The dragon soars: Micro evidence on Chinese outward direct investment

Heiwai Tang, Wenjie Chen

Using a new, unique, and comprehensive data set that covers close to 19,000 Chinese ODI deals from 1998 to 2011, we find that in contrast to the common perception, over half of the ODI deals are in service sectors, with many of them appearing to be related to export promotion. Ex ante larger, more productive, and more export-intensive firms are more likely to start investing abroad. Ex post, ODI appears to enhance firm performance (i.e., total factor productivity, employment, export intensity, and product innovation). Empirical analysis based on firms’ trade transaction data shows a significantly positive effect of ODI on firms’ trade performance, but little technology transfer.

China’s active acquisition of foreign assets has raised anxiety and tension across the world. In 2010, it was the world’s fifth largest source of foreign direct investment after the United States, France, Germany, and Japan.1 He et al. (2012) predict that China’s cumulative outward direct investment (ODI) will exceed $5 trillion USD in 2020, compared to a mere $3 billion in 2010. Given the sheer size of China, the volume of its ODI may be expected; but considering its relatively early stage of development, its recent surge in ODI surprised many. News about Chinese ODI have often hit headlines, such as CNOOC’s2 rejected acquisition of Unocal, Lenovo’s acquisition of IBM PC units, and Dalian Wanda Group’s acquisition of AMC Theaters, among many others. The target sectors are widespread, and even as mundane a product as pork has caught media attention recently after Shuanghui acquired Smithfield.

Despite the rising concerns, existing studies on Chinese ODI are either descriptive in nature or based on aggregate data. Among the recent studies using micro data the focus has been on understanding the motives of ODI, with the primary goal to verify the media hype about China’s attempt to control natural resources and technology around the world (Cheng and Ma 2007, Huang and Wang 2013). Little research has been done on which firms are engaged in ODI and how ODI may enhance their performance.

In Chen and Tang (2014), we use unique and comprehensive micro data to establish several stylised facts about Chinese ODI and then assess the effects of ODI on firm performance. Our data set, made available by China’s Ministry of Commerce, covers close to 19,000 ODI deals of Chinese firms to all destination countries from all sectors between 1998 and 2011.

Who are the Chinese overseas investors?

As emphasised by existing studies, we find that Chinese ODI deals can be broadly categorised into three main types: resource seeking, technology seeking, and market seeking (or export promotion). In contrast with the common perception, both the aggregate statistics and our micro data lend no support to popular speculation that the recent rise of Chinese ODI is driven by resource seekers.

Instead, business services and wholesale/retail trade have accounted for a large and increasing share of Chinese ODI. Banking and finance-related ODI is also important. Figures 1 and 2 show the distribution in terms of the volume of ODI flows and the number of ODI deals across major sectors. In addition to these industrial patterns, the share of private firms in Chinese ODI has been rising. Table 1 shows the distribution of China’s ODI deals across countries. Over half of China’s top twenty ODI destinations are still in Asia. ODI in Sub-Sahara Africa, which has attracted tremendous attention from the media and governments, has steadily accounted for about 10% of the country’s total ODI deals.

We then empirically examine the characteristics of the firms that were engaged in ODI. Based on manufacturing firms’ survey data from China’s National Bureau of Statistics merged with the ODI firm list,3 we find that more productive (measured by total factor productivity), larger (measured by employment), and more export-intensive Chinese firms are more likely to invest abroad. These findings lend support to the studies that typically assume higher fixed costs of horizontal FDI compared to that of exporting (Brainard 1997, Helpman, Melitz, and Yeaple 2004). We also find that relative to domestic private and foreign-invested enterprise, state-owned enterprises (SOEs) are more likely to invest abroad, consistent with the conventional view that the Chinese government is the mastermind behind the country’s ODI flows.

Figure 1. The share of total ODI flows from China by industry (2006-2010)

Source: China's Ministry of Commerce ODI data (2006-2010).

Figure 2. The fraction of total ODI deals from China by sector (1998-2011)

Source: China's Ministry of Commerce ODI data (1998-2011).

Table 1. Fraction of ODI Deals by Region and Year

Note: Numbers are in % in the first eight columns, while they are in whole numbers in the last column. SSA stands for Sub-Saharan Africa.

