China’s Outward Foreign Direct Investment 


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China’s Outward Foreign Direct Investment

Leonard K. Cheng and Zihui Ma

December 2008

In this paper we provide a systematic analysis of the size and composition of China’s outward foreign direct investment (FDI) in 2003-2006. Despite the attention given to China’s recent outward FDI, its FDI flow in 2006 accounted for about 1.74% of the world’s total FDI flow in that year, and its FDI stock by the end of that year accounted for only 0.73% of the world’s total FDI stock. Its FDI flow and stock are smaller than the leading developed countries as well some small industrial economies and emerging developing economies.

The bulk of China’s FDI was made by its largest multinational companies owned by or associated with different levels of government. By the end of 2006, business services accounted for the largest share of China’s outward FDI stock, followed by mining and petroleum, wholesale and retail, transportation and storage, and manufacturing. The true breakdown of the destination of China’s FDI was basically unknown because a predominant share of the investment in recent years was made in the world’s tax havens.

An empirical analysis of the destination of China’s FDI reveals that the host economies’ GDP and sharing of a common border with China had a significantly positive impact, whereas their respective distances from China had a negative impact on the flow but not the stock of FDI from China. Their real per capita GDP had no impact on FDI flow but a negative impact on FDI stock. Cultural proximity was a positive factor in attracting China’s FDI to the host economies that speak the Chinese language. Landlocked countries had a disadvantage in both the flow and stock of Chinese FDI. These results are compared with those of South Korea and Japan.

An empirical analysis of the characteristics of investor economies and their total outward FDI reveals that real GDP, real per capita GDP, foreign reserves, currency appreciation, and status as tax haven all had a significantly positive impact on the source economies’ outward FDI flow. Even after accounting for all of these factors, they made greater investment over time. These relationships may be used for understanding China’s future FDI.

  1. Introduction

China’s has achieved remarkable success in attracting foreign direct investment (FDI) since the earlier 1990s. It became the largest recipient of FDI among developing economies for the first time in 1993 and then became one of the top three recipients of FDI in the world in 2003 – 2005, and No. 4 in 2006 based on preliminary estimates.1 Perhaps as a reflection of this success, there are many papers written on the various aspects of China’s inward FDI. In contrast, China’s outward FDI up to now is small, and thus not as much systematic research has been done on it.

Nevertheless, as China is rapidly integrating with the global economy, its outward FDI has picked up in recent years. More importantly, perhaps, several major acquisition efforts have brought media attention to China as a source of FDI. Among them, Lenovo’s acquisition of IBM PC announced in December 2004 could arguably be the most eye-catching example of these efforts. The other highly visible cases included the electronic appliance manufacturer TCL’s acquisition of France’s Thomson Electronics in 2004, white-goods manufacturer Haier’s building of plants in the US since the late 1990s, China’s third largest oil producer CNOOC’s failed attempt to acquire US oil company UNOCAL in 2005, and Nanjing Automotive’s success in acquiring UK’s MG Rover Group in 2005.2 The energy crunch in 2006 also witnessed numerous stories about China’s effort to invest in oil companies in the world, in particular in Russia, Central Asia, and Africa, giving an impression that resource grabbing was a key driving force behind China’s outward FDI.


A description of China’s outward FDI from 1979 to 1996 can be found in Cai (1999). The country’s annual FDI outflow grew from virtually zero in 1979, when China embarked upon its open door policy, to US$628 million in 1985, and to US$913 million in 1991, before shooting up to US$4 billion in 1992, the year in which China’s paramount leader Deng Xiaoping made an important tour to South China to reaffirm China’s commitment to its reform and open door policy in the aftermath of the Tiananmen crackdown in 1989.

By the end of 1996, China’s total stock of FDI outflows was over US$18 billion. It surpassed South Korea (US$13.8 billion) and Brazil (US$7.4 billion) to move up to the number four position among developing economies, behind Hong Kong (US$112 billion), Singapore (US$37 billion), and Taiwan (US$27 billion) (Cai, 1999, p.861).

