Big Profits – But Who Should Get Them?

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We already know that foreign businesses in China are profitable (see here and here), but US companies’ corporate profits were over US$2 billion in the fist half of 2006 – up over 50 percent on the same period in 2005 – according to a report in USA Today (via China Daily) that is based on research from the US Bureau of Economic Analysis.

Foreigners are, of course happy to be making profits, and that it why they planned moves to China in the first place. However, big profits have a political element to them, and many in China have already been questioning the role of foreign investment and have been angered by the selling off of Chinese state assets to big foreign banks and other “strategic” investors – who can see huge profits almost over night. This is partly why Carlyle was blocked from taking control of Xugong, and why ICBC had a Shanghai listing at the same time as the Hong Kong one.
An article in People’s Daily asks the question openly: “Is China using too much foreign capital?”. The surprise is in their answer:

    “Since China joined the WTO, foreign direct investment (FDI) has grown steadily. The amount of foreign investment used each year between 2002 and 2005 was US$52.7 billion, US$53.5 billion, US$60.6 billion and US$72.4 billion, ranking the highest of all developing countries. In the first half of 2006, the number of newly approved enterprises established with foreign capital fell by 6.89 percent, but the actual scale of investment was still high. Foreign capital is playing an irreplaceable role in China’s economic development.

    A growing number of people are worried about whether China is using too much foreign capital. Using precise econometrics models, many researchers are studying the situation and calculating the proper amount of foreign capital that China should absorb annually. As a matter of fact, the amount of foreign investment used is a moot point.”

The article notes that developed economies use foreign capital, and that “theoretically” China is becoming part of the global economy, and is improving productivity as a result. That in turn should assist in the development of “a better social welfare system”. In regulating foreign investment, the article notes:

    “Industry policy regulates investment, as do some macroeconomic tools such as laws, financial policies, monetary policies and exchange rate policies. Restricted by the market economic system and the WTO’s rules, the number of administrative measures is decreasing and they alone are insufficient to control foreign investment. Instead, equal provisions should be made for both domestic and foreign capital. Foreign capital and all investors needed to be regulated. Industry policy is the key to managing foreign investment, but fails to control its size. It adjusts mainly the structure of foreign investment.”

So the type of foreign investment is controlled by policy and regulation, but not the overall amount (at least in theory). It goes on to say that even abolition of those policies designed to promote foreign investment would not control it. This would include the debate (read “political infighting”) over unified taxation for foreign and domestic firms, as well as the exchange rate policy (which is generally thought to undervalue the RMB).

    “In the traditional planned economy, China believed it could determine the size of foreign investment. However, it found this was not possible in a market economy. It would be a waste of social resources for economists to spend time studying an issue with neither reference value for decision-making nor academic value. “

Strong words, and interesting stuff. It is surely a reflection of some high-level positioning in Beijing. The powerful National Development Reform Commission (NDRC) has stated that its focus is on the quality of foreign investment rather than the quantity. Some would like to harness investment for the general good, and the promotion of the “Harmonious Society”, while others would like to restrict it for strategic or protectionist reasons.

While the debate continues (and after it finishes) I will repeat my advice that foreign firms in China need to watch policy closely, and remain sensitive to local perceptions of their activities and their economic and social impact. A helping hand (such as that from Caterpillar) is likely to be viewed in a different light from a simple grab for some under-valued assets.

See news sources:

    ‘China Dream’ of US firms – rising profits
    China Daily – China
    US corporate profits in China passed $2 billion the first six months of 2006, up more than 50% from the first half of last year, according to the US Bureau of …

    Is China using too much foreign capital?
    People’s Daily Online – Beijing,China
    … capital through indirect regulation. Since China joined the WTO, foreign direct investment (FDI) has grown steadily. The amount of …

One Response to “Big Profits – But Who Should Get Them?”

  1. Says:

    […] llent post on foreign investment by Jeremy Gordon.  No excerpts here, please read the whole thing.  The issue concerns the level of foreign investment coming in to China and wh […]

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