Source: China's Ministry of Commerce ODI data (1998-2011).

The effects of ODI on Chinese firm performance

Does ODI enhance Chinese firms’ competitive advantage – and how? To answer this question, we apply the propensity-score matching techniques, which allow us to compare ODI firms with non-ODI firms that are ex ante similar, to assess the average effects of ODI on firms’ performance. Based on extensive manufacturing survey data, we find that ODI enhances Chinese firms’ performance in terms of total factor productivity, export intensity, product creation, and employment.

Since the positive effects of ODI on firm performance can be due to technology transfer, resource seeking, or export promotion, we use firms’ trade transaction data from China’s Customs to shed light on the relative contributions of the three channels. By employing propensity-score matching techniques again, we find that firms’ ODI participation is associated with a significant improvement in their trade performance, measured by export and import volume, export and import unit values, and number of export destinations. These results show that horizontal FDI from China complements rather than substitutes firms’ trade, consistent with the idea that exporting entails high fixed costs, such as those required for marketing and searching for buyers; and that ODI helps reduce those fixed costs. To the extent that unit value of a product proxies for its quality, our results also imply that ODI induces quality upgrading for both imports and exports.

We find no evidence of a higher import share of capital goods in total imports by ODI firms. There is also no significant effect of ODI on firms’ imports of intermediate inputs. Thus, based on the composition of firms’ imports, we find no evidence that Chinese ODI is motivated by technology seeking. However, it is possible that intangible assets are transferred from Chinese foreign affiliates to their headquarters, unobservable in the trade data (Atalay et al., 2013).

Policy implications

Our findings have important policy implications for countries that have been experiencing rising labor costs after years of foreign direct investment (FDI) and export promotion policies. It has been shown that inward FDI has transferred technology, management skills, and even corporate culture to China. Twenty years after Deng Xiaoping’s famous southern trip in 1992 and China’s economic integration with the outside world, the benefits of promoting exports and inward FDI are diminishing. One challenge to China and other developing countries is rising wages of low-skilled workers. Developing countries will need to go through substantial structural transformation, initially from low-skill manufacturing to high-skill manufacturing, and eventually from manufacturing to high-skill services. While this transition may happen naturally, there could be room for policies to avoid the middle-income trap or to facilitate the transition.

In Chen and Tang (2013) we find evidence of firms upgrading the skill and capital content of their exported products after investing overseas, especially in advanced economies. The results imply that ODI appears to be a way to raise and sustain the benefits of exporting, which may in turn contribute to a country’s successful structural transformation.

References

Atalay, E, A Hortaçsu, and C Syverson (2013), “Vertical Integration and Input Flows”, American Economic Review, forthcoming.

Brainard, S L (1997), “An Empirical Assessment of the Proximity-Concentration Trade-off Between Multinational Sales and Trade”, American Economic Review 87(4): 520-544.

Chen, W and H Tang (2013), “Export Promotion of ODI from Emerging Markets – Transaction-level Evidence from China,” Johns Hopkins University memo.

Chen, W and H Tang (2014), “The Dragon is Flying West: Micro-level Evidence of Chinese Outward Direct Investment”, Asian Development Review, vol. 31 no. 2, pp. 109-140.

Cheung, Y and X Qian (2009), “Empirics of China’s outward direct investment”, Pacific Economic Review 14 (3): 312–41.

He, D, L Cheung, W Zhang, and T T Wu (2012), “How would Capital Account Liberalization Affect China’s Capital Flows and the Renminbi Real Exchange Rates?”, China & World Economy 20(6), 29-54.

Helpman, E, M J Melitz and S R Yeaple (2004), “Exports versus FDI with Heterogeneous Firms”, American Economic Review 94 (1): 300-316.

Footnotes

Source: OECD. China’s ODI flow rank was 17th in 2006, 12th in 2008, 5th in 2009, and 11th in 2011.

2 China National Offshore Oil Corporation.

3 Given that a large fraction of the ODI firms in China are outside the manufacturing sector, the drawback of using manufacturing survey is that all ODI firms in the service sectors are dropped in our analysis. Notice that a firm can be classified as a service firm in the ODI list but can still be merged with the manufacturing survey data, as long as it has some businesses in manufacturing.