In the period of 1979-93, almost two thirds of China’s FDI was made in Asia, including 61% in Hong Kong and Macau. The other regions in descending order were North America (15%), Oceania (8%), Central and Eastern Europe (5%), Africa (2%), Latin America (2%), and Western Europe (2%) (Cai, 1999, p.864). Near 60% of China’s FDI up to 1994 was in the services sector, mainly to service and promote its exports. The remaining FDI was in natural resources (25%) and manufacturing (15%, mainly in textiles and clothing, and other labor-intensive industries, located primarily in Africa, Asia and the Pacific).

The FDI statistics used by Cai were provided by UNCTAD and collected by the IMF based on balance-of-payments accounting. Relative to the UNCTAD statistics, outward FDI statistics provided occasionally by the Ministry of Commerce (MOFCOM) (and its predecessor MOFTEC) up to 2002 represented serious underestimates. 3 Among other things, the MOFCOM excluded investment projects not screened and approved by relevant government agencies, and did not include investment made after the projects’ initial approval, such as the plough back of retained earnings. However, as part of China’s policy of encouraging its firms to go overseas, from 2002 onward, MOFCOM’s FDI statistics have been collected in accordance with OECD definitions and IMF’s balance-of-payments guidelines. Thus, if there were still discrepancies between MOFCOM and UNCTAD’s FDI statistics, the discrepancies from 2003 onwards should be smaller than before.

Hong and Sun (2004), also using UNCTAD’s FDI statistics, reported that the stock of China’s outward FDI reached about US$36 billion by end the of 2002, ranked No. 6 among 118 developing economies. They found that the growth of China’s aggregate FDI outflows during 1988-2002 were quite similar to those of South Korea during the same period, and to Japan’s outflows in the period of 1968-1982. The sector composition of China’s FDI, with 40-50% of shares in the non-trade category, was similar to that of South Korea in the 1980s and that of Japan in the 1960s and 1970s.

Hong and Sun found that the motives, destination, financing, and mode of entry of Chinese investors had undergone changes in the 1990’s. For example, even though natural resources were still an important motive, in the late 1990s increasingly more Chinese firms used FDI to acquire advanced foreign technologies and managerial skills, which had the effect of increasing their investment in the U.S. Also, from 1992 to 2001, Chinese firms increasingly exploited and further developed their comparative advantages in Asia, Africa, and Latin America. In 1997-2001, Africa became the second largest regional destination of Chinese FDI outflows, only after Asia, as it received 24.1% of the total. Since the mid-1990s, more and more Chinese firms used listing in overseas stock markets (Hong Kong and New York) to raise equity capital and to enhance their international reputation. What they found most striking, however, was that mergers and acquisitions gradually became the main form of investing overseas.

Related Literature

Since China was a developing economy which was generally short of capital and foreign exchange, its outward FDI requires some explanations. Cai (1999) identified four motives for Chinese FDI: (a) market; (b) natural resources; (c) technology and managerial skills; and (d) financial capital. These motives were later augmented by other researchers. For instance, Deng (2004) identified two additional motives: (e) strategic assets (e.g., brands, marketing networks), and (f) diversification. Clearly, because China was itself a low-cost production base, cost minimization was not a major motivation of Chinese FDI overseas.

Alternative routes taken by China and its national firms to acquire the above assets and resources have received attention in fields of international business and politics. For example, Child and Rodrigues (2005), on the basis of case studies, examine the pros and cons of three alternative routes taken by Chinese firms in seeking technological and brand assets: (a) Acting as an “original equipment manufacturing” (OEM) firm and forming joint ventures with foreign firms; (b) mergers with and acquisitions of foreign firms; and (c) organic international expansion (i.e., green field investment overseas).

As a world factory, China will become increasingly more dependent on the global supply of raw materials and energy, and China’s FDI in natural resources seems to have captured the world’s imagination. There were many reports of billion dollar deals in 2006 and 2007 involving oil producing African countries (e.g., Taylor), central Asian countries (e.g., International Herald Tribune, October 27, 2006), and elsewhere. This impression of foreign investment activities in natural resources indeed found support in the FDI statistics, which shows that China made US$8.54 billion in 2006 in “mining, quarrying, and petroleum,” accounting for 48.4% of the country’s total FDI in that year.4

As a reflection of Chinese effort to secure the supply of raw materials and energy for its national economy, there is a literature on “resource diplomacy,” which was according to Zweig (2006) defined as “diplomatic activity designed to enhance a nation’s access to resources and its energy security.” While the first and foremost resource sought after by China is oil,5 the country is also in great demand for other minerals such as copper, bauxite, uranium, aluminum, manganese, and iron ore, etc. (see, e.g., Taylor (2007)). As pointed out by Taylor, “the strategy chosen is basically to acquire foreign energy resources via long-term contracts as well as purchasing overseas assets in the energy industry.” These strategic choices also apply to other key natural resources. After a systematic analysis of China’s FDI statistics, we shall highlight its investment in the energy sector.

