in Vietnam and 8 percent in the



Ping Deng


Philippines. However, TCL failed to recognize the true value of the acquired firm because it had not carefully examined Thomson’s brands and related products and services. Hu Qiusheng, a former TCL senior director who was thoroughly involved in the entire negotiation process, was firmly against the deal because of numerous ambiguities and unfavorable terms, including paying license fees for using Thomson’s trademark in Europe after 2008. Consequently, he was not appointed the first CEO of TTE when it was set up in July 2004. Moreover, throughout the negotiation process, TCL did not even hire acquisition experts as its business and financial advisors. TCL did spend 10 million Euros and hired Boston Consulting Group to do an appraisal. Based on the appraisal, the outlook for the deal was not very optimistic due to the risk involved. However, TCL’s chairman, Li Dongsheng, ignored the ‘pessimistic’ report and decided to gamble on the deal simply because it appeared attractive; it was considered an ideal marriage between TCL’s cost advantage and Thomson’s strengths in brands, distribution, and research networks, in Europe and the United States. Unlike Lenovo’s top executives, who were willing to take risks only if they had thoroughly studied the situation and believed that they had a reasonable chance of prevailing, TCL’s top management team acquired Thomson’s TV business without an appropriate financial and competitive justification. As one former TCL executive noted, ‘Our internal review did not articulate a rationale that fits the story line of the entire organization and also did not spell out the economic requirements for integration.’ The Thomson brand in Europe and its RCA brand in the United States were rather tired names. Thomson’s TV and DVD operations lost more than $100 million in 2003. In addition, the deal was highly complex because the joint venture had to negotiate specific contracts for access to those parts of the business not being transferred, including the sales and IP businesses from Thomson. To make matters worse, in late 2004, Thomson surprised the market by announcing that it was taking a small stake in Konka, a TCL rival. As one TCL executive admitted, ‘The international setback occurred mainly because we did not prepare well before the deal. We were not familiar with the local business operations in Europe. We simply thought about the overseas market using our Chinese logic. When we copied the Chinese business model abroad, it did not work.’

Weak combinative capabilities TCL not only lacked prior knowledge related to Thomson’s business operations, it lacked combinative capabilities to integrate and assimilate the acquired knowledge. The shortage of TCL managers with international experience and expertise in global marketing was a major constraint. The new company did not work well with people from different cultures with different experiences and routines. Because of language issues and disagreements on compensation issues, it took a long time for the new company to develop



148

149

a common production strategy. As one TCL senior manager said, ‘We failed to grasp and address the barriers that might hinder the level of integration we desired. In addition, we did not understand organizational barriers that might obstruct the capture of cross-border value, destroying the sources of local and international value associated with the acquisitions.’ In addition, TCL wanted greater management and hierarchical cultural control of its European operations and so it imposed control structures suitable for China but not for France. Many French staff quit in frustration. Some TCL French executives, for example, were unhappy to find that a meeting was planned for the weekend (which occurs regularly in China) and they just turned off their cell phones. TCL managers also failed to understand changes in the industry, initially because they tried to assimilate new external knowledge through old cognitive models. Only after a series of failed assimilation processes did they change their domesticallyoriented cognitive structures. There is no doubt that differences in cognitive structures, value systems and behavioral norms all contributed to the new company being less likely to acquire and assimilate capabilities. As one TCL executive commented, ‘Obviously, TCL was not aware of the cross-border opportunities and managers ignored the chance to collaborate in other parts of the new joint venture. . . . Surprisingly, few people at the new company had the knowledge to truly consider the cross-unit, cross-functional and cross-cultural approach.’

Problematic strategy execution When the deal was done, TCL executives believed that the synergy of the M&A would benefit the firm in the long term, through economies of scale, complementary resources, cost control, and shared R&D capacities. But the challenges and difficulties were much more serious than anticipated. In essence, the M&A went far beyond typical arrangements that shift a Western company’s high-cost manufacturing operations to lower-cost China. Because of too many overlapping product lines and manufacturing facilities, it was not practical for TCL to easily shift production to less expensive facilities in China and realize greater economies of scale. In India, for instance, TTE products appeared under both Thomson and TCL brands. It was hard to save money by using common designs for chipsets and leveraging their buying power as a large customer. On the other hand, the sources of TCL’s competitive edge in China – its relationship, local knowledge, distribution networks – could not be transferred overseas. Moreover, TCL’s international expansion strategy was too rapid and too aggressive; hence, the company failed to develop its own absorptive capacity, and it did not have enough time to integrate the new knowledge and apply it to commercial ends. Besides the Thompson deal, in September 2002, TCL acquired the German-based Schneider Corp. In 2003, it acquired GoVideo,



Ping Deng


an Arizona-based US firm focusing on visual products and DVD players. In August 2004, it created another majority-owned joint venture, TCL & Alcatel Mobile Phones Limited (TAMP), to pursue mobile phone development, production, sales, and services. In 2005, it set up a third majority-owned joint venture, with InFocus Corp., to produce rear-projection TV components. As TCL adopted a course of almost unlimited international expansion, it was unable to learn from its prior experiences and apply them throughout the organization. An effective acquisition should ensure that every deal supports the corporate strategy (Hitt et al., 2001) but almost all TCL’s M&A deals were only generally related to its strategic direction, and the connections were neither specific nor quantifiable. A major motivation behind the acquisition of Thomson’s TV unit was acceleration of TCL’s development of TV technology, but Thomson’s CRT and projection TV technologies were quickly replaced by new technologies. As one TCL senior manager said: Acquisition of Thomson didn’t help because its technical expertise lay in projection TV sets. We had expected to sell a breakthrough design by Thomson in large-screen TVs: a rear-projection model with a 61inch screen in our traditional market, China, but the market simply disappeared for large-screen LCD TVs . . . . Our top decision makers also underestimated the sheer difficulty of getting hundreds of people to cooperate on a common goal. They did not have clear accountability and simply took a one-size-fits-all approach to all the M&A deals. Finally, TCL not only failed to anticipate a boom in consumer demand for flat panel TV sets but was slow to respond to a shift in consumer preferences. Most TVs sold in the USA during the third quarter of 2006 were flat screens. Japan and Europe also reached that milestone in 2006. When customers started switching to new LCD screens and stopped buying old-fashioned CRT and projection TV set, TCL’s European operations faced major restructuring problems. In an effort to catch up, TCL announced plans in 2005 to buy flat panels for its new flat-panel TV sets from LG.Philips LCD Co. Even so, it already lost a key US distribution outlet when its contract expired with Best Buy in 2006. As its CRT and projection TV sales slowed down sharply, TCL not only lost its crown as the world’s largest TV maker to Korean rivals, but it piled up big losses on TCL and Thomson television brands amid a series of strategic missteps.

4. Conclusions and implications Based on theories of absorptive capacity, firms want to improve their competitive advantage by acquiring strategic assets within the constraints of their absorptive capacity. Following this logic, we compare two prominent



150

151

cross-border M&A deals by Chinese MNCs and confirm that a strategy such as an overseas acquisition requires the acquiring firm to know its own absorptive capacity and its determinants. The calculus of acquiring firms’ absorptive capacity captures the extent to which Chinese companies may utilize M&A strategy to acquire strategic assets and achieve superior business performance. Differences in absorptive capacity may therefore explain why acquiring firms, facing similar competitive landscapes, may achieve substantially different outcomes. Firms like Lenovo with strong absorptive capacity have a better understanding of new knowledge and can harness it for innovative activities and financial performance. Without such a capability, acquiring firms like TCL are not able to acquire and transfer new knowledge from the acquired firm. Changing structures and practices of the acquired firm suitable to the new markets destroys the source of competitive advantage. Our study offers practical guidance for decision-makers in formulating and implementing a resource-driven acquisition strategy. A mere preoccupation with the seemingly positive contribution of strategic assets to competitive advantage is not likely to realize M&A potential. Rather, decision-makers must evaluate their own absorptive capacity as the first step in international acquisitions. Only then can they judge whether they can utilize cross-border M&A deals for their global expansion strategy. Even if a firm internalizes transactions through M&A, with weak absorptive capacity, it may be unable to assimilate and successfully apply the benefits of acquired strategic assets, as shown in the TCL case. Alternatively, a firm with strong absorptive capacity can internalize synergies to leverage the acquired strategic assets, thus enhancing its competitive advantage, as shown in Lenovo’s acquisition of IBM PC unit. The biggest challenge that most firms face with overseas acquisitions is not only getting the right deal, but having the capability to handle the integration. This has important strategic implications especially for emerging MNCs eager to know whether acquisitions of foreign firms will allow them to improve their international competitive edge over well-established Western multinationals.

Acknowledgment This paper is a revision of a previous version which was presented at the Academy of Management Annual Meeting, August 7–11, 2009, Chicago, USA. This research was supported in part by the Program for Professor of Special Appointment (Eastern Scholar) at Shanghai Institutions of Higher Learning. I am deeply grateful to the editors (Drs Ilan Alon, Marc Fetscherin, and Philippe Gugler) and four anonymous reviewers for their constructive comments and suggestions, which helped significantly in improving the manuscript.



Ping Deng

152


Alon, I., & McIntyre, J. (eds) 2008. Globalizing of Chinese enterprises. New York, NY: Palgrave Macmillan. Amit, R., & Schoemaker, P. J. H. 1993. Strategic Assets and Organizational Rent. Strategic Management Journal, 14(1): 33–46. Bjorkman, I., Stahl, G. K., & Vaara, E. 2007. Cultural Differences and Capability Transfer in Cross-border Acquisitions. Journal of International Business Studies, 38(4): 658–672. Business China. 2004. Corporate Strategy: Crossing Boundaries. February 16. Capron, L., & Mitchell, W. 2009. Selection Capability: How Capability Gaps and Internal Social Frictions Affect Internal and External Strategic Renewal. Organization Science, 20(2): 294–312. Child, J., Falkner, D., & Pitkethly, R. 2001. The Management of International Acquisition. Oxford, UK: Oxford University Press. Child, J., & Rodrigues, S. B. 2005. The Internationalization of Chinese Firms: A Case for Theoretical Extension. Management and Organization Review, 1(3): 381–410. Cohen, M. W., & Levinthal, D. A. 1990. Absorptive Capacity: A New Perspective on Learning and Innovation. Administrative Science Quarterly, 35: 128–152. Deng, P. 2007. Investing for Strategic Resources and Its Rationale. Business Horizons, 50(1): 71–81. Deng, P. 2009. Why do Chinese Firms Tend to Acquire Strategic Assets in International Expansion? Journal of World Business, 44(1): 74–84. Economist.com. 2007. Global Agenda. Hey, Big Spender. June 4, p. 1. Eisenhardt, K. M. 1989. Building Theories from Case Study Research. Academy of Management Review, 14(4): 532–550. Fortune. 2009. Cover Story: China Buys the World. October 26. Hitt, M. A., Harrison, J. S., & Ireland, R. D. 2001. Mergers and Acquisitions: A Guide to Creating Value for Stakeholders. New York: Oxford University Press. Hayward, M. L. A. 2002. When Do Firms Learn from Their Acquisition Experience? Strategic Management Journal, 31(1): 21–39. Jansen, J. P., van den Bosch, F. A. J., & Volberda, H. W. 2005. Managing Potential and Realized Absorptive Capacity. Academy of Management Journal, 48(6): 999–1015. Kim, L. 1998. Crisis Construction and Organizational Learning. Organization Science, 9: 506–521. King, R., Dalton, R., Daily, M., & Covin, J. 2004. Meta-analyses of Post-acquisition Performance. Strategic Management Journal, 25(2): 187–200. Kogut, B., & Zander, U. 1992. Knowledge of the Firm, Combinative Capabilities, and the Replication of Technology. Organization Science, 3(3): 383–397. Lane, P. J., Koka, B. R. K., & Pathak, S. 2006. The Reification of Absorptive Capacity. Academy of Management Review, 31(4): 833–863. Lane, P. J., Salk, J. E., & Lyles, M. A. 2001. Absorptive Capacity, Learning, and Performance in International Joint Ventures. Strategic Management Journal, 22: 1139–1161. Lei, D., & Hitt, M. A. 1995. Strategic Restructuring and Outsourcing. Journal of Management, 21: 835–859. Morck, R., Yeung, B., & Zhao, M. 2008. Perspectives on China’s Outward Foreign Direct Investment. Journal of International Business Studies, 39(3): 337–350. Nadolska, A., & Barkema, H. 2007. Learning to Internationalize. Journal of International Business Studies, 38(7): 1170–1186.



References

153

Newman, R. 2007. Lenovo’s Great Leap. U.S. News & World Report. October 15. Puranam, P., Singh, H., & Chauduri, S. 2009. Integrating Acquired Capabilities: When Structural Integration Is (un)necessary. Organization Science, 20(2): 312–328. Shimizu, K., Hitt, M., Vaidyanath, D., & Pisano, V. 2004. Theoretical Foundations of Cross-border Mergers and Acquisitions. Journal of International Management, 10: 307–353. Stahl, G. K., & Voigt, A. 2008. Do Cultural Differences Matter in Mergers and Acquisitions? Organization Science, 19(1): 160–176. Szulanski, G. 1996. Exploring Internal Stickiness. Strategic Management Journal: 17(1), 27–43. Van den Bosch, F. A. J., Volberda, H. W., & De Boer, M. 1999. Coevolution of Firm Absorptive Capacity and Knowledge Environment. Organization Science, 10: 551–568. Volberda, H. W., Foss, N. J., & Lyles, M. A. 2010. Absorbing the Concept of Absorptive Capacity: How to Realize Its Potential in the Organization Field. Organization Science, 21(4): 931–951. Xinhua. 2008. China’s First-quarter M&A Value $28.5 Billion. April 5. Yin, R. K. 2003. Case Study Research: Design and Methods. London: Sage Publications. Zahra, S. A., & George, G. 2002. Absorptive Capacity: A Review, Reconceputalization and Extension. Academy of Management Review, 27(7): 185–204. Zollo, M., & Singh, H. 2004. Deliberate learning in corporate acquisitions: Postacquisition and integration capability in US bank mergers. Strategic Management Journal, 25: 1233–1256.



Ping Deng




Part III


Chinese FDI in Europe and North America





8 Yun Schüler-Zhou, Margot Schüller, and Magnus Brod

As Chinese companies have rapidly increased their outward foreign direct investment (OFDI) in the last decade, Europe has become a target for Chinese market-seeking and asset-seeking. The Chinese government plays a proactive role in guiding and supporting overseas investment, in part through its ‘going-global’ policy. The internationalization of Chinese companies is, however, to some extent a response to restrictive (domestic) market conditions. Within China, the growth of companies across provincial borders is still difficult due to regional protectionism (Child & Rodrigues, 2005, p. 388). Intense competition from foreign-funded enterprises in the domestic market also works as a driving force for the internationalization of Chinese companies (UNCTAD, 2006; Masron & Shahbudin, 2008, p. 6). These push factors are complemented by a number of pull factors that attract Chinese companies to the European Union (EU). Market-seeking companies want to explore the huge common market of the now 27 EU member states, while asset-seeking companies are most interested in buying high-tech companies and brand names in highly industrialized EU countries. But some of the very ambitious Chinese acquisition attempts involving well-known hightech companies have not been realized due to legal, public or shareholder opposition. Since the global financial crisis, the investment climate in Europe has relaxed and Chinese investment has become more welcome. The incentive policy of the state-related investment promotion agencies (IPAs) in Europe aims to attract foreign direct investment (FDI), including that from emerging economies such as China. In the competition for FDI, national and subnational governmental investment agencies in Europe have adopted various incentive schemes, including tax exemptions and welcome schemes. These pull factors differ from country to country since no harmonized policy on FDI exists, in contrast to the EU’s common foreign trade policy. The same holds true for the statistical reporting of FDI by EU member countries, which makes the interpretation of FDI flows into the European Union difficult. The debate on multinational company (MNCs) location choice has a long tradition in international business research. Many studies center on the 157



Push and Pull Factors for Chinese OFDI in Europe


question of what drives location decisions. At the firm level, determinants such as size, performance, and industry have been identified (Terpstra & Yu, 1988; Nachum & Zaheer, 2005) as well as the company’s relational linkages (Chen & Chen, 1998). At the country level, home and host country characteristics play a crucial role in location choice (Dunning, 1998; Harzing & Sorge, 2003). In this paper, we concentrate on exploring institutional factors in the home and host countries that determine MNC location decisions. Applying the concept of institutional and structural push and pull factors, we focus on the Chinese government’s policy guidelines regarding investment in the EU in terms of countries and sectors and on the incentives that EU countries offer to attract Chinese investors. While much has been written about the evolution of the Chinese government’s ‘going-global’ policy through its various stages (Voss, Buckley, & Cross, 2008; Luo, Xue, & Han, 2010), no research on the government’s policy on country and industry recommendations for OFDI exists. We consider this aspect of the government’s policy an important push factor and contrast it with the European IPA policy in attracting Chinese OFDI. This is the first time such a study has been undertaken.

1. Push factors for Chinese OFDI Several types of push factors contribute to the internationalization of companies from developing countries (UNCTAD, 2006, Overview). Masron and Shahbudin (2008) differentiate between institutional and structural push factors. While government policy belongs to the institutional push factors category, structural push factors include the domestic economy and market. The research on institutional factors in China focuses on the government’s ‘going-global’ policy, the role of specific incentives, and actors, and their interplay (Scott, 2002; Wang, 2002; Peng, 2005; Voss et al., 2008; SchülerZhou & Schüller, 2009; Luo et al., 2010). Through the approval process for OFDI projects and access to foreign exchange and preferential loans, the government exerts a direct influence on the growth and patterns of OFDI. Initially, only large state-owned enterprises from the natural resource sector were supported to invest abroad. To help small and medium-sized enterprises (SMEs) develop their international markets, a government regulation on capital support for SMEs was introduced in 2000, at the very beginning of the ‘going-global’ policy. In contrast, the promotion of OFDI by privatelyowned companies was only approved in February 2006. The general trend since 2001 has been a gradual relaxation of the investment project approval process, easing access to foreign exchange and granting credit under preferential conditions (Luo et al., 2010, pp. 75–77). In sum, Chinese government policy is intended to shape Chinese OFDI decisions (Voss et al., 2008). To explain the geographical and sectoral distribution of Chinese OFDI, including why Chinese companies invest in the European Union, we focus



158

on government policy for country and industry recommendations as an important push factor. With the introduction of the Countries and Industries for Overseas Investment Guidance Catalog (Duiwai touzi guobie chanye daoxiang mulu; the ‘Catalog’) in 2004, the Ministry of Commerce (MOFCOM) and the Ministry of Foreign Affairs (MoFA) established an instrument for directing OFDI toward specific countries and industries. As a referential list for foreign economic cooperation departments and companies, the catalog offered guidance for investors on preferential policies related to financial support, exchange rates, taxation, and other kinds of favorable treatment (Luo et al., 2010, p. 76). When asked about the function of the catalog at a press conference in July 2004, a MOFCOM representative explained that it should guarantee that OFDI serves China’s economy by securing access to natural resources, enhancing companies’ technological capacity, and acquiring international brands. MOFCOM requested that companies invest in countries that (1) have a close relationship with China, (2) exhibit complementarities to the Chinese economy, (3) are important trading partners of China, (4) have signed investment and taxation agreements, and (5) are part of an important economic region in the global economy (MOFCOM, 2004). The first version of the catalog, published in 2004, was a list of 67 recommended countries and seven recommended industries for OFDI. The country recommendations included 26 Asian countries (three in Central Asia), 13 African countries, 12 European countries (ten of them in the European Union), 11 countries in North and South America, and five countries in Oceania. According to this breakdown, companies were advised to invest primarily in Asia, with Europe ranking second as a recommended destination. The ten EU countries listed in the catalog included France, Germany, Ireland, Sweden, the Netherlands, and the UK, all ‘old’ EU member countries. The catalog included three countries newly incorporated in 2004: the Czech Republic, Hungary, and Poland. One EU applicant, Romania, was also named (EU member as of 2007). The following year, the catalog was extended by an additional 28 countries, of which ten were African countries, eight Asian countries and six were European countries. Two ‘old’ EU member countries, Austria and Spain, and another EU applicant country, Bulgaria (EU member as of 2007), were added (see Table 8.1). An analysis of the types of industries suggested for investment in each EU country in the 2004 and 2005 catalogs reveals that for manufacturing, the most recommended industries were electric machines and consumer electronics, while for services, trade and distribution were suggested most often. In the highly technologically developed EU member countries, France, Germany, the UK, and Sweden, investment in R&D was advocated as well. Rather surprisingly, investment in IT services was recommended in the ‘new’ EU member countries: the Czech Republic, Poland, and Romania. In 2007 MOFCOM and the National Development and Reform Commission



Yun Schüler-Zhou et al. 159

160 Table 8.1 European countries and industries recommended for Chinese OFDI in 2004 and 2005 (based on the 2004 and 2005 ‘catalogs’) Agriculture1 and mining

Manufacturing

Services

UK

Biotechnology, computers

Trade, distribution, transportation and storage, R&D, finance, legal services

Germany

Electric machines and electrical materials, pharmaceuticals, chemical products, electronic products

Trade, distribution, transportation, finance, R&D

France

Handicraft articles, computers, white goods (air conditioners, microwaves, vacuum cleaners)

Trade, distribution, R&D

Sweden

Electronic appliances, computers, building materials, precision instruments

R&D, tourism

Netherlands

Equipment (office equipment), computers

Trade, distribution, transportation, and storage

Ireland

Biotechnology, metal goods

Computer programming, infrastructure

Hungary

Consumer electronics, metal goods, electrical tools, suitcases

Trade, distribution, tourism

Electric machines and electrical materials, electronic appliances, computers, TVs, textiles, pharmaceutical products and equipment

IT services, infrastructure

Consumer electronics, textiles, bicycles and components, products made of wood and plastic, computers

Trade, distribution, telecommunications, infrastructure

Textiles, transport equipment and components (for ships and motorcycles), handicraft articles, moulding machines, electrical equipment

IT services

Country

Poland

Copper

Romania

Czech Republic

Forestry



2004 catalog


Austria

Spain Bulgaria

Fishing

Electronic appliances, spare auto parts, equipment (measuring and office equipment)

Trade, R&D

Textiles, apparel, shoes, building materials, machinery

Trade, distribution

Food, transport equipment (ships), communications equipment, computers, other electronic equipment

Construction

1 Including

forestry, animal husbandry, and fishing. Source: Authors’ compilation based on MOFCOM and MoFA (2004, 2005).

(NDRC) published a third, updated Catalog, which included 32 countries. In Europe, 13 countries, ten of which were EU member countries, were recommended as investment locations. In addition to the ‘old’ EU members, Belgium, Denmark, Greece, and Portugal, also included in the updated catalog were the newly integrated Eastern European countries, Estonia, Lithuania, Slovakia, and Slovenia. Industries recommended for investment included capital- and technologyintensive industries such as chemicals, pharmaceuticals, precision instruments, and machinery (in Belgium, Denmark, and Finland), while in the Eastern European countries investments in communications equipment and electronic appliances were most recommended. In services, the suggested fields for investment in Eastern Europe included tourism, trade, and distribution, while in the ‘old’ EU member countries, investment in R&D and green technology was advocated (see Table 8.2). All together, there were recommendations for 23 EU member countries; four EU countries are not mentioned in the catalog (Italy, Malta, Latvia, and Luxembourg). Due to European integration, the EU market is one of the most interesting destinations for Chinese investors. By entering one EU member country, Chinese companies have access to the entire single European market. There are, however, huge discrepancies between the ‘old’ and the ‘new’ EU member countries in terms of economic and social development levels as well as political and cultural characteristics (Zhang & Filippov, 2009, p. 5). In order to highlight the different strategies which MOFCOM suggested in the catalog regarding the mature, industrialized EU countries and the less developed newer EU members, we divide the 23 EU countries into Western and Eastern EU countries.1 Figure 8.1 shows the different industries MOFCOM suggests for the Western and Eastern EU countries. First, Chinese companies are encouraged to invest in manufacturing in the EU, particularly the manufacture of electronic products, textiles, apparel, and machinery. While Western EU



2005 catalog

162


Country

Agriculture1 and mining

Manufacturing

Services

Belgium

Chemicals and chemical products

R&D, transportation and storage, trade, distribution, water transport

Denmark

Machinery, pharmaceuticals, handicraft articles

Green technology, travel agencies

Greece

Suitcases, consumer electronics

Transportation, travel agencies

Cyprus

Textiles, apparel, shoes, products made of plastic

Travel agencies, tourism, hotels

Estonia

Textiles, apparel, products made of wood, electronic appliances (air conditioners and refrigerators)

IT services, tourism, hotels

Precision instruments

R&D, travel agencies

Finland

Forestry

Lithuania

Leather goods, textiles, apparel, suitcases

Portugal

Communications equipment, computers, other electronic equipment, machinery, building materials

Trade, distribution, travel agencies

Slovakia

Farming machines, electronic appliances


Slovenia

Products made of wood, communications equipment, computers, other electronic equipment


1 Including

forestry, animal husbandry, and fishing. Source: Authors’ compilation based on MOFCOM, MoFA and NDRC (2007).

countries like Germany and Sweden are preferred host countries for the manufacture of high-tech machinery and equipment, the Eastern EU countries such as Hungary, Poland, and the Czech Republic are favored for the manufacture of consumer electronics, textiles, and apparel due to their lower production costs. Second, MOFCOM suggests that companies invest in services in the European Union, particularly trade and distribution and tourism. While the Western EU countries are recommended for investments in trade and distribution, the Eastern EU countries are preferred for investments



Table 8.2 European countries and industries recommended for Chinese OFDI in 2007 (based on the 2007 ‘catalog’)

Yun Schüler-Zhou et al. 163 Financial services Transportation and storage IT and telecommunications R&D Tourism (e.g. travel agencies, hotels)

Food processing Manufacture of wood and of products made of wood Transport equipment (e.g., ships, automobiles) Chemicals, chemical products and pharmaceuticals Manufacture of machinery and equipment Textiles, apparel, and artwork Communications equipment, computers, and other electronic products

0

2

4

6

8

10

12

14

16

Western EU countries Eastern EU countries

Figure 8.1 Industries recommended for investment in Western and Eastern EU member countries Note: Western EU countries include the UK, Germany, France, Sweden, the Netherlands, Ireland, Austria, Spain, Belgium, Denmark, Finland, and Portugal. Eastern EU countries are made up of Hungary, Poland, Romania, Czech Republic, Bulgaria, Greece, Cyprus, Estonia, Lithuania, Slovakia, and Slovenia. Source: Authors’ compilation based on the frequency of recommendations in the 2004, 2005 and 2007 ‘catalogs’.

in tourism development. Investments in R&D and financial services are suggested only for highly industrialized Western EU countries.

2. Pull factors for Chinese OFDI Like push factors, the pull factors can also be grouped into institutional and structural factors. While international and regional investment and trade agreements, as well as institutions such as banks or IPAs involved in OFDI, are counted as institutional pull factors, structural pull factors include low factor costs, markets, and opportunities for asset-seeking companies (Masron & Shahbudin, 2008). Gaining access to local or regional markets is the driving motivation for market-seeking companies that tend to invest more in large economies or economies that are difficult to enter due to the host country’s regulations (e.g., trade barriers). By investing in these economies, companies can reduce operational costs, for instance, transportation costs (Dunning, 1993).



Trade and distribution


Chinese investors have realized the benefits of European integration, which means they can access the entire European market by entering only one EU member country. The European Union is not only China’s most important trading partner, but also the market where Chinese companies face many dumping charges. Therefore, replacing exports with investment in the European Union is a better option for some Chinese companies. Traditionally, the attraction of the huge European market has been the major pull factor for Chinese OFDI (Buckley et al., 2007; Nicolas, 2009). In order to further explore and secure this market, Chinese companies invest in trade-related fields such as logistics, maritime transport, transport insurance, financial services, and distribution, as well as in the development of specific ‘commercial hubs’ in Europe. The Greek government’s announcement that China is going to invest in container terminals, airports, and shipbuilding in Greece is a recent example of this approach (Financial Times, 2010). It is not only the markets but also the high level of technology in many European industries that pulls Chinese companies to the European Union. Strategic asset-seeking and efficiency-seeking investors usually aim to acquire the newest technology, as well as marketing and management expertise, in highly developed host countries (Makino, Lau, & Yeh, 2002, p. 404). In the Western EU countries, Chinese investment targets advanced technology, well-known brand names, and management expertise for industrial and technological upgrading of the Chinese companies through learning and adoption, combined with exploration of the markets. For Mathews, Chinese companies are an example of ‘skilful learning and adoption-cum-adaptation of advanced technologies combined with relentless focus on penetrating western markets’ (Mathews, 2006). The high level of business development is another pull factor for Chinese efficiency-seeking investors, who try to rationalize their business processes, including production, distribution and marketing, by taking advantage of country differences in the cost of factor endowments or by realizing economies of scale and scope (Dunning, 1993). Efficiency-seeking companies tend to go to countries with the best business environment for fully realizing the internalization benefits of the company’s comparative advantages. In contrast to the Western EU countries, Eastern EU countries offer significant advantages of low-cost but skilled workforces combined with low entry barriers for Chinese investment. In addition to the structural pull factors mentioned above, institutional pull factors are crucial in explaining Chinese OFDI in the European Union. Host government policies have an indirect impact on most of the marketrelated factors, but the government-related IPAs offer direct incentives to attract FDI. IPAs are intermediaries that work between markets and the state to influence investor location choices. Although IPAs exist in various organizational forms, they all aim to attract investment, including FDI; maintain contact



164

with investors and other institutions involved in the investment process; and are semi-public or state-owned companies or service units. Although formally independent, IPAs are part of the social networks of the regions they operate in (Drahokoupil, 2004). Within the European Union, there is competition for FDI, especially in the Eastern European countries. In order to be competitive, IPAs try to match their FDI incentives with those of other countries and subregions (Bandelj, 2003, p. 381). As one of the players involved in attracting FDI, IPAs have been analyzed as part of foreign-investment related topics, for example, in the Czech Republic. Their role as intermediaries is especially important in the Eastern EU countries, where they bridge state engagement in the economy with the markets (Drahokoupil, 2004, p. 352). Incentives for attracting FDI usually have to be in line with the market systems in the EU member countries and should not undermine transparency standards (Graham, 2003). However, there exists a broad spectrum of incentives for attracting FDI, which differ in quantity and quality. In order to study the policy approaches of European IPAs for investments from China, we conducted a questionnaire-based survey. Beginning in June 2009, we sent questionnaires to all 92 national and subnational IPAs in the 27 EU member states. The survey focused on how the IPAs monitor Chinese investment (registration of companies, job creation, and the use of these investment data for policymaking) and on the incentives for and restrictions on Chinese investors. We received responses from 35 IPAs (response rate of 38 percent), including 17 national IPAs, which limits the explanatory power of the paper to some extent. Data obtained directly from these IPAs were complemented by a content analysis of their websites and public relations material. Our survey revealed that approximately two-thirds of IPAs (23) have established a special China Desk or Investment Office for handling Chinese investment, either within their home countries/regions or in China (a total of 36 such offices). The IPAs with a subsidiary in China often have a regional focus (48 percent) on economically more developed areas such as Shanghai, Beijing, Jiangsu, and Xiamen. According to the results of the questionnaire, Chinese companies are allowed to invest in almost all industries except for the defense sector, legal advisory services, nuclear goods, and waste disposal. According to the Czech Republic’s IPA, foreign investors face some restrictions in the aerospace, bio- and nanotechnology, and advanced renewable energy industries. In Finland, restrictions exist for foreign investors in biotechnology and pharmaceuticals, while in France, the IPA lists recycling, storage, metals, and construction as restricted industries. With regard to the incentives offered by national and subnational IPAs, some notable variations exist. Most Western EU countries with strong economies and well-developed business infrastructures do not offer any special incentives at all. Respondents stressed that all foreign companies enjoy national treatment with the same rights and obligations as domestic





5

Other incentives 2

Real estate-related services and grants

3

Access to local networks Loans

2

Special economic zones 4)

2 6

Subsidies 4

IPA services 3)

5

State guarantees 4

EU-financed incentives

8

Employment-related incentives 2) 5

R&D-tax incentive

11

Grants 1) 0 Figure 8.2

2

4

6

8

10

12

Incentives offered by IPAs to Chinese investors in the EU

Note: The figures in the diagram represent the addition of the number of IPAs providing incentives in specific fields. 1) Grants refer, for example, to investment grants totaling up to 50 percent of the eligible investment costs or job creation grants. 2) Includes grants and training. 3) Includes immigration consultancy, establishment of business contacts. 4) Refers to special tax conditions and industrial parks. Source: Based on the Questionnaire Survey with IPAs conducted by the authors in 2009.

companies. The IPAs that offer incentives said they apply to all companies without national preferences or discrimination. However, within the Western EU countries, some IPAs rely on specific incentives to attract Chinese investors, including consultancy services, grants for investments, and R&D tax incentives, as well as rent, leasing, and wage subsidies (see Figure 8.2). Compared to the IPAs from Western EU countries, most Eastern Europe IPAs offer stronger and more complex incentives to Chinese investors. They are also allowed to include Chinese investors in the EU-financed structural support programs, which are specially designed to support these new EU member countries. Some of the new members are trying to become the ‘commercial hub’ for Chinese companies in Europe. Hungary’s IPA, for example, courts Chinese investors with slogans like ‘Open Europe Through Hungary’, ‘Hungary, Your Bridge to Europe’ or ‘Set Off Opportunities in Europe with Hungary’ (IDT Hungary, 2005a, 2005b). At the opening of a representative office by the China Investment Promotion Agency in Budapest, the director of Hungary’s IPA underlined the country’s crucial role: ‘China sees Hungary as a regional distribution, manufacturing and logistics centre’ (ITD Hungary,



166

2005a). Poland’s IPA is also keen to attract Chinese investors and is courting companies with the ‘first Chinese industrial park in Europe’ (Special Economic Zone Koszalin City). In addition to the description of its attractive country-specific investment environment (human capital and strategic location), Poland’s IPA touts the huge advantages of companies (including Chinese investors) getting support from the EU: ‘90 billion Euros of EU Funds (2007–2013)’ (Komasa & Dalekowschodnia, 2006). The IPAs claim there are no specific conditions Chinese investors have to fulfil to receive favorable investment conditions. A viable business plan is required for financial assistance or grants, while, for employment grants, the company has to maintain a certain employment level. The majority of IPAs (90 percent of 33 respondents) approach Chinese companies directly and more than half organize ‘road shows’ of their home country, investment locations, and environment as well as on specific industries in China. About 55 percent organize matchmaking seminars, while 12 IPAs rely on other events such as exhibitions, fairs, state visits, and trade missions. One third of the respondents employ at least three to four different vehicles to attract Chinese investors. To some extent, our findings agree with the insights of other authors. Drahokoupil, for example, states that the IPAs operate in a very competitive environment and are under pressure to offer specific incentives to attract investment from transnational companies (TNCs). These companies ‘expect that states or regions will assist and subsidise their activity. The reluctance to do so, or “unpreparedness” ’ [sic], is enough reason to invest somewhere else’ (Drahokoupil, 2004, p. 357).

