It’s No Accident That China’s Tycoons Are Bad Investors
The first priority for wealthy Chinese has been to move as much money abroad as possible. If Beijing has its way, that won't be an option anymore.
China has been on a spending spree overseas in recent years, with both private investors and state-owned enterprises snapping up acquisitions everywhere from Dar es Salaam to Vancouver. But that’s been sharply curtailed in the last few months by the authorities back home.
Tougher restrictions and scrutiny of foreign dealmaking led to a 44 percent fall in non-financial outbound direct investment in the first half of the year, according to the Ministry of Commerce. China’s regulators have subjected some high-profile outward-looking conglomerates, including Dalian Wanda, Anbang Insurance Group, HNA Group, and Fosun International, to multiple rounds of punishment for their foreign ventures. Companies under investigation for potential violations of the country’s new capital controls have already taken significant hits to their valuation.
Officials say they want to stop money laundering and curb “irrational” investments abroad. Media reports suggest the leadership has internally discussed the experiences of Japanese companies in the late 1980s and early 1990s, when a shopping spree of American landmarks such as Pebble Beach golf club and Rockefeller Center ended in disaster.
But are such concerns actually justified? The tentative answer is yes, according to new research conducted by Zixuan Huang and one of us. It turns out that many of the Chinese outboard investment projects aren’t just big — they also perform poorly.
China’s foreign investment has changed dramatically over the past decade. The biggest buyer of foreign assets was historically the People’s Bank of China (PBOC), rather than companies. In 2011, for instance, the PBOC accounted for 80 percent of the country’s total foreign investment. Most of these purchases were used to build its foreign exchange war chest and suppress the value of the yuan, a move that in turn boosted exports.
However, that pattern changed around 2014. The central bank now accounts for only about half of China’s total foreign investment. In its place, enterprises and individuals have surged from just 12 percent of the total in 2011 to nearly 40 percent today.
This change presents a puzzle, however. The PBOC invests in low-yielding, liquid assets such as U.S. Treasurys. Firms and investors, by contrast, typically seek higher-yielding and riskier opportunities. As these companies and investors account for a larger share of the total, one would therefore expect the overall returns on China’s foreign investments to rise.
But that is not the case. Data from the State Administration of Foreign Exchange reveal that the rates of return of China’s outbound direct investment have been declining since 2014 to only 0.4 percent in 2016, lower than the 4 percent rate of return for the country’s foreign reserves, and compared to 6.8 percent for the United States’. In other words, Chinese firms and investors are strikingly bad investors abroad.
There could be many reasons for this. Chinese media often singles out unfamiliarity with the business culture abroad, or the limitations imposed by pesky foreign governments on which sectors Chinese firms can invest in. But the authors’ own discussions with staff at China’s largest private conglomerates suggest some other intriguing theories.
One employee in the foreign investments office of one of these conglomerates says that his team was given targets to prioritize the speed of acquisition over the quality of investment. Only those in the upper echelons of the firms know exactly why these targets were given.
Mid-ranking staff speculate that it may in part be a desire to bulk up in order to become “too big to fail.” Get large enough, and the cost in jobs, prestige, and financial fallout if you go under might be big enough that the government will keep throwing money at you even if you’re investing in an open pit. The desire of the government to keep the economy afloat constitutes an implicit guarantee that creates a dangerous moral hazard throughout China’s financial system. It is an open secret within investment offices that the sheer scale of their lending from state-owned banks to finance acquisitions means the risk of these foreign deals is effectively being transferred to those banks — and thus, in turn, to the Chinese government.
Others suggest executives may be looking to shift assets abroad in order to keep them safe from domestic political struggles. Executives who rose to riches due to their official connections may one day be felled if the political winds shift. Guaranteeing one’s newfound status might require shifting out their own money, or just stealing it from company assets. In either case, it doesn’t matter how good an investment is — it’s the size that counts, not what you do with it.
Still, it’s hard to endorse the crackdown on private international dealmaking that China has now initiated. The double standard with outbound investments earmarked for President Xi Jinping’s pet Belt and Road Initiative, which receive speedy approval for projects with questionable commercial prospects, suggests the government does not always have business interests at heart.
Moreover, the tougher restrictions clearly carry a whiff of a power play. China’s business community felt a frisson of disbelief earlier this year when officials rejected a foreign deal by Wanda — a conglomerate once thought to be nearly as influential as its ostensible regulators. The message is clear: The state and party are reasserting jurisdiction over private business. After years of private individuals gaining greater clout, Xi appears to be putting the party back on top.
Economics has no simple answer for what governments should do when private dealmakers seem to be on a risk-taking binge abroad. Chinese regulators face a genuinely tricky task balancing the need to control risks with a desire to let private enterprise flourish. It’s an issue that they may grapple with for years to come. Early signs of China’s new capital control rules suggest that the portfolio of the country’s foreign assets will likely tilt back to being more state-controlled — matching the same pattern at home as the party, and Xi, reassert just who’s in charge.
Heiwai Tang is assistant professor of international economics at the Johns Hopkins School of Advanced International Studies.