Using statistics on approved outward FDI as published in the Almanac of China’s Foreign Economic Relations and Trade from 1991 to 2005, Cheung and Qian (2007) found that, consistent with the earlier literature, China’s investment was motivated by both market-seeking and resource-seeking. However, they did not find substantial evidence that its investment in African and oil-producing countries was mainly for their natural resources. In addition, they found that China’s international reserves and exports to developing countries tended to promote FDI; the latter finding suggests that the investment in developing countries would be either for the purpose of facilitating or complementing exports.

Researchers in the fields of international business and politics recognize the importance of the role of the Chinese government in China’s outward FDI. This point would not be hard to appreciate because, as we shall see below, until now the lion’s share of China’s outward FDI has been made by firms that have close relationships to various levels of government. Moreover, overseas investment by Chinese private firms requires government approval. Partly as a result of the perceived need to secure key natural resources and technologies through ownership, and partly due to the awareness that Chinese firms must compete in the global arena when foreign firms intensify their entry into the domestic market, China started to initiate a policy to encourage its national firms to “go overseas” in 2001. The government not only relaxed the approval process of outward FDI, but also provided incentives for FDI in target industries and recipient countries. This policy shift toward outward FDI will be further discussed below.

Stimulated by international attention on some successes and failed attempts of buyout by Chinese multinational firms, Antkiewicz and Whalley (2006) discussed three policy issues about cross-border mergers and acquisitions. They were (a) government subsidization of cross-border mergers and acquisitions; (b) transparency of the acquiring firms; and (c) national security concerns of OECD countries whose firms are the targets of buyouts.

The purpose of this paper is four-fold: (a) To provide a brief introduction to China’s “go overseas” policy; (b) to provide a systematic analysis of the size and composition of China’s outward FDI in 2003-2006, the period over which such data are available from China’s Ministry of Commerce; (c) to uncover the determinants of the direction and amount of China’s outward FDI, and (d) to explore the determinants of China’s future outward FDI.

The paper is organized as follows. The next section describes China’s “go overseas” policy first proclaimed in 2001, to be followed by Section III that analyzes the pattern of China’s outward FDI in 2003-2006, including amount, sector composition, geographical distribution, and the status of investing firms in China’s economy. Section IV discusses China’s foreign investment in the energy sector, while Section V attempts to uncover the determinants of the direction and amount of China’s outward FDI with the help of gravity equation regression analysis. Section VI explores the determinants of China’s future outward FDI, in the light of the experience of the world’s leading investors, and with a particular focus on Japan and South Korea’s experience. Section VII compares China sector composition and geographical distribution of FDI against those of Japan and South Korea. The final section summarizes and indicates directions for further research.

  1. China’s “Go Overseas” Policy toward Outward FDI

The Chinese government first proposed Chinese firms to “go overseas” (“zouchuqu”, literally “go out”) in 2001 in its tenth five-year plan. In the sixth national congress of the China Communist Party (CCP) in 2002, President Jiang Zeming proclaimed the “go overseas” policy, which covers FDI, the undertaking of foreign construction and engineering projects, and the export of Chinese employment/labor services. Due to lack of publicly available information, however, it is difficult to provide a complete catalogue of specific measures that have been introduced under the “go overseas” policy. It is known that in the initial stage of the policy’s introduction, policy measures were mainly in the form of relaxation of restrictions on investment overseas, including the vetting and approval of such investment, plus some minor financial support.

In January 2004 the Ministry of Commerce, the Ministry of Finance, and the State Administration of Foreign Exchange promulgated a series of measures that aimed to promote Chinese investment overseas in goods processing (including export processing). Among other things, the vetting and approval of investment in the amount of US$3 million or below were delegated to provincial level government agencies, while project proposal and feasibility study no longer required approval. In addition, RMB2.3 billion of a “Central Foreign Trade Development Fund” was set aside to support investment in overseas processing activities, and both the scope and ratio of interest payment subsidy were increased. For non-finance, non-processing FDI, the approval of foreign investment projects was delegated to local authorities at 12 coastal Chinese cities.