3. Chinese investment in the European Union In contrast to its importance as a destination for Chinese exports, the European Union is not given the same consideration by Chinese companies when it comes to OFDI. Based on MOFCOM statistics for the period from 2005 to 2008, the volume of Chinese investment in the European Union compared to total OFDI remained very small in both flows and stocks. Only the year 2007 saw an investment volume that exceeded US$1 billion, which represented 3.9 percent of the total OFDI (see Table 8.3). If we take the OFDI flows into financial offshore centers in Asia and Latin America into account, however, the distribution pattern changes considerably, with Europe receiving a much larger share of OFDI (Schüler-Zhou & Schüller, 2009). Official OFDI statistics show that Chinese companies invest in all of the now 27 EU member countries (see Table 8.4). In 2007, approximately 13,000 local employees were working for Chinese companies (MOFCOM, 2008). In 2008, Chinese OFDI in the European Union declined by 55 percent compared to 2007, while the total Chinese outflow nearly doubled in that





Table 8.3

Chinese OFDI flows and stocks (in total and in the EU, 2005–2008) Flow (US$ million)

2005 Total EU %

2006

2007

Stock (US$ million) 2008

2005

2006

2007

2008

12.260 17.630 26.510 55.910 57.200 75.020 101.190 147.280 189.54 128.73 1044.12 466.62 768.01 1274.51 2942.1 3173.85 1.5 0.7 3.9 0.8 1.3 1.7 2.9 2.5

Note: In the years 2005 and 2006 financial investments were not included. In 2005 and 2006 the EU consisted of 25 member countries; since 2007 the EU has encompassed 27 member countries. Source: MOFCOM (2009).

year. The main reason was the huge decrease in investments in the financial sector. In contrast to OFDI flows to the financial sector, investment in manufacturing grew from US$100 million in 2007 to US$164 million in 2008 (MOFCOM, 2009). EU countries attracted more than US$3 billion in OFDI stock by the end of 2008 (see Table 8.5). At the end of 2008, the stock of OFDI in manufacturing accounted for 25.6 percent of the total OFDI. The last few years have seen a rapid increase of investment in manufacturing, especially in the UK, Germany, Poland, Hungary, Romania, and France. The stock of OFDI in the financial sector amounted to US$775.28 million, accounting for 24.4 percent of the total outflow to the European Union. The most important destinations for Chinese OFDI in the financial sector were the UK, Germany, and Luxembourg. Trading accounted for 14 percent of total outflow. Sweden, Germany, and the UK were the countries with the highest shares in this sector. The mining sector accounted for 7.2 percent; the main destination was the UK (MOFCOM, 2009). With regard to the geographical distribution of Chinese OFDI in the European Union, the bulk of the investment (OFDI stock) by the end of 2008 occurred in two member states: Germany and the UK, which received more than 50 percent of the total Chinese OFDI stock in the European Union. Among the Eastern EU countries, Poland, Hungary, Romania, and the Czech Republic have also become important destinations for Chinese OFDI. By the end of 2008, these Eastern EU countries, together with small but growing investments in Slovenia, Slovakia, Lithuania, and Latvia, contributed US$332.51 million or 10.5 percent to the total Chinese OFDI in the European Union. Filippov and Saebi (2008, pp. 20–24) note that Chinese companies are using the new EU member countries as a backdoor to Europe. While Chinese companies are especially attracted to the Western EU member countries due to their large markets and highly developed technology base, the Eastern EU countries are considered a manufacturing base for export to the Western EU region. Investment in the Eastern European countries began years before



168

Geographical distribution of the Chinese OFDI in the EU (2003–2008) Flow (US$ million)

Europe EU Belgium Denmark UK Germany France Ireland Italy Netherlands Greece Spain Austria Bulgaria Hungary Malta Poland Romania Sweden Latvia Czech Republic Cyprus Estonia Finland Lithuania Luxemburg Portugal Slovakia Slovenia

Stock (US$ million)

2003

2004

2005

2006

2007

2008

2003

2004

2005

2006

2007

2008

145.03

157.21

1540.43 1044.12 4.91 0.27 566.54 238.66 9.62 0.2 8.1 106.75 0.03 6.09 0.08 – 8.63 –0.1 11.75 6.8 68.06 −1.74 4.97

875.79 466.62 – 1.33 16.71 183.41 31.05 42.33 5 91.97 0.12 1.16 – – 2.15 0.47 10.7 11.98 10.66 – 12.79

676.65

0.05 −7.78 29.39 27.5 10.31 – 3.1 1.91 0.2 1.7 – 0.35 0.1 0.37 0.1 2.68 2.64 – 0.46

597.71 128.73 0.13 −58.91 35.12 76.72 5.6 25.29 7.63 5.31 – 7.3 0.04 – 0.37 0.1 – 9.63 5.3 – 9.1

487.45

0.3 73.88 2.11 25.06 0.45 0.14 0.29 4.47 – – 0.4 0.35 1.18 – 1.55 0.61 0.17 1.58 –

505.02 189.54 – 10.79 24.78 128.74 6.09 – 7.46 3.84 – 1.47 – 1.72 0.65 – 0.13 2.87 1 – –

0.41 74.43 75.15 83.61 13.12 0.24 19.18 5.9 – 101.81 0.7 0.6 5.43 0.37 2.72 29.75 6.07 1.61 0.33

1.64 67.2 108.46 129.21 21.68 0.04 20.84 8.97 0.35 127.67 0.7 1.46 5.42 0.37 2.87 31.1 6.44 1.61 1.11

1272.93 768.01 2.34 96.59 107.97 268.35 33.82 0.04 21.6 14.95 0.35 130.12 0.07 2.99 2.81 1.37 12.39 39.43 22.46 1.61 1.38

2269.82 1274.51 2.67 36.48 201.87 472.03 44.88 25.3 74.41 20.43 0.35 136.72 0.32 4.74 53.65 1.97 87.18 65.63 20.02 2.31 14.67

4458.54 2942.1 33.98 36.75 950.31 845.41 126.81 29.23 127.13 138.76 0.38 142.85 4.04 4.74 78.17 1.87 98.93 72.88 146.93 0.57 19.64

5133.96 3173.85 33.3 38.08 837.66 845.5 167.13 107.77 133.6 234.42 1.68 145.01 4.04 4.74 88.75 4.81 109.93 85.66 157.59 0.57 32.43

–

–

–

–

0.01

2.66

–

–

–

–

4.19

42.13

– – – 0.2 0.1 –

– – – 0.2 0.1 –

0.9 3.93 – – 0.1 0.12

0.93 3.93 – 0.2 0.1 1.4

0.94 3.93 67.02 1.71 5.1 1.4

3.59 3.93 122.83 1.71 5.1 1.4

169

Note: Between 2003 and 2006, financial investments were not included. Source: MOFCOM (2009). 10.1057/9780230361577 - Chinese International Investments, Edited by Ilan Alon, Marc Fetscherin and Philippe Gugler


Table 8.4


Table 8.5

Sectoral distribution of the Chinese OFDI stock in the EU at the end of 2008 Stock (US$ million)

Manufacturing

Services Financial

Trade

Business services Transportation & storage Real estate Agriculture1 Mining

Share of total stock (US$ million)

812.48

25.6%

1791.29 775.28

56.4% 24.4%

444.27

14%

Main destinations

Germany, UK, Romania, Poland, Hungary, Italy, France, Czech Republic UK, Luxembourg, France, Germany, Italy Germany, Sweden, UK, France, Italy, Romania

334.41

10.5%

170.38

5.4%

Netherlands, Ireland, Germany n.a.

66.95 138.49

2.1% 4.4%

n.a. n.a.

227.59

7.2%

UK

1 Including,

forestry, animal husbandry, and fishing. Source: MOFCOM (2009).

their accession and has grown substantially since then (see Table 8.4). In December 2003, the compilation of an Overseas investment guidance catalog for processing trade of consumer electronics in Central and Eastern European countries was announced by China. The introduction of this catalog indicated once again that the Chinese government acknowledged the benefits of the European integration, pushing Chinese companies to invest in those Eastern European countries expected to become EU members. Poland, Romania, Czech Republic, Hungary, and Slovakia were suggested as the main sites for investment in processing trade of consumer electronics. This policy recommendation was based on the belief that these countries have a cost advantage and a skilled, educated workface.

4. Perspective Chinese companies have discovered the European Union as an attractive investment location. So far, the share of Chinese OFDI in the European Union is still rather small and concentrated in only a few countries and industries. Based on our analysis of the pull and push factors, we expect, however, a notable increase of Chinese investment in the European Union



170


Push

Comparing pull and push factors in Western and Eastern EU countries Western EU countries

Eastern EU countries

•

• Recommended for the manufacture of consumer electronics, textiles and apparel • Recommended for investments in the development of tourism • Special tax zones and industrial parks • Development of ‘commercial hubs’ • EU-financed support

• • Pull

• • • •

Recommended for investments in high-tech machinery and equipment Recommended for investments in trade and distribution Recommended for investments in R&D and financial services Strong economies, high incomes Well-developed business infrastructure Market-based services Short-term grants, R&D incentives

in the medium term. The state guidelines for Chinese company investment demonstrate a strategic approach based on the assessment of the particular strengths of industries in each EU country. While Western EU countries are recommended for high tech investment, financial services, and R&D, Eastern EU countries are targeted for OFDI in manufacturing consumer electronics, textiles, and tourism (Table 8.6). In contrast to the non-compulsory nature of policy guidelines in the West, Chinese companies must consider official recommendations in their OFDI strategy, especially state-owned companies. At the same time, companies receive specific government incentives for investing in particular countries and industries in the context of the ‘going global’ policy. Therefore we disagree with Nicolas (2009, p. 5) that the choice of the country is partly opportunistic and depends on the availability of acquisition targets and partly on the strategies of Chinese companies. We argue that Chinese investment decisions are still heavily influenced by the state. The strong interest of IPAs in attracting FDI from China will also contribute to faster OFDI growth in the medium-term. Eastern EU countries are especially eager to absorb FDI in order to restructure their economies. In addition to market-compatible incentives, they offer favorable conditions for Chinese investors, including the establishment of Special Economic Zones (SEZ), industrial parks and EU-financed support. In the West, the global financial crisis has relaxed the attitude toward Chinese OFDI and we believe the investment climate in the Western EU countries will change in the medium term to make Chinese investments more acceptable. EU policymakers at the national and subnational levels should be aware that the Chinese government’s ‘going global’ policy is a strategic approach to support the internationalization of domestic companies. This approach includes setting up specific country- and industryrelated investment guidelines based on a comprehensive assessment of the



Table 8.6


comparative advantages of each EU country, combined with a complex set of incentives. It is doubtful that a similarly strategic attitude toward foreign investment can be found on the EU side, especially with regard to which kind of Chinese investments should be encouraged. This study reveals a distinctive pattern of Chinese OFDI in Western and Eastern EU countries. As a next step, research should focus on how much the comparative advantages of each EU country correspond to the sectoral and geographical distribution of Chinese OFDI and whether existing clusters in the European Union play a role in Chinese investment decision-making.

Note 1. The division between Western EU countries and Eastern EU countries is based on the National Geographic Society’s definition of ‘Western and Eastern Europe’. Due to Greece’s low income level, we have included this country in the group of the Eastern EU countries.

References Bandelj, N. 2003. Particularizing the Global: Reception of Foreign Direct Investment in Slovenia. Current Sociology, 51(3–4): 375–392. Buckley, P.J., Clegg, J., Cross, A.R., Liu, X., Voss, H. and Zheng, P. 2007. The determinants of Chinese outward foreign direct investment. Journal of International Business Studies 38 (4): 499–518. Chen, H. & Chen, T.-J. 1998. Network Linkages and Location Choice in Foreign Direct Investment. Journal of International Business Studies, 29(3): 445–467. Child, J. & Rodrigues, S.B. 2005. The Internationalization of Chinese Firms: A Case for Theoretical Extension. Management and Organization Review, 1: 381–410. Drahokoupil, J. 2004. Post-Fordist Capitalism in the Czech Republic: The Investment of Flextronics in Brno. Sociologický ˆcasopis/Czech Sociological Review, 40(3): 343–362. Dunning, J.H. 1993. Multinational Enterprises and the Global Economy. Wokingham, UK: Addison-Wesley. Dunning, J.H. 1998. Location and the Multinational Enterprise: A Neglected Factor? Journal of International Business Studies, 29(1): 45–66. Filippov, S. and T. Saebi. 2008. Europeanisation Strategy of Chinese Companies: Its Perils and Promises. United Nations University. Working Paper Series No. 055. http://www.merit.unu.edu/publications/wppdf/2008/wp2008-055.pdf. Accessed 12 June 2009. Financial Times. 2010. China Prepares to Invest in Greek Projects, 14 June 2010, http:// www.ft.com/cms/s/0/8e736a84-77d9-11df-82c3-00144feabdc0.html. Accessed 6 July 2010. Graham, E.M. 2003. Attracting Foreign Direct Investment to the United States: The Joust Between Federal Government and the States. In N. Phelps & P. Raines (eds), The New Competition for Inward Investment: Companies, Institutions and Territorial Development. Cheltenham: Edward Elgar Publishing Ltd., pp. 61–172. Harzing, A.W.K. & Sorge, A.M. 2003. The Relative Impact of Country-of-Origin and Universal Contingencies on Internationalization Strategies and Corporate Control in Multinational Enterprises: World-wide and European Perspectives. Organisation Studies, 24(2): 187–214.



172

IDT Hungary. 2005a. Open Europe through Hungary. Program Booklet ‘China Season’, www.itdh.com/resource.aspx?ResourceID=chinaopen. Accessed 23 June 2009. IDT Hungary. 2005b. Set-off Opportunities in Europe with Hungary. Investment Issue ‘China Season’, http://www.itdh.com/resource.aspx?ResourceID=chinainvest. Accessed 23 June 2009. Komasa, B. & Dalekowschodnia, S. 2006. The Attractive Place for Investment and Trade. PAlilZ Presentation China International Fair for Investment & Trade China(Xiamen), 9 September 2006, http://www.chinafair.org.cn/china/forum/10th/ bw/GUOBIE/index_en.htm. Accessed 24 June 2009. Luo, Y., Xue, Q. & Han, B. 2010. How Emerging Market Governments Promote Outward FDI: Experience from China. Journal of World Business, 45: 67–79. Makino, S., Lau, C.-M. & Yeh, R.-S. 2002. Asset-exploitation Versus Asset-seeking: Implications for Location Choice of Foreign Direct Investment from Newly Industrialized Economies. Journal of International Business Studies, 33(3): 403–421. Masron, T.A. & Shahbudin, A.S.Md. (2008). ‘Push Factors’ of Outward FDI: Evidence from Malaysia and Thailand. Manuscript, Universiti of Sains, Malaysia, http://www. wbiconpro.com/468B-Arifin.pdf. Accessed 4 May 2010. Mathews, J.A. 2006. Dragon Multinationals: New Players in 21st Century Globalization. Asia Pacific Journal of Management, 23: 5–27. MOFCOM. 2004. Explanation of the Guidance Catalogue for Overseas Investment in Countries and Industries (Chinese), http://www.mofcom.gov.cn/aarticle/wtojiben/t/ 200407/20040700251387.html. Accessed 4 May 2010. MOFCOM. 2006. Overseas Investment Guidance Catalogue for Processing Trade of Consumer Electronics in Central and Eastern European Countries, http://www.fdi.gov.cn/ pub/FDI/zcfg/tzxd/dqxd/P020060619617022503372.pdf. Accessed 16 July 2009. MOFCOM. 2008. Statistical Bulletin of China’s Outward Foreign Direct Investment 2007, http://www.fdi.gov.cn/pub/upload/pdf/2007pdf. Accessed 16 July 2009. MOFCOM. 2009. Statistical Bulletin of China’s Outward Foreign Direct Investment 2008, http://hzs.mofcom.gov.cn/accessory/200909/1253868856016.pdf. Accessed 30 October 2009. MOFCOM & MoFA. 2004. Introduction of the Guidance Catalogue for Overseas Investment in Countries and Industries I (Chinese), http://investchina.org.cn/chinese/PI-c/626171. htm. Accessed 4 May 2010. MOFCOM & MoFA. 2005. Introduction of the Guidance Catalogue for Overseas Investment in Countries and Industries II (Chinese), http://hzc.hunancom.gov.cn/hzzn/6583.htm. Accessed 4 May 2010. MOFCOM, MoFA & NDRC. 2007. Introduction of the Guidance Catalogue for Overseas Investment in Countries and Industries III (Chinese), http://www.sdpc.gov.cn/zcfb/ zcfbtz/2007tongzhi/W020070227622797287359.doc. Accessed 4 May 2010. Nachum, L. & Zaheer, S. 2005. The Persistence of Distance? The Impact of Technology on MNE. Motivations for Foreign Investment. Strategic Management Journal, 26(8): 747–768. Nicolas, F. 2009. Chinese Direct Investment in Europe: Facts and Fallacies. Briefing paper, Chatham House, http://www.chathamhouse.org.uk. Accessed 10 October 2009. Peng, M.W. 2005. Perspective – From China Strategy to Global Strategy. Asia Pacific Journal of Management, 22: 123–141. Schüler-Zhou, Y. & Schüller, M. 2009. The Internationalization of Chinese Companies: What Do Official Statistics Tell us about Chinese Outward Foreign Direct Investment? Chinese Management Studies, 3(1): 25–42.





Scott, W.R. 2002. The Changing World of Chinese Enterprises: An Institutional Perspective. In A.S. Tsui & C.-M. Lau (eds), Management of Enterprises in the People’s Republic of China. Boston: Kluwer Academic Press, pp. 59–78. Terpstra, V. & Yu, C.M. 1988. Determinants of Foreign Investment of US Advertising Agencies. Journal of International Business Studies, 19: 33–46. UNCTAD. 2006. World Investment Report 2006 – FDI from Developing and Transition Economies: Implications for Development. New York & Geneva: United Nation. Voss, H., Buckley, P.J. & Cross, A.R. 2008. Thirty Years of Chinese Outward Foreign Direct Investment, http://www.ceauk.org.uk/2008-conference-papers/Voss-BuckleyCross-30-years-outward-FDI.doc. Accessed 4 May 2010. Wang, M.Y. 2002. The Motivations Behind China’s Government-Initiated Industrial Investments Overseas. Pacific Affairs, 75(2): 187–206. Zhang, Y. & Filippov, S. 2009. Internationalization of Chinese Firms in Europe. Working Paper Series 2009–041. United Nations University, Maastricht.



174

9 The Rise of Chinese OFDI in Europe

The year 2003 was a watershed for Chinese outward foreign direct investment (OFDI). Since then, Chinese OFDI has reached record levels year by year, increasing from US$33.22 billion of FDI stocks (US$2.85 billion FDI flows) in 2003 to US$245.75 billion of FDI stocks (US$56.53 billion FDI flows) in 2009 (Ministry of Commerce of People’s Republic of China (MOFCOM), 2009, 2010). As it took 25 years since China initiated its reforms to reach the level of OFDI stock achieved in 2003, these recent increases are particularly striking. Investments by Chinese companies in the European Union (EU) followed the general surge of Chinese OFDI with a time lag of a few years. As shown in Figure 9.1 (see also Table 9A.1), Chinese OFDI stock in the EU expanded from US$422 million in 2003 to more than US$3.79 billion in 2009, a ninefold increase within only seven years. Most striking was a jump in annual OFDI in the EU from less than US$129 million in 2006 to US$1.04 billion a year later, though flows diminished later under the impact of the economic crisis. This surge raises several important questions. As little is known about Chinese investments in the EU, it is important to identify their basic characteristics, including preferred destination countries, investment motivations, and preferred entry modes. This chapter examines these characteristics in detail. Moreover, it is intriguing that Chinese investments in the EU constitute an investment flow from an emerging or developing economy to more advanced, mature economies, which is still quite an unusual phenomenon. The key question concerns the specific competitive advantages that make such investments feasible. An alternative question may be to what extent such advantages actually exist – Chinese firms may even invest in the EU in order to source competitive advantages. On the basis of theoretical conceptualizations on the competitive advantages and internationalization of firms investing abroad, this study assesses how investments from China to 175



Jan Knoerich

176


4

1.2 Flows

Stock 3.5

1

3 0.8

2.5 2 1.5

0.4

1 0.2

0.5 0 2003

0 2004

2006

2005

Stock Figure 9.1

2007

2008

2009

Flows

Chinese OFDI into the EU (2003–2009, US$ billion)

Note: Excludes Luxembourg in 2009 (an outlier with unusually high amounts of Chinese OFDI, most likely in transit). Source: MOFCOM (2007, 2008, 2009, 2010) Statistical Bulletin of China’s Outward Foreign Direct Investment.

more advanced economies become feasible and sustainable. Are Chinese investments in the EU undertaken on the basis of existing competitive advantages, or do they constitute the sourcing thereof? I explore whether investments in the EU and other mature economies are an important avenue for firms from developing economies to grow, develop, and catch up with their counterparts from advanced economies. This chapter provides one of the first analyses of Chinese OFDI in the EU as a whole, considering the EU as a cohesive economic entity with its own specific setting. The analysis relies primarily on statistical data and a survey of investment promotion agencies (IPAs). The first seven years since the surge of Chinese OFDI in 2003 form the time frame of analysis, which begins with a discussion of relevant theories and literature, followed by a set of prior assumptions and an explanation of the research design. The body of this study has several analytical sections, ending with a conclusion section.

1. Background and research design 1.1. Theoretical considerations A glance at the development of theories on foreign direct investment (FDI) reveals that they have gone through a set of stages in line with the prevalent



0.6

177

global FDI patterns of the time. Early theories emerged on the basis of studies that examined FDI among developed countries, and soon after also took FDI from developed to developing countries into account (e.g., Dunning, 1958; Vernon, 1966). Many studies of this era paid attention to a firm’s possession of competitive, ownership, proprietary, or oligopolistic advantages that endowed it with a capability to invest, survive, and undertake successful business in a foreign and less familiar environment (Caves, 1971, 1974a; Hymer, 1976). These advantages were seen as coming from a variety of sources, including product differentiation, technological capabilities, marketing skills, managerial abilities, scale economies, and government intervention (Kindleberger, 1969; Caves, 1974b). Dunning incorporated this thinking into his widely acclaimed ‘eclectic paradigm’, adding location and internalization advantages to the picture (Dunning and Lundan, 2008; Dunning, 1993, 2000, 2001a, 2001b). Internalization is the replacement of markets by hierarchies, resulting in the expansion of a firm’s boundaries (Dunning, 1993). The concept of internalization is strongly linked to transaction cost theory, which postulates that, under imperfect markets, the hierarchical form of economic exchanges within the firm is preferred over reliance on the market mechanism if bounded rationality and opportunism constitute a major problem in a transaction (Williamson, 1981; Barney & Hesterly, 1996). If internalization occurs in international markets, multinationals are formed (Buckley & Casson, 1991). Another theory of that time was the internationalization approach (Johanson & Wiedersheim-Paul, 1975; Johanson & Vahlne, 1977). Scandinavian in origin, it suggested that firms internationalize sequentially (e.g., from the servicing of a market through exports via the establishment of representative or sales offices to overseas production), driven by incremental acquisition of experiential knowledge about foreign markets and the reduction of ‘psychic distance’ (i.e., unfamiliarity with norms, society, language, culture, politics, and so on of the host country), which enables firms to gradually increase the level of their resource commitment to the foreign market. This approach was considered particularly relevant in the analysis of the early stages of internationalization (Johanson & Vahlne, 1990). When South-South FDI became an inherent element of global FDI patterns, relevant explanatory theories emerged (Lecraw, 1977; Lall, 1983; Wells, 1983; Pavitt, 1988; Cantwell & Tolentino, 1990; Tolentino, 1993; Beausang, 2003). The major challenge was to identify the sources from which developing country multinationals derived their competitive advantages to invest abroad. The findings emphasize flexible, small-scale, and labor-intensive production and the generation of a relatively low-quality output available for sale at fairly low prices (Lecraw, 1993). OFDI by firms from developing countries was geared toward ‘neighbouring, “downstream,”



Jan Knoerich


developing countries with lower levels of industrialization and technological capabilities’ (Lecraw, 1993). Some findings even suggest that developing country firms do not possess any such ownership advantages and need to build them over time on the basis of inferior technologies and through technology transfer from mature economies (Beausang, 2003). Studies of developing country multinationals are comparatively rare, often case-based, and tend to focus solely on South-South FDI (Yang, 2005). This suggests considerable scope for further research, especially with regard to recent OFDI from developing country multinationals in mature economies and the role and nature of ownership advantages. Perhaps most significant is the recognition during the last two decades that firms also engage in FDI to secure valuable assets to create competitive advantages, termed created or strategic asset-seeking (Wesson, 1993; Dunning, 1995, 1998a, 2001a; Wesson, 1999; United Nations Conference on Trade and Development (UNCTAD), 2006). Several studies confirm the presence of such motivations (Lecraw, 1993; Almeida, 1996; Dunning, 1996; Shan & Song, 1997; Dunning, 1998b; Kuemmerle, 1999; Ivarsson and Jonsson, 2003; Cantwell et al., 2004). Asset-seeking can occur out of a position of weakness with the purpose of overcoming competitive disadvantages vis-à-vis other firms (Wesson, 1999). The concept has recently been used to explain investments from developing country firms in more advanced economies (Moon & Roehl, 2001; Makino et al., 2002; UNCTAD, 2006). In fact, some evidence exists that Chinese firms have asset-seeking as a key motivation when they invest abroad, which they often do from a position of weakness (Zhan, 1995; Young et al., 1996; Child & Rodrigues, 2005; Wu, 2005; Yang, 2005; Deng, 2007, 2008; Ash, 2008; Rui & Yip, 2008). This dichotomy between use of advantages on the one hand, and their pursuit on the other, has become a major point of debate about Chinese OFDI, especially if Chinese firms invest in mature economies. Accounts in the literature of the competitiveness of Chinese firms vary. Some picture Chinese firms either as internationally competitive or becoming increasingly so, with potential to uproot existing global competitive structures (Raskin & Lindenbaum, 2004; Zeng & Williamson, 2003; Sigurdson, 2005). More frequently, however, accounts show a lack of ownership advantages (e.g., in technological, managerial, or innovative capabilities), suggest deficiencies in productivity and company performance, question catch-up potential or refer to strategic weaknesses (Andreosso-O’Callaghan & Qian, 1999; Child and Tse, 2001; Nolan, 2001, 2002; Gilboy, 2004; Steinfeld, 2004; Wu, 2005; Yang, 2005; Deng, 2008; McKinsey, 2008). Given these concerns about the competitiveness of Chinese firms, it is intriguing that OFDI from China to advanced economies in Europe and elsewhere is expanding at a fast pace. Meanwhile, researchers are still struggling to identify what may be the particular and possibly unique characteristics of Chinese OFDI, justifying



178

179

its individual consideration and possibly even a special theory (Child & Rodrigues, 2005; Buckley, Clegg, Cross, Liu, Voss, & Zheng, 2007; Buckley, Cross, Tan, Xin, & Voss, 2008). The body of literature on Chinese OFDI has been constructed only very recently and with limited data availability and restricted access to detailed and reliable information. Existing studies on the internationalization of Chinese enterprises tend to focus on a select few larger and much publicized cases of successful companies (e.g., Haier, Huawei, Lenovo, TCL and ZTE), for which sufficient information exists in the public domain (e.g., Child & Rodrigues, 2005; Wu, 2005; Deng, 2007; Bonaglia, Goldstein & Mathews, 2007; Deng, 2008; Rui & Yip, 2008; Liu & Buck, 2009; Yang, Jiang, Kang, & Ke, 2009). Because they are frequently studied, these cases of larger greenfield investments and mergers & acquisitions (M&As) gradually begin to represent the general pattern of Chinese overseas investments, even though they are more likely special cases that do not reflect the typical experience and situation of most Chinese companies abroad. A few interesting case studies of less well-known companies exist (e.g., Young, Huang, & McDermott, 1996; Zhang, 2003a; Zhang & Edwards, 2007; Knoerich, 2010), together with some notable survey material (e.g., Keller & Zhou, 2003; Asia Pacific Foundation of Canada, 2005, 2006; Liu & Tian, 2008; CCPIT, 2010). Nevertheless, the literature paucity remains, calling for further information from the field. The collection of interview material for this chapter seeks to address this need. Finally, research on Chinese OFDI in Europe is also in its infancy, as it only slowly emerged since inflows peaked in 2007. A key finding in most studies is that Chinese companies primarily invest in Europe to gain market access (market-seeking), and to acquire competitive advantages through asset-seeking with a focus on technology and know-how (Zhang, 2003a; Zhang and Edwards, 2007; Ash, 2008; Filippov & Saebi, 2008; Hay, Milelli & Shi, 2008; Liu & Tian, 2008; Milelli & Hay, 2008; Burghart & Rossi, 2009; Nicolas, 2009; Knoerich, 2010). More needs to be done, however, to understand Chinese investment patterns in the 27 member states. In particular, the above research fails to identify the avenues through which Chinese firms in Europe source competitive advantages. Previous research on inward FDI provides inspiration for the identification of such avenues. The establishment of ‘listening posts’, for example, enables a firm to gather information about the mature economy market and monitor competitors’ products and technologies. Firms may also benefit from ‘reverse spillovers’ (Driffield & Love, 2003; Driffield & Love, 2005; De Propris & Driffield, 2006), which are backward and forward linkages with host economy firms that facilitate the transfer of know-how and skills (JBICI, 2002). Host country competition may also motivate firms to enhance their performance (‘competition effect’) and imitate successful production and business



Jan Knoerich

180


1.2. Assumptions and methodology The theoretical conceptualizations of the previous section give rise to some possible assumptions regarding the patterns and characteristics of Chinese investments in the EU. For example, while an approximately equal spread among EU member countries in proportion to size is the most straightforward assumption about the geographic location of Chinese investments in the EU, theory would suggest preference for less developed (Eastern European) EU countries, where costs are lower, or for countries with a lower perceived psychic distance. Initial empirical findings, however, suggest large countries and major trading partners with China to be preferred destinations (Milelli & Hay, 2008; CCPIT, 2010). The objective of entering a specific country for its individual market should be less significant, given that the EU has established itself as a regional market and economic union. In terms of motivation, the literature suggests both marketand asset-seeking to be relevant, though it remains unclear how Chinese firms undertake both concretely. Finally, large greenfield investments or M&As would be likely entry modes, given the focus on respective cases in the literature. Overall, traditional theory would opt for the assumption that Chinese firms have developed sufficient ownership advantages to invest in the EU, based on competitive strengths developed over 30 years of economic reform and internationalization. Theory suggests that asset-seeking can only have a minor role, and that firms do not invest out of a position of weakness. Therefore, one expects investments by large and strong Chinese firms to undertake productive activities in the host country. To address these issues and verify the correctness of these assumptions, quantitative data was combined with qualitative evidence from field research. Descriptive statistics were derived from the Statistical Bulletins of China’s Outward Foreign Direct Investment, published by the Ministry of Commerce (MOFCOM) of China. The key source of qualitative evidence was information made available from European IPAs. Having contact with many Chinese enterprises that invest in the EU, the staff working for IPAs have a unique kind of oversight, melding both aggregate and firm-level information into their accounts. Hence, information obtained from IPAs forms an interesting middle ground between pure macroeconomic analyses and firm-level or case-based approaches.



practices (‘demonstration effects’), while labor turnover can facilitate diffusion of local skills to foreign firms (see JBICI, 2002; Saggi, 2002, 2004). Finally, host country firms with desired technologies, brands, and capabilities can be purchased. In addition, OFDI can also stimulate exports from the home economy, increase productivity, and in certain cases even enhance employment (UNCTAD, 2010a). This chapter considers these avenues in its examination of Chinese OFDI in the EU.

181

In the summer of 2007, personal interviews of one hour on average were undertaken at IPAs in Beijing and Shanghai, in English, Chinese, or German, and tape recorded and transcribed. Subsequently, further information was requested from IPAs that did not have a representative office in China by phone and email. Taken together, information was received from a total of 27 European IPAs, ensuring sufficient coverage of the entire EU (see Table 9A.2). For further verification, additional interviews were conducted at the China Investment Promotion Agency (CIPA) under MOFCOM and at several Chinese companies in China, Germany, and the United Kingdom. The IPAs were approached with a list of questions (see Table 9A.3). The answers obtained were complemented with material from IPA brochures and websites. Taken together, the various collected materials allowed for a sufficiently comprehensive and insightful assessment of Chinese investment activity in EU member states. A rigorous coding procedure yielded a sizeable database of detailed information from different countries in 27 informational categories (see Tables 9A.4 and 9A.5 for summarized excerpts). To ensure consistency and make the analysis more insightful, all 27 EU member states were included in the full analysis even if they had not yet been EU members in 2003 or later years, and an idiosyncratic approach was followed in dividing the EU into separate areas. Germany and the United Kingdom are considered each as one separate area. The third area consists of the next three large Western European economies, France, Italy, and Spain. Adding the other ten Western European member states yields the next group.1 The fourth group includes the ten economies that entered the EU in 2004.2 Finally, the last two accession states, Bulgaria and Romania, form the fifth group.

2. Evidence on Chinese OFDI in the European Union 2.1. Location of Chinese investment Figure 9.2 depicts Chinese OFDI stock in 2009 by geographical region,3 revealing the following ranking: Asia (35 percent of Chinese OFDI), Africa (19 percent), Oceania (13 percent), Canada and the United States (11 percent), the Commonwealth of Independent States (CIS) and Eastern Europe (10 percent), the EU (8 percent), and Central and South America including Mexico and the Caribbean (4 percent). The results show that Chinese OFDI to the EU takes up slightly less than one tenth of all Chinese OFDI, and is almost at par with North America and many other regions of the world. Given that the EU was China’s largest trading partner in 2010 (DG Trade, 2011), this is a relatively small share. But many Chinese investments in other regions target energy and mining sectors (MOFCOM, 2009), which require larger-scale OFDI, and it is likely that Chinese OFDI in the



Jan Knoerich


EU-27 8%

Latin America 4%

Rest of Europe 0%

CIS and Eastern Europe 10%

Rest of Asia 35%

North America 11%

Oceania 13%

Figure 9.2

Africa 19%

Share of Chinese OFDI stock by region (2009)

Notes: Excludes ‘Greater China’ (Hong Kong, Macau, and Taiwan) and (offshore) financial centers (Bahamas, Bermuda, the British Virgin Islands, the Cayman Islands, and Luxembourg). CIS = Commonwealth of Independent States (post-Soviet states). Source: MOFCOM 2009 Statistical Bulletin of China’s Outward Foreign Direct Investment.

EU (a resource-poor but economically advanced region) exhibits its own characteristics that deserve explicit analysis. An analysis of the distribution of Chinese OFDI among EU member states and the host country preferences of Chinese firms may inform about Chinese firms’ approaches to internationalization and the importance of competitive advantages. Figure 9.3 presents changes in the share of Chinese OFDI stock held over the period from 2003 to 2009. Germany held the largest share of Chinese OFDI in the EU during most of this period, followed by the United Kingdom. Taken together, both countries jointly received the majority of Chinese OFDI in Europe, between one third and two thirds, with their joint share increasing over the years and peaking at 61 percent in 2007. In 2009, the shares of Germany and the United Kingdom were 29 percent (US$1.08 billion) and 27 percent (US$1.03 billion), respectively. The share of Chinese OFDI held by France, Italy, and Spain together was highest among the country groupings at the beginning of the period of analysis (32 percent in 2003). However, their share declined over the sixyear period to 16 percent in 2009 while Germany and the United Kingdom increased their share. The share of all the remaining Western European economies was 18 percent in 2009, slightly above their average share over the analyzed period. The Eastern European accession states of 2004 remained below 10 percent in most years (8 percent in 2009), and were even surpassed



182

Jan Knoerich

183

100% 90% 80% 70% 60%

40% 30% 20% 10% 0% 2003

2004 EU-27

2005

2006

EU-25

United Kingdom

2007 EU-15

2008

2009

EU-5

Germany

Figure 9.3 Share of Chinese OFDI stock in the EU by country or country groups (2003–2009) Notes: EU-5 = France, Italy, Spain; EU-15 = Austria, Belgium, Denmark, Greece, Finland, Ireland, the Netherlands, Luxembourg (except for 2009), Portugal, and Sweden; EU-25 = Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia; EU-27 = Bulgaria and Romania. Source: MOFCOM (2007, 2008, 2009, 2010) Statistical Bulletin of China’s Outward Foreign Direct Investment.

by Romania from 2003 to 2005. The share of Bulgaria and Romania declined over the analyzed period to 3 percent in 2009. Estimates of the number of companies in each country, provided by the IPAs, reinforce this picture (see Table 9A.4). Germany had the highest number of Chinese companies among EU member states, followed by the United Kingdom, with a few hundred companies each. These two countries were the focal point for Chinese investors. A second group of large or medium-sized countries, including France, the Netherlands, and Sweden, each received between 50 and 150 Chinese enterprises. However, the majority of smaller states, both in Western and Eastern Europe, received only a few dozen Chinese companies, and some countries reportedly had fewer than ten. Smaller economies hence appeared less attractive to Chinese companies. The respondents from the IPAs confirmed that Chinese OFDI in the EU was a recent occurrence, as most companies arrived after 2003. Chinese OFDI in the EU is clearly not equally distributed. Rather, Chinese firms prefer large, advanced Western EU economies. Little attention is paid to Eastern European transition economies even though investment costs are lower and psychic distance to China could be less due to similarities



50%

184


2.2. Investment motivation and other determinants Market-seeking motivations help explain Chinese preferences for large, centrally located economies in the EU. These countries (e.g., Germany), and those located in what may be considered as center-periphery (e.g., Belgium, Luxembourg, the Netherlands, Poland, Spain, Sweden, and the United Kingdom), form the ‘Gateway to Europe’ – the larger, centrally located countries because they border on many other states and are in themselves large markets, and the countries in the center-periphery because of their central location with proximity to the sea, with shipping connections and efficient logistics services for Chinese exports to Europe. Countries on the periphery, such as Ireland, Portugal, and many Eastern European countries, are less likely to serve as hubs for Chinese enterprises to enter the European market. This finding confirms Chinese OFDI in the EU to be, at least partially, an effort to exploit existing competitive advantages in advanced markets. Many countries are also at the ‘crossroads’ between the EU and other countries where Chinese enterprises seek business opportunities. Some countries in the periphery (e.g., Cyprus for access to Northern Africa and the Middle East) and the center-periphery (e.g., Italy for the Mediterranean region and Spain for Northern Africa and Latin America) are important in this context. In these developing country markets, Chinese firms can again play out their competitive advantages more fully. However, even the center of Europe can provide a stepping stone for Chinese companies to enter non-EU markets. For example, high-tech products developed and made by a Chinese firm in Germany are better sold worldwide due to the high quality and reputation of products made in Germany, and conformity to German quality certification requirements. Being an international company with a presence in advanced markets also improves the reputation of a Chinese company not only in the eyes of global customers, but also in China itself. Chinese companies are better able to compete in third country markets by simultaneously making use of competitive advantages sourced in the EU host economy. The reports of the IPAs indicated that Chinese companies often chose a country as an investment location if it is known for its strengths in a particular industrial sector or business activity. For example, Belgium and the Netherlands have a reputation for efficiency in logistics; Finland and Sweden are known for research and development (R&D); Germany is important for machinery and equipment; and Luxembourg and London are considered



in economic and developmental history. For the newer member states, EU accession has not made a substantial difference in number of Chinese investments received. Chinese firms may either possess competitive advantages to invest in very sophisticated and advanced economies already, or they may invest there to source them.

