Chinese Illusions of a BIT with the USA

Pork has been an unlikely subject of intense debate in the media lately.  What could appear to be a product of trivial importance to international trade and investments, has garnered a lot of attention from both the US and Chinese governments.  As China’s largest meat processing company, Shuanghui Group, makes a $4.7 billion bid for Virginia’s Smithfield Foods, the US called a congressional hearing to discuss whether the transaction should be allowed.  An interagency committee, the Committee on Foreign Investments in the US (CFIUS), convened in early July to examine the potential threats to national security posed by the Smithfield deal.  While it may be difficult to imagine the relationship between pork and American military defense, the opposition and discussion stimulated by this issue raise important questions about investment relations between the US and China, particularly whether a bilateral investment treaty (BIT) is necessary.  Chinese investors have long lamented about protectionist attitudes in the US impeding investments there, while American investors complain about bias toward state-owned enterprises and restrictions on foreign investments in China.  On the surface, it would appear that a BIT could allay many of these frustrations and should be a mutually beneficial priority for both governments.  However, many skeptics cite historical interactions and future motivations that would undermine any potentially actionable agreement.
China’s staggering economic growth has put it in a position to become a leader in outbound foreign direct investment (OFDI).  Despite this meteoric rise in GDP, Chinese OFDI has remained comparatively low until recently.  In 2012, it ranked below Ireland and Singapore in terms of foreign investments.  The flip side of this argument is the potential for growth in China’s OFDI, which the US could in theory capitalize on: 15% of global FDI flows into the USA, but only 2% of China’s OFDI were focused there in 2012.  While foreign direct investments in the US have been growing, there’s the potential for Americans to reap an even larger share of it by facilitating China’s outbound investment process.  Q1 of 2013 showed a strong increase in Chinese interest in US assets, as eight merger and acquisitions were completed along with nine greenfield projects totaling $2.2 billion with another $10 billion under negotiation.  The flow of wealth into the USA will lead to more high-paying jobs, increased investment in research and development and might invigorate the US manufacturing base.  Additional benefits could include the promotion of new economic activities and the diffusion of western benchmarks of corporate governance, accounting and reporting to Chinese companies.  Chinese companies may also rely on their US affiliates to export products back to China, boosting US exports.
China also stands to benefit from increased investments in the US by engaging in the most developed and complex market.  One factor that has drastically impeded the Chinese economy is its relative lack of technology.  Coupled with their inability to produce high-quality goods, the Chinese have earned a reputation for making unreliable and cheap products.  The primary advantage of channeling China’s OFDI to the USA would be the increased potential for acquisition of technologies that would be otherwise unattainable, not to mention securing vital goods.  The same is true for better manufacturing processes and regulations.  In the case of the Smithfield deal, China is concerned with securing a reputable source of high-quality, uncontaminated pork.  The acquisition would also feasibly lead to increases in the quality of Shuanghui’s other local meat products as Chinese teams learn from their American associates; this same reasoning underlay Chinese buyouts of New Zealand dairy farms after milk contamination scandals.  By channeling investments to the US, China could also become an important overseas investor in the US rather than exclusively an exporter.
Many factors have prevented the full realization of this symbiotic relationship between China and the USA.  The publicized failures of several high-profile merger and acquisitions have spread the perception among Chinese executives that their investments are unwelcome.  Most notably, Cnooc’s bid to purchase Unocal for $18.5 billion was undermined by trade tensions, and CFIUS blatantly thwarted Huawei’s attempts to purchase communication technology companies.  Frustrated by these—and many other examples—Chinese investors have looked to other foreign markets.  In addition, many Chinese companies experience difficulties adhering to the American political, legal and regulatory frameworks.  For example, US tax laws enacted to reduce citizens’ tax evasion create onerous reporting requirements, discouraging FDI.  The Xinhua News Agency has accused the US of being protectionist and punitive toward Chinese companies doing business there.
However, some barriers to Chinese FDI in the US are internal to China.  The US is leery of state-owned enterprises and is suspicious of the government’s role in managing these entities; the fear is the potential for foreign political influence.  Considering that SOEs were responsible for 70% of China’s OFDI stock in 2009, it’s no surprise that they experienced difficulties gaining a position in US markets.  Privately held companies in China are generally much smaller than SOEs and have traditionally not been in a position to acquire foreign assets, although that is changing: in the past 18 months private Chinese investors spent more on FDI than in the previous 11 years combined, comprising 80% of transactions and 50% of total transaction value. The government’s role in SOEs has also contributed to low levels of US investments in China, as the government biases these entities creating an unfair climate for competition.  The government’s influence and restrictions on FDI—whether it be outright bans or limited participation in joint ventures with Chinese companies—have obviously deterred foreign investors.
