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Daniel Wagner

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China Gets a Lesson in Realpolitik

Posted: 10/03/11 10:11 PM ET

Consistent with so much about China's thrust on to the global stage over the past decade, its outward foreign direct investment (OFDI) has grown far faster than OFDI from other transitional economies. Chinese OFDI is largely politically driven, aimed at achieving specific national objectives, such as securing natural resources, acquiring strategic assets in key technologies and service industries, or creating national champion companies. As an extension of state power, China's approach to OFDI has had a profound impact on its relationship with recipient nations at all levels of development and income.

China has tailored its approach to OFDI based on the relative economic and political strength of the recipient country, in exchange for specific benefits. For example, in highly indebted poor countries (HIPCs), China tends to offer to build infrastructure in exchange for the right to access to raw materials. In developing countries, China may offer to help develop an indigenous industry; in emerging markets, grant greater access to the Chinese market; and in developed countries, expand reciprocal agreements related to cross-border investment. In each case, China weighs the relative costs and benefits associated with expanding its relationship with a given county vis-à-vis what it will receive in return.

In order to secure investment transactions, the Chinese government typically offers infrastructure projects, politically important landmarks, soft loans, and grant programs as a package to coincide with a proposed natural resource investment in a developing country. As a result of government financing and political support, Chinese state-owned enterprises (SOEs) are generally able to avoid a plethora of risks that often plague investments in resource-rich poor countries. Political and reputational risks are usually mitigated, and the uncertainty that often accompanies project finance is effectively eliminated.

However, points of conflict with recipient countries can occur in several areas. OFDI by Chinese SOEs may be seen as unfairly competitive with private sector companies. China's support for strategic investments through direct subsidies and official development aid to win contracts allows for project bids to occur, which might not otherwise be viable in a free market context. Government ownership of the investment companies allows for a high tolerance of reputational and operational risk. By virtue of government ownership and backing, Chinese SOEs often operate investments in risky environments where western multinationals prefer not to operate, and at reduced cost -- thereby outmaneuvering western firms.

Chinese aid to unsavory governments in order to promote the OFDI process raises governance and humanitarian concerns among a variety of host governments. China's general willingness to befriend rogue or distasteful governments that other governments seek to avoid -- such as Iran or Venezuela -- creates tension with the developed world. Some of this tension may actually stem from the fact that the exercise of realpolitik by China puts it on top, and outmaneuvers western firms that have had their activities circumscribed in such countries due to sanctions, reputational or political risk.

At the same time, realpolitik can bite back, and China is learning some hard lessons about the way the world works, and how a unidimensional approach to OFDI may not be in its own best interests. For example, the government of Myanmar last week halted the construction of the Myitsone Dam in the country's north, a large hydroelectric project that was under construction along the Irawaddy River was to be completed in 2017. It was to generate up to 6,000 megawatts of power for Yunnan Province in China. However, the project had been highly controversial, largely because of the environmental damage it would cause and the thousands of people who would have needed to be displaced to build the Dam. A broad range of interests and organizations opposed construction of the Dam, which was being was being built by the China Power Investment Corporation - one of China's largest power producers -- and Sinohydro -- one of the world's largest hydropower contractors. On September 30, to the great surprise of many, Myanmar President Thein Sein succumbed to pressure and canceled the project, to the great consternation of the Chinese Government, and to the great delight of environmentalists.

Cancellation of the Dam raises a whole host of issues which China has never before had to address in public. It is extremely rare for a developing country government with a long history of friendly relations with China to publicly challenge the Chinese government in such a manner. Even more interestingly, it is one of the first instances when major Chinese government-owned companies have been forced to deal with issues related to contract cancellation and de facto expropriation of Chinese assets related to OFDI. In such a circumstance, the Chinese government is learning that it is ultimately as powerless as any other government when contracts are canceled in another country. Apart from the potential ramifications of the Myanmar President 'buckling' under pressure -- an unprecedented rarity -- it will be fascinating to see how the Chinese government reacts to the Dam cancellation in the near-term, and how it may modify its approach to OFDI in the longer-term. Hopefully, it will approach the entire subject of OFDI with a bit more humility and common sense.

If it weren't for the West's preoccupation with achieving a higher moral standard and adherence to international standards of acceptable behavior, China would not have been as successful as it has been in securing OFDI in the developing and emerging world to the degree that it has. China is in the process of beating the West at its own game -- identifying what is sees as the West's 'weakness' on the grand chess board and filling in the gaps left behind. If the West played the game the same way, China's investment ambitions would be restricted or at least more expensive. But the West is not going to change its stripes any more than China will be changing its own. In some respects, China is outmaneuvering the west in the "great game" that the west invented. But as the Myanmar example has shown, China will quickly learn the benefits of establishing more equitable and genuinely mutually beneficial bilateral economic relationships, as well as being more sensitive to environmental issues and the concerns of host country inhabitants.

Daniel Wagner is CEO of Country Risk Solutions, a political risk consulting firm based in Connecticut (USA), and author of the book Managing Country Risk, which will be published by Taylor and Francis in March 2012.

 

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