185

centers of excellence in financial services (see Table 9A.5). High-tech industrial sectors are interesting for Chinese companies. Strategic asset-seeking motivations play a role next to market-seeking. Within EU member states, a concentration of Chinese investments in ports and major cities (especially Hamburg and London) was observable, allowing ideal positioning for logistics and proximity to other businesses and government. Other Chinese firms based themselves in clusters of their specific industry, or located near national borders if the actual markets sought were across those borders. Whether individual Chinese firms invest in a specific EU member state to access the EU market as a whole rather than only the market of the host country remains an open question. Some IPAs suggested that Chinese are unlikely to perceive the EU as one entity, but tend to consider each country as a separate market with its own authorities, regulations, legal system, tax rules, language, investment incentives, and sometimes even visa and work permit requirements. According to some IPAs, Chinese companies tend to invest in the largest EU economies because they seek national markets, while Chinese companies hosted by smaller EU member states often want to sell not only within the country of investment, but in neighboring countries. A particular problem faced by smaller EU member states is a reputation deficiency, as they were relatively unfamiliar to people from a huge country like China. While large countries are known for reasons which are business-related (e.g., a strong economy, advanced technology, large markets, famous products), geographical (e.g., Paris, London, Berlin), or even cultural and political (e.g., habits, football leagues, celebrities, Merkel and Sarkozy), smaller EU member states to a much lesser degree enter the sphere of knowledge and interest of a Chinese person. Managers felt more comfortable investing in places where they had some sort of familiarity, even if it was not business-related. Other economic and business factors influencing the decision of a Chinese company to invest in a particular European country were investment incentives, which are more favorable in the transition economies (Invest in Germany, 2007), the amount of trade with China, and the amount of EU member state investment in China. China had also concluded bilateral investment treaties with all EU countries but Ireland (see Table 9A.6). Such treaties commonly address protection, treatment, promotion, and sometimes liberalization of foreign investment (UNCTAD, 2007). Specific business opportunities for Chinese firms with experience from the Beijing Olympics opened up in the United Kingdom in connection with the 2012 London Olympics. In addition, interviewees emphasized non-economic, personal, and emotional aspects that influence location decisions, especially in the early stages of overseas expansion. These include free and personal support provided by IPAs, personal recommendations, language (with the United Kingdom as a preference because of English), visa requirements, the history



Jan Knoerich


of diplomatic relations with China, the existence of personal relations (guanxi) with Chinese or non-Chinese people in the host country, personal experience with a country (e.g., from previous university enrolment there), the possibility of emigrating and settling in Europe, and the prevalence of a larger Chinese community, including Chinese schools, supermarkets and restaurants. Many of these aspects appear to lower psychic distance and suggest that concepts put forward by the internationalization school hold. IPAs play an important role in determining Chinese companies’ emergence in Europe. In parallel with the surge of Chinese OFDI into the EU in 2007, a substantial number of representative offices of Western European IPAs sprung up in major Chinese cities. Each IPA had the goal of establishing contact with Chinese firms as early as possible, to be the first in approaching Chinese companies and bringing them successfully into the country it represented. Most IPAs took a proactive strategy in reaching out. Instead of waiting to be approached by interested firms, they established direct contact with promising ones, introduced business opportunities in EU member states to them, and offered various forms of support in case an investment decision was made. Such an active marketing strategy was necessary as Chinese firms did not often contact the IPAs on their own initiative, often unaware of the business opportunities in Europe as well as the IPAs’ existence. For some IPAs of smaller EU member states, active marketing was the only way to get any Chinese investors interested in the country represented. While the increasing presence of European IPAs in China indicates that Chinese firms are hungry to invest in Europe, this engagement by IPAs in reality reflects a rising interest among European governments in attracting Chinese investors. No European country would accept missing out on the potential benefits that the emergence of Chinese investments could offer its economy in the future. The same few companies were often approached by several IPAs from different EU member states, spurred by increasing competition among European IPAs in reaching out to potential Chinese investors. Underlying this trend was the assumption that Chinese investments would have a positive impact on the European economy, bringing additional capital, tax returns, employment, new business opportunities, and performance-enhancing competition. Chinese companies had acquired European firms in financial difficulty, supporting them in improving or re-launching their business (Knoerich, 2010). IPAs preferred to focus on attracting high-tech investments, and greenfield FDI was preferred to M&As. However, concerns remained that Chinese firms did not sufficiently invest in manufacturing activities and sectors with a high added value. Chinese firms received special attention and treatment from European IPAs because of the high expectations for their future performance. Unaware of the opportunities that EU countries offered to Chinese firms, the



186

Jan Knoerich

187

personalized support provided by IPAs sometimes made a difference in decisions on where to invest and what procedures and strategies to follow. A new generation of IPAs emerged that actively engage in competition for investments directly in their country of origin.

Sales and representative offices, or occasionally larger distribution centers (including warehouses), are the most common entry modes. These offices tend to be small, involving limited activities with a minor amount of employees. After years of simple export activity or engagement as original equipment manufacturers (OEMs) for foreign firms in China, setting up representatives within their own export markets is the next step of expansion for Chinese enterprises. The resulting proximity to their customers in the EU enables Chinese firms to respond more directly to customer demands, to market their products more effectively, and to provide satisfactory aftersales services. Moreover, having one’s own sales office reduces dependence on Chinese or European trading companies and agents, which often charge Chinese enterprises commissions for export and trade facilitation services. Overall, these activities follow the objective to further exploit existing competitive advantages derived from domestic (home country) production, and minimize transaction costs through internalization. Greenfield investments establishing a plant or a factory through a larger commitment of capital are less common. Production, manufacturing and construction work by Chinese companies is largely confined to the new member states of Eastern Europe, where wages are lower, whereas such activities in Western Europe normally involve not more than the assembly of components manufactured in China. Hence, the exploitation of advantages through foreign (host country) production is less common. Industrial parks are popular investment locations for small greenfield investments and sales offices. More frequent in Western European countries is the establishment of R&D centers, usually set up to adapt the features and design of Chinese products to the European market, or to develop new products. Some R&D centers operate on their own, for example by locating within industrial clusters to take advantage of learning opportunities. Several Chinese companies decided to locate near large well-known Western firms (e.g., Philips in the Netherlands, Ericsson in Sweden) in hope of benefiting from this proximity for their own organizational learning. Alternatively, companies seek cooperation in R&D with a European company, laboratory, research institute, or university to take advantage of highly advanced and specialized knowledge. Chinese companies even finance individual research projects in European institutions. Some R&D addresses specific sectors where the Chinese economy places importance on upgrading, such as renewable energies to enhance the environmental situation in China. The establishment



2.3. Entry mode of Chinese investors


of R&D centers is a way to source assets and advantages overseas. For the Chinese, R&D centers do not have to be large, as some operate with fewer than ten and as little as three employees, making them attractive as an approach towards asset-seeking. An R&D function may even be built into a sales office so that R&D projects in Europe are not necessarily connected with high cost. Though often highly publicized in the media, M&A deals of Chinese firms in the EU are still quite rare. A distinction exists between share deals and asset deals. Share deals involve the purchase of shares in an EU firm, implying that business and production within Europe continues following the acquisition. Asset deals involve the purchase of an EU firm’s assets, part or all of which may be transferred back to China. Further business activity within the EU is then not guaranteed. While share deals are usually publicly disclosed, asset deals are usually not, partly because they are occasionally quite controversial (Wenk, 2005). IPAs mentioned that M&As are important for asset-seeking, as they constitute a quick way to gain know-how, technologies and foreign brands (Inkpen, 1998). Cases such as the acquisition of MG Rover (the United Kingdom) by Nanjing Automobile and TCL’s takeover of Thomson (France) illustrate this (Hong & Sun, 2006). The Nanjing Automobile case is an example of an acquisition undertaken out of a position of weakness for the purpose of organizational learning.4 Recent acquisitions in the German machinery and equipment industry are similar in nature (Knoerich, 2010). In summary, most Chinese investment activities in the EU require relatively little investment capital. A typical sales or representative office might have fewer than ten and sometimes as few as two employees, but IPAs indicated that sales offices would expand over time. Investments with more than 100 employees are rare, confined to a few well-known companies (e.g., Huawei, Lenovo and ZTE) undertaking larger investment projects in several EU member states, and investments in Eastern Europe. Some M&As also involve sizeable European target firms. The above discussion suggests that small Chinese investments are made almost entirely for the exploitation of existing advantages. Other modes of entry – in particular, larger and more costly projects, such as M&As – are more often undertaken with asset-seeking considerations in mind. 2.4. Competitiveness of Chinese investors The accounts provided by the IPAs are in conformity with findings in the literature, suggesting a rather mixed picture on the competitiveness of Chinese enterprises in Europe. Some Chinese firms in Europe are highly competitive or even world leaders, as in the white goods (e.g., Haier and Midea) and information and communication technologies (e.g., Huawei and ZTE) sectors. In these industries, Chinese firms are technologically advanced



188

189

while able to offer competitive prices. However, other firms struggle with ineffective sales and promotion efforts, poor branding, insufficient technological capabilities, low product standards, including a reputation for bad quality, and lack of managerial capabilities or strategic thinking. Investments out of a position of weakness certainly occur. Assessments by the IPAs of the preparedness for foreign investments and international experience are mixed at best, and familiarity with the EU is not strong. Europe, with its fragmented structure composed of an array of individual nation-states, cultural-linguistic diversity, and a traditional but less flexible approach to business, is a major challenge for Chinese investors who may have already succeeded in developing countries in Asia and Africa. North America, with its large overseas Chinese population and English as a main language, is an easier investment destination. Problems in Europe relate to administrative procedures, especially immigration, visas, work and residence permits, and authorization to import certain uncommon products such as traditional Chinese medicine. Policy incoherence and inconsistency among EU member states impinges upon Chinese business decision-making (Curran, 2009). However, Chinese investors in Europe do not face the kind of political opposition and criticism observed in the United States, where Chinese investments have occasionally been reviewed and disallowed for national security reasons (Schüller & Turner, 2005; Globerman & Shapiro, 2009). Opposition in Europe remains confined to critical press coverage. Chinese firms in the EU built their competitiveness mainly from a low-cost production base in China, which placed them in a position to manufacture very cheaply. This enables them to sell their products overseas at a low price but with acceptable quality. The competitiveness of many Chinese firms in Europe is based on domestic production rather than foreign production, an anomaly to some extent as FDI is normally associated with foreign production (e.g., Dunning, 1980, 2001a). Manufacturing and production are mostly maintained in China while only related services and other smaller activities are outsourced to the European location. Most of these services and activities, such as after-sales support and distribution, product design, assembly, and R&D, can be handled on a small scale and at low cost. As Chinese firms draw competitive advantages from cheap production in China, overly large investments in Europe may undermine this advantage. Due to the immense cost difference between China and Europe, Chinese firms are more sensitive to costs compared to investors from mature economies. Travel expenses, for example, are kept at the lowest possible level and employees paid at comparatively low rates. The employment of Europeans is avoided in favor of Chinese or depends on the availability of local personnel willing to work for a low salary. A second aspect making Chinese firms investing in Europe competitive is specialized know-how, such as the ability to master an advanced technology



Jan Knoerich


or a China-related capability (e.g., expertise on Chinese medicine in the pharmaceutical sector). In many cases, Chinese firms manage to develop competitiveness in a product that fits into a niche within the European market, based on a technological advantage, but resulting also from the ability to sell in a very low price segment or from some other specific feature of the product that provides a unique selling point. Familiarity with the Chinese market and easy access to it gives Chinese firms an advantage. Products manufactured or assembled in Europe can easily be sold in the enormous Chinese market without major preparation. Chinese companies can assist European partner firms in setting up business in China in exchange for support in the EU market, using their privileged access to the Chinese market as a bargaining tool for support in setting up business in the EU. Another competitive advantage of Chinese companies is their relatively easy access to funding for foreign investments, obtained from vast domestic sales, export earnings or governmental sources. Unlike many Western competitors, they exhibit a high degree of flexibility in doing business and strong adaptability to new market conditions, acquired through prior experience in the cut-throat Chinese market. Finally, Chinese firms benefit from overseas networks of firms and individuals, relying on Chinese communities in the EU for assistance in business matters. In sum, strategic weaknesses exist and must be overcome. Competitive advantages are derived mainly from home country production and product differentiation for niche segments. Chinese investors rarely have a distinct superiority in technological, managerial, or marketing capabilities, often possessed by mature economy investors in developing countries. Moreover, M&As often involve ailing EU firms, and even if synergies are promising, success is far from guaranteed. Essentially, the ability to sell at very low prices is the main reason Chinese firms do not have to avoid competition in Europe. Thus, sales offices set up only for the purpose of marketing and distributing goods produced in China are likely the most competitive Chinese investments in Europe, as they rely on price competitiveness that existed long before the investment.

3. Conclusion This chapter has examined the emergence of Chinese OFDI in the EU. Chinese companies prefer the large economies of Germany and the United Kingdom, guided almost entirely by market- and asset-seeking objectives. Many Chinese investments in the EU make use of pre-existing competitive advantages that originate from low-cost production in China. Sales offices suffice for the exploitation of these competitive advantages and to support incremental internationalization. Chinese investments for the purpose of



190

191

sourcing competitive advantages also exist, often requiring larger-scale entry and even acquisitions. Contrary to traditional theories of ownership advantages, investment is not a result of any general superiority – technological or otherwise – but an intensification of market access for domestically produced cheap goods as well as entry into niche markets. Chinese investment in the EU is primarily an endeavor to expand export markets and existing business rather than seeking entirely new markets. Small-scale activities in the EU in line with early phases of internationalization usually suffice to exploit these advantages and grow internationally. Except for R&D projects, such smallscale activity is not suitable for asset-seeking, one reason being the lack of personnel to absorb knowledge or assets. Beyond sales offices and R&D centers, Chinese activity in Europe is scant, limited to a few larger greenfield projects and M&As. Greenfield projects may assemble products in late stages of the production cycle, but rarely undertake large-scale manufacturing. Benefits from reverse spillovers, backward and forward linkages, competition, and demonstration effects are generally the most significant with this entry mode. Moreover, the importance of M&As in the sourcing of competitive advantages is confirmed by numerous firms, by IPAs and by the literature. This overall picture, not counting small-scale R&D with its benefits for organizational learning, suggests a certain paradox: the pursuit of assets may well involve a larger commitment of capital than is often needed for effective exploitation of ownership advantages. In particular, if firms investing out of a position of weakness wish to engage in the sourcing of competitive advantages to support their own development and catch-up, the requirement for a higher commitment of capital becomes a challenge. Both this potential for development and catch-up with broader benefits to the home economy, and the requirement for larger amounts of capital, could explain the involvement of the Chinese government in supporting, sometimes financially, overseas investments by Chinese firms (Zhang, 2003b; Antkiewicz & Whalley, 2006; Voss, Buckley, & Cross, 2009; Luo, Xue, & Han, 2010). Table 9.1 provides a final overview of the nature and types of Chinese investments in Europe and the key avenues for exploitation and sourcing of competitive advantages. The various opportunities for exploitation and sourcing of competitive advantages, if utilized effectively, will enable Chinese enterprises to further internationalize, grow and expand, and benefit from organizational learning opportunities and access to technologies and know-how. To some extent, this will allow Chinese firms to move forward in their quest to catch up with their mature economy counterparts. The economic impact resulting from Chinese OFDI in the EU has not been felt until now. The nature of activities and scale of Chinese investments in the EU are still too limited to make European competitors experience heightened competition from Chinese investors beyond the competition



Jan Knoerich

192


Sales/ representative office

R&D center

Greenfield (production or assembly)

M&A

Size

Small

Small to medium

Medium to large

Medium to large

Capital (amount)

Low

Low to medium

Medium to high

High

Clusters; proximity to research institutions or leading firms

Proximity to markets; low-cost areas; skilled workforce

Location of partner firm

Proximity to Main markets location determinants

Exploitation of advantages: main avenues

Low-cost production in China; niche products; flexibility and adaptability

–

Niche products; flexibility and adaptability

Access to finances (with government support); Chinese market backing

Sourcing of advantages: main avenues

‘Listening post’; competition effects

R&D collaboration; ‘Listening post’ (market research); labor turnover

Reverse spillovers (backward and forward linkages); competition and demonstration effects; labor turnover

Purchase of capabilities (technologies, brands, management skills, distribution networks); direct access to a skilled workforce

Development benefit to Chinese firm: key aspects

Growth of firm; market expansion

Organizational learning; catch-up

Growth of firm; market expansion; organizational learning; catch-up

Growth of firm; market expansion; organizational learning; catch-up

already felt from international trade with China. However, this may well change as Chinese companies raise their competitive presence in the world stage. This chapter’s findings open interesting paths for further research. More research is needed on how developing country firms can effectively source



Table 9.1 Characteristics and types of Chinese investments in Europe: exploitation and sourcing of competitive advantages

193

competitive advantages in mature economies without running large investment risks. Moreover, studies on Chinese OFDI should refrain from focusing only on the same few large firms, and analyze lesser-known investment projects (see Table 9A.5 for examples). My findings further reveal that Chinese investment decisions often involve a spontaneous or personal element, including individual perceptions, relationships (guanxi), coincidence (e.g., which IPA approaches a company first), and even personal motivations (e.g., immigration and citizenship). This poses a challenge to business researchers who assume firm behavior based on strategic considerations, and may open up new research paths. Last but not least, this research illustrates that (potential) Chinese investors in themselves form a distinct group of clients, sought by non-Chinese government institutions – foreign IPAs – in a competitive manner. This new generation of IPAs venturing into emerging markets to influence early investment decisions should receive more in-depth consideration in future research.

Acknowledgments This research was conducted while the author was conducting PhD research at the School of Oriental and African Studies, University of London, UK. The author thanks all interviewees and respondents from investment promotion agencies and enterprises, whose cooperation was essential in making this research project a success. Research funding from the University of London Central Research Fund and the School of Oriental and African Studies was gratefully received.



Jan Knoerich

194


Appendix Table 9A.1 Chinese OFDI stock and flows into the EU by member states (2003, 2008, and 2009, US$ million)

Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom Total

2003

2008

0.70 0.41 0.60 – 0.33 74.43 – – 13.12 83.61 – 5.43 0.24 19.18 1.61 – – 0.37 5.90 2.72 0.20 29.75 0.10 – 101.81 6.07 75.15 421.73

4.04 33.30 4.74 1.36 32.43 38.08 1.26 3.59 167.13 845.50 1.68 88.75 107.77 133.60 0.57 3.93 122.83 4.81 234.42 109.93 1.71 85.66 5.10 1.40 145.01 157.59 837.66 3173.85

Flow 2009

2003

1.55 0.40 56.91 0.30 2.31 0.35 1.36 – 49.34 – 40.79 73.88 7.50 – 9.04 – 221.03 0.45 1082.24 25.06 1.68 – 97.41 1.18 106.82 0.14 191.68 0.29 0.54 1.58 3.93 – 2484.38 – 5.03 – 335.87 4.47 120.30 1.55 5.02 – 93.34 0.61 9.36 – 5.00 – 205.23 – 111.89 0.17 1028.28 2.11 6277.83 112.54 (3793.45*)

2008

2009

– – – – 12.79 1.33 – 2.66 31.05 183.41 0.12 2.15 42.33 5.00 – – 42.13 0.47 91.97 10.70 – 11.98 – – 1.16 10.66 16.71 466.62

– 23.62 −2.43 – 15.60 2.64 – 1.11 45.19 179.21 – 8.21 −0.95 46.05 −0.03 – 2270.49 0.22 101.45 10.37 – 5.29 0.26 – 59.86 8.10 192.17 2966.43/ (695.94*)

Note: *Excluding the financial center of Luxembourg. Source: MOFCOM ( 2007, 2008, 2009, 2010). Statistical Bulletins of China’s Outward Foreign Direct Investment.



Stock

195

Country

IPA or other institution

Website

Austria

Advantage Austria

http://www.advantageaustria.org/

Belgium

Flanders Investment & Trade

http://www.flandersinvestmentandtrade. com/

Bulgaria

InvestBulgaria Agency

http://www.investbulgaria.com/index.php

Cyprus

Cyprus Investment Promotion Agency

http://www.cipa.org.cy/

Czech Republic CzechInvest

http://www.czechinvest.org/en

Denmark

Invest in Denmark

http://www.investindk.com/ default.asp?artikelID=9664

Finland

Invest in Finland

http://www.investinfinland.fi/

France

Invest in France

http://www.invest-in-france.org/de

Germany

Invest in Germany

http://www.gtai.com/web_en/homepage

Hungary

ITD Hungary

http://www.itdh.com/engine.aspx?page= Itdh_Befektetes

Ireland

IDA Ireland

http://www.idaireland.com/

Italy

Italian Trade Commission I.C.E.

http://www.italtrade.com/

Latvia

Investment & Development Agency of Latvia

http://www.liaa.gov.lv/eng/home/news/

Lithuania

Lithuanian Development Agency

http://www.lda.lt/en/index_de.html

Luxembourg

Consulate General (Shanghai)

Malta

Malta Enterprise

http://www.maltaenterprise.com/

Netherlands

Netherlands Foreign Investment Agency

http://www.nfia.com/

Poland

Polish Information and Foreign Investment Agency

http://www.paiz.gov.pl/index/

Romania

ARIS Invest

http://www.arisinvest.ro/

Slovakia

SARIO Slovak Investment and Trade Development Agency

http://www.sario.sk/?home

Slovenia

Public Agency of Republic of Slovenia for Entrepreneurship and Foreign Investments

http://www.investslovenia.org/



Table 9A.2 List of contacted European IPAs

196


Country

IPA or other institution

Website

Spain

Economic and Commercial Office of Spain in Shanghai

http://www.investinspain.org/

Sweden

ISA Invest in Sweden Agency

http://www.investsweden.se/

United Kingdom

Scottish Development International

http://www.sdi.co.uk/

United Kingdom

Think London

http://www.thinklondon.com/

United Kingdom

Advantage West Midlands

http://www.advantagewm.co.uk/

United Kingdom

UK Trade & Investment

https://www.uktradeinvest.gov.uk/

Table 9A.3 List of questions posed to European IPAs A) General Data and Information on China’s OFDI in [EU member state]: • • • • • • •

Total amount of Chinese companies that have invested in [EU member state] Names of Chinese companies that have invested in [EU member state] Common type of entry mode (e.g., sales office, greenfield, merger & acquisition) Average size of investments (e.g., capital invested, number of subsidiary employees) Common type of industrial sector (e.g., high-tech, low-tech) Average age of investments Average ratio of [EU member state] employees to Chinese employees

B) Questions on China’s OFDI in [EU member state]: 1) About what issues do Chinese companies consult you? 2) What kind of support do you provide to Chinese companies? 3) How well prepared are the Chinese companies for the foreign investment before they approach you, how familiar are they with [EU member state]? How much previous international business experience do the Chinese firms have? 4) How do Chinese firms become aware of OFDI opportunities in [EU member state]? 5) How competitive domestically and internationally are the Chinese companies on average before they invest abroad? 6) What competitive advantages and unique capabilities do Chinese companies have that assure the competitiveness of their foreign investment in [EU member state]? 7) What are the motivations, goals, and expectations of the Chinese companies when they invest in [EU member state]?



Table 9A.2 (Continued)

8) Why do Chinese firms choose [EU member state] as investment location, what are [EU member state]’s strengths and weaknesses as a location, in the view of Chinese firms? Where in [EU member state] do Chinese firms prefer to invest, for what reasons? 9) In view of the [EU member state] economy, what are the implications (positive and negative) of Chinese investments in [EU member state]? 10) How strong is the competition that Chinese firms face in [EU member state] and how do they deal with it? 11) How intensive are the contacts between Chinese firms in [EU member state] and [EU member state] firms, and what kind of contacts are these commonly? 12) How satisfied are Chinese firms with their investments in [EU member state], are expectations met, what are the major benefits? 13) What are the positive and negative experiences of Chinese firms in [EU member state], how are difficulties dealt with? 14) Over time, do Chinese firms in [EU member state] improve their business due to learning experiences made in the [EU member state] market? 15) To what extent do Chinese companies in [EU member state] plan to expand their business or reverse their investments and leave the country? 16) Do Chinese firms in [EU member state] benefit from gaining access to know-how or strategic assets? If so, what type of know-how and strategic assets, and how are they obtained?



197

Common entry modes

Size (employees)

Age (years or date)

Main motivations

Main host country determinants

Main sources of enterprise competitiveness

Main areas for sourcing of advantage

Austria

2–3

SO/RO

–

–

–

–

–

–

Belgium

15–20; < 5 per year

SO/RO R&D Greenfield JV

Small; e.g., 1 or 2

2–5

Market; Distribution; Know-how; Business development

Gateway; Incentives; Promotion; Know-how

Low-cost; Leading position; Strong finances

S&M; R&D

Bulgaria

7 major investments

Greenfield JV M&A

e.g., 40, 280

e.g., 2001

–

–

–

–

Cyprus

–

–

–

–

Crossroads; Incentives; Promotion; Know-how; Reputation

–

–

Czech Republic

3 major investments

–

30–300

e.g., 2005, 2006

–

–

–

–

Denmark 15–20; 2–4 per year

SO/RO R&D

Small; e.g., 3–7

2–3

Market; Know-how

Promotion

–

Technology; R&D; Qualified labor; e.g., wind energy

Estonia

–

–

–

–

–

–

–

–



Number of investments

198

Table 9A.4 Overview of IPA survey results on Chinese OFDI in the EU (2007–2008)

–

SO/RO R&D Greenfield

–

–

Market

Gateway; Promotion; Know-how

Niche

R&D

France

60–100 or above

SO/RO R&D Greenfield JV M&A

Small; 15 in SO/RO; a few large ones

from 2000

Market; Know-how; Business development

Crossroads; National market; Incentives; Promotion

Low-cost; Leading position

Germany

400–800

SO/RO R&D Greenfield M&A

Small; a few large ones

from 1997

Market; Production; Know-how; Business development

Crossroads; National market; Incentives; Promotion; Know-how; Reputation

Flexibility

0

–

–

–

–

–

–

Ireland

3–4

SO/RO

Small

–

–

–

–

Italy

–

SO/RO M&A

Small

3

–

Incentives; Promotion; Know-how Crossroads; National market; Promotion; Know-how

–

Brands


199

Greece

S&M; Technology; R&D; Brands; Management; Qualified labor; e.g., consumer electronics S&M; Technology; Brands; Qualified labor; Competing firms; e.g., machine building, consumer electronics –


Finland

Number of investments

Common entry modes

Size (employees)

Age (years or date)

Main Motivations

Main host country determinants

Main sources of enterprise competitiveness

Main areas for sourcing of advantage

Latvia Lithuania Luxembourg

0 34 above 10–20

– – SO/RO

0 – 10–20

– – Low-cost

– – –

>100 related to Chinese holdings

–

– – Market; Business development –

– – Gateway; Incentives

Malta

– – Small; a few large ones –

–

–

–

Netherlands

130–150

SO/RO R&D M&A

5–10; a few large ones (>200)

2–3

Market; Know-how

Gateway; Incentives; Promotion; Reputation

Low-cost

Poland

75

2–5

Market; Production

Gateway; Incentives

Niche

Technology; R&D; Management; Qualified labor; Competing firms –

Romania

–

–

–

–

–

–

Slovakia

2

SO/RO Small; Greenfield large ones M&A with e.g., 1276, 1200 – e.g., 120, 150, 2000 R&D e.g., 400

Slovenia

117

–

–

–

–

Market

–

–

R&D

–

–

Crossroads; Know-how

–

Qualified labor



200


50

Greenfield e.g., 20 M&A

8–10

Market

Gateway; Crossroads; National market; Incentives; Promotion

Low-cost; Leading position

R&D; Management; Qualified labor; Competing firms

Sweden

above 100

1 to a few SO/RO hundred R&D Greenfield M&A

3

Market; Know-how

Gateway; National market; Promotion; Know-how

Niche

Technology; R&D; Brands; Qualified labor; e.g., ICT, biotechnology, clean environment

United Kingdom

above 300; 50 per year

Small; SO/RO some larger R&D Greenfield ones M&A

4

Market Know-how

Gateway; Incentives; Promotion; Know-how

Low-cost; Niche; Leading position; Strong finances; Networks

S&M; Technology; R&D; Brands; Competing firms; e.g., financial services, renewable energy, low carbon


201

Notes: Indications are all estimates and averages. SO/RO = Sales Office or Representative Office; JV = Joint Venture; Gateway = ‘Gateway to Europe’ (see text); Crossroads = ‘Crossroads between EU and other countries’ (see text); S&M = Sales and Marketing. Source: Information constitutes summarized and simplified excerpts of interviews and data collected (spontaneous or email answers by respondents from IPAs) in 2007 and 2008.


Spain

202

Chinese companies

Typical sectors

Belgium

AMOI/SPB, BBCA Group, Beijing Gongmei Europe, China Coal, China National Offshore Oil Corp. (CNOOC), China Ocean Shipping (Group) Company (COSCO), China Shipping, Drakkar Holdings, Great Wall Library, Hainan Airlines, Hisense, HWL, Shantai, Tianjin Light, Torin Jacks, Tianjin International Corp.

White goods, X-ray systems, TV screens, food, dumplings, trading (chemicals, metals)

Bulgaria

Chongqing Lifan Weili Appliances Ltd., Huawei, SVA Group Co. Ltd., Tianjin Dikuang International Trade Co., Wenzhou Huahang Electric Co. Ltd., Yatun, ZTE Corporation

TV and radio sets, sound and image recording and reproduction devices, electric household appliances, trading, computers, electricity distribution and control devices, auto parts, textiles, renewable energy (wind power parks)

Cyprus

–

Trade and repairs, real estate

Czech Republic

Shanghai Maling, Shanghai Yuncheng Plate-Making Group, Sichuang Changhong Electric, Tatung

Food processing, fabricated metal products, electrical equipment

Denmark

Air China, ShangPharma

Travel agencies, logistics, IT, telecommunications, life sciences, traditional Chinese medicine, wind energy

Finland

Huawei

ICT

France

Air China, BBCA Group, China Aerospace Science and Industry Corp. (CASIC), China Eastern, China National Aero-Technology Import and Export Corporation (CATIC), China National BlueStar Group, China National Chemical Corporation, China Southern Airlines Co. Ltd., COSCO, China UnionPay, The Export-Import Bank of China, Haier, Hisense, Huawei, Midea, Shengzhen Sailong Fiberglass Co. Ltd., Shenzhen Yibo Electronics Co. Ltd., TCL, Watchdata, Xiamen Overseas Chinese Electronic Co., Zhejiang Wangbin Decorative Material Co. Ltd., ZTE Corporation

Electronics, pharmaceuticals, cosmetics, chemicals, (financial) services, international training, telecommunications, aviation



Table 9A.5 Examples of Chinese companies in the EU and typical sectors of investment

203

Hungary

Advanced Technology and Materials (AT&M), Beijing No. 1 Machine Tool Plant, Carry Logistics, COSCO, D’Long Group, Hangzhou Machine Tool Group (HZMTG), Haerbin Measuring and Cutting Tool Group Co. Ltd., Huasheng Enterprises, Huawei, Lenovo, Lianyungang Zhongfu Lianzhong Composites Group Co. Ltd., Sailstar Shanghai, Shanghai Electric Corporation (SEC-Group), Shenyang Machine Tool Group, Suntar Membrane Technology, TCL, Technotronic Industries, Zhong Qiang Electric Tools (ZQ Tools), ZTE Bank of China, Hisense, Huawei, Lenovo

Ireland

Bank of China, Huawei

Italy

Chang’an Automotive Group, COSCO, Haier, Huawei Technologies, Mindray, Qianjiang Group

Latvia Lithuania Luxembourg Bank of China, Industrial and Commercial Bank of China (ICBC) Malta Netherlands Bank of China, China National Machine Tools Corp., China Shipping (Group) Company, China Southern Airlines, CIMC, eBao, Great Wall Airlines, Haier, Hikvision Digital Technology Co., Hisense, Huawei, Jade Cargo International, Jiangsu Yoke Technology Co., Lenovo, Netsun, Newland Group, Mindray, Norco, Xiangtan Electric Manufacturing Corporation (XEMC), Xinhai Group, ZTE Poland Haier, Lenovo, TCL, TPV Technology

Renewable energy (solar energy, wind turbines), biotechnology, machinery and equipment, trading, digital radio technology, automotive, IT

Banking, LCD manufacturing, IT, desktop manufacturing, wholesale trade and logistics, tourism Aviation, financial services Automotive, logistics, infrastructure (ports), ICT, telecom, biotechnology, nanotechnology, electronic appliances, motorcycles Food Wholesale and retail trade (food), consumer goods Banking, textiles, consulting Shipping, catering, trading (import and export) Container manufacturing, machinery, ICT, logistics

Chemicals, motorbikes, bicycles, TV, real estate, infrastructure, IT, LCD screens, electronics, sport equipment



Germany

204

Chinese companies

Typical sectors

Romania

BYD, China Tobacco International Europe Co., Huawei, Sinoroma

Wholesales, retailing, construction, agriculture, transport, tourism, tobacco industry, electronics, metallic constructions

Slovakia

Huawei, Lenovo

Telecommunications, computer

Slovenia

Catering

Spain

Cheng Hai Fisheries, China Eastern Airlines, China National Fisheries Group, China Shipping, COSCO, Huawei, Huipu Electronics (Shenzhen) Co. Ltd., Li Ning, Shandong Group Corporation of Fisheries Enterprises, Shanghai Marine Spain, Shanghai Fisheries General Corp. Group (SFGC), Suntech, ZTE

Ports, renewable energies (solar energy), textiles (sportswear), logistics, fishing, telecommunications

Sweden

Air China, China Minmetals Corp., Huawei, Shanghai Automotive Industry Corp. (SAIC), State Grid Corporation of China (SGCC), ZTE

ICT, biotechnology, trading, automotive, pharmaceuticals, energy

United Kingdom

Air China, Bank of China, China Central Television (CCTV), China Eastern, China Export & Credit Insurance Corp. (Sinosure), China Petroleum & Chemical Corp. (Sinopec), China Mobile, China National Petroleum Corp. (CNPC), China Netcom, China Shipping (Group) Company, China Telecom, CNOOC, COSCO, Crystal Digital Technologies Co. Ltd., Haier, Haixin, Hangfeng Group, Heilan, Huawei, ICBC, Lenovo, Menshun Fireworks, Midea, Nanjing Automobile (Group) Corp., SAIC, Shenzhen China Tex, Shenzhen HYT Science & Technology Co. Ltd, Smart Act Technology, Sunmoon Education Group, SVA Technologies Co. Ltd., Tianjin Pipe (Group) Corp. (TPCO), Tiens Group Co. Ltd., ZTE

Biotech, automotive, ICT (telecoms, IT, software, computer devices, internet technology), life sciences (medical devices and pharmaceuticals), creative industries (computer games, software, publishing, design, media), financial services, energy (renewable energy), textiles, electronics, catering, retail, white goods, black goods, trading, logistics, tourism

Source: Information provided by IPAs.




Jan Knoerich

205

Date of signature

Date of entry into force

Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom

12 September 1985 6 June 2005 27 June 1989 17 January 2001 8 December 2005 29 April 1985 2 September 1993 15 November 2004 26 November 2007 1 December 2003 25 June 1992 29 May 1991 – 28 January 1985 15 April 2004 8 November 1993 6 June 2005 22 February 2009 26 November 2001 7 June 1988 9 December 2005 16 April 2007 7 December 2005 13 September 1993 14 November 2005 27 September 2004 15 May 1986

11 October 1986 1 December 2009 21 August 1994 29 April 2002 1 September 2006 29 April 1985 1 June 1994 15 November 2006 – 11 November 2005 21 December 1993 1 April 1993 – 28 August 1987 1 February 2006 1 June 1994 1 December 2009 1 April 2009 1 August 2004 8 January 1989 26 July 2008 1 September 2009 25 May 2007 1 January 1995 1 July 2008 – 15 May 1986

Total number

26

24

Source: UNCTAD (2010b); available from: http://www.unctad.org/sections/dite_pcbb/docs/bits_ china.pdf. Accessed 27 October 2010.

Notes The views expressed in this article are those of the author and do not necessarily reflect the views of the UNCTAD Secretariat. 1. This group is comprised of Austria, Belgium, Denmark, Greece, Finland, Ireland, the Netherlands, Luxembourg, Portugal, and Sweden. In this study, investments for Luxembourg in 2009 are excluded – Luxembourg received an enormous amount of Chinese OFDI in that year, which would distort any meaningful analysis of respective investment trends in Europe. 2. The accession states of 2004 are Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia.



Table 9A.6 Bilateral investment treaties concluded between China and EU countries as of June, 1, 2010

206


References Almeida, P. 1996. Knowledge sourcing by foreign multinationals: Patent citation analysis in the U.S. semiconductor industry. Strategic Management Journal, 17: 155–165. Andreosso-O’Callaghan, B. & Qian, W. 1999. Technology transfer: A mode of collaboration between the European Union and China. Europe-Asia Studies, 51(1): 123–142. Antkiewicz, A. & Whalley, J. 2006. Recent Chinese Buyout Activity and the Implications for Global Architecture. Working Paper 12072, National Bureau of Economic Research. http://www.nber.org/papers/w12072. Accessed 10 August 2010. Ash, R. 2008. Europe’s commercial relations with China. In D. Shambaugh, E. Sandschneider & Z. Hong (eds), China-Europe Relations: Perceptions, Policies and Prospects. London and New York: Routledge, pp. 189–230. Asia Pacific Foundation of Canada, The China Council for the Promotion of International Trade. 2005. China goes global: A survey of Chinese companies’ outward direct investment intentions. Asia Pacific Foundation of Canada, The China Council for the Promotion of International Trade. 2006. China goes global II: 2006 survey of Chinese companies’ outward direct investment intentions. Barney, J.B. & Hesterly, W. 1996. Organizational economics: Understanding the relationship between organizations and economic analysis. In S.R. Clegg, C. Hardy & W.R. Nord (eds), Handbook of Organization Studies. Thousand Oaks, CA: Sage Publications Ltd., pp. 115–147. Beausang, F. 2003. Third World Multinationals: Engine of Competitiveness or New Form of Dependency. New York: Palgrave Macmillan. Bonaglia, F., Goldstein, A. & Mathews, J.A. 2007. Accelerated internationalization by emerging markets’ multinationals: The case of the white goods sector. Journal of World Business, 42: 369–383. Buckley, P.J. & Casson, M. 1991. The Future of the Multinational Enterprise. Basingstoke: Macmillan. Buckley, P.J., Clegg, J.L., Cross, A.R., Liu, X., Voss, H. & Zheng, P. 2007. The determinants of Chinese outward foreign direct investment. Journal of International Business Studies, 38(4): 499–518. Buckley, P.J., Cross, A.R., Tan, H., Xin, L. & Voss, H. 2008. Historic and emergent trends in Chinese outward direct investment. Management International Review, 48(6): 715–748. Burghart, N., & Rossi, V. 2009. China’s overseas direct investment in the UK. Chatham House Programme Paper IE PP 2009/06. http://www.chathamhouse.org.uk/files/ 15511_1209pp_china_odi.pdf. Accessed 31 May 2010. Cantwell, J.A., Dunning, J.H. & Janne, O.E.M. 2004. Towards a technology-seeking explanation of U.S. direct investment in the United Kingdom. Journal of International Management, 10: 5–20.



3. Methodologically, I exclude mainland Chinese OFDI to Hong Kong, Macao, and Taiwan (‘Greater China’) and to the Bahamas, Bermuda, the British Virgin Islands, and the Cayman Islands (the main offshore financial centers) from this analysis, as investment flows to these economies are special cases that offer little analytical value and may even distort the findings. Luxembourg is excluded for similar reasons. 4. Personal interview in Nanjing, Summer 2007.

