Written By Shujie Yao.

China has been one of the largest recipients of foreign direct investment (FDI), which has been a main driver of its fast economic growth. From 2004, Chinese companies started to invest aboard. By 2012, the total amount of outward foreign direct investment (OFDI) was over $70 billion, rising by 29% from the previous year, making China one of the five largest foreign investors in the world.

At the Bo Ao Forum in 2013 held in Hainan, President Xi Jinping predicted that China will import $1 trillion of goods from other countries and invest $500 billion in the rest of the world in the next 5 five years. This implies that in five years’ time China will have become one of the world’s top two or three largest foreign investors. It will also invest more overseas than it will receive capital from other countries.

China’s OFDI has several motivations. One is to seek strategic foreign resources, particularly iron ore, oil and gas. As traditional exporters of natural resources have built a strong relationship with the US and other western countries, China has to focus its resource-seeking efforts on the emerging and developing economies such as Russia, Africa and Latin America. Australia and Canada are two other important resource exporters to China in terms of iron ore, coal and oil.

However, the impression that China invests only to seek strategic resources is false, as over two-thirds of its OFDI are not related to resources.

Emerging economies have increasingly become important markets for Chinese goods and services since the world financial crisis broke out in 2009. In 2012, for example, when the trade volume between China and its largest trading partner, the EU, declined, the trade volume between China and Africa rose more than 30%. China’s trade with other emerging economies such as Brazil, India, Russia and South Africa also increased much faster than before.

China’s OFDI has been predominantly made by its largest state-owned enterprises (SOEs), as investment made by private companies is still insignificant.

There are many constraints on Chinese companies to invest abroad. These include lack of human capital; unawareness of cultural, regulatory, legal, and labour market differences; and lack of an efficient international marketing network. When Chinese companies compete with foreign multi-national enterprises (MNEs), they may lose out because of these constraints.

The constraints also explain why private firms are more reluctant to go global than SOEs. This is because SOEs still enjoy significant support from the state in terms of soft budget constraints and indirect subsidies through some generous arrangements of bank credit.

Despite the fact that all the large SOEs are now listed on stock exchanges and hence partially privatized, they are still not entirely responsible for their gains and losses. When large SOEs make huge profits, they do not need to deliver them to the state. SOE directors have full autonomy to allocate all the retained profits, either for paying extraordinarily high wages to their employees or making investments, domestic as well as foreign.

The most profitable SOEs enjoy significant monopoly power in the domestic market (e.g., Petro China, Chinalco and ICBC). Once these companies accumulate sufficient amounts of monopolistic profits, they will be able to take big risks and invest in other countries.

The second kind of support that the state can provide to SOEs making foreign investments is through easy bank credits with preferential terms of condition regarding the payback time and interest rate.

For instance, when Chinalco was proposing to buy a further stake in Rio Tinto in 2009 at the peak of the world financial crisis, four large state-owned banks were happy to provide a huge loan worth $21 billion. The proposed interest rate that Chinalco would have to pay was significantly lower than the prevailing rate that foreign MNEs would have to pay for a similar kind of borrowing.

The deal between Chinalco and Rio Tinto failed in the end because Rio Tinto found another solution to resolve its financial problems after a few months of strong performance of its share price in the stock market. Although Chinalco felt it was let down by Rio Tinto, on reflection, the failed deal saved the four state-owned banks hundreds of millions dollars which would have been covered by the state.

Not all international investments conducted by Chinese companies have been supported by the state, but the fact that the state has played an important role in helping these companies become global has triggered some theoretical debates as to why the government is happy to support such listed and partially privatized companies.

Considering that the state has the objective of helping individual enterprises to become global and such enterprises lack the capability and hence willingness to go abroad without state support, then it is easy to understand that the state and company objectives are in fact complementary.

State objectives are twofold: gaining reputation and world power, and securing a stable supply of resource at reasonable prices.

As China is rapidly becoming the largest economy in the world with a large population, it has to build a good reputation in the global system and to impose its influence on the globalisation process. Without massive investments abroad and without a large number of national champions to lead the way for this purpose, the national ambition will not be fulfilled.

