Reciprocity and investment liberalization

Some thinking on the rapidly deteriorating situation in 2017 for Chinese companies seeking to invest abroad

I recently finished a really fantastic book called “American Wheels, Chinese Roads: The Story of General Motors in China” by a guy called Michael J. Dunne. Like a very small handful of other – I guess you would call them – “business books” on China that I have read over the years, this one has many truly insightful hidden gems just waiting to see the light of day. One that I found particularly prescient given developments since 2011 (when the book was published) is right at the back of the book and is a mock or simulated memo that an industry veteran now acting as a special advisor would send to the president’s special auto task force. This pretend memo has lots of great advice but I liked it for three rules that the memo lays out for US negotiators dealing with a future Chinese auto industry hungry for international expansion (which is likewise true in many other industries where Chinese companies are starting to contest global markets) Dunne’s three rules are as follows

Rule # 1: If the Chinese want to sell their cars to Americans, they must invest in plants in America;

Rule # 2: Chinese companies will be free to own 100 percent of their operations in America – provided that American car companies get the same rights in China. (If the Chinese refuse, then America will reciprocate. Chinese companies that want to sell in America will be required to joint venture with city or state government). Have the Chinese start out with the City of Detroit and the UAW as partners). [Emphasis in original].

Rule # 3: Profits from operations stay inside the Unites States. Repatriation to China will be limited and will require approvals from the U.S. government. That’s not an extreme demand – it’s just quid pro quo.”

I called this prescient because in the time that has elapsed since then, this is precisely the direction US trade and investment policy has taken. Look at the six core principles articulated in the “Model Bilateral Investment Treaty” released in April 2012 by the Obama Administration: (1) national treatment and most-favored nation (MFN) treatment at all stages of investment [i.e. same rules for US investors that Chinese and other foreign investors have to abide by]; (2) rules on expropriations and compensation if this occurs; (3) ability to transfer funds in and and out of the country [i.e. no more capital controls]; (4) limits on performance requirements (such as domestic content targets or mandated technology transfer); (5) neutral arbitration of disputes; and (6) freedom by investors to appoint their own senior officials.

The Trump administration looks like it will go even further. Page 5 of its recently released 2017 Trade Policy Agenda and Annual Report contains the following paragraph that is very revealing:

“It is time for a more aggressive approach. The Trump Administration will use all possible leverage to encourage other countries to give U.S. producers fair, reciprocal access to their markets. The purpose of this effort is to ensure that more markets are truly open to American goods and services and to enhance, rather than restrict, global trade and competition. Such a policy will help grow the global economy by breaking down long-standing trade barriers and promoting increased competition.”

But it’s not just the U.S. that is starting to demand a more measured approach to welcoming outbound Chinese investment to its shores. A number of European Union countries recently requested that the European Commission grant them more far-reaching powers to screen Chinese investment in potentially sensitive or critical sectors (particularly high-tech and infrastructure). A February 19 article by Emanuele Scimia published in the Asia Times entitled “The EU’s Great Firewall against Chinese Investment” describes the issue in some detail. Paraphrasing the demands of the Italian, French and German governments to the European Commission, Scimiar writes:

“EU companies have to be treated in China in the same way as Chinese investors in Europe. The EU is open to foreign competition and calls on China to do the same.”

My take on this is that for more than two decades now, foreign investors in China, particularly from the U.S. and Europe, were not particularly happy with all the restrictions placed on them when they wished to enter the Chinese market. But they were willing to abide by these rules and take their chances because they sensed that the sheer size of the Chinese market and the profits to be made there would dwarf anything they had previously experienced. Joe Studwell (another favorite author of mine) described this line of thinking in his superb 2002 book “The China Dream: The Quest for the Last Great Untapped Market on Earth“. And for many companies this proved to be true. As Michael J. Dunne points out in “American Wheels, Chinese Roads”, at the height of General Motors’ 2009 bailout following the Financial Crisis, the Chinese unit of GM was by far the most profitable globally, and was a compelling reason that the United States Treasury (Steven Rattner in particular) didn’t decide right then and there to shutter GM forever.

On the geopolitical front, countries were of course aware of these restrictions but were willing to cut China some slack, since they had business leaders telling them not to go too hard, they also felt that a policy of friendly engagement would serve their interests better than confrontation, and finally because China was seen by many as a developing country with billions of poor peasants trying to eke out an existence in the countryside. China was also very astute at playing one set of foreigners off against another if one group pushed too hard, and was also more than happy to bring up the many historical injustices it suffered at the hands of foreigners aggressively pushing to enter its markets in the age of colonization (see James McGreggor’s superb book “One Billion Customers: Lessons from the Front Line of Doing Business in China” for more on this).

But those days are now well and truly over. Western business interests have now largely given up on the soft approach since they have seen their ability to operate profitably in China become increasingly more constrained over the last decade or so. And now that China is the 2nd largest economy in the world and starting to field a modern navy, as well as a state of the art space program, nobody seems to want to handle China with kid gloves anymore.

This is now becoming a freedom of action issue for Chinese companies investing abroad, and so I predict that in the next few years, Chinese policymakers will need to consider carefully opening their markets anew. This is especially true if they want to assume the leadership on regional and international trade and investment liberalization that they are now actively asserting at places like last year’s APEC conference in Lima and at the 2017 World Economic Forum meeting in Davos. These are certainly interesting times for trade and investment policy wonks. Thanks again to Michael J. Dunne for his book.

Originally published by the author on LinkedIn.