China Slowdown and Foreign Investment

It is becoming clear that the Chinese economy is experiencing a significant decline in its recent growth rates. Growth in Chinese real GDP has been at least 8%/year since 2000, and at least 9%/year since 2004, peaking at near 12% in 2007. In 2012, growth will almost certainly be below 8%, and possibly below 7%. And the growth trend is downward, including because recent growth has been fueled by uneconomic investment and a property bubble that are producing serious and unsustainable economic imbalances in China. Although growth around 7% sounds healthy from a Western perspective, it is much more dangerous in China where government financing relies heavily on approaches such as taking land from individual owners and reselling it to developers at a significant profit.

These trends are negative for domestic investment flows in China. But the same conclusion does not follow for foreign investment by the Chinese government and private sector in foreign companies. In fact, the opposite is likely to be true, for several reasons.

• First, China will remain a substantial net exporter for the foreseeable future, generating significant funds for investment, and this investment is increasingly likely to flow abroad because of the trends discussed above.  
• Second, in order to transform from a low-cost economy towards an advanced economy, China will increasingly require access to advance, cutting-edge technologies. Notwithstanding perceptions that China tries to steal foreign technologies through industrial espionage, the reality is that Chinese businesses looking for technology will have no choice to significantly increase foreign investments. China does not yet approach the West in successful technology innovation, and is unlikely to catch up soon.  
• Third, Chinese direct investments in Western companies (at least outside natural resources sectors) have so far been relatively moderate (in contrast to the large Chinese investment in US Treasury securities, and similar assets). This is particularly the case in Europe, as illustrated by a recent study "Chinese Overseas Direct Investment in the European Union", published by the Europe China Research and Advice Network. In short, there is almost no way to go but up.

All of these factors suggest to us that there will be a long-term trend of increasing Chinese investment in Western companies, particularly technology companies, notwithstanding the ongoing (and likely increasing) slowdown in Chinese growth.

Of course, there are barriers to growth in Chinese foreign direct investment.  Some governments, notably the United States, have blocked Chinese investments perceived to be in strategic sectors, sometimes with rather weak rationales. In some cases, such actions smack of protectionism, and distrust of a powerful China in a lower-growth world. Differences in negotiating styles, as well as communications challenges, between Chinese and Western companies are also real challenges. But these barriers will not be sufficient to derail the trend, particularly as experience and sophistication of both Chinese investors and their Western partners continues to grow.

Maury Shenk, Lily Innovation Advisors