In addition to policies in support of FDI, funds were also set up to support Chinese firms in bidding for foreign construction/engineering projects, in the form of subsidy for project finance and insurance.

To promote Chinese firms to “go overseas,” a wide range of services was provided by the government, ranging from promoting national firms during official visits by government officials and state leaders, to incorporating business negotiations into inter-governmental cooperation frameworks, to building databases on investment environment and opportunities in specific host countries,6 to providing consultancy services to Chinese firms that consider investing overseas. Furthermore, in addition to the central government and its overseas offices, local governments are also involved in supporting investment overseas. Government agencies work closely with investing firms and industry associations to promote the investing firms’ interests. Both policy banks and commercial banks are involved in assisting the finance of overseas activities, including FDI.

The government started early to promote non-state owned firms to go overseas, but there was no agreement about the policy measures’ effectiveness. A regular mechanism was set up by the Ministry of Commerce in association with All-China Federation of Industry and Commerce as early as May 2004 to encourage private firms to go overseas, and a draft document that surfaced in 2006 called for stronger support for non-state owned firms in the areas of taxation, finance, foreign exchange, and insurance. An example was the facilitation of obtaining finance from the global capital market, including listing in overseas stock markets, debt issuing, project finance, and guarantee for overseas subsidiaries.

Private Chinese firms appear to have different experience with the government’s “go overseas” policy. Some felt that by 2006 government restrictions on their going overseas were largely gone, but they had not seen any helping hand yet. Government officials in the Ministry of Commerce felt that there were already many policy measures to assist the private firms (such as interest subsidies and deductibility of the cost of feasibility studies in the case of natural resource development), but the firms did not utilize them due to lack of information. According to some researchers in the government, while there were many such promotional measures, their effectiveness was limited. The same researchers also questioned the rationale for subsidizing outward FDI with taxpayer’s money.

Other private firms felt that they were not free to make quick investment decisions in a rapidly changing world economy. They complained that the investment facilitating measures were unclear and the approval of overseas investment project proposals still took a long time. Instead of going through successive levels of the Ministry of Commerce, then to the Commission on Development and Reform, and finally to the State Administration of Foreign Exchange, Chinese private firms wanted to have a one-stop shop to get all the approvals. Some other private firms complained that on the one hand they were unable to obtain long term loans from policy banks due to quotas on total lending, on the other hand commercial banks were not willing to take any risk in longer term lending. While obtaining finance overseas with domestic collateral was not permitted by the Chinese government, some private firms did it illegally anyway.

In 2006 China started to explore the ideas of setting up “overseas China economic and trade cooperation zones” in host countries. These zones were perceived to serve several purposes: (a) To expand exports through the host economies that satisfy rules of origin in order to lessen bilateral trade frictions caused by rapid increase in Chinese exports; (b) to develop Chinese firms and to build Chinese brands in the global market place; (c) to reduce the overflowing foreign reserves, and (d) to provide employment in host countries, thus contributing to the host economies and bilateral relations.

The idea of encouraging Chinese firms to invest in these zones rather than in other locations in the host countries is that Chinese firms would be more effective when they go overseas in groups, rather than as individual firms. That way, they will be able to support each other and to enjoy better support by host governments. In addition, the terms of agreement reached between host governments and Chinese investing firms will be firmed up as part of the bilateral investment agreements between the Chinese and host governments.

The hosts for these zones are chosen mostly on the basis of good bilateral relations, political stability, and comparative advantages. The host countries include North Korea, Russia, Kazakstan, Nigeria, and Pakistan. China envisions building 50 or so zones in the near future. By the end of November 2007, eight zones were approved and one was officially established. Each approved zone may get RMB200-300 million of fiscal support and up be RMB2 billion of medium- to long-term loan. The following are examples of such zones: 7

  1. “Haier-Ruba economic and trade cooperation zone” in Pakistan: Officially established in November 2006, this is an industrial park mainly for the production of consumer electronics;

  2. “Ussuriysk economic and trade cooperation zone” in Russia: Officially approved in October 2006, it focuses mainly on lumber, textiles, and logistics

  3. “Lake Tai international economic cooperation zone” in Cambodia: It is mainly a regional trade center for distribution of goods produced in Jiangsu Province.