Enter the bilateral investment treaty, which has the potential to alleviate the majority of these complaints.  The core purpose of any BIT is to protect foreign investors from discriminatory government practices.  This could translate to reduced red tape for Chinese executives seeking visas and improvements in tax policies for companies.  The US would hope for the elimination of investment barriers like strict equity caps and opening of certain sectors to FDI.  The real value of a BIT, however, lies in reciprocity.  The two countries have drastically different economies and it’s illogical to demand identical policies.  There is likely no acquisition worth $4.7 billion that the US is interested in making in China, but China’s need for a safe pork supply—a nutritional staple—presents the opportunity for the US to make other gains.  The US could leverage China’s interest in directing OFDI into the country to force reforms in other areas of the Chinese economy, such as the financial markets.  It is important to note that a BIT in and of itself cannot address larger issues underlying Chinese economic relations, like bilateral trade deficit, currency manipulations and other skewed trade practices.
All of these potential outcomes sound very promising, but many question whether any discussion of a BIT will lead to fruition.  There have been several instances in the past in which talks were started between China and the US to no avail.  In 2008, US and Chinese leaders pledged to create an investment treaty under the Bush administration, but abandoned efforts once Obama took office.  The real impediment in the past has been China’s lack of incentive and willingness to reform its practices.  Many analysts question whether the current Chinese administration is genuinely interested in reform now, or whether it will end in a series of empty promises.
I would argue that China is, in fact, profoundly interested in increasing OFDI in the US, and perhaps reform as well.  China’s astounding economic rise over the past decades has been due in great part to an unsustainable growth model.  Increasing the GDP via heavy investments in infrastructure, real estate and manufacturing has left the country with a great number of products, but without a population of consumers to utilize them.  As foreign economies slow, China’s dependence on exports has also revealed itself as a weakness.  Currently, China’s new government is intent on shifting growth to a more sustainable consumption-driven path.  A key to such an economy is a large population of consumers with the means to make purchases and incentives to spend their incomes.  At present, China’s population would require wage increases in order to lift them to a level of spending power capable of supporting the new economic model, eating into profit margins.  Chinese producers would subsequently have to hike prices, but their low-quality reputation could not justify increases sufficient to support desired profit margins.  In an effort to improve the appeal of their products, Chinese companies are looking to invest in US markets to acquire the technology and practices they sorely lack, and the knowledge to make better goods.
OFDI directed toward the US is, therefore, a linchpin in the new economic direction undertaken by Li Keqiang’s administration, and may very well serve as the impetus necessary for other types of Chinese reform.  Despite China’s promises, the US is dubious that changes will actually occur.  Chinese organizations and the government have broken their word in the past and left international treaties unfulfilled.  In the eyes of the US—whether deserved or not— the Chinese have acquired an unreliable reputation.  For example, the Chinese government dealt a crushing blow to Google when it tried to enter Mainland China’s market.  The American ideal of nomocracy does not exist in China, and its absence creates an unfamiliar environment for Americans to do business.  Numerous courses of action are available when a party defaults on a contract in the US, even the government is beholden to the judicial system.  In China, recourse for wronged companies is limited, and few opportunities exist for foreign entities to rectify broken contracts.  It may be true that a high level of foreign investments in the US would actually supply leverage and a certain degree of control over the investor and possibly his country, but this would be very difficult in the US due to its judicial system and very easy to accomplish in China.
Despite the prior arguments, the US is not likely to draft a BIT with China in the near future for one reason alone: it will never relinquish its technological superiority.  As China’s economy is anticipated to eclipse the US in coming years, Americans must come to grips with the fact that they are no longer the sole global super power.  This is a very tough psychological pill for the US to swallow.  However, the US will retain its position at the forefront of technology, and will never compromise its last source of strength and advantage over the rest of the world.  Not only does sharing this information present a real threat to US national security, but there is some uneasiness in the US regarding imperialist Chinese attitudes.  At the heart of China’s drive to create a BIT with the US is the desire to acquire high-level technology and export it home.  Even if strict controls were kept to ensure that technology vital to national security was protected, a BIT could provide an opportunity for access.  Compounding this fear are accusations of intellectual property theft, which have become a major source of contention between the US and Chinese governments.  A Massachusetts company, AMSC, recently sued Sinovel of Beijing for trade secret theft and criminal copyright infringement.  Legal proceedings are underway in China, but the Chinese judicial system is proving disappointing and either unwilling or unable to protect American business interests in China.
China’s sole motivation for promoting a BIT is the hunt for technology that the US is unlikely to concede.  Many of the other OFDI destinations are already possible without any additional investment facilitations: there are currently few legal restrictions on Chinese investments in the US.  Despite this, the Chinese are being met with resistance even when overpaying for a meat processing company.  While some may argue that giving the Chinese a powerful stake in the US food supply could undermine national security, this situation better serves to highlight American attitudes toward the Chinese.  As a whole, Americans do not have a positive conception of the Chinese.  Although clearly not justified, the idea exists that the Chinese are robbing the US of vital jobs and contributing to unemployment.  The Chinese have not endeavored to make themselves likeable in the eyes of the world; other than food there has been little export of culture or tradition.  In order to move forward and improve investment relationships with the US, China needs to make serious improvements to its public image in order to win over the people necessary to put political pressure on the government to allow greater entry into US markets.