207

Cantwell, J.A. & Tolentino, P.E. 1990. Technological accumulation and third world multinationals. Discussion Paper in International Investment and Management No. 139. Reading: University of Reading. Caves, R.E. 1971. International corporations: The industrial economics of foreign investment. Economica, 38(149): 1–27. Caves, R.E. 1974a. Industrial organization. In J.H. Dunning (ed.), Economic Analysis and the Multinational Enterprise. London: George Allen & Unwin, pp. 115–146. Caves, R.E. 1974b. Causes of direct investment: Foreign firms’ shares in Canadian and United Kingdom manufacturing industries. Review of Economics & Statistics, 56(3): 279–293. Child, J. & Rodrigues, S.B. 2005. The internationalization of Chinese firms: A case for theoretical expansion? Management and Organization Review, 1(3): 381–410. Child, J. & Tse, D.K. 2001. China’s transition and its implications for international business. Journal of International Business Studies, 32(1): 5–21. China Council for the Promotion of International Trade (CCPIT) in cooperation with the European Commission and the United Nations Conference on Trade and Development (UNCTAD). 2010. Survey on current conditions and intention of outbound investment by Chinese enterprises. http://trade.ec.europa.eu/doclib/docs/ 2010/may/tradoc_146193.pdf. Accessed 30 January 2011. Curran, L. 2009. Chasing the dragon: The emerging EU-China relationship and its impact on business. In I. Alon, J. Chang, M. Fetscherin, C. Lattemann & J.R. McIntyre (eds), China Rules: Globalization and Political Transformation. Basingstoke: Palgrave Macmillan, pp. 192–215. Deng, P. 2007. Investing for strategic resources and its rationale: The case of outward FDI from Chinese companies. Business Horizons, 50: 71–81. Deng, P. 2008. Resources, capability, and outbound FDI from Chinese companies. In I. Alon & J.R. McIntyre (eds), Globalization of Chinese Enterprises. New York: Palgrave Macmillan, pp. 17–30. De Propris, L. & Driffield, N. 2006. The importance of clusters for spillovers from foreign direct investment and technology sourcing. Cambridge Journal of Economics, 30: 277–291. DG Trade. 2011. China: EU bilateral trade and trade with the world. http:// trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113366.pdf. Accessed 30 January 2011. Driffield, N. & Love, J.H. 2003. Foreign direct investment, technology sourcing and reverse spillovers. The Manchester School, 71(6): 659–672. Driffield, N. & Love, J.H. 2005. Who gains from whom? Spillovers, competition and technology sourcing in the foreign-owned sector of UK manufacturing. Scottish Journal of Political Economy, 52(5): 663–686. Dunning, J.H. 1958. American Investment in British Manufacturing Industry. London: Allen & Unwin. Dunning, J.H. 1980. Toward an eclectic theory of international production: Some empirical tests. Journal of International Business Studies (pre-1986), 11(1): 9–31. Dunning, J.H. 1993. The Globalization of Business: The Challenge of the 1990s. London: Routledge. Dunning, J.H. 1995. Reappraising the eclectic paradigm in an age of alliance capitalism. Journal of International Business Studies, 26(3): 461–491. Dunning, J.H. 1996. The geographical sources of the competitiveness of firms: Some results of a new survey. Transnational Corporations, 5(3): 1–30. Dunning, J.H. 1998a. Location and the multinational enterprise: A neglected factor? Journal of International Business Studies, 29(1): 45–66.



Jan Knoerich


Dunning, J.H. 1998b. Globalization and the new geography of foreign direct investment. Oxford Development Studies, 26(1): 47–69. Dunning, J.H. 2000. The eclectic paradigm as an envelope for economic and business theories of MNE activity. International Business Review, 9: 163–190. Dunning, J.H. 2001a. The eclectic (OLI) paradigm of international production: past, present and future. International Journal of the Economics of Business, 8(2): 173–190. Dunning, J.H. 2001b. The key literature on IB activities: 1960–2000. In A. M. Rugman & T.L. Brewer (eds), The Oxford Handbook of International Business. New York: Oxford University Press, pp. 36–68. Dunning, J.H. & Lundan, S.M. 2008. Multinational Enterprises and the Global Economy. Cheltenham, UK: Edward Elgar. Filippov, S. & Saebi, T. 2008. Europeanisation strategy of Chinese companies: Its perils and promises. United Nations University UNU-MERIT Working Paper Seires #2008–055. http://www.merit.unu.edu/publications/wppdf/2008/wp2008-055.pdf. Accessed 31 May 2010. Gilboy, G.J. 2004. The myth behind China’s miracle. Foreign Affairs, 83(4): 33–48. Globerman, S. & Shapiro, D. 2009. Economic and strategic considerations surrounding Chinese FDI in the United States. Asia Pacific Journal of Management, 26: 163–183. Hay, F., Milelli, C. & Shi, Y. 2008. Présence et stratégies des firmes chinoises et indiennes en Europe: Une perspective dynamique et comparative. Ministère de l’Economie, des Finances et de l’Emploi Direction Générale des Entreprises. http:// www.ifri.org/files/centre_asie/RAPPORT_Chine_Inde.pdf. Accessed 31 May 2010. Hong, E. & Sun, L. 2006. Dynamics of internationalization and outward investment: Chinese corporations’ strategies. The China Quarterly, 187: 610–634. Hymer, S.H. 1976. The International Operation of National Firms: A Study of Direct Foreign Investment. Cambridge, MA: MIT Press. Inkpen, A.C. 1998. Learning and knowledge acquisition through international strategic alliances. Academy of Management Executive, 12(4): 69–80. Invest in Germany. 2007. Welcome to the no. 1 business location. Ivarsson, I. & Jonsson, T. 2003. Local technological competence and asset-seeking FDI: An empirical study of manufacturing and wholesale affiliates in Sweden. International Business Review, 12: 369–386. Japan Bank for International Cooperation Institute (JBICI). 2002. Foreign direct investment and development: Where do we stand? JBICI Research Paper No. 15. Johanson, J. & Vahlne, J.-E. 1977. The internationalization process of the firm – A model of knowledge development and increasing foreign market commitments. Journal of International Business Studies, 8(1): 23–32. Johanson, J. & Vahlne, J.-E. 1990. The mechanism of internationalisation. International Marketing Review, 7(4): 11–24. Johanson, J. & Wiedersheim-Paul, F. 1975. The internationalization of the firm – Four Swedish cases. The Journal of Management Studies, 12(3): 305–322. Keller von, E. & Zhou, W. 2003. From middle kingdom to global market: Expansion strategies and success factors for China’s emerging multinationals. Roland Berger Strategy Consultants. http://www.rolandberger.com/expertise/en/ html/publications/82-publications_sc_middle_kingdom_to_global_market.html. Accessed 4 March 2006. Kindleberger, C.P. 1969. American Business Abroad: Six Lectures on Direct Investment. New Haven: Yale University Press.



208

209

Knoerich, J. 2010. Gaining from the global ambitions of emerging economy enterprises: An analysis of the decision to sell a German firm to a Chinese acquirer. Journal of International Management, 16: 177–191. Kuemmerle, W. 1999. The drivers of foreign direct investment into research and development: An empirical investigation. Journal of International Business Studies, 30(1): 1–24. Lall, S. 1983. The New Multinationals. The Spread of Third World Enterprises. Chichester: Wiley. Lecraw, D.J. 1977. Direct investment by firms from less developed countries. Oxford Economic Papers, New Series, 29(3): 442–457. Lecraw, D.J. 1993. Outward direct investment by Indonesian firms: Motivation and effects. Journal of International Business Studies, 24(3): 589–600. Liu, L. & Tian Y. 2008. The internationalisation of Chinese enterprises: The analysis of the UK case. International Journal of Technology and Globalisation, 4(1): 87–102. Liu, X. & Buck, T. 2009. The internationalisation strategies of Chinese firms: Lenovo and BOE. Journal of Chinese Economic and Business Studies, 7(2): 167–181. Luo, Y., Xue, Q. & Han, B. 2010. How emerging market governments promote outward FDI: Experience from China. Journal of World Business, 45: 68–79. Makino, S., Lau, C.-M. & Yeh, R.-S. 2002. Asset-exploitation versus asset-seeking: Implications for location choice of foreign direct investment from newly industrialized economies. Journal of International Business Studies, 33(3): 403–421. McKinsey. 2008. Competition from China: Two Mckinsey surveys. Milelli, C. & Hay, F. 2008. Chinese and Indian firms’ entry into Europe: Characteristics, impacts and policy implications. EconomiX Working Paper 2008–35. http:// economix.fr/pdf/dt/2008/WP_EcoX_2008-35.pdf. Accessed 29 January 2011. MOFCOM. 2007. 2006 statistical bulletin of China’s outward foreign direct investment. MOFCOM. 2008. 2007 statistical bulletin of China’s outward foreign direct investment. MOFCOM. 2009. 2008 statistical bulletin of China’s outward foreign direct investment. MOFCOM. 2010. 2009 statistical bulletin of China’s outward foreign direct investment. Moon, H.-C. & Roehl, T.W. 2001. Unconventional foreign direct investment and the imbalance theory. International Business Review, 10: 197–215. Nicolas, F. 2009. Chinese direct investment in Europe: Facts and fallacies. Chatham House Briefing Paper IE BP 2009/01. http://www.chathamhouse.org.uk/files/14121_ 0609ch_odi.pdf. Accessed 31 May 2010. Nolan, P. 2001. China and the Global Business Revolution. Hampshire, UK: Palgrave. Nolan, P. 2002. China and the global business revolution. Cambridge Journal of Economics, 26(1): 119–137. Pavitt, K. 1988. International patterns of technological accumulation. In N. Hood & J.-E. Valhne (eds), Strategies in Global Competition. Croom Helm. Raskin, A. & Lindenbaum, B. 2004. China: Is the world really prepared? Bernstein Investment Research and Management. http://www.bernstein.com/CmsObjectPC/ pdfs/050114_ChinaBlackbook.pdf. Accessed 25 August 2011. Rui, H. & Yip, G.S. 2008. Foreign acquisitions by Chinese firms: A strategic intent perspective. Journal of World Business, 43: 213–226. Saggi, K. 2002. Trade, foreign direct investment, and international technology transfer: A survey. The World Bank Research Observer, 17(2): 191–235.



Jan Knoerich


Saggi, K. 2004. International Technology Transfer to Developing Countries. London: Commonwealth Secretariat. Schüller, M. & Turner, A. 2005. Global ambitions: Chinese companies spread their wings. China Aktuell, 4: 3–14. Shan, W. & Song, J. 1997. Foreign direct investment and the sourcing of technological advantage: Evidence from the biotechnology industry. Journal of International Business Studies, 28(2): 267–284. Sigurdson, J. 2005. Technological Superpower China. Cheltenham, UK: Edward Elgar Publishing. Steinfeld, E.-S. 2004. Chinese enterprise development and the challenge of global integration. In S. Yusuf, M.A. Altaf & K. Nabeshima (eds), Global Production Networking and Technological Change in East Asia. Washington, D.C.: The World Bank and Oxford University Press, pp. 255–296. Tolentino, P.-E. E. 1993. Technological Innovation and Third World Multinationals. London: Routledge. UNCTAD. 2006. World Investment Report 2006: FDI from Developing and Transition Economies: Implications for Development. New York and Geneva: United Nations. UNCTAD. 2007. Bilateral Investment Treaties 1995–2006: Trends in Investment Rulemaking. New York and Geneva: United Nations. UNCTAD. 2010a. World Investment Report 2010: Investing in a Low-carbon Economy. New York and Geneva: United Nations. UNCTAD. 2010b. Total number of bilateral investment treaties concluded, 1 June 2010. http://www.unctad.org/sections/dite_pcbb/docs/bits_china.pdf. Accessed 27 October 2010. Vernon, R. 1966. International investment and international trade in the product cycle. Quarterly Journal of Economics, 80(2): 190–207. Voss, H., Buckley, P.J. & Cross, A.R. 2009. An assessment of the effects of institutional change on Chinese outward direct investment activity. In I. Alon, J. Chang, M. Fetscherin, C. Lattemann & J.R. McIntyre (eds), China Rules: Globalization and Political Transformation. Basingstoke: Palgrave Macmillan, pp. 135–165. Wells, L.T. 1983. Third World Multinationals – The Rise of Foreign Investment from Developing Countries. Cambridge, Mass: MIT Press. Wenk, K. 2005. Diskrete Investoren aus dem Reich der Mitte. Die Welt, 8 November 2005. http://www.welt.de/data/2005/11/08/800478.html. Accessed 17 January 2007. Wesson, T. 1993. An alternative motivation for foreign direct investment. PhD Dissertation, Harvard University. Wesson, T. 1999. A model of asset-seeking foreign direct investment driven by demand conditions. Canadian Journal of Administrative Sciences, 16(1): 1–10. Williamson, O.E. 1981. The economics of organization: The transaction cost approach. The American Journal of Sociology, 87(3): 548–577. Wu, F. 2005. Corporate China goes global. http://www.cctr.ust.hk/articles/200509_ corporate.pdf. Accessed 3 December 2005. Yang, D. 2005. China’s Offshore Investments: A Network Approach. Cheltenham, UK: Edward Elgar. Yang, X., Jiang, Y., Kang, R. & Ke, Y. 2009. A comparative analysis of the internationalization of Chinese and Japanese firms. Asia Pacific Journal of Management, 26: 141–162. Young, S., Huang, C.-H. & McDermott, M. 1996. Internationalization and competitive catch-up processes: Case study evidence on Chinese multinational enterprises. Management International Review, 36(4): 295–314.



210

211

Zeng, M. & Williamson, P.J. 2003. The hidden dragons. Harvard Business Review, 81(10): 92–99. Zhan, J.X. 1995. Transnationalization and outward investment: The case of Chinese firms. Transnational Corporations, 4(3): 67–100. Zhang, M. 2003a. Transferring human resource management across national boundaries: The case of Chinese multinational companies in the UK. Employee Relations, 25(6): 613–626. Zhang, Y. 2003b. China’s Emerging Global Businesses: Political Economy and Institutional Investigations. Basingstoke: Palgrave Macmillan. Zhang, M., & Edwards, C. 2007. Diffusing ‘best practice’ in Chinese multinationals: The motivation, facilitation and limitations. The International Journal of Human Resource Management, 18(12): 2147–2165.



Jan Knoerich

10 Chinese M&A in Germany

China’s outward foreign direct investment (OFDI) has become a popular area of research as its impact has widened. Buckley and colleagues (2007) investigate the determinants of Chinese OFDI and suggest that capital market imperfections, special ownership advantages, and institutional factors are potential arguments to be nested in the general theory of FDI. From the political economy point of view, institutional escapism and governmental promotion are logically complementary to each other to offset the disadvantages of emerging market enterprises in global competition (Luo et al., 2010). A recent empirical study shows that the entry mode choice of Chinese firms for OFDI depends largely on a firm’s strategic fit and its strategic intent (Cui & Jiang, 2009). Cross-border merger and acquisition (M&A) has become the primary mode of entry for Chinese firms (Alon & McIntyre, 2008). However, researchers have not explored the M&A integration process following the deal in the context of Chinese cross-border M&As. Research also needs to investigate the concept of absorptive capacity as part of the asset-driven M&A intent (Deng, 2009). Our research focuses on Chinese firms entering Germany via cross-border M&As. Germany, as the worldwide leader in many technological areas, cultivates global companies in a niche market – the so-called ‘Hidden Champion’ (Simon, 2009). China overtook Germany in 2009 to become world export champion (Atkins & Dyer, 2010), and they are strong trade partners. In 2009 China was ranked as the second country for Germany’s imports, and as the eighth country for Germany’s exports. Despite the financial crisis that began in 2007, Chinese OFDI in Germany grew from 309 million Euros in 2006 to 428 million Euros in 2007 and 568 million Euros in 2008 (Germany Trade & Invest, 2010). From 2000 to the first half of 2010, Chinese M&A investments in Western Europe totaled 120 transactions, and the upward trend continues (ZEW, 2010). China needs to upgrade the technological capacities of its industries and move up the value chain to better integrate into the global value creation network. This study investigates integration in Chinese cross-border M&As 212



Yipeng Liu and Michael Woywode

by applying the absorptive capacity construct (Zahra & George, 2002) from organizational learning research. M&A studies mainly focus on developed economies (see Cartwright & Schoenberg, 2006, for a review). Integration is important for synergy realization after deals are closed (Schweiger, 2002). In a recent empirical survey of M&A deals in Asia (Cogman & Tan, 2010), the authors found that about half of all Asian deals differ significantly from the western post-merger integration model. Over a third involve only limited functional integration and an additional 10 percent no functional integration at all. We call this the ‘light touch approach to M&A’. Our observations from our sample of Chinese cross-border M&As in Germany confirm the light touch integration approach. How can we explain this approach, even though the literature clearly favors hard touch post-merger integration? We conceptualize a model of absorptive capacity integrating various factors to distinguish potential absorptive capacity and realized absorptive capacity. The model explains the light touch integration approach by Chinese investors. This chapter is structured as follows: first, we review the literature on M&As and integration. We describe the light touch integration approach and outline its potential advantages and disadvantages. Second, we review the theory of absorptive capacity and the literature on organizational learning, followed by a conceptual framework integrating multidimensional factors, including individual-, organizational-, and national-level dimensions to explain light touch integration. Third, the research methodology and data sample are described. Fourth, two representative cases of Chinese crossborder M&As in Germany are analyzed to illustrate the explanatory power of the conceptual framework. Fifth, we conclude with implications and future research directions.

1. M&As and integration 1.1. Literature review Strategic management scholars study M&As from a diversification approach, focusing on the motives of merging firms (Walter & Barney, 1990) and performance effects of different management objectives (Lubatkin, 1987). Finance scholars focus on acquisition performance by relying primarily on stock market-based measures (Jensen & Ruback, 1983). Organizational and human resource management scholars emphasize the post-merger integration process (Pablo, 1994) and highlight the importance of effective communications, cultural clashes, and conflict resolution. King and colleagues (King et al., 2004) conducted a meta-analysis of 93 published studies and found that none of the most commonly studied antecedent variables were significant in predicting post-acquisition performance. Their findings signal the complexity of the M&A puzzle and call for an integrative approach.



Yipeng Liu and Michael Woywode 213


One case survey of synergy realization reflects a strategic, organizational, and human resource perspective (Larsson & Finkelstein, 1999). A tentative model examines how cultural differences affect integration benefits from M&As (Stahl & Voigt, 2008). The existing wisdom on M&A states that integration is where the synergetic value can be realized. Schweiger (2002) argues that the execution of a well-designed integration process is critical to maximizing value creation and minimizing value destruction. Integration should occur at several levels, such as procedures, physical assets, and corporate culture (Shrivastava, 1986). In addition, a quick integration program to catch the momentum of a deal is suggested, where the firms can capture the synergies that justified the deal. Managers need to implement a systematic integration process, which may include a post-merger integration (PMI) office and a 100-day program (Uhlaner & West, 2008). Two aspects of the integration process are critical for synergy realization: socio-cultural integration and task integration (Birkinshaw et al., 2000). Task integration is measured by transfer of capabilities and resource sharing while human integration involves developing a sense of shared identity and positive attitudes toward the new organization. Integration is an interactive process, requiring both socio-cultural and task integration efforts. The M&A literature devotes little attention to cross-border M&As (Hitt et al., 2001; Haleblian et al., 2006) and more theoretical and empirical research on the topic is necessary (Shimizu et al., 2004). An integrative model of the impact of cultural differences on capability transfer in crossborder M&As emphasizes the mediating roles of capability complementarity, absorptive capacity, and social integration (Björkman et al., 2007). 1.2. The light touch approach of integration A recent study investigates 120 acquisitions for controlling stakes from the beginning of 2004 through the third quarter of 2008 in Asian cross-border M&As (Cogman & Tan, 2010). Over one-third of the Asian deals involved only limited functional integration and focused on capturing synergies in areas such as procurement, with an overwhelming emphasis on business stability. Ten percent of the cross-border deals involved no integration efforts at all. What integration strategy will Chinese investors realize in Sino-German cross-border M&As? Unlike most studies emphasizing the importance of the post-merger integration process for M&As as one of the critical value generation mechanisms, this study illustrates the light touch approach adopted by Chinese investors in cross-border M&As. As we define it, light touch integration consists mostly of (1) keeping the domestic management team intact, (2) keeping the brand, (3) offering advice while giving local entities a high degree of freedom in decision-making, and (4) the acquirer joining the advisory board.



214

The light touch approach, we argue, carries several advantages which we illustrate by focusing on two challenges, as suggested by Larsson (Larsson & Finkelstein, 1999): organizational integration and employee resistance. Organizational integration can be divided conceptually into (1) the degree of interaction between joining firms, and (2) the extent of coordination to improve the quality of that interaction. Although the degree of interaction is relatively low for the light touch approach, the coordination is performed by the interface communicator between the acquired company and the acquiring company. As for employee resistance, the light touch approach helps to compensate for the resistance from employees of acquired firms. It reduces negative consequences stemming from ‘we versus they’ antagonism (Levinson, 1970; Astrachan, 1990). When the Chinese investors keep the management team intact, it helps to maintain the motivation and team morale of the original German team. Visits by Chinese investors and high-profile political figures can create a friendlier environment. Investment plans and job creation for the regional economy also help to alleviate employee resistance. Even though we acknowledge the importance of integration for realizing synergy during M&As, we want to highlight the special characteristics of Chinese cross-border M&As, to identify explanatory antecedents.

2. Absorptive capacity Organizational learning scholars characterize firms as routine-based, historydependent systems that encode inferences from experience into routines or knowledge (Levitt & March, 1988). Over time, these routines occur with less conscious effort to bind the firm’s search for alternatives to previous actions, which reinforces path-dependent learning (Nelson & Winter, 1982; March, 1991). In M&As, firms develop acquisition process knowledge and skills with regard to due diligence, deal negotiation, financing, and integration (Finkelstein & Haleblian, 2002). Absorptive capacity is the ability to recognize the value of new information, assimilate it, and apply it to commercial ends (Cohen & Levinthal, 1990). Firms must have the capacity to absorb the new knowledge available. If the knowledge bases of the two firms are substantially different, neither firm may have the appropriate absorptive capacity to learn the knowledge stocks of the other. The transfer of knowledge requires cooperation between the parties involved (Hitt et al., 2000). Absorptive capacity is categorized as potential absorptive capacity and realized absorptive capacity along four dimensions: acquisition, assimilation, transformation, and exploitation (Zahra & George, 2002). In essence, firms can acquire and assimilate knowledge as potential absorptive capacity (potential ACAP), but may not possess the capability to transform and exploit the knowledge as realized absorptive capacity (realized ACAP).





A recent process-based definition states that absorptive capacity is a firm’s ability to utilize external knowledge through the sequential processes of exploratory, transformative, and exploitative learning (Lane et al., 2006). Lichtenthaler (2009) illustrates the multidimensional nature of absorptive capacity by identifying technological and market knowledge as two critical components in the organizational learning processes of absorptive capacity. We agree on the multidimensional nature of absorptive capacity and integrate a multilevel perspective into the concept of absorptive capacity. 2.1. A multilevel perspective on absorptive capacity In this section, we conceptualize the individual-, organizational-, and national-level elements into the absorptive capacity framework. A multilevel approach to the absorptive capacity concept can be helpful in explaining the complexities and ambiguities of the reality in the business world, especially for Chinese business. To illustrate our idea we report the following findings from other management research studies that report significant multilevel effects to explain Asian business realities. Managers’ micro-interpersonal ties with top executives at other firms and with government officials help to improve macro-organization performance. The nature of a micro-macro link is tested by using survey data from China (Peng & Luo, 2000). A comparative study of corporate social responsibility between India and China investigates the corporate social responsibility communication intensity from a threelevel perspective, considering country-, industry-, and firm-level factors, and finds significant correlations (Lattemann et al., 2009). We distinguish among three different levels of influence (individual, organizational, and national). Individual level On the individual level, we focus on the capability and experience of individuals. We do not claim that these are the only individual characteristics deserving consideration, but we believe they are important in converting potential absorptive capacity into realized absorptive capacity. The Chinese higher education system has a huge capacity to produce graduates. Economic performance is improved by producing more human capital and a more educated workforce (Heckman, 2003). In the past, the competition to enter universities was fierce. After the expansion of higher education, however, it has become easier, but the consequent oversupply of Chinese graduates is a big concern since job market growth is way behind the growth of new graduates. Nevertheless, the educational system focuses on theoretical training instead of practical training, which results in limited practical capabilities of graduates. Additionally, professional and vocational training systems are less developed. In China, formal education and pre-employment training remain the dominant practices. Greater emphasis is given to preemployment training than to in-employment training, although increasing



216

attention is being paid to the latter (Cooke, 2005). Chinese firms do not offer comprehensive training to employees whereas German firms routinely do so (Ausbildungsysteme in Germany) (Grollmann & Rauner, 2007). Hence, there is a lack of capability in China in product development knowledge, project management, and team work skills. China must produce more graduates fit for employment in world-class companies if it wants to avoid the talent crunch and sustain economic growth (Farrell & Grant, 2005). Moreover, Chinese employees have relatively few international experiences, although the ‘reform and opening policy’ was implemented in China 30 years ago, and China has been a member of the World Trade Organization since 2001. International experience, however, is a prerequisite to absorb knowledge and know-how for success in global business. To address this lack of international experience, Chinese overseas students, once they return and join a large corporation, may fill the gap in cross-border M&A strategy experience. When the reverse brain drain happened, many overseas returnees left developed countries to pursue career advancement and expanding opportunities in their home countries (Wadhwa, 2009). But Chinese returnees with international experience are unlikely to join a large Chinese corporation, such as a state-owned enterprise (SOE), when the opportunity for entrepreneurship is available and encouraged by the government (Liu, 2011) with monetary and prestige rewards. According to Kshetri (2007), China recently earned a reputation as one of the world’s most entrepreneur-friendly countries. Only a few employees of established Chinese firms have practical international working experience. Hence, readiness for international collaboration at the individual level is not adequate, which constrains both knowledge transfer and the potential for joint product development between Chinese firms and their international counterparts (or entities via cross-border M&A).

Organizational level At the organizational level, the corporate governance functions in both the host and the target country of the merging firms affect the ability of the acquirer to reorganize the target (Capron & Guillén, 2009). Two papers provide a good overview of corporate governance historical development and practices in China (Liu, 2006; Kang et al., 2008). They show that, although progress has been achieved in corporate governance, there are still many challenges. We pinpoint two traits that this study considers. One is the organizational structure, and the other is the communication style. Although companies went public to be listed on either the Shanghai Stock Exchange or the Shenzhen Stock Exchange, some firms, mainly SOEs, are only partially listed. Not all shares are tradable, and the tunneling effects are extensive, which hurts minority interests (Liu & Lu, 2007). The organizational structure of





the parent company that owns the listed firms is not clear. The same is true for firms not listed yet. Moreover, even with an organizational structure in place, firms tend to name only functions instead of individuals associated with clear responsibilities. Investor relations of listed companies are relatively weak and listed firms often switch auditors to weaken the monitoring role of auditing firms (Lin & Liu, 2009). Non-public Chinese firms have even fewer incentives to communicate. Leadership appointment is also problematic. Under Chinese company law, senior management is appointed by the board of directors, but the board’s decision may be greatly influenced by government intervention in both former and current SOEs. Although managers of SOEs are no longer government bureaucrats (Hua, Miesing, & Li, 2006), state and local governments still influence appointments. Hence, we argue that the unclear structure of the organization, communication styles, and shifts of leadership may present obstacles to joint project work and collaboration between Chinese firms and their international counterparts (or entities via cross-border M&A). Scholars agree that prior acquisition experience influences acquisition behavior (Haleblian, et al., 2006) but, until recently, M&As in China, especially cross-border deals, were rare, because foreign entry was discouraged. By contrast, joint ventures were promoted in the 1980s and wholly owned foreign enterprises (WOFEs) were promoted in the 1990s. M&As in China gained strength as the new wave of FDI began (Peng, 2006). But it was not the Chinese companies that made these experiences but the foreign companies entering China. The lack of M&A experience of most Chinese companies was an additional hurdle for their cross-border M&A endeavours.

National level At the national level, we consider Chinese business systems (Whitley, 1991) and institutional settings. Chinese businessmen and officials hold on to their own values and the business system functions differently from Western counterparts. A dense network of long-term individual, corporate, and political relationships influences Chinese business culture. Today, confucianism and capitalism are the main ideologies of Chinese society blended with selected socialist ideals. Moreover, emerging economies such as China undergo profound institutional transformations (Wan, 2005; Tan et al., 2009). It is worth noting the dynamic characteristics in viewing the institutional environments in emerging economies. Albeit that tremendous improvements of institutions from the national level have occurred, China, arguably, is still undergoing the early stage of market transition at present (Yang & Li, 2008). According to the type of capitalism theory (Hall & Soskice, 2001), there are two extreme capitalism systems: the liberal market model of capitalism



218

with the United States and United Kingdom as Anglo-Saxon examples and the coordinated market model of capitalism with Germany as an example. Many countries can be distributed along the spectrum defined by these two extremes. Moreover, the Asian economies exhibit special characteristics. Asian capitalism is co-evolutionary (Carney & Gedajlovic, 2002) and emphasizes both institutional perspectives and the reciprocal impact of firm strategies. Different institutional settings shape how networks and learning affect M&As within a comparative study of the United States and China (Lin et al., 2009). In the context of this study, labor laws in Germany and China affect M&As. While in Germany a complex and costly system of labor laws and industrial relations has evolved over time, which gives workers, work councils, and unions important information, decision, and control rights, China has a much less elaborate system of labor laws and industrial relations in place. Hence, we believe that the differences in business systems and institutional settings between Chinese firms and their international counterparts (or entities via cross-border M&A) might constrain potential synergy realizations for Chinese cross-border M&As. 2.2. Absorptive capacity from a multidimensional perspective Through the theoretical lens of absorptive capacity, we conceptualize a framework to identify the underlying reasons for the integration approach adopted by Chinese companies in their cross-border M&As. Responding to the call for further research by Deng (2009), we integrate absorptive capacity into asset-seeking M&A intent to draw a complete picture of the process for acquiring strategic assets for sustainable competitive advantage. A process-based perspective categorizes absorptive capacity into an exploratory learning and an exploitative learning process. Exploratory learning corresponds to the notion of potential absorptive capacity, while exploitative learning incorporates the idea of realized absorptive capacity (Zahra & George, 2002). Technological knowledge and market knowledge from overseas companies are targeted by Chinese companies during their strategic analysis prior to an M&A. We argue that the asset-seeking strategic intent results in exploring the technological knowledge base, including technical know-how, product knowledge, technical capabilities, and experiences of employees. Market knowledge includes reputation, brand equity, distribution channels, and sales services. This exploratory dimension refers to potential absorptive capacity, but other factors such as organizational structure, communication approaches, cultural differences, and institutional differences are generally not investigated before the M&A transaction closes. Yet they significantly influence exploiting the acquired knowledge and know-how that results in realized absorptive capacity. We propose a conceptual framework to understand the light touch approach of integration adopted by Chinese investors for their M&A activities in Germany.




220

Chinese FDI in Europe and North America A model of absorptive capacity Individual level • Capability • Experience Potential ACAP

Organizational level • Structure • Communication style

Realized ACAP

Light touch approach • Keep brand • Keep management team • Chinese as coordinator

National level • Business system • Institutional settings

Figure 10.1

A conceptual model of absorptive capacity

As shown in Figure 10.1, even though cross-border M&As offer Chinese acquirers the opportunity to absorb technological know-how, market knowledge, and management skills, the potential absorptive capacity (potential ACAP) is not realized. There are many differences between Chinese acquirers and German acquired firms. Applying our conceptual framework, all three factors may constrain realized absorptive capacity to some extent. The different types of absorptive capacity (individual, organizational, and national) act as a filtering process, and realized gains influence which integration mode Chinese investors prefer.

3. Data and methods 3.1. Methods The nature of the research questions of this study suggests fine-grained case studies as the preferred research method (Eisenhardt, 1989). It is generally best to obtain this information through qualitative interviews. We conducted in-depth interviews with CEOs and top-level managers from German companies acquired by Chinese investors. In addition, semi-structured interviews were conducted with people closely involved in Sino-German cooperative initiatives. The interviews, which were tape recorded and transcribed, were structured and analyzed using the software tool ATLAS.ti. 3.2. The sample This research focuses on cross-border acquisitions by Chinese companies in Germany. All the sample companies are in the machine tools industry, where many cross-border M&As occurred. The acquired companies are privately owned middle-sized firms (Mittelstand in Germany). Of the seven Chinese acquirers, five are SOEs. The transactions took place from 2004 to 2009 (see Table 10.1).



• Strategic intent • Industry complementarity

Yipeng Liu and Michael Woywode 221 Table 10.1 Samples in case studies Chinese firms

German firms

Ownership

Structure1

1

State

11 companies

Yes

2

State

12 companies

Yes

3

State

40 companies

4

State

500 companies

5

Private

10 companies

Yes

Yes

6

State

168 companies

Yes

Yes

7

Private

5 companies

Experience in Experience in Branch cross-border international M&A2 business3

Yes

Yes Yes

Yes

Machine tools Machine tools Machine tools Machine tools Machine tools Machine tools Machine tools

Deal year

2004 2005 2005 2006 2008 2008 2009

1 The

number of companies in the group, including joint ventures and fully owned companies. to the experience of the company which transacts the cross-border M&A, not the group level experience. 3 Refers to group-level experience, including import/export and international subsidiaries. 2 Refers

3.3. Data collections Data were collected mainly via the contacts and networks of the authors. We first looked at news, press releases, websites, and company announcements to gather information. Then we checked with the SDC Platinum from Thomson Financials and expanded the samples. Only the strategic M&As are considered for this study. Invitation letters invited German CEOs and top managers to participate in this study. The semi-structured interviews contained three sections: (1) Where did pre-M&A contacts with Chinese firms come from? How long did the contacts exist? What are the motivations for M&A? (2) Who are the involved stakeholders? What does the decision-making process look like? (3) Are there any integration activities post-M&A? What are they? How are Chinese acquirers involved in your daily business? At the end of the interview, we asked the interviewees to name three major challenges regarding cooperation with Chinese companies and the M&A. The insights provided by each interviewee were compared with what is known from the research. After each interview, the conceptual framework was adapted incrementally, based on the new information provided and then discussed with the next interviewee for validation and additional



Case


comments (Eisenhardt, 1989). This replication logic (Yin, 2003) uses multiple cases to build an understanding of a relatively new domain and in supplying direct application of the information. For data collection, in the first phase, August/September 2008, one native Chinese researcher and a German researcher conducted interviews in German. The questions were co-designed in English by a native Chinese researcher and German consultants who have Chinese experiences. The interviews in this phase were principally conducted in German except when the interviewee did not speak German well. The data collection approach combines face-to-face interviews and telephone interviews. The initial results were discussed with more than 15 German and Chinese managers at a China Forum Bayer meeting at the end of September 2008 in Munich, Germany. In the second phase, September, October, and December 2009, more semi-structured interviews were conducted with people closely involved in Sino-German cooperation. In the third phase, we conducted some interviews with Chinese companies in the summer of 2010 to obtain more observations and to validate the observations from Germany. If the interviews were conducted in Mandarin Chinese, the interview protocols were translated into English. One of the authors is a native Chinese speaker and conducted the translations.

4. Results and cases in point This section contains the aggregated results of the observations from our study, linking the evidence to our multilevel conceptual framework of absorptive capacity. Then we look at two representative cases to offer more in-depth insights through the theoretical framework of absorptive capacity. Most acquirers kept the existing management of the German company after the acquisition. Almost no integration took place after the acquisitions, let alone the M&A specific concept of ‘100 Day’ program. Unlike the conventional wisdom of integration, Chinese companies apply the light touch approach. They are passively involved in the operation of the company but influence the strategic direction of the German companies by retaining seats on the supervisory boards to keep the management team intact and maintain local employee morale. The current management knows the company and also knows the local suppliers and customers well. But lack of integration means that the benefits such as joint project development or skill transfer occur only to a very limited extent. Further, the uni-directional technologic advancement is slow and frictions occur. Within our sample, most of the Chinese companies have prior international exposure, such as the import/export business, overseas subsidiaries, or joint ventures in China, but very few have cross-border M&A experience.



222


There was no integration, and the Chinese partner is too passive. They can be more active besides the monthly and yearly reporting. Although the Chinese employees are very curious and engaged in learning, they need time to accumulate experience. The CEO of a German company states (Case 6: the Chinese firm is stateowned): We had some integration such as restructuring the organization, personnel changes and communication. From my perspective, it was quite positive. The Chinese had some international experience before, and this definitely helped. As the Chinese company was becoming international, it built up tacit knowhow which helped individuals broaden their international experience and later apply it to cross-border M&As. This may help to convert potential absorptive capability into realized absorptive capacity. On the organizational level, it is worth noting the difference between Chinese cross-border M&As and multinational M&As from developed economies. The ‘Go Abroad’ policy promoted by the Chinese central and local governments speeded up the entry of Chinese companies onto the global M&A scene. Within our samples of seven Chinese firms, five are SOEs, including some national champions. This reflects the strong willingness of the Chinese government to push the Chinese firms going global with financial support. Generally, the Chinese companies have adequate cash and prefer thinking from a long-term perspective. The CEO of a German firm explains (Case 3: the Chinese firm is stateowned): We needed capital, and Chinese investors brought the money. But it looks to me like equity investment instead of M&A involvement. They didn’t integrate. However, the SOEs often have complex organizational structures and sophisticated corporate governance mechanisms. By contrast, privately owned enterprises are relatively more transparent. In addition, the decision-making process of privately owned enterprises is faster, and they have a stronger willingness to learn. One acquiring privately owned Chinese firm succeeded in convincing the German entity to undertake a cost optimization program.