  4. China Non-Ferrous Metal Group to invest in a non-ferrous mine in Zambia, especially in the Chambishi copper mine.

  5. “Transbaikai economic and trade cooperation zone” in the area of Transbaikai, Chita, on the China-Russia border: It is mainly for industrial processing and cross-border trade.

  1. Patterns of China’s Recent Outward FDI

From this point onward, we shall omit the adjective “outward” if the meaning of FDI is clear without it. In this section, we first present the amount of China’s aggregate annual FDI flow from 1982 to 2006, and its global shares in aggregate flows and stocks from 2002 to 2006. After that we shall examine the sector composition and geographical distribution of Chin’s FDI flows and stocks, to be followed by an analysis of the organizational background of the Chinese investors. The difference between the FDI stocks (measured as of end of year) of two successive years is not necessarily equal to the FDI flow of the later year, as one might expect, due to reasons such as re-valuations of the stock of investment.

III.1. Amounts and Global Share of China’s Outward FDI

By the end of 2006, more than 5,000 Chinese firms had established nearly 10,000 overseas subsidiaries, joint ventures, and representative offices in 172 countries (regions) around the world.8 The flow of China’s FDI from 1990 to 2006 is depicted in Figure 1, where the data from 1982 to 2001 were based on UNCTAD’s World Investment Reports while data from 2002 were provided by MOFCOM based on international definitions and data collection methods. Note that statistics for FDI in financial industries in 2002 - 2005 was not available. To maintain consistency, the total FDI for 2006 shown in the figure excluded FDI in financial industries, even though such statistics became available for the first time in that year.

In 2006, China’s total FDI flow amounted to US$21.16 billion, 24.4% of which was made up of new equity investment, and 31.4% of which was made up of reinvestment of current profits. From a different angle, 39% of the total FDI took the form of merger of acquisition (M&A), and 35.4% of FDI in financial industries took the form of M&A. In addition, about half of the non-finance FDI was in the form of loans extended by parent companies in China to its overseas units.

It should be pointed out that the statistics for 2002-2005 were underestimates of China’s actual FDI because FDI in financial industries such as banking and insurance was not included due to lack of data. When statistics on FDI in financial industries became available for the first time in 2006, such FDI accounted for about 1/6 of the flow in that year and the stock at the end of the same year. Moreover, the banking industry accounted for the lion’s share of that year’s FDI in the financial industries: 71% of flow and 79% of stock; insurance, second in place, accounted for 5% of the stock.9 If the shares of financial industries in China’s total FDI flow and stock in 2006 were indicative of their importance in earlier years, then the statistics from 2002 to 2005 should be adjusted upward by about 17%.

China’s FDI flow in non-finance industries on average grew by 59.5% per annum (compound) between 2002 and 2006; its FDI stocks in the non-finance industries on overage growth by 34.5% per annum (compound). Despite such rapid growth, its shares of the world’s total FDI remained very small. As shown in Table 1, China’s FDI flow in 2006 accounted for about 1.74% of the world’s total FDI flow, and 0.73% of the world’s total FDI stock. The figures in the earlier years were even smaller, and any adjustment to account for FDI in financial industries would not have made any significant difference.

When compared against the 2006 of FDI statistics of other countries, the amounts of China’s FDI flow and stock in 2006 would rank No. 17 and No. 24 , respectively. They were not only much below those of the world’s major industrial economies such as the US, UK, and France, but also below some small developed economies and developing economies that were also the world’s significant foreign investors. For instance, its FDI flow in 2006 at US$21.16 billion was more than tripling its flow in 2004, but still below that of Hong Kong (US$43.5 billion), Sweden (US$24.6 billion), and Holland (US$22.7 billion) in 2006. Its FDI stock in 2006 at US$90.63 billion, doubling that of 2004, was below that of Holland, Australia, Ireland, Denmark, Hong Kong, Singapore, and Russia.

Nevertheless, given the expectation that China’s FDI flows in the future will continue to grow rapidly, it would be reasonable to expect China’s rankings to continue to move up further.

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