January 21, 2015
China’s outward investment flows have expanded enormously over the past decade. This has led to predictions, often from China, that its outward investment will soon exceed its inward investment. These predictions have been taken up outside China, and have been recycled in the Western media, including the Financial Times and the Economist among many others.
The day China becomes a net exporter of foreign direct investment (FDI) will have both symbolic and real importance. While not on the same level of importance as the moment when China becomes the largest economy in the world (according to the IMF, on a PPP basis China already is the largest economy), it will nevertheless be seen as symbolic of the increasing importance of the Chinese economy in the world. It would arguably also mark a real point of change where Chinese companies are competing on level terms with their international counterparts.
The prediction that this moment is imminent has one major problem: it has no basis in reality. The view that China’s ODI will soon exceed inward foreign direct investment (IFDI) is based on statistics from China’s Ministry of Commerce (MOFCOM). These statistics (Chart 1) show that over many years since the 1980s IFDI flows to China have exceeded ODI flows. This gap grew rapidly in the early 1990s, and remained large for the following decade. The main reason was that in this period the Chinese government strongly promoted IFDI but strictly controlled ODI. One of the main reasons for this policy was to increase capital inflows and discourage outflows. Over the last decade controls on ODI have been relaxed and Chinese companies have been encouraged to go abroad. As a result ODI has grown rapidly, at the same time there has been a leveling off of IFDI flows and the gap between the two has narrowed sharply The latest MOFCOM figures for 2014 indicate that the gap has continued to narrow, and will soon be closed.
Chart 1: China Inward and Outward Investment Flows 1982-2013 MOFCOM, UNCTAD
These statistics are widely quoted internationally, and are also used by UNCTAD in their databases on FDI flows. The problem is that the MOFCOM figures do not fully represent China’s FDI flows. The MOFCOM statistics are based on China’s investment approval system for both IFDI and ODI. This only records initial investment approvals, but leaves out important elements in FDI flows. Internationally recognized statistics on investment flows are usually based on balance of payments (BOP) figures. China’s BOP statistics, which are published by the State Administration of Foreign Exchange (SAFE) and are based on IMF principles, show a very different picture to those from MOFCOM. While the picture in the early years is almost identical, there has been an increasing divergence between the two sets of figures over the past decade (Chart 2). Rather than the gap between IFDI and ODI closing in recent years, it has actually widened.
Chart 2: China BOP Inward and Outward Investment Flows 1982-2013 Source: SAFE
The reason for the difference in the two sets of figures is that there are elements of investment flows which are included in BOP statistics but that are ignored by the MOFCOM system. The most important of these is reinvestment of earnings, which is included in BOP statistics but not in the MOFCOM data. In recent years there has been a significant increase in foreign companies’ reinvested earnings in China. A breakdown of Chinese statistics is not available, but BOP data from Eurostat show, for instance, that reinvested earnings in China from Germany increased from €36 million in 2005 to €3.8 billion in 2013. Other EU member states also recorded significant increases in reinvested earnings in China. Statistics from the US show that its reinvested earnings in China increased from US$1.8 billion in 2005 to US$6.7 billion in 2013. The biggest contribution to these reinvested earnings comes from Hong Kong, which is the largest investor in mainland China.
Chart 3: China Net Direct Investment Flows (ODI-IFDI) 1982-2013 Source: MOFCOM, SAFE
One point that emerges from the BOP data is that, although they have fluctuated in recent years, often as a result of global economic conditions as much those in China, IFDI flows to China are significantly larger than is commonly believed. At the same time, ODI remains relatively small. The gap between IFDI and ODI, rather than closing, actually appears to be widening (Chart 3). It is possible that one day in the future China will be become a net exporter of FDI. Despite optimistic claims that this day is close, the reality is that it will not happen soon.
Author : Duncan Freeman