Our observations illustrate that there is a higher propensity for Chinese firms to integrate if they were previously involved in cross-border M&A activities. A marketing director of a German firm explains (Case 4: the Chinese firm is state-owned):

224


German production lines are not very cost effective but Chinese firms are good at cost savings. So, some practices have been transferred and accepted by the German company. The organizational differences between the acquiring and acquired firm form additional obstacles to integration. Relatively less developed organizational functions hinder the Chinese firms from integrating the German entity. A sales director of a German firm states (Case 5: the Chinese firm is privately owned): They [Chinese] cannot integrate after the M&A transaction. We have ERP (Enterprise Resource Planning) systems in place, but they only use Excel. We are one-step more advanced. On the national level, huge institutional differences create hurdles to realized absorptive capacity. Although professional service firms, such as accounting, financial advisory, and law firms, are involved in cross-border M&A transactions, they generally leave after the transactions close. The advice on paper needs to be implemented. One Chinese firm brought private equity firms on board after the cross-border transactions. The private equity firms’ rich cross-border experiences and long-term commitments might have helped to close the institutional distance to some extent, which might result in a larger realized absorptive capacity of the Chinese firm. The institutional distance varies according to the country bases of the acquiring and acquired firms. The national differences between China and other European countries may also influence the realized absorptive capacity as suggested in the conceptual framework. After seeing the big picture, we investigate two cases with different outcomes. This comparative approach is helpful to look for what really influences the M&A integration strategy and outcomes. We adopt a descriptive approach in analyzing the two cases. Due to a confidential issue, the company names in the cases are hidden. 4.1. Case study of MachineA MachineA, a German company, specializes in manufacturing advanced metal cutting tools used in the automotive and aerospace industry. In the early 1990s, it had about 30 employees and revenues of approximately



Although it might have been caused by the financial crisis, which offered the Chinese companies the opportunity to implement more active advice to the German counterparts, the ownership type and willingness to learn might also be a potential explanation. The CEO of the Europe Division of a Chinese firm says (Case 7: the Chinese firm is privately owned):

2 million Euros. The first contact of MachineA with a Chinese company was in 2001 when the contractor for constructing a machine ordered from a Chinese company. Later, the CEO of MachineA realized the potential of the Chinese market and hoped to diversify via a strategic partnership to gain access in China. A Chinese company, ChineseM, at that time was searching for a strategic partner in the West with key know-how in manufacturing. ChineseM first met MachineA at a trade fair and shortly after a deal closed in April 2005. ChineseM owned a majority stake of MachineA with the CEO of MachineA owning the remaining shares. The deal included the provision that the CEO of MachineA owned extended rights in decisions on management, selection of production location, and sale of stakes in MachineA, despite the fact that he was the minority shareholder. ChineseM allowed these conditions and adopted a light touch approach at the very beginning. Both sides aimed for ‘Win-Win’ cooperation, hoping to leverage valuable assets, from the advanced technology in Germany to the market potential in China. Considering the complementary strategic meaning, the potential absorptive capacity was huge. After the transaction, there was almost no involvement in daily business from ChineseM except for routine meetings on monthly and annual reports as well as planning sessions. Investment in production facilities in Germany was readily accepted by Chinese shareholders. Firms’ absorptive capacity depends on the individuals who stand at the interface of the firm and the external environment. In the context of crossborder M&As, it relates to the individuals who are closely involved in the deal on both sides. Without an effective interface function, achieving realized absorptive capacity is difficult. This affirms the concept of transactive organizational learning (TOL) proposed by Kieser and his associates (Kieser & Koch, 2008). Collaboration is feasible by involving specialists, and specialists can help to reduce learning (Grunwald & Kieser, 2007). MachineA employed one native Chinese engineer, mainly acting as the translator to communicate with the Chinese company. Although MachineA tried to install one Chinese employee as an interface, the new graduate, who had no experience dealing with Chinese companies, could not offer too much help. Moreover, the project manager at ChineseM, who was responsible for negotiating the deal, left the company shortly after the deal closed. This created communication obstacles between the two companies. The project manager position had not been filled yet when we conducted the interview in 2008. Regarding technology transfer, the initial agreement was to transfer knowhow to China to produce less specialized machinery at a lower cost. However, this plan proved difficult to realize due to a lack of competence of technical engineers from China. Although ChineseM also invested in absorptive capacity directly by sending personnel to Germany for advanced





technical training, it was a small-scale initiative. Relying on a small set of technical gatekeepers may not be sufficient; the group of workers as a whole must have an elevated level of background knowledge to absorb new technological know-how. On the organizational level, the CEO of ChineseM was appointed to lead another Chinese company after the deal closed. The momentum associated with the arrival of a new leader may have affected the strategy consistency. Also, the vision of the new leader was not aligned with his predecessor’s. The special properties of corporate governance in this case negatively influenced the integration activities of ChineseM. Moreover, the differences in organization structure of Chinese and German companies led to misunderstandings and frictions. The Chinese organizational structure mainly represents functions without denoting the responsible individuals explicitly, whereas German companies appoint individuals responsible for each function and make them transparent. The CEO of MachineA complained: After almost three years of cooperation, I still don’t understand their organizational structure and I don’t think I will understand. There was a lack of cultural understanding on the Chinese side regarding the German leadership style. Used to the ‘follow the command’ approach, ChineseM expected MachineA to listen passively to the parent company. They assumed that the know-how transfer from a daughter company to the parent company could easily be implemented. In addition, MachineA employees lacked motivation to engage in the know-how transfer because they saw a lack of cooperation from the parent company. Although there were many problems after the transaction occurred, MachineA still managed to increase the number of employees to 165 and had over 35 million Euros in revenue in 2008. From this standpoint, the light touch approach benefited the acquired company. But company growth mostly originated from the internal strengths of the German company and not from collaboration with the Chinese partner. Knowledge transfer to the Chinese partner was scant. This not-so-successful case in terms of synergy realization reveals some useful lessons that Chinese companies can learn. We suggest: • More interactive communications are needed as well as a more hands-on approach. • Achieving cross-cultural understanding and lowering the institutional distance are important conditions for knowledge transfer from German to Chinese corporations. • Understanding the organizational structure as well as the roles and responsibilities of leading managers in the German organizations are



226


important prerequisites for successful collaboration, interaction, and integration. • Chinese companies need to enhance their absorptive capacity (the realized ACAP).

MachineB was a traditional family business focusing on machine tool manufacturing before it was acquired by a US machine manufacturing company in the mid-1980s. Since the American firm and the acquired German firm MachineB had product overlaps, there were many restructuring activities. MachineB product development and regional market channels were constrained by the US parent. The US firm filed for Chapter 11 bankruptcy in 2003. Hence MachineB was searching for new opportunities. A German machine tool company took over MachineB. The unhappy international merger experience was the start of the next journey for MachineB with a company from the Far East. The Chinese firm MachineCN is a SOE ranked in the top three in the machine tool industry in China. Although it bears the characteristics of a SOE, it began international collaboration with MachineB in 1984. At the beginning, the cooperation was structured so that MachineCN was merely a customer of MachineB, ordering products and procuring maintenance services. The Chinese firm realized the importance of advanced technology and started looking for acquisition opportunities. In 2005, when the German machine tool company lost interest in MachineB, the Chinese firm MachineCN acquired it. From the learning perspective, prior experience with the seller-buyer relationship allowed both parties to know each other. After negative experiences by MachineB during two handovers, the morale of employees was quite low. It needed a clear direction and a strategy. MachineCN always was very explicit in describing its intentions, as the CEO of MachineCN says: We will not move the German manufacturing plant at all but will keep and grow the company in Germany. As usual with most Chinese firms, MachineCN did not have much international experience before this deal. They clearly realized the risks involved with the complex and cross-continental task. On the individual level, the lack of experience limited the potential of realized absorptive capacity of MachineCN, although the prior cooperation experience may have offset this shortcoming. MachineCN kept the management team and jointly developed a new strategy, utilizing the technological and market know-how from MachineB to expand into international markets. In China, they explicitly used the



4.2. Case study of MachineB


‘Made-in-Germany’ brand to market the products by combining the Chinese sales force and channels with German technologies. MachineCN made its operational structure clear enough to facilitate smooth communications between MachineB and MachineCN. MachineCN let the management team of MachineB concentrate on their core competencies, namely market knowledge and technology. On the national level, MachineCN was aware of the business system differences and tried to cultivate a culture to understand the differences. They invited the management team to visit China and MachineCN factories, explained the historical and recent economic development of China, and imparted Chinese cultural and historical stories to the MachineB delegates. Mutual respect for cultural differences and commonalities were ongoing and frequent. They used external media, such as local newspapers, to report the success of the cooperation. As a success story, the facts speak for themselves. MachineB increased revenues from 64 million Euros in 2005 to 172.5 million Euros in 2009, while the number of employees grew from 500 in 2005 to 750 in 2009. This successful case illustrates the explanatory power of the model of absorptive capacity. We conclude: • Prior working experience and the frequent exchange of employees diminish individual constraints on absorptive capacity. • The clear structure of the organization on the operational level and interactive communications smoothed cooperation and unleashed the realized absorptive capacity. • Awareness, respect, and mutual understanding of business system differences may enhance the chance of converting potential absorptive capacity to realized absorptive capacity.

5. Discussion 5.1. Managerial and policy implications Different factors influence the conversion from potential to realized absorptive capacity. Managers from both Germany and China should be aware of the differences from a multidimensional perspective. Light touch integration may be explained by the conceptual framework we propose. Keeping the light touch approach and finding an optimal way to maximize the synergy from cross-border endeavours are challenges for managers. One possible way is to understand the different dimensions of absorptive capacity, and invest in absorptive capacity. Not just the potential absorptive capacity from a strategic perspective, but also the process-based view on collaboration, might enhance the realized absorptive capacity.



228

Although the proposed framework was developed based on the German machine tool industry, it may apply to upcoming Chinese cross-border M&As in Europe. The latest high profile case is Geely Automobile, which purchased the Swedish brand Volvo for US$1.5 billion from Ford Motor Co., who paid US$6.45 billion for Volvo in 1999 (Reed, 2010). To enhance the realized absorptive capacity, we suggest the Chinese acquirer should involve European private equity investors, specialized automotive consultants, and automotive service companies in the M&A. Their understanding of the institutional environment, local laws and regulations, and professional experiences may substantially shorten the institutional distance encountered by Chinese companies. By joining forces, European financial investors can structure a deal before the transaction, and European investors may complement and be more actively involved in the operational management of the acquired firms in Europe after the deal, given the light touch integration approach adopted by the Chinese companies. This type of collaboration can only generate synergy if both the Chinese strategic investors and European financial investors can trust each other and align their interests accordingly. As for policy implications, it is necessary for both countries to expand existing collaboration across different levels. A variety of intermediaries, such as governmental agencies, industrial associations, educational institutions, international organizations, and consulting firms can contribute to meet the critical challenges and prepare business leaders with the mutual understandings before they become involved in the cross-border M&A activities. 5.2. Limitations and future research directions Due to the characteristics of the case study research, the framework cannot be simply generalized, although it may reflect the reality of Chinese M&As in the German machine tool industry. Since more and more cases are available, our propositions can be tested via quantitative methods, such as surveys. The consequences of the light touch approach are difficult to evaluate due to the relatively short history of Chinese cross-border M&As. It will be valuable to monitor the further development of these M&As and measure the organizational performance through a longitudinal study. Researchers can test this framework in other industries and other countries in the cross-border M&A context. A quantitative approach can be used to test the framework and validate the propositions, even with small samples but multiple observations in each cross-border M&A case.

6. Conclusion Departing from the strategic intent perspective in the literature on Chinese OFDI, this study focuses on the integration approach of Chinese cross-border





M&As in Germany and explores the light touch approach. Unlike the conventional approach to M&A integration, Chinese cross-border M&As in Germany adopt light touch integration. A conceptual framework integrating individual, organizational, and national level dimensions into the concept of absorptive capacity explains the light touch integration approach. This qualitative study includes seven Chinese M&A cases in the German machine tools industry. Cross-case analyses were conducted to test and illustrate the explanatory power of the conceptual framework. Although we believe in the explanatory power of the conceptual framework based on finegrained case studies, we suggest further research to test it in the cross-border context, covering different countries and different industry sectors. We contribute to a better understanding of Chinese cross-border M&As in three ways. First, we focus on the integration approach from the theoretical lens of absorptive capacity; second, a multilevel approach covering individual-, organizational-, and national level dimensions is adopted to analyze this complex issue; third, based on organizational learning theory, we emphasize the importance of understanding the absorptive capacity concept from a multidimensional perspective. Our theoretical contributions include the illustration of the multidimensional traits of absorptive capacity in cross-border M&As. The proposed conceptual framework may help managers and policymakers to understand the light touch integration approach and to realize the potential synergy from Chinese cross-border M&As. We encourage Germany and China to further expand their existing collaboration by leveraging the know-how and experiences from different types of organizations, such as governmental agencies, industrial associations, and professional firms.

Acknowledgments The authors would like to thank the participants of the ‘China Goes Global Conference’ at Harvard University for the helpful feedback. We appreciate the kind support from CEOs and managers who offered us the opportunity to conduct this research study. Financial support from the University of Mannheim is greatly acknowledged.

References Alon, I., & McIntyre, J. (eds.) 2008. Globalizing of Chinese Enterprises. New York: Palgrave Macmillan. Astrachan, J. H. 1990. Mergers, Acquisitions, and Employee Anxiety: A Study of Separation Anxiety in a Corporate Context. New York: Praeger. Atkins, R. & Dyer, G. 2010. China confirmed as world’s top exporter, FT.com, www.ft. com/cms/s/0/35de8406-155c-11df-8f05-00144feab49a.html, accessed 5 April 2010.



230

Birkinshaw, J., Bresman, H., & Håkanson, L. 2000. Managing the Postacquisition Integration Process: How the Human Integration and Task Integration Processes Interact to Foster Value Creation. Journal of Management Studies, 37(3): 395–425. Björkman, I., Stahl, G. K., & Vaara, E. 2007. Cultural Differences and Capability Transfer in Acquisitions: The Mediating Roles of Capability Complementarity, Absorptive Capacity, and Social Integration. Journal of International Business Studies, 38: 658–672. Buckley, P. J., Clegg, J., Cross, A. R., Liu, X., Voss, H., & Zheng, P. 2007. The Determinants of Chinese Outward Foreign Direct Investment. Journal of International Business Studies, 38(4): 499–518. Capron, L., & Guillén, M. 2009. National Corporate Governance Institutions and Post-acquisition Target Reorganization. Strategic Management Journal, 30: 803–833. Carney, M., & Gedajlovic, E. 2002. The Co-evolution of Institutional Environments and Organizational Strategies: The Rise of Family Business Groups in the ASEAN Region. Organization Studies, 23(1): 1–31. Cartwright, S., & Schoenberg, R. 2006. Thirty Years of Mergers and Acquisitions Research: Recent Advances and Future Opportunities. British Journal of Management, 17(S1): S1–S5. Cogman, D., & Tan, J. 2010. A Lighter Touch for Postmerger Integration. McKinsey on Finance, 34: 8–12. Cohen, W. M., & Levinthal, D. A. 1990. Absorptive Capacity: A New Perspective on Learning and Innovation. Administrative Science Quarterly, 35: 128–152. Cooke, F. L. 2005. Vocational and Enterprise Training in China: Policy, Practice and Prospect. Journal of the Asia Pacific Economy, 10(1): 26–55. Cui, L. & Jiang, F. 2009. FDI Entry Mode Choice of Chinese Firms: A Strategic Behavior Perspective. Journal of World Business, 44: 434–444. Deng, P. 2009. Why Do Chinese Firms Tend to Acquire Strategic Assets in International Expansion? Journal of World Business, 44: 74–84. Eisenhardt, K. M. 1989. Building Theories from Case Study Research. Academy of Management Review, 14: 532–550. Farrell, D., & Grant, A. J. 2005. China’s Looming Talent Shortage. McKinsey Quarterly, www.mckinseyquarterly.com/Organization/Talent/Chinas_looming_talent_ shortage_1685, accessed April 5, 2010. Finkelstein, S., & Haleblian, J. 2002. Understanding Acquisition Performance: The Role of Transfer Effects. Organization Science, 13: 36–47. Germany Trade & Invest, 2010. Germany‘s Major Investment Partners: China, www. gtai.com, accessed October 18, 2010. Grollmann, P., & Rauner, F. 2007. Exploring Innovative Apprenticeship: Quality and Costs. Education + Training, 49(6): 431–446. Grunwald, R., & Kieser, A. 2007. Learning to Reduce Inter-organizational Learning: An Analysis of Architectural Product Innovation in Strategic Alliances. Journal of Product Innovation Management, 24: 369–391. Haleblian, J., Kim, J., & Rajagopalan, N. 2006. The Influence of Acquisition Experience and Performance on Acquisition Behavior: Evidence from the U.S. Commercial Banking Industry. Academy of Management Journal, 49(2): 357–370. Hall, P. A., & Soskice, D. 2001. Varieties of Capitalism: The Institutional Foundations of Comparative Advantage. New York: Oxford University Press. Heckman, J. J. 2003. China’s Investment in Human Capital. Economic Development and Cultural Change, 51(4): 795–804.





Hitt, M. A., Dacin, M. T., Levitass, E., Arregle, J. L., & Borza, A. 2000. Partner Selection in Emerging and Developed Market Contexts: Resource-based and Organizational Learning Perspectives. Academy of Management Journal, 43(3): 499–467. Hitt, M. A., Ireland, R. D., & Harrison, J. S. 2001. Mergers and Acquisitions: A Value Creating or Value Destroying Srategy? In M. A. Hitt, J. S. Harrison, & E. Freeman (eds.), Handbook of Strategic Management. Oxford: Blackwell Publishers. Hua, J., Miesing, P., & Li, M. 2006. An Empirical Taxonomy of SOE Governance in Transitional China. Journal of Management and Governance, 10(4): 401–433. Jensen, M. C. & Ruback, R. S. 1983. The Market for Corporate Control: The Scientific Evidence. Journal of Financial Economics, 11: 5–50. Kang Y., Shi L., & Brown, E. D. 2008. Chinese Corporate Governance History and Institutional Framework. Rand Center for Corporate Ethics and Governance, 618: 1–60. Kieser, A., & Koch, U. 2008. Bounded Rationality and Organizational Learning Based on Rule Changes. Management Learning, 39: 329–347. King, D. R., Dalton,D. R., Daily,C. M. & Covin, J. G. 2004. Meta-analyses of post-acquisition performance: Indications of unidentified moderators. Strategic Management Journal, 25: 187–200. Kshetri, N. 2007. Institutional Changes Affecting Entrepreneurship in China. Journal of Development Entrepreneurship, 12(4): 415–432. Lane, P. J., Koka, B., & Pathak, S. 2006. The Reification of Absorptive Capacity: A Critical Review and Rejuvenation of the Construct. Academy of Management Review, 31: 833–863. Larsson, R., & Finkelstein, S. 1999. Integrating Strategic, Organizational, and Human Resource Perspectives on Mergers and Acquisitions: A Case Survey of Synergy Realization. Organization Science, 10(1): 1–27. Lattemann, C., Fetscherin, M., Alon, I., Li, S., & Schneider, A. 2009. CSR Communication Intensity in Chinese and Indian Multinational Companies. Corporate Governance: An International Review, 17(4): 426–442. Levinson, H. 1970. A Psychologist Diagnoses Merger Failure. Harvard Business Review, 48(2): 139–147. Levitt, B., & March, J. G. 1988. Organizational Learning. Annual Review of Sociology, 14: 319–340. Lichtenthaler, U. 2009. Absorptive Capacity, Environmental Turbulence, and the Complementarity of Organizational Learning Process. Academy of Management Journal, 52(4): 822–846. Lin, Z. J., & Liu, M. 2009. The Determinants of Auditor Switching from the Perspective of Corporate Governance in China. Corporate Governance: An International Review, 17(4): 476–491. Lin, Z. J., Peng, M. W., Yang, H., & Sun, S. L. 2009. How Do Networks and Learning Drive M&As? An Institutional Comparison between China and the United States. Strategic Management Journal, 30: 1113–1132. Liu, Q. 2006. Corporate Governance in China: Current Practices, Economic Effects and Institutional Determinants. CESifo Economic Studies, 52(2): 415–453. Liu, Q., & Lu, Z. 2007. Corporate Governance and Earnings Management in the Chinese Listed Companies: A Tunneling Perspective. Journal of Corporate Finance, 13: 881–906. Liu, Y. 2011. High-Tech Ventures’ Innovation and Influences of Institutional Voids: A Comparative Study of Two High-Tech Parks in China. Journal of Chinese Entrepreneurship, 3(2): 112–133.



232

Lubatkin, M. 1987. Merger Strategies and Stockholder Value. Strategic Management Journal, 8: 39–53. Luo, Y, Xue, Q., & Han, B. 2010. How Emerging Market Governments Promote Outward FDI: Experience from China. Journal of World Business, 45: 68–79. March, J. G. 1991. Exploration and Exploitation in Organizational Learning. Organization Science, 2: 71–87. Nelson, R. R., & Winter S. G. 1982. An Evolutionary Theory of Economic Change. Cambridge, MA: Belknap Press. Pablo, A. L. 1994. Determinants of Acquisition Integration Level: A Decision-making Perspective. Academy of Management Journal, 37: 803–836. Peng, M. W. & Luo, Y. 2000. Managerial Ties and Firm Performance in a Transition Economy: The Nature of a Micro-macro Link. Academy of Management Journal, 43(3): 486–501. Peng, M. W. 2006. Making M&A Fly in China. Harvard Business Review, March 2006. Reed. J. 2010. Geely completes purchase of Volvo for $1.5bn. FT.com, www.ft.com/ cms/s/0/b25238b6-9e1e-11df-b377-00144feab49a.html, accessed October 18, 2010. Schweiger, D. M. 2002. M&A Integration: A Framework for Executives and Managers. New York: McGraw-Hill. Shimizu, K., Hitt, M. A., Vaidyanath, D., & Pisano, V. 2004. Theoretical Foundations of Cross-border Mergers and Acquisitions: A Review of Current Research and Recommendations for the Future. Journal of International Management, 10: 307–353. Shrivastava, P. 1986. Postmerger Integration. Journal of Business Strategy, 7: 65–76. Simon, H. 2009. Hidden Champions of the Twenty-First Century: Success Strategies of Unknown World Market Leaders. Berlin: Springer. Stahl, G. K., & Voigt, A. 2008. Do Cultural Differences Matter in Mergers and Acquisitions? A Tentative Model and Examination. Organization Science, 19(1): 160–176. Tan, J., Yang, J., & Veliyath, R. 2009. Particularistic and System Trust among Small and Medium Enterprises: A Comparative Study in China’s Transition Economy. Journal of Business Venturing, 24(6): 544–557. Uhlaner, R. T., & West, A. S. 2008. Running a Winning M&A Shop. The McKinsey Quarterly, Corporate Finance, March 2008. Wadhwa, V. 2009. A Reverse Brain Drain. Issues in Science and Technology, Spring: 45–52. Walter, G. A., & Barney, J. B. 1990. Management Objectives in Mergers and Acquisitions. Strategic Management Journal, 11: 79–86. Wan, W. P. 2005. Country Resource Environments, Firm Capabilities and Corporate Diversification Strategies. Journal of Management Studies, 42(1): 161–182. Whitley, R. D. 1991. The Social Construction of Business Systems in East Asia. Organization Studies, 12(1): 1–28. Yang, J. Y., & Li, J. T. 2008. The Development of Entrepreneurship in China. Asia Pacific Journal of Management, 25(2): 335–359. Yin, R. K. 2003. Case Study Research: Design and Methods. Thousand Oaks, CA: Sage. Zahra, S. A., & George, G. 2002. Absorptive Capacity: A Review, Reconceptualization, and Extension. Academy of Management Review, 27(2): 185–203. ZEW. 2010. Schwerpunkt M&A-Report. ftp.zew.de/pub/zew-docs/zn/schwerpunkte/mareport/MA-Report1010.pdf, accessed 28 October 2010.




11 Chinese SMEs in Prato, Italy

China’s ongoing ambition of global leadership includes its growing investments outside China. Although China has the reputation for being the world’s factory, manufacturing up to 70 percent of electronics, toys, textiles, clothing, and footwear (Lardy, 2002; Gu, 2006; Harney, 2008), a growing number of Chinese have set up businesses outside the country, most recently in Europe. Today, China not only runs the world’s workshop but operates workshops around the world, a phenomenon resulting from increased Chinese outward foreign direct investment (OFDI), which has doubled to US$52 billion between 2007 and 2008 (Roberts & Balfour, 2009, p. 42). Key players in China’s global push are Chinese state-owned enterprises (SOEs) and Chinese multinational enterprises (MNEs). Their goal is to open new markets, access natural resources, and buy Western brands overseas. However, besides the ‘investment hunger’ of large Chinese companies, it is the growing number of small-to-medium-sized enterprises (SMEs) set up in Europe by Chinese migrants (xin yimin)1 that also contribute to China’s global advancement. They have stayed in the shadow of larger Chinese enterprises so far but they deserve more attention as part of Chinese international migration. Moreover, they are labor rather than capital intensive. This chapter draws upon interviews with more than 30 Chinese entrepreneurs in Prato, Northern Italy, investigating the business rationale and strategies of these Chinese SMEs.

1. China’s long march to become a global investor China’s change from an inward-looking self-reliant country toward becoming more globally integrated determined its two-pronged investment policy: to attract foreign investments and become an investor overseas. The flow of foreign direct investment (FDI) into China, as one of the largest FDI recipients in the world over the past three decades (OECD, 2008; Sauvant & Devies, 2010; UnctadStat, 2010), has witnessed a ‘counter-flow’ – investment by China and Chinese enterprises in other parts of the world 234



Anja Fladrich

Anja Fladrich 235

Other parts of the world

Other parts of the world

Foreign direct Investment

Overseas direct Investment

China

(zou chu qu)

China Figure 11.1 China’s dual approach toward sustainable economic development Note: Figure by author, see also Fuchs (2007), Kurihara (2008), and Tang et al. (2008).

(see Figure 11.1). These two investment streams are referred to as ‘coming in’ (yin jin lai) and ‘going out’ (zou chu qu) and are complementary forces in China’s sustainable economic development and global advancement (Tang et al., 2008; Ge & Ding, 2009). Chinese OFDI has over the past decades mainly targeted Asia and the United States. More recently, however, a growing number of Chinese SOEs and MNEs have begun to invest in Europe (Gugler & Boie, 2008). Starting from a small base and representing only a fraction of Chinese OFDI worldwide, Chinese investments in Europe have grown modestly but steadily. Most investments have gone into the service industries, information communication technology (ICT), and automobile manufacture (see Table 11.1 below).2 Amongst European countries, the United Kingdom and Germany Table 11.1

World Europe (excl. Russia) Germany Italy UK France Spain Sweden Netherlands

Top 10 recipient countries of Chinese ODIs flows in Europe (US$ million) Flows 2003

Flows 2004

Flows 2005

Flows 2006

Flows 2007

Flows 2008

2,854.65 114.41

5,497.99 79.90

12,261.17 189.54

17,633.97 128.73

26,506.1 1,062.82

55,907.2 480.56

25.06 0.29 2.11 0.45 n.a. 0.17 4.47

27.50 3.10 29.39 10.31 1.70 2.64 1.91

128.74 7.46 24.78 6.09 1.47 1.00 3.84

76.72 7.63 35.12 5.60 7.30 5.30 5.31

238.66 8.1 566.54 9.62 6.09 68.06 106.75

183.41 5 16.71 31.05 1.16 10.66 91.97

Source: Pietrobelli, Rebellotti, and Sanfilippo (2010).



(yin jin lai )


receive most Chinese OFDI, while Italy, like most other European countries, has only over the past few years attracted more investment from China. Although Chinese investment in Italy has multiplied more than 20 times since 2003, Italy is still a minor recipient (Pietrobelli, Rebellotti, & Sanfilippo, 2010, p. 8). The 2008 global financial crisis (GFC) is expected to result in a further influx of Chinese OFDI in Europe as ailing European companies offer attractive investment opportunities. As Roberts and Balfour (2009, p. 40) describe it, China is ‘bottom-fishing’, which leaves struggling European firms vulnerable to the Chinese ‘insatiable appetite’ (Nicolas, 2009). Although China’s investment in Europe remains limited, it is nevertheless an integral strategic part of and destination for China’s global ambition, and should increase further (Deutsche Bank Research, 2006; Gugler & Boie, 2008; Nicolas, 2009). Two landmark events mark China’s long march to global leadership and investment: the Open Door Policy (Kaifeng zhengce) in 1978, and China’s accession to the World Trade Organization (WTO) in 2001. The Chinese government is instrumental in China’s investment overseas, including the expansion strategy ‘Going Global’ (zou chu qu) initiated by Jiang Zemin. In effect since 1999, this strategy gained additional impetus from members of the Chinese Politburo in mid-2009 (Fuchs, 2007; Roberts & Balfour, 2009) (Figure 11.2). Over the past three decades, China has gradually moved from prohibiting OFDI to actively promoting it, with the zou chu qu strategy as a core element (Cai, 1999; Voss et al., 2008). This strategy was designed for large Chinese SOEs such as Baosteel and Sinopec but selected MNEs, including Lenovo, Haier, and Huawei, also benefited. These firms are all amongst the 30-to-50 companies that have already built up a significant resource base and have been involved in international competition. The Chinese government has been committed and eager to build these companies into ‘Global Champions’ (Gu, 2006; Fuchs, 2007, p. 30; Alon & McIntyre, 2008; Tang et al., 2008; Yang & Stoltenberg, 2008). While an estimated 30,000 Chinese companies operate outside China today, the Global Champions have a

1978: China’s open door policy

1999: Expansion strategy: zou chu qu Figure 11.2

2001: China’s WTO accession

2009: Reiteration of zou chu qu strategy

Landmarks of China’s ambition to global leadership



236

special role representing model enterprises and constituting the flagship of China’s global ambitions. The government hopes that these companies will equal the standard of the world’s top 500 companies. Support mechanisms by the Chinese government for the Global Champions have been designed to make overseas investment attractive to more Chinese companies and increase their international competitive position. These mechanisms include easier access to start-up capital at favorable interest rates, government subsidies, and insurance protection from the Bank of China, the China Development Bank, and Sinosure (China Export and Credit Insurance Corporation). Approval processes for investment projects have been simplified to accelerate their execution. Provincial governments now become involved only if the investment exceeds US$ 100 million, while smaller investment projects are approved at lower levels (Deutsche Bank Research, 2006; Fuchs, 2007; Nicolas, 2009). The reasons for this preferential treatment include China’s strategy for independence in key industries (including energy, natural resources, and food) as well as the emergence of a ‘. . . new patriotism and self-confidence . . .’ (Fuchs, 2007, p. 22). Despite the growing number of Chinese SOEs and MNEs now operating in Europe that are strategically important to China’s global advancement, a growing number of micro-enterprises and small-to-medium-sized enterprises (SMEs) have also contributed to China’s global expansion – outside government initiatives, strategy, and scope. Set up by ‘new’ Chinese migrants (xin yimin) in a ‘bottom-up’ approach, these small Chinese firms often operate in the shadow of China’s large SOEs and MNEs. They may sometimes even be hidden from the host country’s authorities. These Chinese microenterprises and SMEs have only recently started to attract scholarly interest (Ceccagno, 2003, 2007, 2009; Wu & Zanin, 2007; Fladrich, 2009b). Unlike the large Chinese companies eager and able to acquire foreign companies which we read about on the front pages of business newspapers, the Chinese micro-enterprises and SMEs attract coverage and controversy in local newspapers of the host country only. The attention given to the small enterprises by Chinese migrants originates from the large influx of Chinese migrants into Europe over the past ten years, as well as allegations of labor exploitation and unfair competition by Chinese micro-enterprises and SMEs. Since we have only nascent knowledge on the smaller firms and their investments in Europe, questions arise as to what their motivation and business rationale is, what entry mode Chinese migrant entrepreneurs adopt, what business strategies, and which industries. To what extent do Chinese SME investment paths and patterns mirror those of their ‘larger brothers’, that is Chinese SOEs and MNEs? What significance do the ethnic enclave and Prato, as one of Europe’s most concentrated Chinese enclaves, have as a traditional industrial district for Chinese SME investments? Against the background of these questions, the following section reviews the literature on Chinese OFDI and addresses the concepts of industrial



Anja Fladrich 237

238


2. Characteristics and development of Chinese OFDI Research on China’s investment overseas has long remained in the shadow of the literature on FDI flows into China. As part of China’s reform policy over the past three decades, Chinese OFDI has also been characterized by a gradualist approach. China, once it became aware of international concerns, was eager to avoid the perception by companies and governments overseas of being too ambitious and aggressive in its global asset pursuits. For the last decade, scholars have been exploring the characteristics and development of Chinese OFDI. Luo et al (2010); Voss et al. (2009), Wong and Chan (2003), and Wu and Chen (2001) assess the scale and pace of Chinese investment overseas and identify different stages or phases. Starting from a small number of projects concentrated in a few industries and driven by political motives of fostering international relationships, Chinese OFDI has become more economics-driven, fast-paced, and focused on large-scale investments. Cross and Voss (2008) show that prior to 2000, OFDI followed trade and were defensively market-seeking, while, after 2000, Chinese OFDI targeted markets with substantial growth potential, and thus trade followed OFDI. Recent scholarship (e.g., Liu, Buck, & Shu, 2005; Hong & Sun, 2006; Buckley et al., 2007; Deng, 2007) examines the motives and dynamics of Chinese OFDI. Employing Dunning’s (1992, 2000) theory, according to which the search for foreign markets, resources, efficiency, and strategic assets motivates foreign investment, Buckley et al. (2007) conclude that, in the case of Chinese OFDI, the host countries’ resource endowments, institutional environment, and policy liberalization in the home country constitute influential factors. The authors identify cultural proximity and political risk as significant drivers and suggest that Chinese firms investing overseas prefer an environment comparable to their home environment. Deng (2007) and Pietrobelli, Rebellotti, and Sanfilippo (2010) emphasize that China is a latecomer on the global stage, prompting the country to catch up with global competition by engaging in strategic asset-seeking. Deng (2007, p. 74) argues that, unlike traditional exploitation and transfer of resources to the home country, the asset-seeking approach of Chinese foreign investment ‘. . . is undertaken . . . to access new resources and . . . gain new capabilities or acquire necessary strategic assets in a host country’. Luo et al. (2010) advocate that the dual forces of competence-constraint and institutional



districts, cluster theory, and ethnic enclaves to explain the development of Chinese SMEs in Prato. This chapter draws on the five dimensions of business rationale, investment strategy, preferred industries, and financial and human capital to illustrate the differences among Chinese SOEs, MNEs and SMEs.

escapism, usually discussed separately, in actuality both influence enterprises from emerging countries to expand globally. Analyzing the role of the Chinese government in OFDI, the authors admit that China’s OFDI policies and initiatives are not necessarily transferable to other countries. Spurred by the desire for rapid economic development, China has been eager to access natural resources, mature technologies, management skills, and brands, all of which it lacks but which are vital for its economic growth. This has prompted inquiry on how Chinese OFDI occurs, including entry mode and strategies. Wu and Chen (2001, p. 1243) identify five investment vehicles as modes of entry: equity joint ventures, contract joint ventures, wholly owned enterprises, branch offices, and full or partial acquisitions. The China National Offshore Oil Company (CNOOC) is an example of the global reach of Chinese SOEs that had signed petroleum contracts with more than 70 foreign oil companies in 21 countries by 2006 (Johnson, 2008). Gugler and Boie (2008) emphasize joint ventures (JVs) and mergers and acquisitions (M&As) as the preferred investment forms for Chinese firms. However, greenfield operations and research and development (R&D) centers in host countries are also crucial in China’s ambition (Buckley et al., 2007; Deng, 2007; Fuchs, 2007; Kurihara, 2008; Simmons, 2008; Tang et al., 2008). Against the background of Western businesses and countries viewing Chinese ODFI as a threat3 and hence eager to counter these initiatives, scholars ask how much Chinese OFDI follows conventional FDI investments or whether it takes an idiosyncratic approach, that is constitute FDI ‘with Chinese characteristics’. Scholarship increasingly supports this latter view (Child & Rodrigues, 2005; Buckley et al., 2007; Gugler & Boie, 2008; Luo et al., 2010). While the literature on Chinese OFDI in Europe mostly focuses on the United Kingdom and Germany as the main European destinations, Pietrobelli, Rebellotti, and Sanfilippo (2010) provide an additional perspective in their work on Chinese OFDI in Italy. They argue that although Chinese OFDI in Southern Europe is still in its infancy, Chinese MNEs are eager to tap core competencies in Italy’s industrial districts. Pietrobelli, Rebellotti, and Sanfilippo (2010) emphasize that the Italian and Chinese economies share certain features, including strong location advantages due to the agglomeration of firms in the automotive, textiles, and home appliances sectors. The authors support Buckley’s et al. (2007) view that similarity between home and host environment constitutes a vital factor for Chinese OFDI. The following section discusses the concepts of industrial districts, clusters, and ethnic enclaves.

