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Columbia FDI Perspectives
Perspectives on topical foreign direct investment issues
No. 138 January 5, 2015
Editor-in-Chief: Karl P. Sauvant ([log in to unmask])
Managing Editor: Adrian P. Torres ([log in to unmask])
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The growth of outward foreign direct investment (OFDI), particularly from China, has generated substantial controversy about whether government-controlled or state-influenced foreign investors should be treated differently than other foreign investors by host country governments. [1] Indeed, several developed country governments impose special review procedures on OFDI undertaken by state-owned enterprises (SOEs). For example, in 2012 the Canadian government announced that takeovers of domestic companies by foreign SOEs would face “strengthened scrutiny,” permitting them only in “exceptional circumstances.” [2]
The fundamental concern about SOEs is that their business activities will harm the host economy because they are dictated primarily by political, rather than commercial, objectives. The degree to which this is presently true is debatable. Moreover, the policy implications of this assessment, however valid, are rarely rigorously articulated and evaluated. Rather, it is assumed that the pursuit of non-commercial objectives by foreign investors harms the host economy and, therefore, should be discouraged or prevented entirely.
If there is a theme linking the impact of OFDI by SOEs to the welfare of the host economy, it is that the pursuit of non-commercial objectives will result in inefficient behavior and performance on the part of SOEs, which in turn will weaken the host economy. However, to the extent that SOEs willfully engage in inefficient economic behavior, the harm will be experienced primarily by the SOEs’ owners, and not by residents of the host economy. This argument rests on the notion that the foreign investor ordinarily pays a price for foreign assets acquired (usually an operating company) that reflects the discounted present value of the assets when owned and managed by an investor whose objective is to maximize profits by operating the acquired assets efficiently. Put simply, in a competitive market for corporate assets, SOEs will need to bid prices that reflect the efficient or profit-maximizing use of the assets to be acquired, even if the SOEs intend to engage in certain non-efficient behaviors. The result is that existing domestic owners should be no worse off financially by selling to an SOE than they would be by selling to a privately owned foreign investor. Indeed, they should be at least marginally better off, given that the winning acquirer presumably pays a higher price than unsuccessful bidders.
So who in the host economy is made worse off by SOE investments? One argument is that multinational enterprises (MNEs) from emerging markets behave less responsibly than their for-profit counterparts headquartered in developed countries in areas like environmental and labor practices. SOEs are also seen as being much less transparent in their financial and social impact reporting than privately owned MNEs. These issues highlight the concern that SOEs from emerging markets are likely to impose costly externalities on host economies.
Yet, regulators, particularly those in developed countries, can restrain SOE behavior, thereby reducing negative externalities. [3] Even if Chinese and other SOEs are imperfectly informed about the regulatory environment when entering a host economy, substantial fines and regulatory censure should quickly educate SOE management about legal and illegal business practices. To be sure, not all objectionable business practices by SOEs are regulated, or even detected, by regulators; however, other market participants can also act as a check on opportunistic behavior by SOEs. For example, prospective employees should demand higher wages from SOEs than from private companies if SOEs implement unfair labor practices. Similarly, consumers should demand lower prices from SOEs than from private companies if the former are perceived as being less safety conscious. In short, corporate misbehavior by SOEs could be substantially internalized by those SOEs in the form of lower profits.
Finally, while many governments provide direct or indirect support for OFDI to their MNEs investing abroad, the support provided by the Chinese government has been criticized for giving Chinese SOEs an unfair advantage in acquiring foreign assets or for driving out efficient domestic firms. [4] Related to an earlier point, competitive bidding for foreign assets may result in much of the Chinese government subsidies being captured by shareholders of acquired companies in host economies. Furthermore, if the acquired assets are managed inefficiently, foreign affiliates of SOEs may require ongoing financial subsidies in order to survive in the marketplace against more efficient rivals. Even the Chinese government faces financial limits to its ability to support its home country MNEs. The termination or reduction of government subsidies would invite the re-entry of efficient host-country firms.
