In 1793, the Qing Emperor, Qianlong, informed his Britannic Majesty’s first Ambassador, Lord George Macartney that “As your Ambassador can see for himself, we possess all things. I set no value on objects strange or ingenious, and have no use for your country's manufactures.” Attitudes of economic nationalism in China have been suspended, but have not changed. What is interesting about economic nationalism in China is that the Chinese leadership were able to keep it at bay for so long.
In other Asian countries like Japan and Korea, their incredible economic growth over the past fifty years has been created mostly by internal savings. Investment by foreign firms has often been actively discouraged. In 2003 Lonestar, an American private equity group bought a controlling, 50.1 per cent stake in a troubled Korean bank, Korea Exchange Bank, for $1.2 billion. The proposed sale of its investment for $6 billion to another Korean Bank has provoked investigations and even an arrest warrant. Last March the prime minister described foreign capital as “a shark and devour everything.”
Nor is economic nationalism limited to Asia. Russia has recently passed several laws limiting participation in its oil industry to local, usually state owned firms. More advanced countries are hardly immune. France’s prime minister, Dominique de Villepin, cobbled together a merger between Suez, a formerly state-owned French water and power company and Gaz de France (GDF), a state-controlled gas company to fend off a possible hostile bid by Enel, a massive Italian electricity company.
What is interesting about China is that they were able to tolerate such massive amounts of foreign investment. This was basically a measure of the desperation that the country found itself after thirty years of Mao style communism. Like the Meiji Japan, China needed foreign money, management, markets and technology to modernize its economy.
The benefit of an autocracy at the beginning of an economic modernization is that they can focus the economy without any local opposition. They do not have to worry about constituencies, labor unions, zoning, local businesses or anyone else who might object to foreign competition. . They can build the infrastructures necessary to attract foreign investment without consulting anyone, who might be harmed by the process. They can lower taxes, without worrying about protests from other taxpayers. They can force state owned banks to loan money at favorable interest rates with bothering with either minority shareholders or depositors. They can find workers or even prisoners, who will work for pennies. There is no need to provide any protection for employees, so extensive overtime or dangerous work environments need not concern foreign investors. If truly motivated, autocracies can sweep away any and all impediments. For most of the past twenty years, the Chinese were truly motivated, but things change.
Chinese leaders have also learned that there is another major benefit to foreign investors. When they have served their purpose, they can be thrown out. After twenty years of spectacular economic growth, Chinese leadership is beginning to debate the need for foreign investors. Like leaders everywhere they are beginning to believe their own spin and that the success of China is due to their skill alone. The reality is that 80 per cent of the Chinese export machine is the result of foreign companies. In fact, China's economy is so unproductive, that it has to continually feed money into the economy to sustain its economic growth. Already China needs almost $5 of fresh capital to generate $1 of incremental output. The growth of local Chinese state owned companies is often due to cheap loans, stolen intellectual property and protected markets rather than managerial skill and technological prowess. They gorge themselves on over 73% of bank credit, yet produce less than half of GDP.
The recent IPOs of Chinese state owned banks have been wildly successful. Forty billion dollars have been poured into minority stakes of insolvent banks. Rather than pat themselves on the back for legally accomplishing the most successful financial scam of all times, the Chinese are beginning to view the sales of these assets as an attempt to colonize China economically. The reality is that the Chinese gave away nothing in return for the sales of these minority stakes. The Chinese retain full control of these banks and even the strategic have little to say in their management. In exchange they received a wall of money that can be squandered without restraint. Still, the backlash against foreign investors is beginning to resonate through the Chinese economy.
The recent Bank of China IPO was originally set to sell far more of its existing shares than the 16.85 per cent that were actually put on the market. Temasek Holdings, the Singapore state investment company wanted a 10 per cent stake in the offering, but that was cut in half to just 5 per cent.
In a private deal Citigroup was supposed to purchase 85% of Guangdong Development Bank (GD
. Despite its 13m customers, 500 branches and a strong franchise in the manufacturing center of Southern China, GDB is probably not worth owning since its bad loans are reported to be at least 25% of assets, probably much more. Originally, Citigroup was to team up with Carlyle, the US private equity firm to buy at least 40% of the bank. Citigroup did finally get its deal, but its share of GDB is limited to only 20%. The vast majority of the bank is owned by State Grid, a Chinese utility, China Life, the mainland's biggest insurer and Citic Trust. All of these companies are state owned. So although it was reported that Citigroup has “operation control”, the real control of GDB remains with the Chinese government.
It is not just the financial industry. Last fall, Carlyle was all set to become the first foreign buyout group to gain control of a big Chinese company. Carlyle inked a contract for the purchase of 85% of Xugong, the country's leading maker of construction machinery in exchange for $375 million, which was a mere 30% premium over previous deals.
The deal collapsed, when Xiang Wenbo, chief executive of Sany Heavy Industries wrote in his personal blog that his company wanted to bid for Xugong. Although Sany is only a third the size of Xugong, the blog bid was taken seriously because Mr. Xiang was allegedly protecting a strategic industry. Carlyle’s squeals of an in place agreement had no effect. Eventually Carlyle had to settle for a 50% interests at a slightly higher price.
Direct obstruction of FDI by the Chinese authorities is bad enough. In addition there are many trade barriers that the Chinese have recently used to stymie direct investment in China. For example, despite its vocal opposition elsewhere, Wal Mart has been forced to accept a union in China. The union in question is the All-China Federation of Trade Unions basically an arm of the Chinese government.
Foreign products can also be attacked indirectly through Chinese regulators. Procter & Gamble was recently the victim of one of these attacks. The Shanghai General Administration of Quality Supervision, Inspection and Quarantine said that it had found traces of chromium and neodymium in three products in the SK-II line of cosmetic products. P&G denied that any metals had been found in it products and no contamination was ever proved. Still P&G’s brand was damaged and it was forced to give refunds. Similar attacks have been made on other western investors including Dell, General Mills, Heinz, KFC, Lipton teas, Colgate-Palmolive and Sony.
China's top economic planning agency, the National Development and Reform Commission (NDRC) has stated in it most recent pronouncement that it wants China to shift to a "quality, not quantity" in terms of FDI. Finding quality will most likely depend on how much a premium the foreign investor is willing to pay rather than the type of investment.
The Chinese have convinced themselves and most of the world that the best place to make money is in China. Since this is their view, it is not surprising that the Chinese want to keep most of that money for themselves. To insure this occurs the Chinese government will do all in its power to squeeze the highest premium from foreign investors. In addition it will use a variety of means to make life difficult for companies who are already operating in China. This will be especially true if the foreign company is competing with a local state owned company.
This escalation is likely to continue until foreign investors are forced to awake from their China dreams by the alarms from their bottom lines. Since profit is not a motive for the Chinese leadership, their delusions are likely to last much longer. As their cognitive biases begin to effect the economy the Communist will eventually follow the Qing dynasty.
