Inside China’s massive $3tn overseas acquisition spree

{"text":[[{"start":7.45,"text":"China’s lightspeed economic rise is the global economic story of the last half century. And as MainFT’s China Shock 2.0 series has showcased, they’re not done yet. Last week a paper quietly dropped co-authored by a group of academics and policy types that helps put data meat on the bone as to how exactly technology transfers might have helped China’s latest step up."}],[{"start":31.4,"text":"Luc Laeven, director general of the ECB’s research department, along with co-authors professor Jenny Bai of Georgetown, and Hong Ru and Yaojun Ke of Nanyang Technological University, assembled a micro-level dataset of 161,773 firms across 159 countries. They then built multi-layered ownership chains to trace capital through offshore tax havens to its ultimate origin — which they reckon account for over 80 per cent of global assets of non-financial firms."}],[{"start":61.9,"text":"What they found were Chinese investors with around $3.3tn of global corporate assets skewed heavily to Europe (42 per cent of outbound investment) and North America (38 per cent). "}],[{"start":null,"text":""}],[{"start":74.15,"text":"Investments were concentrated in knowledge-intensive sectors, and the knowledge-intensity of investment targets intensified following the release of the Made in China 2025 government initiative."}],[{"start":85.60000000000001,"text":"Fine, but don’t we know all this stuff already? Actually no. Almost two-fifths of this investment flowed through at least one tax haven, and standard foreign direct investment statistics just aren’t up to working out that these flows come from China. The authors estimate that almost $800bn of Chinese ownership is taken via the Cayman Islands, accounting for almost half the country’s non-financial corporate assets in the dataset."}],[{"start":109.30000000000001,"text":"So the extent and location of this outbound investment — “a global footprint that is substantially larger and more strategically concentrated than indicated by official FDI statistics” — looks like genuinely new news."}],[{"start":124.45000000000002,"text":"But much much more interesting is what the authors do next."}],[{"start":128.55,"text":"They interrogate their dataset longitudinally, looking at the behaviour of target firms in the period following their purchase by Chinese private and state-owned enterprises. "}],[{"start":137.75,"text":"And they find that post-acquisition, these firms generally boosted research and development and become more capital intensive. However, this R&D bump was rewarded with a patent bump that was not only infinitesimally small, but also statistically insignificant."}],[{"start":155.05,"text":"Moreover, profits at the target firms took a hit: average return on assets fell by 1.1 percentage points compared with the control group of non-Chinese owned firms over the same period. Given an average return on assets across non-Chinese owned firms the dataset of only 4 per cent, this hit to profits looks big."}],[{"start":null,"text":""}],[{"start":175.20000000000002,"text":"Are Chinese owners just really really bad at managing western firms? Perhaps."}],[{"start":179.35000000000002,"text":"Maybe Chinese head offices were systematically smooth talked into greenlighting western researchers’ passion projects that the firms’ previous owners had effectively resisted? Or maybe Chinese owners shifted research agendas to projects that had much longer pay-offs, denting both short-term patent filings and ROA? Either is possible. "}],[{"start":197.75000000000003,"text":"But the authors found something else going on at the Chinese parent that suggests an alternate explanation:"}],[{"start":null,"text":"

… we find evidence of innovation ‘spillbacks’: while target firms exhibit no increase in patenting, the Chinese parent firms experience a sharp increase in granted patents following their first developed-economy acquisition.

"}],[{"start":203.70000000000002,"text":"Professor Bai, when Alphaville contacted her, caveated the spillback section of the paper as a work in progress. Duly warned, let’s plug on and look at the data."}],[{"start":214.50000000000003,"text":"By the end of the reporting year in which Chinese firms acquired their first overseas developed market subsidiary, the average number of patents the Chinese parent companies filed had more than trebled. For Chinese state-owned enterprises, the average number of patents filed quadrupled."}],[{"start":null,"text":""}],[{"start":230.25000000000003,"text":"The authors don’t, and can’t, establish causation. And the sequencing of the facts they establish — 1) Chinese parent companies splurge out acquiring major stakes in foreign research-intensive firms; 2) acquired foreign firms’ R&D jumps, profits drop, and patents flatline; 3) the Chinese parent enjoys an immediate bonanza in domestic patent filings — could be entirely coincidental. "}],[{"start":254.30000000000004,"text":"Moreover, the definition they built around Chinese ownership captures not only those firms wholly-owned by a Chinese parent, but also firms in which a Chinese parent has a stake of at least 10 per cent. And so Bang & Olufsen, the fancy Danish consumer electronics firm, is flagged due to its 15.1 per cent Bermudian shareholder, New Sparkle Roll International Group Limited, which is in turn linked to an ultimate Chinese owner. As is Rio Tinto, the UK mining behemoth, due to its 14 per cent Singaporean shareholder, Shining Prospect PTE LTD, which is in turn linked to the Aluminum Corporation of China, a Chinese SOE. "}],[{"start":291.6,"text":"But it’s easy to nod along with the authors’ interpretation that “China represents a unique state-driven paradigm that accepts substantial short-run performance costs to internalise global technological capacity”."}],[{"start":304.90000000000003,"text":"Especially when, interrogating their dataset to see whether similar patterns show up for other nations’ outbound investments, they find this pattern unique to China."}],[{"start":314.50000000000006,"text":"Investors buying overseas firms with an intention to siphon off profits need to navigate withholding taxes — leaving a slug with foreign tax authorities. Siphoning off pre-patent intellectual property — if this is really what has happened — might be a way to avoid the oversight of foreign governments, turbocharge domestic economic development, and also extract value without paying pesky taxes. Or as the authors put it:"}],[{"start":null,"text":"

In other words, some of the returns to Chinese acquisitions may appear as home-country innovation rather than as higher patenting in the acquired firms.

"}],[{"start":339.70000000000005,"text":"The notion that technology transfer is a major rationale for Chinese overseas investment is hardly new. But this systematic, firm-level analysis of the global network of Chinese corporate ownership looks like it has done a good job of exhuming evidence."}],[{"start":354.75000000000006,"text":"Further reading:"}],[{"start":356.25000000000006,"text":"— The China shock 2.0 (MainFT)"}],[{"start":367.75000000000006,"text":""}]],"url":"https://audio.ftcn.net.cn/album/a_1777875811_1186.mp3"}