One should not conclude from this discussion that OFDI by SOEs does not raise any public policy issues. For example, specific investments may raise concerns about national security. However, national security concerns may also arise from OFDI by European or United States (US) MNEs, as demonstrated by recent revelations about U.S. electronic espionage in Europe. The main point is that host country governments should reassess their hostility toward investments by SOEs or risk losing access to an important source of investment capital.
* Steven Globerman is the Kaiser Professor of International Business at Western Washington University’s College of Business and Economics and is a Senior Fellow at the Fraser Institute. The author is grateful to Shaun Donnelly, Peter Enderwick and Curtis Milhaupt for their helpful peer reviews. The views expressed by the author of this Perspective do not necessarily reflect the opinions of Columbia University or its partners and supporters. Columbia FDI Perspectives (ISSN 2158-3579) is a peer-reviewed series.
[1] Most OFDI from China is undertaken by SOEs. See Ken Davies, China Investment Policy (Paris: OECD, 2013).
[2] Wendy Dobson, “China’s state-owned enterprises and Canada’s FDI policy” (Calgary: University of Calgary, 2014).
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The material in this Perspective may be reprinted if accompanied by the following acknowledgment: “Steven Globerman, ‘Host governments should not treat state-owned enterprises differently than other foreign investors,’ Columbia FDI Perspectives, No. 138, January 5, 2015. Reprinted with permission from the Columbia Center on Sustainable Investment (www.ccsi.columbia.edu).” A copy should kindly be sent to the Columbia Center on Sustainable Investment at [log in to unmask].
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For further information, including information regarding submission to the Perspectives, please contact: Columbia Center on Sustainable Investment, Adrian Torres, [log in to unmask] or [log in to unmask].
Most recent Columbia FDI Perspectives
- No. 137, Dylan G. Rassier, “Locating production and income within MNEs: An alternative approach based on formulary apportionment,” December 22, 2014.
- No. 136, Gus Van Harten, “Canada’s non-reciprocal BIT with China: Would the US or Europe do the same?” December 8, 2014.
- No. 135, Stephen M. Schwebel, “In defense of bilateral investment treaties,” November 24, 2014.
- On January 22, 2015, CCSI and Chadbourne & Parke LLP will be hosting a “Year-in-Review” focusing on 2014′s key developments in investor-state arbitration. The event will draw together academics, government representatives, and practitioners in order to present and discuss outcomes, trends, and outliers in disputes involving governments and claimants from around the world, and explore implications for pending and future cases. For more information, please go to our website here. Registration is free but required.
- On January 26, 2015, CCSI will offer a free CLE session at Columbia Law School, led by Lee Caplan, Partner, Arent Fox LLP. This CLE session will provide governments, investors and other interested stakeholders with an overview of the Transparency Rules, the Mauritius Convention on Transparency, and what these instructions mean for them. Registration is free, but required. Practitioners seeking CLE credit can register here. Students can register here.
- Deadline extended: On March 8-13, 2015, CCSI will offer a new interdisciplinary Executive Training course on Sustainable Investments in Agriculture, designed primarily for public sector officials and civil society representatives from low- and middle-income countries, whose responsibilities relate to investments, agriculture, land or rural development. The course will take place at Columbia University and will provide an overview of pressing issues related to agricultural investments, as well as an introduction to relevant practical skills. Please visit the training website for the application materials and additional details about the program. The extended deadline for applying is January 5, 2015.
- From January to April 2015, CCSI will host its ninth annual International Investment Law and Policy Spring Speaker Series. This year’s speakers include (in the order of their talks) Josh Kallmer, Diane Desierto, Giorgio Sacerdoti, Emmanuel Gaillard, Kabir Duggal, Eloise Obadia, Xavier Carim, and Lee Caplan. The series will be co-sponsored by Crowell & Moring LLP and Curtis, Mallet-Prevost, Colt & Mosle LLP, and moderated by Ian Laird and Borzu Sabahi. Select presentations will be webcast; please see our website for the schedule and more details. No registration is required.
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Karl P. Sauvant, Ph.D.
Resident Senior Fellow
Columbia Center on Sustainable Investment
Columbia Law School - Earth Institute
Ph: (212) 854-0689
Fax: (212) 854-7946
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