This national objective, however, cannot depend on any single enterprise to achieve it. However, going global is not in the form of a nation, it is in the form of individual firms. Asking individual enterprises to fulfill a national ambition means that the state has to provide some incentives, as a firm’s private objective is profit maximisation. If an investment project does not generate as much profit abroad as it does domestically, there is no incentive for the firm to go out.

Nonetheless, going out is better for the state than if the firm just stays at home. In this situation, the state has to provide some guaranteed incentive to make foreign investment attractive enough for the firm.

There is another reason for the state to support a firm going out. For instant, if an investment in a foreign resource company can guarantee a steady supply of resources to China at reasonable (not manipulated) prices, the whole industry which uses such resources will benefit in China. However, the firm which makes this kind of investment may not benefit directly itself.

In the case of Chinalco, for example, its investment in Rio Tinto is not just for Chinalco to make financial gains. All the steel makers in China would have benefited if Chinalco had been able to secure a large stake in Rio Tinto to influence its price setting behaviour and to guarantee a steady supply of iron ore for China’s steel industry.

From 2001 to 2009, the price of iron ore rose multiple times, reducing the profit margins of steel makers in China to such an extent that the total profit of its entire steel industry was less than half of that of any of the three largest miners in the world, Rio Tinto, BHP and the Vales.

If Chinese companies could have participated in the price setting process of iron ore, China would have gained more than $600 million per year for every one percentage reduction in the export price of iron ore. This amount of saving was enough for the interest rate concession that was proposed to Chinalco when it were about to secure an 18% stake in Rio Tinto in 2009.

Other examples of state support to Chinese companies going abroad has included the outright acquisition of Volvo by Geely, a private car maker in China. The support, of course, was not in the form of direct subsidies, but in the form of easy and low interest rate bank credits.

In short, Chinese companies becoming global were led by large SOEs, which have been supported by the state in the forms of soft budget constraints and easy bank credits. China’s OFDI is not just for resource seeking, but also for market expansion and technology seeking. As exports have been more difficult in recent years, China’s OFDI will become an important impetus for its future export growth.

As Chinese firms become more and more competitive globally over time, the direct and indirect support by the state to them will be reduced and eventually eliminated.

Shujie Yao is Professor of Economics and Chinese Sustainable Development and Head of the School of Contemporary Chinese Studies, University of Nottingham, UK. 


  1. The blog could have been more closely checked for accuracy as the statement “From 2004, Chinese companies started to invest aboard” is incorrect, which I am sure would Shujie acknowledge. One of the most interesting features about Chinese FDI is that not only has it been since the early 1990s one of the largest – sometimes the largest – recipient of FDI inflows globally, but it has also been an major exporter of capital, that is, engaged in outward FDI. This has certainly increased hugely over the past decade. But it began back in the 1980s, not in 2004. One of the earliest and for many years the largest was the 1986 decision to buy into the Mount Channar iron ore mine in Western Australia. Off the top of my head I think the investment was then about US$100m. The mine is owned by Rio Tinto (60%) and Sinosteel (40%), and is a major supplier of iron ore to China’s steel-making industry.

  2. Professor Yao, I am not sure whether rating countries by their outward FDI is a helpful measure, because it does not account for the assets held by specific organizations in other countries, the per capita or per size of the outwardly investing country or the net foreign assets already held by other countries. For example, the liquid assets managed by individual foreign portfolio investment companies, e.g. taking on its own Black Rock Asset Management, the US largest asset management firm, come close to matching China’s entire foreign exchange reserves. Moreover, non-financial companies such as Shell Oil, Vodaphone and XStrata (all UK) own or have owned vastly more foreign assets independent of overall outward annual FDI for the UK. So while OFDI highlights a trend of increasing ownership by Chinese companies abraod, the political obstacles and enormous head start of other countries and companies in accumulating assets rightsize any claim to China’s OFDI companies reflecting China going global by comparison. Unfortunately, Volvo was seen by many as a failed small-medium enterprise and I’m not sure I know of any other Chinese acquisitions – although did China not recently buy Weetabix cereals? – how will China overcome the political obstacle to doing business at any substantial level or scale outside of China?

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