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How to get a slice of the money flowing out of China

By artofchad on October 6, 2013 • ( 3 )

In 2008, I wrote an article for an international business consultancy newsletter that outlined the opportunities associated with Chinese investing abroad. In the article, I wrote that since China commenced opening up in 1979, most international capital flow has been into China rather than out of it.

By 2008, this capital flow had contributed to China accumulating domestic savings in excess of $1.7 trillion. The Chinese government subsequently decided that capital flow should be a two-way street and much of this $1.7 trillion would be headed abroad.

When hearing of the new policy, my immediate suspicion was that would also make it easier for corruptly acquired money to be laundered in foreign countries; however, I put my cynicism aside to simply stitch together the economic reasons that the consultancy gave in support of the government’s strategy.

According to the consultancy, the most pressing reason was to offset problems caused by foreign investment in China. The flow of money into China increased money supply, in turn leading to inflation. In February 2008, China’s increase in CPI reached a 12-year-high of 8.7 %, which was categorised as severe inflation.

Not only did the inflation decrease profits for China’s exporters, it also placed pressure on the exchange rate. With less money circulating in the Chinese economy as a result of capital outflow, inflation could be pulled back to a more manageable level. Longer-term, more investment abroad would make it easier to smooth the flow of money in and out of China to reduce the threat of rapid economic shocks.

A second reason to invest abroad was to further diversify the Chinese economy. The need to diversify became even more pressing due to the American and European financial crisis of 2007/08. From 1996-99, the average annual growth in trade between America and China was 12.8%. In 1999, China exported US$42 billion of goods to the United States, accounting for 21 per cent of its total exports. In addition, China’s exports to Asian economies accounted for 53 per cent of its total exports, and these economies were in turn heavily dependent upon America. China was well aware that it needed to reduce its dependence on American consumers for its long-term prosperity.

A third reason was to gain more expertise in its industries that were well developed outside of China but not developed in China. In order to make the transition to a technology economy, China needed more expertise in the new industries. By investing in a foreign company, China could gain that expertise. For example, after purchasing advanced equipment and technologies, China could invest more in its research and development. This would in turn help China make the transition from low-end products with small profit margins and high environmental cost, to high-end products with higher profit margins but lower environmental costs.

As well as gaining technological expertise, China also wanted service expertise. Asset management, marketing, human resources, media relations were all advanced industries in western countries but still relatively underdeveloped in China. Investing abroad would help Chinese companies access their products as well as methods to market them.

After reflecting on these reasons, I again turned to my initial suspicion that individuals in government wanted to launder corruptly gained money. Obviously, I didn’t raise my suspicions because my job was basically to turn the research they gave me into articles. Four years on, I think sufficient time has passed to be able give my beliefs without feeling like I’ve betrayed the consultancy that I wrote for.

In regards to sending capital abroad to reduce the exchange rate, this seemed a bit odd considering the RMB is centrally controlled. As for reducing dependence on American consumers, while that was a pressing concern, I would have thought investing in the domestic consumption potential of 1.3 billion Chinese would have been the best course of action and that meant keeping money in China.

Gaining foreign technology made sense, except a cheaper way would be for China to buy a product and then reverse engineer it (ignoring all patents) as they usually do. The transition to a service based economy utilising western expertise in human resources, marketing, management and media relations struck me as odd considering that I could not imagine western models being able to function in guanxi-orientated China.

For example, in its initial issue in China, Rolling Stone magazine put a copy of Chinese rock star Cui Jian on the cover. In the west, this provocative move would have got the magazine attention. In China, it resulted in the magazine’s publishing licence being revoked. Basically, in a business culture that revolves around building relationships with various bureaucratic layers in a restaurant, all foreign expertise relating to marketing, human resources and media relations is not really expertise at all. It is like trying to run software written for Windows on a Mac.

Anyway, through the grapevine I’ve heard some stories of Chinese migrants to Australia making a fortune and I have to say that many of their money making schemes seem highly implausible. Perhaps the moral of the story is that for those wanting to make their fortune out of China’s rise, instead of investing in China, perhaps it is best to help China invest abroad. Maybe they will be honourable investments or maybe they wont; however, like a Swiss banker in World War II, it might be best not to ask too many questions.