3. Industrial districts, clusters, and ethnic enclaves The concept of the industrial district originates from the work of Alfred Marshall (1920) and his theories on localized industries. Marshall (1920)



Anja Fladrich 239


identifies three drivers of industrial localization: pooling of labor, availability of specialized inputs, and spillover effects of technology that allow SMEs to compete with large companies due to their geographical agglomeration (Krugman, 1991). Geographical factors reduce transaction costs and allow higher productivity and more specialized inputs and services. Geographical proximity enhances the flow of information on products and markets. According to Marshall (1920), industrial districts with amalgamations of SMEs rely less on economies of scale but have flexibility, short distances, and the pooling of resources. Hence many localized SMEs specialize in various stages or phases of the same production process. When scholars (Becattini, 1990, 2000; Pyke & Sengenberg, 1990; Harrison, 1992; Markusen, 1996; Fioretti, 2001; Sforzi, 2002) revisited Marshall’s concept, Becattini (1990, p. 19) referred to the industrial district as ‘. . . a socio-territorial entity, which is characterized by the active presence of both a community of people and a population of firms in one naturally and historically bounded area’. Becattini (1990, 2000) emphasizes that the value system in the industrial district is shared and handed down over generations, acting as source of productivity and innovation. Pyke and Sengenberg (1990) point to the closer relationships among the social, political, and economic spheres in industrial districts, while Markusen (1996) confirms that not only relationships but intentional cooperation among competing firms, including staff exchanges between customers and suppliers, characterize the industrial district. While Marshall’s theory is vital for the development of cluster theory, Porter (1998a, 1998b, 2000) is arguably the most influential contemporary scholar on the concept of clusters, which is often referred to as ‘. . . neoMarshallian cluster concept . . .’ (Martin & Sunley, 2001, p. 6). Porter (1998a, 2000) conceptualizes an industrial or business cluster as a group of interconnected corporations operating in a similar field and located in close geographical proximity. They are linked by commonalities as well as complementarities. Companies in a cluster usually operate in the same sector or sub-sector, have strong interdependent relations in the value chain, and share cost and risks (OECD, 2001). As Markusen (1996) points out, the growth of clusters results from networking and the twin-concept of cooperation and competition, which can be found in developed as well as developing economies. Porter (2000), however, argues that clusters in developed countries tend to be more advanced. Portes (1981, pp. 290–291) cites characteristics of industrial districts and clusters as vital for migrant communities in host societies, terming the situation of migrants in a geographical agglomeration an ethnic enclave, which according to Portes: . . . consists of immigrant groups which concentrate in a distinct spatial location and organize a variety of enterprises serving their own ethnic market and/or the general population. Their basic characteristic is that a



240

Anja Fladrich 241

The Chinese community in Prato appears to be a ‘cluster within a cluster’. As a traditional industrial district hosting a large number of SMEs in the textile sector (Dei Ottati, 1994; Fioretti, 2001), Prato has witnessed the emergence of a Chinese enclave nested within the industrial district. The emergence and development of Chinese firms in the enclave appear to differ from the Chinese SOEs and MNEs discussed in the literature, and their business rationale and strategies are of particular interest and value to the discourse on Chinese OFDI.

4. Methodology This chapter is based on a scoping study of 36 interviews (including repeat interviews) with Chinese entrepreneurs undertaken by the author in Prato in 2008 and 2009.4 The interviews lasted up to two hours and were conducted in Chinese (Mandarin). Notes were taken during each interview and transcribed into a research journal. The respondents were approached employing an opportunistic approach by visiting their business outlets in the Chinese enclave. All the respondents were owner-operators and 15 percent operated the firms as co-preneurs. As Table 11.2 shows, almost half of the respondents were female, with an average age of 29 for male and female respondents. This mirrors the demographic of the overall young Chinese community in Prato that has in recent years seen an increase in its female population (Denison et al., 2009). Most of the respondents operate their business in the services and retail industry. Although the manufacturing of textiles has been vital to Chinese companies and the community for more than two decades, the services and retail sectors have gained importance only recently, and by 2008 dominated the Chinese businesses in manufacturing (Ceccagno, 2009). With usually fewer than half a dozen employees, most of the respondent firms were micro-entrepreneurs or SMEs. The small number of manufacturing companies included in the research employed between 10-to-25 workers on average, many of whom were contractual and hence these firms had a Table 11.2

Respondent gender and age

Number Percentage Average age∗

Male interviewees

Female interviewees

Total

18 53 29 years

16 47 29 years

34 100 29 years

Note:∗ includes five respondents who did not reveal their age.



significant proportion of the immigrant labor force works in enterprises owned by other immigrants.

Chinese FDI in Europe and North America Table 11.3

Number Percentage Size

Company size and industry Manufacturing

Services and retail industry

Total

6 18 > 8 employees

28 82 < 8 employees

34 100 n/a

more volatile workforce determined by industry demand. The dominance of small workforces applies also to Chinese SOEs and MNEs in Italy (Pietrobelli, Rebellotti, & Sanfilippo, 2010, p. 10) (Table 11.3). The majority of Chinese firms in Prato are located along Via Pistoiese, Via Fabio Filzi, and neighboring streets outside the medieval town center. Several large old textile manufacturing factories are also located here that the Chinese bought from the Italians during and following the crisis of the fashion industry in Prato in the late 1980s. This area has since become the focal point of the Chinese community, with the market square on Via Pistoiese as the center. Starting from the square, where initial interviews were conducted, the author visited, at times repeatedly, business outlets in the Chinese enclave in 2008 and 2009. During each visit, the researcher addressed market entry and business set-up, and the use of financial, human, and social capital as well as current and future opportunities and challenges. The interview results follow and the author contrasts them with the approach used by Chinese SOEs and MNEs. The next section first gives an overview of Chinese enterprises in Italy followed by an introduction to the research site that has long been known as the industrial district for woolen fabrics and textiles (Sforzi, 2001), and more recently as Europe’s most concentrated Chinese community.

5. Chinese enterprises in Italy At the beginning of the new millennium, the total number of Chinese in Europe was estimated at approximately one million, including illegal Chinese migrants. Although this is only a small proportion of the more than 35 million overseas Chinese, it has grown during the past decade. Chinese people have migrated especially to Southern Europe, and Italy in particular, making it Europe’s gravity center for Chinese migrants. The difficulty of ascertaining the number of Chinese migrants in Europe, and especially Italy, is due to the large number who are illegal and undocumented. Known in Italy as the clandestini, they may augment the official number of Chinese by up to 50 percent. Despite variations in the estimates of Chinese in different Italian locations, Chinese migrants in Italy accounted for 5 percent of the Italian population by the end of 2007. In several Italian cities the



242

percentage of Chinese is even higher. For example, in Rome the Chinese account for 7.5 percent of the total population, about 1.5 times the national average (Cristaldi, 2002), Prato, in Tuscany, hosts the most concentrated Chinese community in Italy and second largest in Europe – after Paris – with a conservative estimate of 12 percent (Nadeau, 2007) (Table 11.4). Nascent scholarship on Chinese migrants in Italy suggests that they migrate (especially to Prato) with the long-term ambition of setting up their own businesses (Denison et al., 2009). Bond (1998, p. 81) refers to the goal of becoming an entrepreneur as a part of Chinese culture reflecting ‘. . . a widespread hunger . . .’ while Leung (2004, p. 93) claims Chinese entrepreneurial aptitude is driven by gongzhi buchutou, or the belief that ‘. . . working for others [is] a dead end street’. In Prato, this entrepreneurial spirit has resulted in more than 3,500 micro-enterprises and SMEs that have grown exponentially over the past decade, accounting for more than half of all Chinese firms in Tuscany and more than half of all SMEs in Prato (population 180,000). Compared with the number of Chinese companies in the Italian region of Veneto and the German city-state of Hamburg, with more than four million residents between them, Prato has many more Chinese business start-ups (see Table 11.5). The number of Chinese SMEs in Prato also dwarfs the investment of Chinese MNEs that Pietrobelli, Rebellotti, and Sanfilippo (2010, p. 9)

Table 11.4 The Chinese community in Italy between 1991 and 2007 Year

Number Of Chinese

Growth (in nos.)

Growth (in %)

1991 2000 2007

18,700 48,650 168,750

n/a 29,950 120,100

n/a 260 347

Sources: Blangiardo (2007), Ceccagno (2003, 2007), calculations by author.

Table 11.5 Comparison of Chinese firms in Prato, Veneto, and Hamburg (1991–2009) Year

Chinese firms in the city of Prato

Chinese firms in the region of Veneto

Chinese firms in the city-state of Hamburg

1991 2001 2007 2009

212 1,753 3,177 3,500

35 312 2,903 n/a

n/a 330 >360 +400

Sources: The figures for the region of Veneto were captured for a period of time and not a point in time. Table compiled by the author with data from Ceccagno (2003), Denison et al. (2009), HWF (2009), Kynge (2006), UIP, interview July 2009.



Anja Fladrich 243


quantify, with 61 projects intended to open in Italy as a new and sophisticated market, acquire strategic assets in the areas of design, product development, technology, and management. According to the authors, these investments are mainly concentrated in Lombardy and Piedmont in the North of Italy, as is Prato. Unlike the Chinese in Prato, who appear to come to Prato deliberately to set up their own businesses, Chinese SOEs and MNEs, according to Pietrobelli, Rebellotti, and Sanfilippo (2010) do not view Italy as their first location preference. Although the first Chinese investment project in Italy occurred as the Chinese began arriving in Prato (i.e., when Air China opened its first office in Rome in 1986), the growth patterns of Chinese SOEs and MNEs in Italy and SMEs in Prato differ. While Chinese policy liberalization and the zou chu qu-strategy accelerated SOEs and MNEs from 2000 onward, the growth of Chinese SMEs in Prato gained momentum approximately five years earlier. The exponential growth of Chinese firms in Prato is of particular interest given that the Chinese entrepreneurs are migrants who, unlike employees in Chinese SOEs and MNEs, operate in what can be described as a hostile environment. The Chinese migrants were often ridiculed by the Italians, and resistance and resentment from the host society toward Chinese migrants followed, partially fuelled by negative media coverage (Lee-Potter, 2007; Thomas, 2007). A different scenario applies to the Chinese Global Champions as these firms usually enjoy a positive reception in the host country, benefit from host and home government endorsement and assistance, including access to financial capital and human capital. On the contrary, the Chinese entrepreneurs in Prato often face multiple obstacles in the host country due to their migrant status, which are compounded by the fact that the Chinese rarely bring any significant human or financial capital when they arrive. They usually have a basic education only, are often unskilled, and arrive not only with empty hands but often with debts incurred from the passage to the host country (Ceccagno, 2003). While some of the Chinese MNEs and SOEs may also encounter difficulties with access to human capital, their overseas investment is partially and deliberately driven by their global ‘hunt for talent’. Roberts and Balfour (2009) find that Chinese Global Champions employ up to 60 percent staff locally. Hence many of their human resources come from the host country, allowing the Chinese Global Champions to tap into employees’ local knowledge and business intelligence, which provides the company with a competitive edge. This approach stands in stark contrast to Chinese SMEs in Prato, who almost exclusively recruit a co-ethnic workforce (Fladrich, 2009a). Transaction costs are lower as a result of similar values, work ethic, and ease of recruitment and the co-ethnic workforce is vital for the Chinese companies’ success, and especially for the growth of the Chinese economy in Prato, where employment within a Chinese firm provides a critical springboard or launching pad to future Chinese entrepreneurs.



244

As conceptualized by Portes (1981), Chinese firms in the enclave serve both the local and the ethnic clientele, while Chinese SOEs and MNEs serve the local market in the host country in their pursuit of global expansion. The ethnic enclave depends on geographic proximity, which in the case of Prato extends to half a dozen streets. While Chinese SOEs and MNEs overseas are not necessarily confined to the small scale found in Prato, they nevertheless gravitate to locations that host sectors of specialization: Turin for automotives, Varese for white goods, Emilia Romagna for machinery, and Campania and Liguria for logistics (Pietrobelli, Rebellotti, & Sanfilippo (2010). In a similar manner, Prato is the preferred location for Chinese SMEs, initially only in the textile manufacturing sector, but increasingly for the services and retail sectors directed mainly toward the local Chinese, but more recently to the local Italian clientele (Fladrich, 2009b).

6. Prato: A Chinese enclave within an industrial district Prato, in Tuscany, is one of Italy’s largest and oldest industrial centers, well known as one of Italy’s main producers of textiles and Europe’s most important fashion centers. Located between Florence and Pistoia, Prato has developed into a center for commerce and trade comprising more than 6000 mostly small- and medium-sized firms (Piscitello & Sgobbi, 2004). Prato has a long history as a textile town, with woolen fabrics first being manufactured and traded in the twelfth century. Prato continued its textile prominence with the introduction of mechanization in the nineteenth century (Becattini, 2000; Dei Ottati, 2003). After World War II, Prato’s textile industry flourished and its labor force increased from 22,000 to 60,000 textile workers. This new dynamic changed Prato into one of the fastest growing economic centers and industrial districts5 in Italy, relying on traditional design and craftsmanship performed by many small businesses engaged in all aspects of textile production (Dei Ottati, 2003; Khosravian & Bengston, 2006). In the mid-1980s, however, Prato’s textile industry experienced a severe crisis as the demand for carded wool dwindled and 37 percent of the Italian textile businesses closed down. The textile sector managed to reposition itself in the early 1990s and developed again into a pillar industry in Prato. Critical for the turnaround of Pato’s textile industry was the availability of migrant labor including the Chinese, who first arrived in the early 1980s, and continued to migrate there ever since. Indeed, the increase in Prato’s population appears entirely due to the influx of migrants from 3091 in 1995 to 24,153 in 2008, an increase in the foreign population of 8 percent. Prior to the mid-1990s, foreigners in Italy constituted a negligible minority since Italy was an emigration country (Cristaldi, 2002), where foreigners accounted for 0.6 percent only.



Anja Fladrich 245


In Prato, the Chinese today live and work outside the old city, on Via Pistoiese and adjacent streets, where a Chinese enclave has emerged, of which the market square outside Xiaolin Supermarket embodies the focal point. While the Chinese introduced their so-called Pronto Moda business model of ready-to-wear fast fashion into the Pratese textile sector, they have also begun to diversify into other industries, especially the service industries, including hospitality, communication, travel, and retail, which represent the majority of Chinese businesses in Prato (Ceccagno, 2007).

7. Insight from Chinese enterprises in Prato This section analyzes the business operations of Chinese entrepreneurs in Prato and compares them with those employed by Chinese SOEs and MNEs. Employing the five dimensions of business rationale, investment strategy, industry preference, and financial and human capital, Table 11.6 highlights the differences among SOEs, MNEs, and SMEs. Upon their arrival in Prato, the Chinese are not ‘ready-made’ entrepreneurs able to access resources and open new markets for existing

Table 11.6

Chinese SOEs, MNEs, and SMEs compared

Dimension I. Business/ investment rationale

Chinese SOEs/MNCs in Europe

Chinese SMEs in Prato, Italy

Implementing expansion zou chu qu strategy

Following ‘dream’ of setting up own business as avenue unable to pursue at home (in China).

•

•

II. Investment strategy

SOEs: political-driven to secure energy and general resources supply; MNEs: commercial-driven to open new markets, acquire and build brands.

Mergers & Acquisitions, R&D centers: •

Gradual and slow opening of markets with low level of visibility and media coverage where possible.

Start-up as Greenfield operations, at times buying out existing firms in the host country. •

•

Rapid expansion and growth of number of Chinese firms initially in cluster only, more recently diversified, also geographically with Chinese firms highly visible in Prato. At individual firm level, slow acquisition of market share per firm due to limited financial capital.



246

Anja Fladrich 247 III. Preferred industries firms operate in

Natural resources, manufacturing, services industries.

Initially textile and leather manufacturing;

IV. Financial capital

Financial incentives and access to funds for overseas operations partially provided by the government.

Restricted to migrant’s own savings:

Resorting to existing skills base and experience from domestic operations employing a combination of Chinese expatriates’ overseas and local staff.

Relying almost exclusively on Chinese staff in the host country;

• Firms are eager to expand skills base, especially acquiring technical and managerial know-how overseas (‘hunt for talent’).

• from past paid employment; • equity from family and friends; and • reinvestment of profit/earnings.

• occasional relocation of staff from China; • usually un- or semi-skilled only; commonly not possessing relevant skills.

products and/or services. According to the respondents in the survey, the Chinese in Prato usually start as employees in companies of fellow Chinese – not necessarily in Prato, though – and use their employment with other Chinese as a springboard to set up their own business. Although the Chinese government has helped these Chinese through regulations that allow easier access to obtain passports and travel permits, the rationale and impetus of the Chinese to invest in Europe goes back to the individual, in some cases for generations, and the tradition of chain migration. While the set-up of one’s own firm constitutes a dream for many (Bond, 1998), Chinese chain migration goes back to the fourteenth century and has mainly been driven by Chinese from ‘sending communities’ or qiaoxiang – poor regions in Zhejiang, Guangdong, and Fujian provinces. People from these regions turned to internal and external migration as a way to make a living and support their families through remittances. Hence Chinese migrant entrepreneurs in Prato are not expanding an existing business and relying on entrepreneurial know-how, but starting as novice entrepreneurs from scratch and from a limited resource base. They often have only their entrepreneurial drive and determination.



V. Human capital

• Stronger diversification away from manufacturing toward services sector.

248


Emigration is prompted by the prospect of, and hope for, business opportunities relayed back to China by migrant success stories, remittances, and donations to their hometowns. A push-pull situation exists where the socioeconomic situation in China necessitates emigration, while the positive experience of Chinese migrants overseas – often family and/or friends – lures the migrant to invest in a business career overseas. These Chinese are part of the Chinese diaspora and benefit from pioneer family members’ accommodation and/or work for the new arrivals. Lancee (2010, p. 203) contends that these arrangements using family networks allow migrants to ‘get by’, while pointing to the limitations of these networks to help migrants with job advancement. The growth and increased diversification of the Chinese community in Prato has somewhat limited these arrangements. All Chinese entrepreneurs interviewed in Prato were novices who set up a business for the first time. The first Chinese entrepreneurs in Prato in the early 1980s bought out existing Italian textile firms, most of which were family businesses of small and medium size caught up in the crisis of the textile industry at that time. While the majority of the Chinese micro-enterprises in Prato today appear to be set up as greenfield operations, the Chinese entrepreneurs in Prato reinvigorated the local textile industry through the introduction of the innovative Pronto Moda business model of ready-to-wear fast fashion. Starting as sub-contractors to local Italian textile companies manufacturing textiles to order, the Chinese became involved in textile design over the past several years, and are now involved in all stages of textile production (Ceccagno, 2007). Moreover, the Chinese introduced lighter fabrics instead of the often heavy woolen fabrics traditionally used and gained competitive advantage through their fast production. Employees often reside on the premises and work up to 16 hours per day, seven days a week.6 The recruitment of a co-ethnic workforce has a number of additional advantages. including a similar work ethic, communication, and values that have a positive impact on cost and productivity. Efficiency has been a contributing factor to the competitive advantage of Chinese SMEs in Prato. For employees and the development of the Chinese enclave in Prato, the co-ethnic workforce has also been important since it has served as a platform for on-the-job training that gives employees skills for future business ventures. However, the innovation of Pronto Moda was the single most important development and helped Prato evolve into one of the most concentrated



I migrated to Italy in 1998 on recommendation of a friend of mine. He had migrated to Milan earlier and told me that I could find a job, save money and run my own business. This convinced me. However, I did not think it would take me almost 10 years to set up my own business. It has taken long hours, but today I have three businesses in Prato, and my son has followed me to Prato, where he is also running a business. (Interview January 7, 2009, Prato)

Chinese communities in Europe, with more than 40,000 Chinese running more than 3,000 businesses today. This development was only possible due to the specific local context, that is Prato as a traditional industrial district where a large number of SMEs work on a homogenous product, namely woolen fabrics and textiles. The ItalianChinese agreement for economic cooperation from 1985 on that allowed the Chinese to set up their companies in Italy and employ a limited number of Chinese workers was instrumental for Prato’s development. Several amnesties granted to migrants since 1996 by the Italian government reflect their acknowledgment of the value of migrant labor. The majority of Chinese firms in Prato are run as micro-enterprises by one or two people, at times by couples (co-preneurs), father and son, or siblings. Larger firms usually have not more than ten employees, similar to the Chinese form of geti gongshang hu or, in short, getihu: a single industrial or commercial business unit employing up to eight people (Garnaut et al., 2001). Chinese enterprises in Prato are usually staffed by Chinese who have been recruited via existing personal networks (guanxi). Since 2007, and as a result of the further growth and diversification of the Chinese community in Prato, an enclave labor market has emerged that complements, at times substitutes for, personal networks through hand-written and electronically displayed job announcements and classified ads in local Chinese newspapers (Fladrich, 2009a). While most Chinese firms in Prato were mainly engaged in the manufacturing of textiles and leather until 2007, the growth of the Chinese enclave has made more services for the Chinese community necessary since they often continue to live separately from the local host society. The service sector has now exceeded in number the Chinese firms engaged in manufacturing. It comprises restaurants, travel agencies, hairdressers, and internet cafes as well as translation and migration services. Textile manufactures today have also started to engage in forward vertical integration and open retail clothes outlets in and outside the Chinese enclave (Fladrich, 2009b). In comparison, Chinese SOEs and MNEs act with the endorsement and support of the Chinese government. In many host countries, governments are eager to attract Chinese investments by providing tax incentives, assistance with business set-up, and networking opportunities. Chinese migrant entrepreneurs, however, operate under very different circumstances, without any government incentives or encouragement. Many entrepreneurs face resistance and resentment in the host society as well as bureaucracy. Unlike Chinese SOEs and MNEs overseas building on existing physical, financial, and human capital, Chinese micro-entrepreneurs in Prato often start with debts incurred from the expenses of their migration passage. They often cannot rely on any resources other than their social capital in the form of personal networks. These are of vital importance in providing Chinese entrepreneurs with access to human and financial capital. Personal networks



Anja Fladrich 249


(guanxi) have been important tools and the lifeblood of Chinese chain migration since its inception, linking migrants in the host society to one other and back home. As enforceable relationships among family, kin, and friends, personal networks are reciprocal obligations largely based on trust (Weidenbaum & Hughes, 1996; Seligman, 1999). Guanxi were vital for Chinese migration as this bond allowed new migrants to find shelter, food, and often work at their destination – all the necessities to start their lives at the new place (Lancee, 2010, p. 203). Using these networks, success stories, some of them exaggerated, traveled back and forth, acting as strong, unofficial communication tools driving the growth of the Chinese community in Prato. These networks are usually only accessible to people from family, kin, or the same hometown, but may at times include school or workplace and Chinese speaking the same dialect: I am new to Prato. I am not from Wenzhou as many Chinese here are, but from Fujian. There is a fairly strict separation between the Chinese from different provinces and we speak different dialects. We can only ask people from our hometown for help, but there are not many Fujianese in Prato now and this makes it difficult for me. (Interview January 4, 2008, Prato) Personal networks can also have a strong sub-ethnic dimension. In Prato, this applies to Chinese migrants from Wenzhou in Zhejiang, from where the majority originate. While arrangements for newly arriving Chinese migrants today are not necessarily comprehensive anymore, they can still result in employment and business opportunities. The latter often arise from a Chinese employee working in a company where they acquire necessary skills for a particular industry. Chinese personal networks are of vital importance in financing business ventures. Chinese entrepreneurs in Prato resort to internal as well as external funds, including their own savings from paid employment as well as money they borrow from family, kin, and friends. I would not consider borrowing money from a bank but I can borrow money from my friends almost any time. If they do not have the money themselves, they will borrow money from their friends to give it to me. If a friend wants to borrow money from me and I do not have money, I am expected – I have to – borrow money from other friends and give it to my friend. If I would not, I would lose face, possible future business and investment opportunities. I have no choice since it is my obligation and that of other Chinese. (Interview July 17, 2009, Prato) This financing mechanism represents the only option for Chinese entrepreneurs since neither the Chinese nor the Italian government will



250

grant Chinese migrants loans. All respondents claimed that even if they could, they would not approach a bank to borrow money, in contrast to most Chinese SOEs and MNEs. However, to Chinese migrants this comes as no surprise since funds sourced via personal networks usually require neither documentation nor interest and are obtained faster. But in borrowing money using guanxi, one enters a lifelong obligation to the lender, not only to pay the money back, but also to render money and/or other favors in return in the future. For Chinese migrants in Prato, social capital embodied in their personal networks is often invaluable and the gateway to the acquisition of human and financial capital. Without social capital, the ‘dream’ of owning a business would remain just a dream. In Prato, the Chinese enclave is conducive toward the emergence and growth of entrepreneurship. However, beyond this, the individual ability to master guanxi finally decides on entrepreneurial success or failure.

8. Conclusion The discourse on Chinese OFDI has an under-researched facet – the thousands of SMEs set up by Chinese migrants. This chapter profiles the Chinese enclave in Prato, Northern Italy, where Chinese SMEs outnumber SOEs and MNEs. The author investigates the differences in motivation and strategies employed by Chinese migrants. Unlike Chinese SOEs and MNEs, the Chinese SMEs in Prato reflect grassroots entrepreneurship. Chinese originating from poor regions in China lacking business opportunities and capital are driven by a combination of economic necessity at home and opportunity abroad. Emigration to Prato has become a strategy for an increasing number of migrants, who are less eager to acquire strategic assets and resources or exploit efficiency and open markets, but motivated by a dream of opening up their own business, most often as greenfield operations. With no support from the home country government, the growth of Chinese SMEs in Prato is facilitated by amnesties of the Italian government, Chinese embracing the industrial district, and the entrepreneurial spirit of Prato’s strong and growing Chinese enclave. The latter provides labor, and financial and human capital accessible to the Chinese employing their social capital. While Chinese SOEs and MNEs are increasingly perceived as economic and political threats by Western businesses and governments due to their acquisition of strategic assets worldwide, Chinese SMEs in Prato, according to some researchers, constitute ‘hidden carriers’ of China’s global push that pose a challenge to the social fabric of the host society. With more than 3,000 Chinese firms accounting for 10 percent more than the local Italian companies in Prato, the large number of Chinese SMEs and their success have caused social envy and resentment amongst the local Italians (Donadio, 2010). Italian politicians addressing prevailing socio-economic tensions have increased their scrutiny of Chinese SMEs.



Anja Fladrich 251


China’s global push will continue to be met with attention and apprehension as it becomes more visible. This challenges economists, politicians, and sociologists in the home and host countries alike to embrace the complexity and dynamics of Chinese OFDI, which mirrors China’s size and diversity. This complexity defies the one-model-fits all-approach and has ramifications beyond the economic and political sphere. We need to widen the discourse on Chinese OFDI to include the socio-cultural perspective. The case of Prato points to an additional, significant driver of Chinese OFDI: the ambition of individual Chinese migrants to set up their own business overseas. The risk propensity, innovative capability, and determination that Chinese migrants in Prato demonstrate could be a powerful force if mobilized, and if migrants had, for example, easier access to capital and the support of the home and host governments. To date, however, the Chinese government has mostly ignored the business ventures set up by Chinese migrants in Europe. This is surprising since certain areas of China’s countryside have greatly benefitted from migrants’ remittances. The extension of China’s zou chu qu policy and government assistance to include Chinese SMEs could bring desirable results. In the same way that Chinese private enterprises have been the engine of the Chinese economy, Chinese SMEs overseas could help China’s ambition to accelerate the growth of its OFDI. The perception of the ‘China threat’ could ease as small-scale business operations are usually less prominent, unless they outnumber indigenous enterprises, as it is the case in Prato. Finally, more host countries should embrace investments by Chinese SMEs and attract and channel investments into designated areas and industries through monetary and non-monetary incentives and cooperation arrangements – to the benefit of Chinese migrants and the host countries.

Notes 1. Wong (2008) referred to the Chinese who have mainly migrated to Southeast Asia since the late 1970s as xin yimin (new migrants). This term is argued to also apply to the Chinese who have migrated to Europe almost two decades later. 2. For an elaborate overview of the distribution of Chinese OFDI flow and stock by industry, see Gugler and Boie (2008, p. 3). 3. Schortgen (2009) provides a valuable analysis of reasons behind the perception of China and its global ambitions as a threat. 4. This scoping study was undertaken to assess the feasibility of more detailed research needed for a doctorate. Interviews undertaken included conversational and in-depth interviews, the latter of which were conducted as repeat interviews. 5. The industrial districts in Italy and Prato in particular have been discussed in varying contexts including Andall (2007), Dei Ottati (1994), Fioretti (2001), Piscitello and Sgobbi (2004), Sabel (2006), Sforzi (2001), and Trigilia (1995). 6. See Ceccagno (2003, 2007, 2009) for further details on the Pronto Moda business model.



252

Anja Fladrich 253

Alon, I. & McIntyre, J. R. (eds.) 2008. The Globalization of Chinese Enterprises. London: Palgrave Macmillan. Andall, J. 2007. Industrial Districts and Migrant Labour in Italy, British Journal of Industrial Relations, 45(2): 285–308. Becattini, G. 1990. The Marshallien Industrial District as a Socio-economic Notion. In F. Pyke, G. Beccattini & W. Sengenberger (eds.), Industrial Districts and Inter-firm Cooperation in Italy. Geneva: International Institute of Labour Studies. Becattini, G. 2000. Il distretto industriale. Un novo modo di interpretare il cambiamento economico. Torino: Rosenberg and Sellier. Blangiardo, G. (2007) ‘Rapportot sulla popolazione,’ Retrieved 14 April 2007 from http://www.ecplanet.com/canacle/varie-5/societa-57/1/0/30555/it/ecplanet.rxdf. Bond, M. H. 1998. Beyond the Chinese Face. Insights from Psychology. New York: Oxford University Press. Buckley, P. J. et al. 2007. The Determinants of Chinese Outward Foreign Direct Investment. Journal of International Business Studies, 38: 499–518. Cai, K. C. 1999. Outward Foreign Direct Investment: A Novel Dimension of China’s Integration into the Regional and Global Economy. The China Quarterly, 160: 856–880. Ceccagno, A. 2003. New Chinese Migrants in Italy. International Migration, 41(3): 187–210. Ceccagno, A. 2007. Compressing Personal Time: Ethnicity and Gender within a Chinese Niche in Italy. Journal of Ethnic and Migration Studies, 33(4): 635–654. Ceccagno, A. 2009. Chinese Migrants as Apparel Manufacturers in an Era of Perishable Global Fashion: New Fashion Scenarios in Prato, Italy. In G. Johanson, R. Smyth & R. French (eds.), Living Outside the Walls: The Chinese in Prato. Newcastle: Cambridge Scholars Publishing, pp. 42–74. Child, J. and Rodrigues, S. B. (2005) ‘The internationalization of Chinese firms: a case for theoretical extension?’, Management and Organization Review 1(3): 381–410. Cristaldi, F. 2002. Multiethnic Rome: Toward Residential Segregation. GeoJournal, 58(2–3): 81–90. Cross, A. R. & Voss, H. 2008. Chinese direct investment in the United Kingdom: An assessment of motivations and competitiveness. Paper Presented at ‘Corporate Strategies in the New Asia’, University of Bremen, 1–2 February 2008. Deng, P. 2007. Investing for Strategic Resources and Its Rationale: The Case of Outward FDI from Chinese Companies. Business Horizons, 50: 71–81. Dei Ottati, G. 1994. Trust, Interlinking Transactions and Credit in the Industrial District. Cambridge Journal of Economics, 18: 529–546. Dei Ottati, G. 2003. Exist, Voice and the Evolution of Industrial Districts: The Case of the Post-World War II Economic Development of Prato. Cambridge Journal of Economics, 27: 501–522. Denison, T. et al. 2009. Community Connections: The Chinese Community in Prato, Italy, and Their Use of Technology. In G. Johanson, R. Smyth, & R. French (eds.), Living Outside the Walls: The Chinese in Prato, Newcastle: Cambridge Scholars Publishing, pp. 161–173. Deutsche Bank Research. 2006. Global Champions in Waiting. Perspectives on China’s Overseas Direct Investment. Current Issues. China Special, 4 August 2006. Donadio, R. 2010. Chinese Remake the “Made in Italy” Fashion Label. The New York Times, 12 September 2010.



References


Dunning, J. H. 1992. The Competitive Advantage of Countries and the Activities of Transnational Corporations. Transnational Corporations, 1 (1), 135–168. Dunning, J. H. 2000. The Eclectic Paradigm as an Envelope for Economic and Business Theories of MNE Activity. International Business Review, 9: 163–190. Fioretti, G. 2001. Information Structure and Behaviour of a Textile Industrial. Journal of Artificial Societies and Social Simulation, 4(4), retrieved 9 December 2009 from: http://jasss.soc.surrey.ac.uk/4/4/1.html. Fladrich, A. M. 2009a. The Chinese Labour Market and Job Mobility in Prato. In G. Johanson, R. Smyth, & R. French (eds.), Living Outside the Walls: The Chinese in Prato, Newcastle: Cambridge Scholars Publishing, pp. 96–129. Fladrich, A. M. 2009b. Moving Inside the City Walls. Chinese Entrepreneurs’ Location and Orientation in Prato, Italy. Poster presented at The Roundtable on Entrepreneurship Education REE Asia 2009, Stanford Technology Ventures’ Program, Chinese University of Hong Kong, 21–23 October 2009, Hong Kong. Fuchs, H. J. 2007. Die China AG. Zielmärkte und Strategien chinesischer Markenunternhmen in Deutschland und Europa [China Inc. Target markets and strategies of Chinese MNCs in Germany and Europe]. Munich: FinanzBuch Verlag. Garnaut, R., Ligang, S., Yand, Y., & Xiaohyu, W. 2001. Private Enterprise in China. Canberra: Asia Pacific Press, The Australian National University. Ge, G. L. & Ding, D. Z. 2009. The Effects of the Institutional Environment on the Internationalization of Chinese Firms. In Ilan Alon et al (eds.), China Rules. Globalization and Political Transformation. London: Palgrave Macmillan, pp. 46–68. Gu Zhihin, G. 2006. China’s Global Reach. Markets, Multinationals and Globalization. Revised and Updated Edition. Palo Alto CA: Fultus Books. Gugler, P. & Boie, B. 2008. Emergence of Chinese FDI: Determinants and Strategies of Chinese MNEs. Paper presented at the Conference Emerging Multinationals: Outward Foreign Direct Investment from Emerging and Developing Economies, Copenhagen Business School, Copenhagen, Denmark, 9–10 October 2008. Harney, A. 2008. The China Price: The True Cost of Chinese Competitive Advantage. New York: The Penguin Press. Harrison, B. 1992. Industrial Districts: Old Wine in New Bottles. Regional Studies, 26(5): 469–483. Hong, E. & Sun, L. 2006. Dynamics of Internationalization and Outward Investment: Chinese Corporations’ Strategies. The China Quarterly, 187: 610–634. Johnson. J. P. 2008. Paths to Globalization: The Korean Chaebol and Chinese Stateowned Enterprises. In I. Alon and J. R. McIntyre (eds.), Globalization of Chinese Enterprises. Houndmills and New York: Palgrave Macmillan, pp. 133–145. Khosravian, C. & Bengston, M. 2006. The Industrial District of Prato. An Analysis of the Textile Industry, 1991–2001. Bachelors Thesis within Economics, Internationella Handelshögskolan, June 2006. Krugman, P. 1991. Geography and Trade, Cambridge, MA: MIT Press. Kurihara, J. 2008. The Globalization of Northeast China’s MNCs: A Study of the Electronic Industry. In I. Alon and J. R. McIntyre (eds.), Globalization of Chinese Enterprises, Houndmills: Palgrave Macmillan, pp. 159–177. Lancee, B. 2010. The Economic Returns of Immigrants’ Bonding and Bridging Social Capital, PhD Thesis, European University Institute (EUI), Department of Political and Social Sciences, San Domenico di Fiesole (FI) – Italy. Lardy, N. R. 2002. Integrating China into the Global Economy. Washington, DC: Brookings Institution Press.



254

Lee-Potter (2007), ‘Designer labels’ sweatshop scandal,’ Sunday Mirror, 2 December 2007. Leung, M. W. H. 2004. Chinese Migration in Germany. Making Home in Transitional Space. Frankfurt and London: IKO-Verlag für Interkulturelle Kommunikation. Liu, X., Buck, T., & Shu, C. 2005. Chinese Economic Development, the Next Stage: Outward. International Business Review, 14: 97–115. Luo, Y., Xue, Q., & Han, B. 2010. How Emerging Market Governments Promote Outward FDI: Experience from China. Journal of World Business, 45: 68–79. Markusen, A. 1996. Sticky Places in Slippery Space, Economic Geography. Economic Geography, 72: 293–313. Marshall, A. 1920. Principles of Economics. London: Palgrave Macmillan. Martin, R. & Sunley, P. 2001. Deconstructing Clusters: Chaotic Concept or Policy Panacea. Revised version of Paper Presented at the Regional Studies Association Conference on Regionalising the Knowledge Economy, London, 21 November 2001. Nadeau, B. 2007. Made by Foreign Hands. Newsweek, 2–9 July 2007. Nicolas, F. 2009. Chinese Direct Investment in Europe: Fact and Fallacies. Briefing Paper: IE BP2009/1, Chatham House. June 2009. OECD. 2001. Innovative Clusters – Drivers of National Innovation Systems. Paris. OECD. 2008. OECD Investment Policy Reviews: China 2008. Paris, pp. 57–63. Pietrobelli, C., Rebellotti, R. & Sanfilippo, M. 2010. The “Marco Polo” Effect: Chinese FDI in Italy. IE Programme Paper: IE PP 2010/04, Chatham House, http://www. chathamhouse.org.uk/files/16054_pp0210italy.pdf, accessed 28 January 2011. Piscitello, L. & Sgobbi, F. 2004. Globalisation, E-Business and SMEs: Evidence from the Italian District of Prato. Small Business Economics, 22: 33–47. Porter, M. E. 1998a. Location, Clusters and the ‘New’ Microeconomics of Competition. Business Economics, 33(1): 7–17. Porter, M. E. 1998b. Clusters and the New Economics of Competitiveness. Harvard Business Review, December: 77–90. Porter, M. E. 2000. Location, Competition, and Economic Development: Local Clusters in a Global Economy. Economic Development Quarterly, 14(1): 15–35. Portes, A. 1981. Modes of Structural Incorporation and Present Theories of Labour Immigration. In M. Kritz, C. B. Keeley & S. Tomasi (eds.), Global Trends in Migration, New York: Center for Migration Studies, pp. 279–297. Pyke, F. & Sengenberg, W. 1990. Industrial Districts and Local Economic Regeneration. Geneva: International Institute for Labour Studies. Roberts, D. & Balfour, F. 2009. China’s Shopping Spree. Businessweek, 27 July 2009, pp. 40–43. Sabel, C. 2006. What to Make of the Changes in Industrial Districts? Three Questions. In A. Lundeström and S. Halvarsson (eds.), Entrepreneurship Research: Past Perspectives and Future Prospects. Boston and Delft: NOW Publishers. Sauvant, K. P., & Devies, K. 2010. What will an appreciation of China’s currency do to inward and outward FDI? Columbia FDI Perspectives. Perspectives on topical foreign direct investment issues, Vale Columbia Center on Sustainable International Investment, No. 30, 18 October 2010. Schortgen, F. 2009. A Contextual View of Chinese Enterprise Internationalization. In Ilan Alon et al (eds.), China Rules. Globalization and Political Transformation. London: Palgrave Macmillan, pp. 15–45. Seligman, S. D. 1999. Guanxi: Grease the Wheels of China. China Business Review, 26(5): 34–38.



Anja Fladrich 255


Sforzi, F. 2002. The Industrial District and the ‘New’ Italian Economic Geography. European Planning Studies, 10(4): 439–447. Simmons, M. S. 2008. Huawei Technologies: The Internationalization of a Chinese Company. In I. Alon & J. R. McIntyre (eds.), The Globalization of Chinese Enterprises. London: Palgrave Macmillan, pp. 194–207. Tang, F.-C., Gao, X.-D. & Li, Q. 2008. Knowledge Acquisition and Learning Strategies in Globalization of China’s Enterprises. In I. Alon & J. R. McIntyre (eds.), The Globalization of Chinese Enterprises. London: Palgrave Macmillan, pp. 31–43. Thomas, D. (2007), ‘Made in China on the Sly,’ New York Times, 23 November 2007. Trigilia, C. 1995. A Tale of Two Districts: Work and Politics in the Third Italy. In A. Bagnasco & C. Sabel (eds.), Small and Medium-Size Enterprises. London: Pinter. UnctadStat. 2010. Inward and outward foreign direct investment flows, annual, 1970– 2009, China, http://unctadstat.unctad.org/TableViewer/tableView.aspx, accessed 28 January 2011. Voss, H., Buckley, P. J. & Cross, A. R. 2008. Thirty years of Chinese-outward foreign investment, http://www.ceauk.org.uk/2008-conference-papers/Voss-Buckley-Cross30-years-outward- FDI.doc, accessed 28 January 2011. Voss, H., Buckley, P. J. & Cross, A. R. 2009. An Assessment of the Effects of Institutional Change on Chinese Outward Direct Investment Activity. In Alon et al (eds. ), China Rules. Globalization and Political Transformation. London: Palgrave Macmillan, pp. 135–165. Weidenbaum, M. & Hughes, S. 1996. The Bamboo Network. How Expatriate Chinese Entrepreneurs are Creating a New Economic Superpower in Asia. New York: Martin Kessler Books. Wong, Sin-Kwok R. 2008. Chinese Entrepreneurship in a Global Era. Chinese Worlds Series. London and New York: Routledge. Wong, J. & Chan, S. 2003.China’s Outward Direct Investment: Expanding Worldwide. China: An International Journal, 1(2): 273–301. Wu, B. & Zanin, V. 2007. Globalization, International Migration and Wenzhou’s Development. Draft paper for the International Conference on China’s Urban Transition and City Planning, 29–30 June 2007, Cardiff. Wu, H. & Chen, C. 2001. An Assessment of Outward Foreign Direct Investment from China’s Transitional Economy. Europe-Asia Studies, 53(8): 1235–1254. Yang, X. & Stoltenberg, C. 2008. Growth of Made-in-China Multinationals: An Institutional and Historical Perspective. In I. Alon & J. R. McIntyre (eds.), The Globalization of Chinese Enterprises. London: Palgrave Macmillan, pp. 61–76.



256

12 Xiaohua Lin and Qianyu Chen

In July 2009, Teck Resources Limited, Canada’s largest mining company, approved the purchase by China Investment Corporation (CIC) of 101.3 million Class B subordinate voting shares of Teck through a wholly owned subsidiary. The CIC would indirectly hold approximately 17.5 percent of Teck’s outstanding Class B subordinate voting shares, representing 17.2 percent equity and 6.7 percent voting interests in Teck (Bouw, 2010). By the end of 2009, CIC’s stake in Teck was worth US$3.5 billion, making Teck its largest single equity holding (Perkins, 2010). At about the same time, in December 2009, Canada and China signed a deal for PetroChina to invest US$1.7 billion in two Canadian tar-sand deposits in Alberta (Polzcer, 2009). If successfully implemented, these two deals will become the largest acquisitions so far by China’s State-Controlled Funds and Entities (SCFEs) in North America. The impact of these deals could change the rules. SCFEs from China have not been successful in North America. In mid-2005, the China National Offshore Oil Company (CNOOC), another oil giant with state affiliation, withdrew its bid for Unocal after failing to navigate the US political environment. Indeed, the rise of Chinese SCFEs has added to the already heated debate over growing outward foreign direct investments (OFDI) from emerging market economies because the investing firms tend to be closely associated with the government (Sauvant, 2009). Sovereign welfare funds (SWFs) are particularly scrutinized for their outright government ownership (OECD, 2007). The failed attempt of China Minmetals to acquire Noranda in 2004, along with the withdrawal of the China National Offshore Oil Company bid and other abortive attempts, has generated public debate over government policy concerning SCFEs in the United States and Canada. The ongoing economic recession pushes the debate to an even more heated level as the world now understands that countries such as China are probably the richest sources of capital investment. Indeed, the Chinese government 257



Chinese State-Controlled Funds and Entities in Canada


has speeded up its OFDI through SCFEs, most noticeably with the newly established CIC. However, despite its importance and timely nature, academic researchers have not paid enough attention to this phenomenon. It is not clear, for example, why Canada banned Chinese SCFEs but let deals such as those involving CIC and PetroChina go through. The lack of scholarly interest and appropriate theoretical frameworks to guide scholarly research has prevented international business (IB) researchers from engaging in such public discourse. The current study takes a step to fill the literature void. We first review the literature on SCFEs, Canada’s foreign direct investment (FDI) policy, and Chinese investment in Canada. From a game perspective, yet without taking a mathematical approach, we then consider the national governments and local enterprises of developed nations and emerging market-based SCFEs as three major players in a game concerning a potential investment. We begin by describing the interests and move options of each player in the bargaining arena where investments take place, and then translate those interests into strategic combinations. We assess the combinations and make predictions using various assumptions. Finally, we apply the model to the PetroChina case and illustrate its utility. We discuss implications of the current study and conclude the chapter with an agenda for moving this line of research further.

1. Literature review 1.1. State-controlled funds and entities The accelerated globalization of Chinese firms signifies China’s deepening involvement with the outside world as well as its economic transformation from within (Buckley et al., 2007). Until recently, most scholars looked at China as a destination of FDI but not the origin. Today, both scholars and practitioners are considering prospects for the country to become a major source of FDI (Meyer & Boisot, 2008). Some scholars even consider China’s OFDI a new feature of globalization (Alon et al., 2009) and suggest that the global playing field is being reshaped by internationalizing Chinese firms (Williamson & Yin, 2009). Table 12.1 shows the progress of China’s OFDI between 2002 and 2009. The recent surge in China’s OFDI has much to do with the fact that it is primarily carried out by state-controlled entities, including conventional state-owned enterprises (SOEs) and newly formed Sovereign Wealth Funds (SWFs) (Khana, 2009). About 80-to-90 percent of China’s FDI activities have been carried out by SOEs. While global FDI has fallen, China’s has doubled since the recent worldwide economic downturn, indicating that the position of SOEs from China may be strengthening (Davies, 2009). SOEs are subject to substantial government influence and control, and were the main



258

Xiaohua Lin and Qianyu Chen China’s outward FDI flows and stocks (2002–2009, US$

Year

Flow

Stocks

2002 2003 2004 2005 2006 2007 2008 2009

2.7 2.85 5.5 12.26 21.16 26.51 55.91 56.63

29.9 33.2 44.8 57.2 90.63 117.91 183.97 245.75

Source: 2009 Statistical Bulletin of China’s Outward Foreign Direct Investment, Ministry of Commerce of the People’s Republic of China.

vehicle the government used to carry out both economic and political agendas in China, where they remained dominant until the early 1980s. When making FDIs, SOEs are likely driven by imperatives beyond just economics (Child & Rodrigues, 2005). Among many institutional influences, the government’s global expansion strategy has a direct impact on Chinese SOEs’ internationalization drive (Luo, Xue, & Han, 2010). Besides SOEs, government can also impact a country’s FDI through sovereign wealth funds (SWFs), defined as ‘government-owned investment vehicles that are funded by foreign exchange assets’ (OECD, 2007). SWFs can be divided into two subcategories: sovereign private equity funds and government investment companies, the aggressive investment vehicles that assume management stakes, rely on leverage, and target high returns. Generally speaking, SWFS function as tools for foreign investment and are owned by the state government, with the typical owners being emerging economies and oil-producing countries. So far, 22 countries and regions have set up SWFs. The most recent example, CIC, was established by the Chinese government on September 2007, with its first investment of US$3 billion used to buy shares in the Blackstone Group in the United States (Martin, 2008). SOEs and SWFs are not identical, but they are similar as far as state ownership and control are concerned. The questions raised about both are also similar in terms of FDI (Bordonaro, 2010). SCFEs have distinctive features: strong government background, rapid expansion, high risk, and low transparency. These features concern developed countries in areas such as national security and conflicting commercial and non-commercial interests (Miao, 2008). While most developed nations offer a favorable environment for FDI, SCFEs cause concern because they are government-owned and controlled. For instance, the launch of CIC, which has US$200 billion in China’s foreign exchange reserves at its disposal, has fueled speculation about the



Table 12.1 billion)

259


link between Chinese OFDI and the country’s wider geopolitical goals (Kwan & Sauvant, 2008). The incident involving CNOOC, on the other hand, shows that developed nations tend to attach strategic importance to their resource industries and become suspicious when SCFEs try to enter this industry. SOEs are believed to maintain lower standards in areas such as labor relations, environmental issues, and community practice than developed nations due to the nature of governments in developing nations (Conference Board of Canada, 2004). However, faced with SCFEs’ exploding appetite for lucrative market opportunities in the developed world, the latter may have to reconsider its FDI terrain, which has thus far been largely closed to countries such as China. Could the PetroChina and CIC cases presented at the beginning of the paper signal such a change, at least in Canada? 1.2. Canada’s FDI regime Canada, like many other countries, depends on investment and capital formation to stimulate economic growth, innovation, and sustainable development. FDIs bring higher productivity and efficiency, enlarge the pool of capital for investment, create jobs, and increase government revenues (Hodgson & Paris, 2006). However, Canada has not been an attractive place for FDI due to its small market size, relatively high resource cost, low operational efficiencies, and, especially, its regulatory barriers. Until recently, Canada was considered one of the world’s most restrictive regulatory regimes for foreign investment (Government of Canada, 2008). While Canada clearly needs more foreign investment and FDI in Canada has grown in absolute terms since the 1980s, its share of world FDI has fallen during the same period (Conference Board of Canada, 2004). Canada adopted its formal FDI policy, the Investment Canada Act (ICA), in 1985. Non-Canadians who acquire control of an existing Canadian business or who wish to establish a new unrelated Canadian business are subject to this Act, and they must submit either a notification or an application for review. But during the Act’s 20-year existence, all foreign acquisitions were cleared except for one. Since the Act reviews only major FDIs, most large foreign investors, including China Minmetals (which entered an exclusive negotiation to purchase mining giant Noranda in 2004), could easily meet the economic criteria applied to the so-called net benefit test. The public concerns that essentially forced China Minmetals out of the deal were not so much economic as political, reflecting concern about selling a national icon to a ‘foreign government-controlled’ company. Although the Noranda case was probably the most visible, it was not the only one that involved SOEs from foreign countries (Bhattacharjee, 2009). In response to public concern about increasingly active FDI by foreign SOEs – especially those from the Middle East, China, India, and Russia – the Canadian federal government ultimately issued guidelines under the



260

261

Act In December 2007, these guidelines were announced for the review of acquisitions of control by investors that are owned or controlled, either directly or indirectly, by a foreign government (Franklyn & Glossop, 2009). On March 12, 2009, the Canadian federal government amended the ICA to include a broadly worded ‘national security test’. Clearly, this new test, alongside the existing net benefit test, is a further response to public concerns about FDIs that involve SCFEs, as the idea emerged immediately after the Noranda incident (Bhattacharjee, 2009). Although a final definition of national security remains to be clarified, the creation of the test may further liberalize the country’s foreign investment policy, with a more transparent and less uncertain framework. The Investment Canada Act and changes to it are summarized in Table 12.2. 1.3. Chinese investment in Canada So far, Chinese investments in North America represent a small percentage of total FDI. However, China has become a significant FDI source for Canada since the Chinese government shifted its policy to support outward investments in 2002. Chinese direct investment in Canada increased from US$54 million in 1991 to US$220 million in 2004, and then to US$1.3 billion in 2006. China ranked 16th in 2006 out of all countries with

Table 12.2 Change of investment Canada Act Year

Policy

Focus

1985

Investment Canada Act

Using economic criteria when considering whether a foreign investor will be allowed to acquire control of a Canadian company.

2007

Guidelines – Investment by state-owned enterprises – Net benefit assessment

The Net Benefit Test, while retaining the economic focus, is aimed at SOEs. The six economic criteria concern adherence to Canadian laws and governance standards, influence of foreign government, continuation of commercial orientation, Canadian influence in corporate governance, Canadian influence in management, and status of the new business/acquiring company.

2009

ICA Amendments – National Security Review of Investment Regulation

Added a stand-alone national security review test to review sovereign investments and any other foreign investments with potential threats to national security.

Source: Investment Canada Act, Industry Canada, http://www.ic.gc.ca/eic/site/ica-lic.nsf/eng/ home.



Xiaohua Lin and Qianyu Chen


Table 12.3 million)

Canada: geographical distribution of inward FDI stock (2000–2008, US$

Economy World Developed economies European Union United States Emerging economies India Russian Federation Brazil China

2000

2008

214,893 210,599 64,579 130,405 4,139 12 6 418 129

473,606 435,973 124,376 275,430 22,683 959 348 11,182 2,582

Growth (%) 120.4 120 98 111 448 7,809 5,642 2,574 1,897

Source: Statistics Canada: CANSIM, Table No. 376–0051.

FDIs in Canada, while its ranking was 27th in 2004. According to Statistics Canada, cumulative Chinese FDI in Canada reached US$2582 billion in 2008, representing a 1897 percent increase over the number in 2000 (Table 12.3). The federal government and some provinces, including Quebec, Saskatchewan, and Ontario, have welcomed Chinese investment, while the creation of a ‘strategic partnership’ between Canada and China indicates deep cooperation in the future. According to a recent survey (APF and CCPIT, 2009), Canada ranked sixth out of the ten top destinations for Chinese outward direct investment, following Hong Kong, Macau, the United States, Vietnam, and Australia. As the second largest economy in the world, China, with 1.3 billion people, is Canada’s second biggest individual trading partner. A rapidly growing China has the potential to become a significant source of FDI in Canada. Like the United States, Canada has imposed certain limitations on FDI from China, mostly due to national security and national interest concerns. When the bidding companies have ties with the Chinese state and when the FDI involves strategic assets or sensitive industries, these limitations are closely observed. There is the suspicion that FDI, especially acquisitions by Chinese state-owned companies, is driven not by commercial motives only, but also by political or strategic goals. More recently, Canada has expressed concern over the governance (e.g., non-transparency) and political agenda of SWFs from China. The China Minmetals–Canada Noranda case was typical. In 2004, China Minmetals Corporation attempted to buy Canada’s largest mining company. With revenues of US$4.65 billion, Noranda is the ninth largest copper producer in the world and produces 96 percent of Canada’s lead, 54 percent of its zinc, and 14 percent of its nickel. Even though the Cold War is long



262


263

over, fears remain that the Chinese government might attempt to use politics and business to overpower the economic benefits that Canada would gain. Largely under political pressure, China Minmetals quickly withdrew from its exclusive negotiation with Noranda.

Game theory was originally developed by John von Neumann and Oscar Morgenstern in their book, The Theory of Games and Economic Behavior (1944). In a typical game or competition with fixed rules, ‘players’ try to outsmart one another by anticipating the others’ decisions or moves. A solution to a game prescribes the optimal strategy or strategies for each player and predicts the average, or expected, outcome. Until a highly contrived counterexample was devised in 1967, it was believed that every contest had at least one solution (Encyclopedia Britannica, 2010). According to Vega-Redondo (2003), there are two forms in any given game: the extensive and the strategic. The former is the most general since it explicitly describes the players’ order of moves and the information available to them at each point in the game. It embodies a formal specification of the tree of events, where each of the intermediate nodes has a particular player associated with it who decides how the play (i.e., the ‘branching process’) unfolds. Eventually, a final node is reached that has a corresponding vector of payoffs that reflect how the different players evaluate such a path of play. In contrast, the strategic form of a game is based on the fundamental notion of strategy. A player’s strategy is a contingent plan of action that anticipates every possible decision point of the player in the course of game. Given a profile of players’ strategies, the path of play is uniquely defined as well as the corresponding outcome and pay-offs. In essence, the strategic form of a game is a compact description of the situation through corresponding mapping from strategy profiles to pay-offs. This can be further extended into the four categories applied in game theory: the static game of perfect information, the dynamic game of perfect information, the static game of incomplete information, and the dynamic game of incomplete information. The classification depends on the time series and the comprehensiveness of the information. Traditional applications of game theory attempt to find equilibriums in these games. In equilibrium, each player adopts a strategy they are unlikely to change. There have been many equilibrium concepts, each with a different motivation, depending on the field of application, although they often overlap or coincide. This methodology is not without criticism, and debates continue over the appropriateness of particular equilibrium concepts. Scholars have applied game theory to a wide range of FDI-related issues, such as multinational enterprise strategic choice between FDI and export facing varied tax regimes (Davies, Egger, & Egger, 2010); incentive competition between two countries vying for FDI (Luski & Rosenboim, 2009); and the



1.4. Game theory and applications


probability of FDI formation as a result of interaction between transnational investors and host countries (Lee & Wang, 2006). Applying game theory to FDI, one study (Mueller & Lovelock, 2000) identifies four players – the Chinese state, China’s responsible Ministry/China Telecom, China Telecom’s domestic rivals, and foreign strategic investors – who negotiate for access to foreign capital and technology in China’s telecommunication services. Based on the complete information assumptions, the authors predict that China would not have opened up to FDI in telecom services without the need to bargain for WTO accession. An analysis of their preference assumptions then suggests the chosen strategy combination, that is, the equilibrium: the state retains a ban on foreign direct investments, China Telecom (the dominant domestic firm) continues as a developmental arm of the state, smaller domestic competitors continue to survive, and foreign investors continue participating in the market via non-equity instruments. However, a review of the inter-disciplinary literature suggests that most research has treated FDI formation as a decision by international investors, with the interests, concerns, and behaviors of host countries merely one factor in the former’s consideration set (Lee & Wang, 2006).

2. Research questions and game modeling The current study addresses several related questions: Why have Chinese SCFEs had little luck in Canada until recently? Do cases such as CIC and PetroChina signal changes in Canada’s FDI scene? What has to happen for deals to be successful? Clearly, we are looking at a strategic situation where one party’s success in making choices depends on the choices of others. This is a classic case where game theory is most applicable (Lee & Wang, 2006). In this exploratory study, we consider a simple model to account for three key players and their strategic combinations. We take only the general approach from a game perspective without resorting to game theory in the technical sense. We assume that, in this game arena, all the players know one another’s characteristics and will adjust their strategies according to the other’s actions by the time sequence, such as the scale of investment or the investment policy. We can thus define the negotiation among developed countries, local enterprises, and the SCFEs as the dynamic game of perfect information. Generally speaking, this means that when the attacker makes a move, the incumbent responds. As most SCFEs consist of state funds representing the national interests of developing countries and are less transparent, they easily arouse protectionism in developed nations. Considering the national security implications and political influence of these investment funds, developed nations would set up a variety of restrictions on market entry. But for the requisite



264


265

globalization, developed nations need various investment flows into their own market while maintaining a high degree of sensitivity. Through the game lens, we identify key players, their interests and concerns, available strategies, and the structure of the game in the following discussions.

We consider three players – developed nations, local enterprises, and SCFEs – in the negotiation of potential investment by SCFEs. By developed nations we mean the governments in developed nations, usually national governments. However, in certain situations such as that of Canada, ‘governments’ could mean both federal and provincial or other territorial legislative jurisdictions. We further assume that, in most cases, local enterprises are non-government commercial entities. In a free enterprise, market-based economy, such enterprises are assumed to function autonomously but have to comply with the state’s FDI regime. 2.2. Players’ interests and concerns Developed nations’ main interests include national economy (domestic market, employment, and enterprises, etc.), community and society (public opinion, human rights, environment, etc.), and relations with SCFE nations. With globalization and open markets, FDI has increasingly become a much sought-after resource to generate growth. Most developed nations recognize the benefits of FDI to generate such benefits as higher productivity and efficiency, increasing the pool of capital for investment, enhancing labor markets. On the other hand, the national government can use its jurisdiction over the matter as leverage in dealing with a foreign state. Local enterprises in developed nations may have these interests and concerns: survival, growth, profitability; and legitimacy. As profit-driven commercial entities, local enterprises are largely concerned with how FDI can contribute to their business growth. In a typical M&A case, for instance, a target firm might be mostly interested in capital injection. However, they will have to also take into account local interests and concerns such as implications for employment and tax revenues, as evidenced in the recent case involving a bid by BHP (Australia) for Potash Co. of Saskatchewan (Whittington, 2010). SCFEs are interested in profit maximization and policy imperatives. Although SCFEs bear the burden of state ownership and can be heavily influenced by government mandates, they have fiercely defended themselves as commercially driven. Indeed, their motives, including gaining access to foreign resources and markets, can be seen both as profit-driven (e.g., due to rising prices) and policy-driven (e.g., securing resource supplies on behalf of national government).



2.1. Key players

266


2.3. Player strategies We project three possible moves by the developed nations:

Strategy A retains the ban on SCFEs’ FDI, representing a protectionist approach against firms owned by foreign governments. With strategy B, a developed nation will put restrictive conditions in place to address the influence of SCFE home countries. By restrictions, we mean measures beyond those already applied to FDI. So if an SCFE proposal is subject to reviews based on, but not beyond, criteria applicable to all foreign investments, then it is a situation ‘without restrictive conditions’. As an example of restrictive investment concerning SCFEs, Industry Canada issued the ‘Guidelines – Investment by state-owned enterprises – Net benefit assessment’ as an amendment to the Investment Canada Act in 2009. When assessing whether acquisitions benefit Canada, the Minister will examine the corporate governance and reporting structure of the non-Canadian SOE as well as the ability to operate on a commercial basis (Industry Canada, 2007). Local enterprises may choose one of the following options concerning SCFEs: D. Remain closed to SCFEs E. Open up to SCFEs with conditions F. Open up to SCFEs totally. We assume that local enterprises, like for-profit commercial entities, act on economic rationality. Thus, these enterprises should negotiate an investment deal based on considerations such as control and, in a partial acquisition case, managerial integration, without particular attention to the investor’s political affiliation, to the point when such affiliation may be seen as detrimental to business performance, and so on. Inevitably, local enterprises are influenced by the limitation of restrictive policy made by the national government. Finally, SCFEs may adopt the following strategies: G. No investment H. Restrictive investment I. Investment without limitation. SCFEs bear a certain level of duality in terms of commercial and political interests. Developing nations are likely to tie business and politics together



A. Remain closed to SCFEs B. Open up to SCFEs with restrictive conditions C. Open up to SCFEs without restrictive conditions.

267

as far as SCFEs are concerned. For example, the ‘largest outward investments by Chinese MNEs are undertaken by SOEs, and all investment projects follow a scheme that ensures that they are in strict line with government policies’ (Gugler & Boie, 2008, p. 23). As such, when deciding whether or not to proceed with an investment, SWFs tend to be heavily burdened by political factors above and beyond commercial concerns. Even if faced with an investment environment where both national government and local enterprises are completely open to SCFEs, the specific SWF will have to consider factors such as the relations between the two national states involved. 2.4. Game structure Figure 12.1 maps the different situations under which the game is played. Although SCFEs tend to initiate investment projects, they have to negotiate the possibilities and terms with local enterprises, which in turn need to act (often proactively) within the FDI policy of the national state where sovereignty resides. Table 12.4 lists the strategy combinations or situations that make up the ‘consideration set’ by all the players when they bargain toward an investment deal. We explain the meaning of each combination.

Devoloped nations Close A Local enterprise close D SWFs&E No investment ADG

Limited open B Local enterprise close D SWFs&E No investment BDG

Local enterprise limited open E SWFs&E No investment BEG

SWFs&E Restrcitive investment BEH

Totally open C Local enterprise close D SWFs&E No investment CDG

Local enterprise limited open E

Local enterprise totally open F

SWFs&E No investment CEG

SWFs&E No investment CFG

SWFs&E Restrcitive investment CEH

SWFs&E Restrcitive investment CFH

SWFs&E totally investment CFI

Figure 12.1 Game structure





Table 12.4

Strategy combinations

Strategy combination

Meaning

ADG

Developed nations remain closed to SCFEs, local enterprises are not open to SCFEs, and no investment comes from SCFEs

BDG

Developed nations open to SCFEs with restrictive conditions, local enterprises remain closed to SCFEs, and no investment from SCFEs happens

BEG

Developed nations open to SCFEs with restrictive conditions, local enterprises limited open to SCFEs, but SCFEs do not make investment

BEH

Developed nations open to SCFEs with restrictive conditions, local enterprises limited open to SCFEs, and SCFEs make restrictive investment

CDG

Developed nations open to SCFEs without restrictions, but the local enterprises remain closed to SCFEs, and no investment from SCFEs happens

CEG

Developed nations open to SCFEs without restrictions, local enterprises limited open to SCFEs, but no investment from SCFEs happens

CEH

Developed nations open to SCFEs without restrictions, but local enterprises limited open to SCFEs, and SCFEs make restrictive investment

CFG

Developed nations open to SCFEs without restrictions, local enterprises open to SCFEs totally, but no investment from SCFEs happens

CFH

Developed nations open to SCFEs without restrictions, local enterprises open to SCFEs totally, but SCFEs make restrictive investment

CFI

Developed nations open to SCFEs without restrictions, local enterprises open to SCFEs totally, and SCFEs make investment without limitation

3. Model interpretation We analyze the motives, behaviors, and outcomes under each strategy combination or ‘situation’. We assume that national states (i.e., ‘developed nations’) have the decisive influence in SCFE investment formation and that other players (i.e., ‘local enterprises’ and ‘SCFEs’) will react to the decision of the national state. In the case of foreign acquisition of a Canadian resource company, for example, the jurisdiction would reside in Ottawa. We further assume that the national state can potentially choose to make three different decisions: keep the FDI field closed to Chinese SCFEs, open it with



268


269

restrictions, or open it fully. The application of our model is limited to the industries deemed to be of strategic and national interest to the developed nations.

Why would Canada be open to Chinese SCFEs? No examples of politically charged SWF investments have been reported since SWFs became active 50 years ago (Fotak & Megginson, 2009). There is a long-held assumption that SOE investors may not follow the laws, rules, or norms of Western developed countries and thus will not be good employers or good corporate citizens. But no evidence shows difficulties in compelling a Chinese-owned firm to obey local laws, at least not from Canada’s experience (Conference Board of Canada, 2004). However, investment from China, which is still considered a Communist regime, is new. Canada, as well as other developed countries, is still not ready to accept China in full. In short, the possibility that developed nations open completely to SCFEs seems remote. 3.2. When market is closed This was the status quo as of late 2008, prior to the global financial turmoil. Although Canada needed FDI and began to view China as a possible source country, it had alternative sources of foreign investment, chiefly from the United States. This created a state of equilibrium, preventing Canada from seriously considering China as a viable source of FDI. For this reason, Canada expressed its discomfort with Chinese government influence and actually kept selected industries closed to Chinese investment. Under this scenario, local enterprises would have no choice but stay away from potential Chinese state investors. When China Minmetals announced its intention to purchase mining giant Noranda in 2004, the deal was killed within a month even without the Canadian government getting formally involved (as a reference, the Investment Canada Act has been used only once to deny a takeover application). However, the united, intense opposition from all corners of Canadian society signaled that the deal would have been rejected by Ottawa if a proposal were sent to the government for review. Essentially, the door is closed to Chinese SCFEs. 3.3. When restricted access is allowed Deals involving CNOOC and China Minmetals were dead, but the issue was not going away. Although China, along with other emerging market economies, has steadily enhanced its FDI profile during the past decade or so (see Table 12.3), the ongoing economic recession has moved Chinese SCFEs to the forefront of the global stage. As shown in Table 12.5, inward FDI flows in Canada have dramatically decreased from 2007 to 2009. While worldwide FDI has fallen 43 percent, FDI from China has broken a new record: net flows in 2009 reached US$56.53 billion, increasing by 1.1 percent



3.1. When markets are open

270


Table 12.5

Canada: inward FDI flows (2000–2008, US$ billion)

Economy

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Canada

66.8

27.7

22.1

7.5

–0.4

25.7

59.8

108.3

44.8

19.3

compared to 2008. Since the benefits of a low-barrier FDI policy are recognized by developed nations and SCFEs have become a major source of FDI, developed nations had to seriously consider how to take advantage of SCFEs while controlling possible negative effects. This has opened the possibility of restrictive investment through actively seeking solutions to address the key concerns about SCFEs. These concerns existed but were unexplored in the past, for example, when China Minmetals was bidding for Noranda in 2004. We model three situations where developed nations are open to SCFEs with restrictive conditions. The investment cannot occur when the local enterprise remains closed to SCFEs (BDG). As noted earlier, we assume that local enterprises behave based on economic rationality. Thus, the reason for the rejection is likely due to commercial/financial concerns. When local enterprise is open to SCFEs, investment may not occur (BEG). As with the situation BDG, the SWF’s decision is likely to arise from business concerns. For example, the SWF investment could be restricted to a certain size, which may prevent the project from reaching its optimal scale. As explained fully in the next section, the most likely scenario will be BEH; that is, investment occurs with concessions from all involved parties. 3.4. Prediction With SCFEs offering an attractive option for capital-hungry developed nations, their federal governments will have to move toward relaxing FDI rules. However, unless concerns about SCFE adverse effects can be fully addressed (i.e., assurances of no state influence), there is no possibility of opening countries to SCFEs in the near future. Thus, among the three strategies available to developed nations, restrictive investment has the greatest likelihood for adoption. Next, between the two strategies available to local enterprises, opening to SCFEs is more likely than not opening. In fact, one should assume that any investment is likely to be initiated by the enterprise. Our discussions then boil down to two situations where the developed nation allows for restrictive investment and the local enterprise is open to SCFEs. As discussed earlier, an SCFE should enter a negotiation with interest but could end the negotiation for either commercial or political concerns. In light of mutual interest in the deal and the likely dynamics, for example, in the political arena, the ‘no investment’ outcome is relatively unstable and could be replaced by a deal through further negotiation or due to changes of



Source: UNCTAD’s FDI/TNC database, available at: http://stats.unctad.org/fdi/; Acharya et al. (2010).

271

a non-commercial nature. In sum, according to the various assumptions we set out above, including the complete information assumption of our game model, we predict situation BEH (realized SCFEs investment under restrictive conditions) will be the favored choice by the developed nation, the local enterprise, and the SCFEs. A concession to some degree of all players – majority control from local enterprises and managerial control from SCFEs – makes it possible for investment to move forward. The task, then, is to identify the equilibrium point at which the three players can draw maximum benefits from cooperation.

4. Model application: The Petro-China case In December 2009, the Canadian government approved a deal to allow PetroChina, the market arm of the state-owned China National Petroleum Corp., to invest US$1.7 billion for 60 percent ownership in two Canadian tar-sand deposits in Alberta. According to the government, the investment is of net benefit to Canada. It will also increase local employment. However, the PetroChina deal for the largest acquisition by a Chinese SCFE in North America is not without conditions. Except for concessions of an economic nature (e.g., contributions to the projects’ development costs), PetroChina promises to (1) maintain a regional head office for the next five years, (2) allow Canadians to hold a majority of the senior management positions associated with the project, and (3) retain the public company status while controlling these oil projects. It appears that Canadian interests will be well protected by these conditions. While the Canadian side has ceded majority ownership, it has effectively maintained management influence. Without a regional office staffed by local managers, there would be no possibility for Canadian management to exert such influence. The third condition is more crucial since it speaks directly to concerns about the role of the Chinese government. As a public company listed in New York and Hong Kong, the Chinese parent will be subject to monitoring by stockholders, thus canceling potential adverse interference from the Chinese state. In sum, the outcome of the PetroChina case is consistent with our model prediction that SCFEs will invest in developed nations as they formulate regulatory responses to the capital needs of domestic industries and resolve concerns about SCFE state ownership. Chinese SCFEs have stalked Canadian oil projects for years, but Ottawa’s conclusion that this particular investment ‘is likely to be of net benefit to Canada’ (Minister Clement) could only take place at a time when China is recognized as vital source of FDI to Canada. The rest of the game between local target firms and Chinese SOEs should be easier as they identify each party’s concerns and assure the integrity of both parties’ interests. Although ongoing accumulation of knowledge about SCFEs and their impact may lead to a more relaxed FDI regime, restrictive




272


investment (i.e., BEH) is what we are going to see in the years to come, or the equilibrium of our model from a game perspective.

SCFEs have become the dominant form of outward FDI from emerging economies and other developing nations. Compared with their relative success in the developing world, however, SCFEs in the developed economies represent only a small percentage of the total. On the surface, the situation can be explained by looking at the investment target countries, the developed nations. Most of the developed nations face a dilemma while looking for inbound FDI since SCFEs are the richest source currently available in the world market, yet they are considered the most problematic with regard to their state ownership and control. To account for this emerging and understudied phenomenon, we propose and find evidence that SCFE investment formation in developed nations can be investigated from a game perspective. We argue that a ‘win-win’ situation will emerge if all players in the game, including but not limited to the developed nations’ governments and SCFEs, can make reasonable compromises to ensure deal results. Indeed, our game model could have predicted the happenings in the recent PetroChina case or similar deals since it offers an understanding of the domestic (in Canada) and bilateral (Canada-China) bargains that move toward that solution. Timing is the key. Following the crisis involving China Minmetals in 2004, Canadians started wondering about the consequences of allowing foreign government-controlled firms to invest, even with certain restrictions. However, the Canadian government was not proactive since China was viewed as having only the potential to become an important source of foreign investment in Canada (Conference Board of Canada, 2004). It was not until China proved to be a real player in FDI that Canada sought new rules of the game to engage Chinese SCFEs. We take a first step toward modeling SCFE investment in developed nations from a game perspective. To explore the model’s utility, we adopt a simplified approach and we limit consideration to three players. In reality, however, the game tends to involve more players and additional situations. For example, Canada has the largest oil reserve outside the Mid-East and is the main supplier of crude oil to the United States. For this reason, the United States has a clear and significant interest in the Canadian oil sector. If the investment by SCFEs involves acquisition of an existing firm in a developed nation, a distinction could be made even between the national and provincial government. In the recent instance of BHP’s (Australia) bid for Potash Corp. of Saskatchewan, the Premier Minister of Saskatchewan claimed that potash is owned by its people. He appealed to



5. Discussion

273

the federal government, which is known for its red carpet policy toward FDI (Whittington, 2010). By taking into account additional players, future research can take better advantage of game modeling in understanding SCFE investment situations. Another venue for extending the current study would employ a game model in a specific industry. Besides the oil industry, agriculture would be worth investigating from a game perspective. After the recent crisis in the world financial systems, SCFEs are looking for investment opportunities in less risky sectors than volatile financial commodities, as well as traditional manufacturing and even the real estate industry. Agriculture seems to be a safe haven since the prices for agricultural products have continued to rise and the number of people lacking basic food supplies is at a record high worldwide. Indeed, there is a call for Chinese investment in Canada’s agricultural sector. Besides policy and managerial implications, the examination of specific industries is necessary for enriching a game theory of SCFE investment. The current study suggests that SCFE investment is possible if players compromise. Future research should explore the areas where compromises are likely and perhaps the way players reach such compromises. The ultimate goal of a game theory-guided investigation is to inform the establishment of the ‘rules of the game’ so that an investment can be easily negotiated and safely implemented. In this regard, we echo Fotak and Megginson (2009), who call for accumulating knowledge about SWFs and their local impact to guide proper regulatory response. Finally, the uniqueness of SCFE investments lies in the role of the state. It may be useful to compare it to investments involving non-statecontrolled entities from China. Evidence shows that privately owned firms have already surpassed SOEs in the pace of internationalization (Chen, 2006) and many are favorably positioned to become global players over the next decade alongside SOE counterparts (IBM, 2006). Although relatively small in scale, Chinese private firms have also entered resource sectors in Canada. State-affiliated and privately owned Chinese firms behave differently when expanding overseas since their motivations and capabilities often differ (Lin, 2010). It would be interesting to see how private Chinese firms are received and what kinds of deals they can negotiate in Canada, in contrast with the experience of SCFEs.

6. Conclusion Canada faces a dilemma: SCFEs from China have become a major source of sorely needed FDI, but the government is suspicious of these state-controlled entities. Triggered by the ongoing world economic recession, however, Canada has taken a step toward loosening its restrictions on Chinese SCFEs




274


in its resource sectors, which have been mostly closed to FDI from China until recently. Experience will show whether Canada can take full advantage of Chinese investments while resolving its hesitations and whether SCFEs from China and other transition economies can be accepted as a sustainable source of FDI in the developed nations.

The paper was presented at the 5th China Goes Global Conference, Harvard University, 6–8 October 2010. The authors thank Eva Woyzbun for her help in improving the paper.

References Acharya, R., Rao, S., Bhattacharjee, S., & Wright, L. 2010. Inward FDI in Canada and Its Policy Context, Columbia FDI Profiles. Alon, I., Chang, J., Fetscherin, M., Lattemann, C., & McIntyre, J. 2009. Introduction. In Ilan Alon et al. (eds.), China Rules: Globalization and Political Transformation. New York: Palgrave Macmillan, pp. 1–12. APF and CCPIT. 2009. China Goes Global 2009: Survey of Outward Direct Investment Intentions of Chinese Companies. Vancouver: Asia Pacific Foundation of Canada and China Council for the Promotion of International Trade. Bhattacharjee, S. 2009. Extended Note: National Security with a Canadian Twist: The Investment Canada Act and the New National Security Review Test. Columbia FDI Perspectives, July: No. 10. New York: Vale Columbia Center. Bordonaro, F. 2010. China’s Thirst for Oil: PetroChina and the Canadian Oil Sands, http://fbordo.blogsome.com/2010/01/12/chinas-thirst-for-oil-petrochina-and-thecanadian-oil-Sands. Accessed 2 February 2010. Bouw, B. 2010. Teck Gets S&P Rating Upgrade. Globe and Mail, 16 April. Buckley, P., Clegg, J., Cross, A., Liu, X., Voss, H., & Zheng, P. 2007. The determinants of Chinese outward investment. Journal of International Business Studies, 38: 499–518. Chen, X. H. 2006. The Internationalization Strategies for Chinese Enterprises (in Chinese). Beijing: People’s Press. Child, J. & Rodrigues, S. B. 2005. The internationalization of Chinese firms: A case for theoretical extension? Management and Organization Review, 1(3): 381–410. Conference Board of Canada. 2004. Should Canada update its foreign investment rules? The China Minmetals-Noranda case. Insights You Can Count On, November, 1–7. Davies, K. 2009. While global FDI falls, China’s outward FDI doubles. Columbia FDI Perspectives. New York: Vale Columbia Center. Davies, R. B., Egger, H., & Egger, P. 2010. Profit taxation and the mode of foreign market entry. The Canadian Journal of Economics, 43(2): 704–727. Encyclopedia Britannica. 2010. Game Theory, http://www.britannica.com/EBchecked/ topic/224893/game-theory. Accessed 28 April 2010. Fotak, V. & Megginson, W. 2009. Are SWFs welcome now? Columbia FDI Perspectives. New York: Vale Columbia Center. Franklyn, P. & Glossop, P. 2009. Doing Business in Canada. Osler Guides, http://www. osler.com/newsresources/Details.aspx?id=1215. Accessed 28 October 2010.



Acknowledgments

275

Government of Canada. 2008. Compete to Win: Final Report. Ottawa: Competition Policy Review Panel. http://www.ic.gc.ca/eic/site/cprp-gepmc.nsf/eng/h_00040html. Accessed March 30, 2009. Gugler, P. & Boie, B. 2008. The Emergence of Chinese FDI: Determinants and Strategies of Chinese MNEs, 9–10 October 2008, Copenhagen, Denmark: Copenhagen Business School. Ho, P. C. 1979. International Investment via Game Theory. Review of Financial Economics, 15(1): 56. Hodgson, G., & Paris, R. 2006. The Benefits of Foreign Direct Investment: How Investment in Both Directions Drives Our Economy. The Conference Board of Canada Executive Action Report. Ottawa: The Conference Board of Canada, March. IBM. 2006. Going global: Prospects and challenges for Chinese companies on the world stage. IBM Institute for Business Value, Report 03–06. New York: IMB Global Services. Industry Canada. 2007. Guidelines – Investment by State-owned Enterprises – Net Benefit Assessment, http://www.ic.gc.ca/eic/site/ica-lic.nsf/eng/lk00064.html. Accessed 2 February 2010. Khana, T. 2009. Forward. In Ilan Alon et al. (eds.), China Rules: Globalization and Political Transformation. New York: Palgrave Macmillan, pp. ix–x. Kwan, C. & Sauvant, K. P. 2008. Chinese direct investment in the US – The challenge ahead. Columbia FDI Perspectives. New York: Vale Columbia Center. Lee, C. K. & Wang, C. M. 2006. Foreign investment preferential policy formulated by host country: An application of game theory. The Business Review, 6(2): 298–304. Lin, X. 2010. State versus entrepreneurial MNCs from China: Initial conceptualizations and evidence. International Marketing Review, 27(3): 366–380. Luo, Y., Xue, Q., & Han, B. 2010. How emerging market governments promote outward FDI: Experience from China. Journal of World Business, 45(1): 68–78. Luski, I. & Rosenboim, M. 2009. Optimal policy for FDI incentives: An auction theory approach. European Research Studies, 12(3): 61–76. Martin, M. F. 2008. China’s Sovereign Wealth Fund. CRS Report for Congress, January 22. Washington DC: Congressional Research Service. Meyer, M. & Boisot, M. 2008. Which way through the open door? Reflections on the internationalization of Chinese firms. Management and Organization Review, 4(3): 349–364. Miao, Y. C. 2008. The rise of SWFs and the new changes in international economic relations. International Studies, 5: 55–60. Mueller, M. & Lovelock, P. 2000. The WTO and China’s ban on foreign investment in telecommunication services: A game-theoretic analysis. Telecommunications Policy, 24: 731–759. OECD. 2007. International Investment of sovereign wealth funds: Are new rules needed? OECD – Investment Newsletter, October 2007, 5(4). Perkins, T. 2010. China Investment Chief to Canada: Fear Not, 19 October 2010, http:// www.theglobeandmail.com/report-on-business/economy/china-investment-chiefto-canada-fear-not/article1764369/. Accessed on 30 October 2010. Polzcer, S. 2009. PetroChina’s $1.9B buy in oilsands approved. Calgary Herald, December 30, http://www.calgaryherald.com/business/PetroChina+oilsands+ approved/2389885/story.html. Accessed on 2 February 2010. Sauvant, K. 2009. Driving and countervailing forces: A rebalancing of national FDI policies. Yearbook on International Investment Law and Policy 2008–2009. New York, NY: Oxford University Press, pp. 239–240.




276



Vega-Redondo, F. 2003. Economics and the Theory of Game. Cambridge, UK: Cambridge University Press. Whittington, L. 2010. Stakes high for Harper with Potash. Toronto Star, November 3, p. A6. Williamson, P. & Yin, E. 2009. Racing with the Chinese dragon. In Ilan Alon et al. (eds.), China Rules: Globalization and Political Transformation. New York: Palgrave Macmillan, pp. 69–100.


Part IV


Chinese FDI in Africa





13 Gayle Allard

The African continent has become an important target for foreign investors. Since 1985, outward foreign direct investment (OFDI) inflows to the region have risen from US$2.4 to US$62 billion, and stocks have soared from US$40 billion in 1980 to US$315 billion in 2006 (UNCTAD, 2008; McKinsey, 2010). Africa’s lure for foreign investors lies in its demographic and economic growth with the resulting rise in consumer markets, its abundant natural resources, and an improving business environment in many countries that makes them more attractive to investors. The Chinese have joined investors around the world in taking important positions on the continent. China is not a new arrival to Africa, however. Chinese companies have been entering the continent since 1949, with their focus moving from ideologically driven support for decolonizing states in China’s post-revolution period, to broader and more market-oriented projects that range from resource extraction and infrastructure to low-skilled manufactures and trading.1 Most recently, large-scale and highly publicized Chinese projects have emerged across Africa, mainly in the resource sector. The visibility of these projects and the fact that some are located in countries with authoritarian and repressive governments raises the question: does China’s OFDI in Africa have a different focus than the OFDI flowing into the continent from the rest of the world? Specifically, is China more than other investors mainly securing resources in Africa to supply its fast-growing economy, and tolerating or even bolstering corrupt governments in the process?

1. Theory and hypotheses The profile of multinational investment has been undergoing a process of transformation since the 1990s. The multinational enterprises (MNEs) from North America, Western Europe, and Japan that once dominated OFDI flows have been joined in recent years by large multinational companies from other parts of the world. These ‘new’ MNEs come from upper-middle-income 279



Chinese OFDI in Africa: Trends, Prospects, and Threats


economies (Spain, Portugal, South Korea, Taiwan), emerging economies (Brazil, Chile, Mexico, China, India, Turkey), other developing countries (Egypt, Indonesia, Thailand) and major oil producers (United Arab Emirates, Nigeria, Venezuela), and their role in global investment flows and host economies is increasingly important (Guillén & García-Canal, 2010). China is of particular interest among these emerging investors, not only due to its sheer size, but because it is one-of-a-kind in its social market economy and the special interplay of government and market forces that it represents, both at home and abroad (Alon & McIntyre, 2007). The rise of MNEs from less prosperous and even undemocratic nations raises important questions about how these investors behave and what motivates them to invest in developed and developing countries around the world. Guillén and García-Canal (2010) suggest that the ‘new’ MNEs have six characteristics that distinguish them from traditional foreign investors. First, their speed of internationalization is accelerated rather than gradual, perhaps due to their desire to quickly close the gap between their foreign presence and that of the traditional multinationals (Mathews, 2006). Second, since they face the disadvantage of being latecomers, they have been forced to undergo a rapid upgrading of their capabilities to reduce the competitiveness gap (Mathews, 2006). Third, they generally have better political capabilities, since they are accustomed to dealing with unstable political environments or a weak institutional context in their home countries (Cuervo-Cazurra & Genc, 2008). Additionally, the ‘new’ MNEs tend to choose a dual expansion path, entering developed and developing countries simultaneously; they tend to expand through alliances and acquisitions rather than wholly owned subsidiaries; and they have a high organizational adaptability because of their limited international presence. The third characteristic is of particular interest in a study of China’s presence in Africa. A concern that Western countries have voiced as China’s presence has advanced on the African continent is that the Asian giant could be fueling a ‘race to the bottom’ by lending tacit support to poor governance, corruption, and even human rights violations across the region. Criticisms range from the practice of using ‘rogue aid’ to finance projects that promote China’s regional and international geopolitical aims even though they stifle real progress and hurt citizens in the host country, to turning a blind eye to human rights issues when investing in order to secure resource supplies. Some recent examples of Chinese support for corrupt regimes include its decision to double direct investment (from US$3 to US$6 billion) in Nigeria, especially in its oil sector; and to invest US$7 billion in oil and mining infrastructure in return for preferential treatment in mining projects in Guinea, whose government took power in a military coup. Human rights activists charge that Chinese aid and investment is propping up regimes with severe human rights violations in countries like Zimbabwe, Sudan, and the Democratic Republic of Congo.



280

China and many African nations, however, see this same situation in a positive light. China committed itself in the Asian-African Bandung Conference in 1955 not to meddle in domestic African politics. Many Africans believe that China’s non-interference allows it to play a necessary role in combating poverty and promoting development in countries where Western governments refuse to get involved. Paul Kagame, president of Rwanda, recently told the German newspaper Handelsblatt: ‘The Chinese bring what Africa needs: investment and money for governments and companies. China is investing in infrastructure and building roads. European and American involvement has not brought Africa forward. Western firms have to a large extent polluted Africa and they are still doing it’ (BBC News, 2009). When the investor is a Chinese SOE or the project is financed by Chinese aid, these concerns may be justified. Due to its undemocratic system of government and its abundant cash, China can offer direct investment projects that are bundled with huge foreign aid packages, which Western nations currently cannot imitate (though the trade-OFDI-aid link is an invention of their own colonial past). Often in these massive bundled projects, Chinese ‘aid’ funds never leave China but are instead transferred from the EXIM bank to the Chinese SOE carrying out the project (Kaplinsky & Morris, 2009). One example is China’s recent bid for access to 10 million tons of copper and 2 million tons of cobalt in the Democratic Republic of the Congo, in exchange for a US$6–9 billion package of infrastructure investments (McKinsey, 2010). Although many international donors and multilateral organizations promote a ‘rights-based’ aid agenda designed to promote freedom and economic progress in recipient countries, China does not agree with all of these objectives and hence does not orient its aid and statedriven OFDI projects in that direction (Mohan & Power, 2008). This has led to highly publicized criticisms of some Chinese decisions, most recently centered on Darfur in Sudan, where China is buying 60 percent of the country’s oil output from a government accused of mass murder and severe human rights violations. These examples raise the question of whether China’s investment presence in Africa might be markedly different from that of MNEs originating in other, more traditional investor countries. China has a very different institutional environment from developed-country investors, and might be expected to place less emphasis on issues such as governance, absence of corruption, or secure property rights in the host countries where it operates. In line with the literature, the first hypothesis we explore is: H1: Compared with global OFDI flows and stocks, Chinese OFDI will show a stronger association with African countries that are ranked as more corrupt. In addition to examining the characteristics of the new MNEs, business scholars have also begun to explore the key motivations of investors from



Gayle Allard 281


emerging economies for their OFDI projects. Two of the key motivations identified are the need to establish backward linkages into raw materials, and to create forward linkages into foreign markets (Fields, 1995; UNCTAD, 2006). In the case of China, media accounts give the impression that its OFDI targets mainly natural resources on the African continent. Up until the twenty-first century, it appears that this image was not correct. Chinese OFDI in Africa seems to have been spread across sectors, with manufacturing and retail playing an important role alongside resource extraction and infrastructure. Private enterprises that either come from China to Africa or are founded in Africa by members of the Chinese diaspora operate mainly in manufacturing and trade (Gu, 2009). Although many are SOEs and some are large private concerns such as Huawei Technologies, Holley Group, and Zhongxing ZTE Corporation, the vast majority are small- and medium-sized firms, often family owned, that are involved in manufacturing or wholesale or retail sales. For these firms, the primary driving forces behind their investments are the opportunities in the domestic market and in Africa’s export markets, and the chance to escape intense competitive pressure among firms within China (Gu, 2009). According to UNCTAD data, in the 1979–2000 period 46 percent of Chinese OFDI flows went to manufacturing (mainly clothing), 28 percent to resource extraction, and 18 percent to services, principally construction. Table 13.1, from Kaplinsky and Morris (2009), shows where Chinese investment is concentrated in the African countries where it plays a significant role. Many of the sectors are dominated by small-scale commerce or low-skilled manufacturing. This profile has changed recently, however. Muekalia (2004) says that the post-Mao era has witnessed a major shift in China’s relations with Africa: rather than pursuing an ideological agenda, the Chinese government’s focus has moved toward securing resources to promote its own economic growth in the twenty-first century. This conclusion is supported by partial data for a group of 20 countries where ‘scoping studies’ on Chinese OFDI were carried out for the African Economic Research Consortium for the period up to 2008.2 According to these studies, nearly half of the major Chinese investment projects in these countries since 2001 have been in the oil and gas sector, and another 5 percent have been in the extraction of other natural resources. Close to a quarter is in general manufacturing, while nearly 18 percent is in the telecommunications sector.3 The breakdown is given in Table 13.2. Access to natural resources is likely to continue to drive Chinese OFDI in Africa as its energy needs soar: it is expected to import 7.3 millions barrels of crude a day, equivalent to half of Saudi Arabia’s planned output, by 2020 (Kaplan, 2009). China is now the world’s leading consumer of aluminum, copper, lead, nickel, zinc, tin, and iron ore, which could boost the importance of ores and metals in investment decisions in the future.



282

Main sectors for Chinese OFDI in selected Sub-Saharan African countries

Country

Sectors invested in Oil/Gas

Angola

Mining

Agriculture

X

Ethiopia

X

Ghana

Poultry

Madagas-car

Sugar

Nigeria

X

X

Retail

Infrastructure

Manufacturing

Telecom

Small traders

Telecoms, electricity, water

Small traders

Construction, infrastructure Construction

Garments, shoes/leather

Financial, telecoms Telecoms, technical services

Mauritius Sudan Zambia

Services

X X

Small traders Import-export Small traders Import-export Small traders

Garments, shoes/leather Garments, general spread Construction, infrastructure

Small traders Import-export Small trader Cotton

Agro-processing Textiles, garments, general spread

Construction

Agro-processing

Source: Kaplinsky and Morris (2009).

283



Table 13.1


Table 13.2

Chinese OFDI projects in 20 African countries by sector (2001–2008)

Sector Oil and gas General manufacturing Telecommunications Other natural resources Other services (including tourism) Agriculture Trade Construction

% of reported Chinese OFDI for period 48.37 25.52 17.89 4.63 1.30 1.12 0.7 0.48

Source: AERC scoping studies for selected countries.4 Own calculations.

For government-driven investment decisions, China’s objective of securing the energy, metals, and strategic minerals that it needs to support its huge population and their rising living standards and to ensure its industrial competitiveness will continue to be important in years to come (Kaplan, 2010). As the literature predicts, could this resource focus be more intense for China, and other ‘new’ MNE investors, than it is for investors from developed nations? Specifically, is this new, heavily resource-oriented profile for OFDI a distinguishing characteristic for China, which, due to its very rapid growth rates and high population, requires an especially abundant and secure supply of natural resources to fuel its expansion? In line with this need, do public and private Chinese investors in Africa tend to prefer resource-abundant host countries more than global foreign investors do? Again following the literature, this paper will empirically test the following hypothesis: H2: Chinese OFDI will show a stronger association than global OFDI with African countries that are more oriented toward exploitation and export of natural resources such as fuels, metals, and ores.

2. Data and methodology 2.1. Sample and measures The dependent variable for this study is the ratio between Chinese and global FDI (both stocks and flows, in alternate models) as a percent of GDP in the recipient nation. A higher ratio indicates a greater concentration of Chinese investment in a given country compared to the world overall. Obtaining the data for this variable involves a key challenge, which is the paucity and/or irregularity of data on China’s OFDI in foreign countries, and particularly in Africa. It is difficult to discern from public sources the



284

magnitude of Chinese investment in individual African countries, since both Chinese and African recording practices can be unreliable (Kaplinsky & Morris, 2009). The most recent UNCTAD data in theory cover the 1995–2006 period, but for Chinese OFDI, data are reported mainly for 2003–2005. The Chinese Ministry of Finance and Commerce (MOFCOM) publishes data for 2003–2007 only. For some countries (Burkina-Faso, Burundi, Central African Republic, Comoros, Djibouti, Eritrea, Gambia, Guinea-Bissau, Madagascar, Malawi, Mozambique, Namibia, Nigeria,5 Sao Tome and Principe, Somalia, South Africa, Swaziland, Zambia), either no OFDI information for China is provided, or only stocks or flows are given, but not both. (Mauritius was eliminated from the data set as an outlier due to its extraordinarily high levels of Chinese OFDI.) Keeping these serious limitations in mind, Tables 13.3 and 13.4 present 2005 figures on OFDI stocks in the African countries for which data were available from MOFCOM, as a percent of host-country GDP and as a percent of all global OFDI stocks in the country. The countries are ranked by the importance of Chinese OFDI stocks in their economies. Tables 13.3 and 13.4 show that, even in the countries where it bulks largest as a percent of GDP, Chinese OFDI stocks generally are small relative to the size of the receiving economies (less than 4%). They are also small (less than 10%) in relation to global OFDI stocks in most countries, with the exception of Niger and Madagascar. The figures do underline, however, the magnitude of China’s presence in troubled countries like Sudan. Data for 2003 are presented in the Appendix (Table 13A.1 and Table 13A.2) for the purpose of comparison. These same figures indicate that China’s OFDI in Africa is increasing much faster than that of other countries. Both UNCTAD and MOFCOM data show that the growth in Chinese investment in Africa was explosive during the first decade of the twenty-first century. Keeping in mind the limitations of the data set, and recalling that local inflation and currency movements could have an impact on the stock figures, the numbers show dramatic nominal increases in Chinese OFDI in Africa in the 2003–2007 period, which are usually many times higher than those for the world as a whole in the region. By 2005, the stock of Chinese OFDI in Africa was nearly three and a half times the size it was in 2003, based on UNCTAD figures; according to MOFCOM figures, the stock of Chinese OFDI in Africa was 420 percent larger in 2006 than it was in 2003. In contrast, the growth rates in OFDI stocks from all world sources to Africa were 11.9 percent (2003–2005) and 60.8 percent (2003–2006). Despite this growth, the total is still a small fraction of China’s total OFDI abroad, which the Economist Intelligence Unit projects to reach US$72 billion in 2011 (EIU, 2007) (Tables 13.5 and 13.6). The availability of data for the dependent variable determined the sample size for this regression experiment. The MOFCOM figures were chosen, since they included more countries than the UNCTAD series (32–36 countries in



Gayle Allard 285

286

Country Zambia Liberia Sudan Sierra Leone Guinea Madagascar Niger Zimbabwe Benin Tanzania Congo, Democratic Republic Seychelles Mauritius Gabon Mali Kenya Congo, Rep Togo Ethiopia Mozambique Gambia Central African Republic Equatorial Guinea Rwanda Côte d’Ivoire Botswana Algeria Nigeria Mauritania Ghana Chad Cape Verde Libya Cameroon Uganda Djibouti Lesotho Angola South Africa Egypt Senegal Malawi Morocco Tunisia Comoros

OFDI stocks (US$ million)

OFDI stocks/GDP

160.31 15.95 351.53 18.45 44.22 49.94 20.44 41.63 19.00 62.02 25.11 4.19 26.81 35.36 13.28 58.25 13.32 4.78 29.82 14.68 1.19 2.00 16.56 4.72 29.11 18.12 171.21 94.11 2.40 7.33 2.71 0.60 33.06 7.87 4.97 0.40 0.60 8.79 112.28 39.80 2.35 0.73 20.59 2.15 0.01

3.92 3.01 2.10 1.53 1.22 1.15 0.94 0.75 0.69 0.49 0.48 0.47 0.43 0.41 0.40 0.38 0.33 0.32 0.30 0.25 0.23 0.22 0.20 0.20 0.18 0.17 0.17 0.16 0.13 0.12 0.10 0.09 0.08 0.07 0.06 0.06 0.06 0.06 0.05 0.04 0.04 0.04 0.03 0.01 0.00

Source: MOFCOM and World Bank. Own calculations.



Table 13.3 Chinese OFDI stocks in African countries as a percentage of host-country GDP (2005)

287 Chinese OFDI stocks in African countries in comparison with world stocks

Country

Niger Madagascar Benin Sudan Gabon Guinea Kenya Sierra Leone Rwanda Zambia Mauritius Mali Botswana Congo, Democratic Republic Algeria Zimbabwe Tanzania Libya Central African Republic Ethiopia Congo, Democratic Republic Senegal Togo Côte d’Ivoire Mozambique Ghana Seychelles Nigeria Liberia Cameroon Uganda Gambia Djibouti Cape Verde Equatorial Guinea Malawi Chad Lesotho Angola Mauritania South Africa Egypt Morocco Comoros Tunisia

Chinese OFDI stocks (US$ million) 20.44 49.94 19.00 351.53 35.36 44.22 58.25 18.45 4.72 160.31 26.81 13.28 18.12 13.32 171.21 41.63 62.02 33.06 2.00 29.82 25.11 2.35 4.78 29.11 14.68 7.33 4.19 94.11 15.95 7.87 4.97 1.19 0.40 0.60 16.56 0.73 2.71 0.60 8.79 2.40 112.28 39.80 20.59 0.01 2.15

Chinese OFDI stocks as a % of total world stocks 31.17 23.16 9.75 7.48 7.24 6.89 6.48 6.21 6.20 5.19 3.33 2.45 2.25 2.24 2.05 1.85 1.58 1.55 1.48 1.29 1.19 1.03 0.94 0.75 0.64 0.60 0.52 0.50 0.47 0.34 0.29 0.29 0.28 0.25 0.22 0.21 0.20 0.16 0.15 0.15 0.14 0.14 0.10 0.07 0.01

Source: MOFCOM and UNCTAD. Own calculations.



Table 13.4 (2005)


Table 13.5 Year

2004 2005 2006 2007

Growth of Chinese OFDI flows in Africa (current US$, 2004–2007) % change of Chinese OFDI flows in Africa (year/year) 324.31 23.39 32.73 202.83

% change of all OFDI flows in Africa (year/year) −19.65 30.42 6.44 61.96


Table 13.6

Growth of Chinese OFDI stocks in Africa (current US$, 2004–2007)

Year

% change Chinese OFDI stocks in Africa (year/year)

2004 2005 2006 2007

83.14 77.32 60.18 74.56

% change all OFDI stocks in Africa (year/year) 21.32 19.03 11.88 20.81


each of the four models used). Lists of the countries in the sample set are included in the Appendix (Table 13A.3). For the independent variables, this paper focuses on the two factors described above that might distinguish Chinese OFDI into Africa from global OFDI flows overall, which are the resource abundance of the host country and the presence or absence of corruption there. For resource abundance, two measures from the World Bank’s Data Catalog were used: one was metal and ore exports6 as a percent of total merchandize exports, and the other was fuel exports as a percent of total merchandize exports. While neither of these is a perfect measure of the resource intensity of the host country, they do help reflect the relative importance of resources in national output, and hence a country’s attractiveness for foreign investors. Data for these variables were available for 43 African countries for fuel exports and 45 for ore and metal exports. The missing countries were Angola, Chad, Congo, Democratic Republic of the Congo, Equatorial Guinea, Liberia, and Libya. To represent corruption in the host countries, this paper uses the Corruption Perception Index produced annually by Transparency International to rank countries from least to most corrupt, based on extensive surveys conducted by independent institutions. African countries generally rank poorly on the CPI: in the 2007 CPI, which was used in this study, 7 of the 13 countries considered to be the world’s most corrupt were African. Since the CPI relies on subjective responses to polls for its scores, it is an imperfect indicator. However, empirical studies frequently use the CPI as a proxy for



288

different corruption levels across countries and over time. Data on all African countries except one were available for this variable. As an alternative to the CPI, both the Polity variable, which quantifies the authority characteristics of states, and the World Governance Indicators from the World Bank were considered and tested in several models. Due to their special characteristics or their broader nature, however, only the CPI was retained for the final models. Finally, as a control variable, real GDP growth was used to represent the attractiveness and dynamism of the host-country market for investors, following UNCTAD (1999) and many business scholars who consider it a key determinant of OFDI flows (e.g., Asiedu, 2002 in her study of African OFDI). To smooth out any volatility in OFDI flows, an average was taken of the available data between 2000 and 2005 for the dependent variable. GDP growth was also averaged for 2000–2005. The CPI indicator for 2007 was used, since it incorporated the largest number of African countries and it was considered to be stable enough over time that a later year would still be a good reflection of the national situation in 2000–2005. The resource variables were from the year 2005. A description of the variables used and their correlation coefficients are given in Tables 13.7 and 13.8 below.

Table 13.7 Descriptive statistics

1. Chinese OFDI flows as % of world OFDI flows 2. Chinese OFDI stocks as % of world OFDI stocks 3. Corruption perception index 4. GDP growth 5. Ore and metal exports as % of total merchandize exports 6. Fuel exports as % of total merchandize exports

Mean

Standard deviation

3.76 2.47 2.84 13.22 4.33 11.21

5.79 4.92 0.92 4.19 18.18 26.13

Table 13.8 Correlation matrix 1 1. Chinese OFDI flows as a % of world OFDI flows 2. Chinese OFDI stocks as a % of world OFDI stocks 3. Corruption perception index 4. GDP growth 5. Ore and metal exports as % of total merchandize exports 6. Fuel exports as % of total merchandize exports

2

3

4

5

6

1.00 0.87

1.00

−0.36 0.09 0.55

−0.29 −0.06 0.43

1.00 0.17 −0.33

1.00 −0.09

1.00

−0.04

0.03

−0.23

0.04

−0.15

1.00



Gayle Allard 289

290


2.2. Methodology

Yi = α + βj Xij + δZi + εi where Y = dependent variable X = the set of independent variables j Z = the control variable (real GDP growth) i refers to the 26–36 countries included in the different samples and ε is the error term for the regression. The difference in the models was as follows: Model 1 : Chinese OFDI flows = α + β1 (ore and metal exports)i Global OFDI flows i + β2 (corruption perception index)i + δZi + εi Model 2 : Chinese OFDI flows = α + β1 (fuel exports)i Global OFDI flows i + β2 (corruption perception index)i + δZi + εi Model 3 : Chinese OFDI stocks = α + β1 (ore and metal exports)i Global OFDI stocks i + β2 (corruption perception index)i + δZi + εi Model 4 : Chinese OFDI stocks = α + β1 (fuel exports)i Global OFDI stocks i + β2 (corruption perception index)i + δZi + εi 2.3. Results The results of the regression experiment for the four different models are presented in Table 13.9.



The regression used Generalized Least Squares to correct for heteroskedasticity and obtain robust standard errors. Four different models were used, with different dependent variables in some cases and alternate independent variables in others. They all conformed to the following general model:

Gayle Allard 291 Table 13.9 Regression results Independent variables Corruption perception index

1. China OFDI flows as % of world flows

−1.138 (0.5985)∗

2. China OFDI flows as % of world flows

−0.8735 (0.4413)∗

3. China OFDI stocks as % of world stocks

−0.6306 (0.4095)

4. China OFDI stocks as % of world stocks

−0.8533 (0.4589)∗

Ore and metal exports as % merchandize exports

Fuel exports as % of merchandize exports

0.0166 (0.0275)

0.0008 (0.0142)

0.0431 (0.0189)∗∗

−0.0045 (0.0148)

Sample size R2

GDP growth (%)

0.205 0.1851

33

0.038

0.0479 (0.155)

32

0.014

0.0177 (0.123)

36

0.036

0.0361 (0.1582)

35

0.017

The results confirm that China is, indeed, more closely associated with corrupt environments than are global investors: the CPI variable was statistically significant in all models but one. On the resource side, however, fuels and metals/ores present different pictures. For fuel there is no significant difference between OFDI from China and the world as a whole. In contrast, the coefficient on ore and metal exports is strongly significant in one model, indicating that China is a relatively larger investor in countries that are major exporters of metals and ores than are global investors. GDP growth, in contrast, did not have a statistically significant coefficient, indicating that this variable has roughly the same importance for Chinese as for global investors. 2.4. Conclusions and discussion This exercise offers some valuable insights into China’s current and future role on the African content. The fact that Chinese OFDI is more closely linked than global OFDI to corrupt countries in Africa, confirming Hypothesis 1, gives support to both the theories of business scholars such as Cuervo-Cazurra and Genc (2008) and the popular impressions nurtured by the international press and many political observers. It should be kept in mind as well that some of the most corrupt countries in Africa according to Transparency International are missing from some or all of the



Dependent variable


data sets used in the regression models, such as Burundi, Chad, Somalia, and Sudan. A simple bivariant regression of the CPI on a dummy variable to reflect missing countries shows that the omitted countries are in fact more corrupt than those that are included in the sample (see Appendix, Table 13A.4). Hence China is favoring more corrupt countries to a larger extent than global investors in Africa. Since China’s OFDI flows and stocks are still relatively small compared to those of global investors overall, it would be an exaggeration in most cases to say that it was ‘propping up’ corrupt regimes. But clearly Chinese investors, whether public or private, are more comfortable with corrupt environments in Africa than traditional investors are. This fact, as China’s presence in Africa continues to grow, could pose risks for human rights in the region and could frustrate efforts by the global community to promote better governance and thus promote human development and freedom on a deeper level for African citizens. Hypothesis 2 is also partially supported: Chinese OFDI is more resourceseeking in Africa than global OFDI overall when it comes to metals and ores; while in fuels there seems to be no difference between Chinese and global investors. Again, the impressions given in the popular press appear to be correct. Although a broad base of small-scale Chinese investments in services and manufacturing exists across many African countries, and continues to flourish, much recent, large-scale Chinese OFDI is in fact driven by resource opportunities in metals and ores. This fact has implications for Africa’s future. As many development economists have warned (Easterly, 2002; Collier, 2008; Moyo, 2009), natural-resource wealth in countries with weak or underdeveloped institutional frameworks can undermine governance and eventually put at risk long-term economic growth and development. If Chinese OFDI is concentrated in resource extraction, especially in poorly governed countries, and a blind eye is turned to corruption, it could end up aggravating the governance problems and bringing benefits principally to the national/political elites in the host country. China’s determination to win these types of investment contracts also has implications for other foreign investors. The Chinese government, working through its SOEs, can offer conditions and bundles of financing and aid which are difficult to compete with. Hence there are justified concerns about the characteristics and side effects of this type of Chinese investment in Africa. It is also clear, however, that much of the Chinese investment in Africa is different from what makes headlines. There are reasons to believe that the dense web of smaller-scale investors in the manufacturing and retail sectors in many African countries, along with the large telecoms and technology companies, have different objectives from the Chinese SOEs. This web is being nourished by a substantial flow of Chinese immigration to Africa



292

Gayle Allard 293

3. Limitations and future research Much remains to be done in order to precisely quantify and correctly evaluate the impact of Chinese OFDI on the African continent. This exercise shows that even the best official statistics are incomplete, and may fall short of the numbers that are published in the international media on the huge projects being carried out by Chinese firms. Better data could help us to evaluate not only the governance implications of Chinese investment, but also their impact on environmental protection/destruction in host countries, which is a concern that will take on increasing weight in the future. Complete information on resource endowments rather than exports could help to clarify the reasons that foreign investors select particular countries. One interesting focus for future research on Chinese OFDI in Africa might be on the micro-level, to determine whether small and/or private Chinese firms behave differently there than the government or its SOEs. China’s economy is growing at breathtaking speed, and it needs the resources Africa can provide. Planned future investments on the continent will be in transportation (railways linking the coasts of Africa from Zambia to the DRC), financial services and banking, and natural resources. China appears to have a forward-looking plan in Africa that is tied into its strategic interests. In Moyo’s view, China’s role in Africa is wider, more sophisticated, and more businesslike than any other country’s at any time in the post-war period (Moyo, 2009). Is China ‘conquering’ Africa with its aggressive investment policies? Does it have a hidden agenda to counter the move toward democracy in the region? Is it turning a blind eye to the environmental impact of its investments? Even if good data were available, questions about China’s intentions would be impossible to answer. And only time will tell what the real effects of its arrival in Africa will be for the continent. But even if China’s investments could be shown to damage the governance, social and environmental objectives that the West holds dear, a similar criticism could be leveled at the actions of Western countries in the region not only in recent years but over decades of European colonial history. If China is a danger for Africa, the West must beware and perhaps be poised to react; but it is hardly the best party to point the finger.



(Alden, 2007; Mohan & Power, 2008). Private Chinese business owners, especially the small ones, are likely to pursue objectives that are more similar to those of private foreign investors around the world. As their relative weight increases, they could comprise a merchant class or lobby that could become a force for social and even political change, and not necessarily in a negative direction.

294

Appendix

Country Zambia Liberia Madagascar Niger Zimbabwe Guinea Mali Gabon Togo Benin Equatorial Guinea Mauritius Kenya Rwanda Mauritania Ghana Tanzania Nigeria Seychelles Côte d’Ivoire Ethiopia Senegal Cameroon Mozambique Malawi South Africa Botswana Lesotho Uganda Egypt Gambia Morocco Algeria Tunisia Congo, Dem. Rep. Sudan Libya Angola

OFDI stocks (US$ million)

OFDI stocks as % GDP

143.70 5.80 28.13 12.50 36.74 14.34 12.09 24.05 4.73 7.71 8.64 12.59 25.53 3.30 1.82 6.60 7.46 31.98 0.42 8.05 4.78 2.51 5.73 2.42 0.72 44.77 2.10 0.24 1.33 14.29 0.04 4.31 5.70 1.56 0.24 0.55 0.86 0.30

3.90 1.41 0.71 0.60 0.60 0.46 0.40 0.40 0.33 0.30 0.29 0.22 0.19 0.15 0.14 0.12 0.07 0.06 0.06 0.06 0.06 0.05 0.05 0.05 0.04 0.03 0.03 0.03 0.02 0.02 0.01 0.01 0.01 0.01 0.01 0.00 0.00 0.00

Source: MOFCOM and World Bank. Own calculations.



Table 13A.1 Chinese OFDI stocks in African countries as a percentage of host-country GDP (2003)

295 Chinese OFDI stocks in African countries as a percentage of global OFDI

Country

Niger Madagascar Benin Rwanda Guinea Zambia Zimbabwe Kenya Mali Mauritius Togo Senegal Ghana Mauritania Cameroon Ethiopia Malawi Côte d’Ivoire Equatorial Guinea Botswana Tanzania Liberia Nigeria Libya Mozambique South Africa Uganda Algeria Egypt Seychelles Lesotho Morocco Sudan Congo, Democratic Republic Gambia Tunisia Angola

OFDI stocks ($US million)

OFDI stocks as a % total world stocks

12.50 28.13 7.71 3.30 14.34 143.70 36.74 25.53 12.09 12.59 4.73 2.51 6.60 1.82 5.73 4.78 0.72 8.05 8.64 2.10 7.46 5.80 31.98 0.86 2.42 44.77 1.33 5.70 14.29 0.42 0.24 4.31 0.55 0.24

20.56 15.08 5.14 4.43 4.37 3.64 3.47 2.66 2.54 1.57 1.02 1.00 0.50 0.46 0.26 0.25 0.24 0.23 0.23 0.18 0.17 0.16 0.14 0.14 0.10 0.10 0.09 0.09 0.07 0.06 0.06 0.03 0.02 0.01

0.04 1.56 0.30

0.01 0.01 0.00




Table 13A.2 (2003)

296 The countries included in the regressions

Model 1 (33 countries)




Algeria Benin Botswana Cameroon Cape Verde Côte d’Ivoire

Algeria Benin Botswana Cameroon Cape Verde Côte d’Ivoire

Egypt Ethiopia Gabon Gambia Ghana Guinea Kenya Lesotho Madagascar Mali Mauritania Morocco Mozambique Niger Nigeria Rwanda Senegal Seychelles Sierra Leone South Africa Sudan Tanzania Togo Tunisia Uganda Zambia Zimbabwe

Egypt Ethiopia Gabon Gambia Ghana Guinea Kenya Lesotho Madagascar Mali Mauritania Morocco Mozambique Niger Nigeria Rwanda Senegal Seychelles South Africa Sudan Tanzania Togo Tunisia Uganda Zambia Zimbabwe

Algeria Benin Botswana Cameroon Cape Verde Cent. African Republic Comoros Côte d’Ivoire Egypt Ethiopia Gabon Gambia Ghana Guinea Kenya Lesotho Madagascar Malawi Mali Mauritania Morocco Mozambique Niger Nigeria Rwanda Senegal Seychelles Sierra Leone South Africa Sudan Tanzania Togo Tunisia Uganda Zambia Zimbabwe

Algeria Benin Botswana Cameroon Cape Verde Cent. African Republic Comoros Côte d’Ivoire Egypt Ethiopia Gabon Gambia Ghana Guinea Kenya Lesotho Madagascar Malawi Mali Mauritania Morocco Mozambique Niger Nigeria Rwanda Senegal Seychelles South Africa Sudan Tanzania Togo Tunisia Uganda Zambia Zimbabwe



Table 13A.3

Gayle Allard 297 Table 13A.4 Results of regression of corruption perception index on dummy variable of missing values

Model 1 Model 2 Model 3 Model 4

Missing value dummy −0.55 (0.25)∗∗ −0.60 (0.25)∗∗∗ −0.50 (0.27)∗ −0.55 (0.26)∗∗

Note: *