Responsa: Schell and Chinese Direct Investment in the US

In the Hutong
Waiting for the Golden Season
2114 hrs.

Venture Sprout founder and CEO Elliott Ng responded my post “Schell Gets China Investment Problem Half Right” with a thought-provoking comment that calls for more than an offhanded reply.

David, Isn’t Party and government involvement in acquisitive Chinese companies part of the problem in getting approval from foreign countries for acquisition, not just a “Brand China” issue? This issue was discussed in MacGregor’s “The Party” and if large companies at scale have significant government ownership and/or Party involvement, it seems that most large, strategic acquisitions will be rejected. Baidu or Tencent buying companies is very different from CNOOC or Anshun [sic] Steel cases mentioned in the Schell piece. All of the Japanese companies mentioned above are not controlled by the ruling political party and/or owned by the Japanese government. I don’t think this is a “Brand China” issue — it is a “Team China” issue. When the acquirers are SOEs — under SASAC purview — it’s only natural that countries around the world would be concerned about assets being acquired by the commercial arm of the Chinese government (and Party).

Elliott raises several interesting issues.

Is this a “Brand China” Issue?

At the heart of the issue lie three problems: first, American people and legislators do not trust Chinese companies or the Chinese government; second, few in the United States understand that some Chinese companies are, in fact, privately owned, believing instead that any company in China is government-owned to some degree; and third, the implicit belief is that any government-owned company is a de-facto arm of the government itself.

Until and unless individual Chinese enterprises and the government itself move credibly to allay those fears, mistrust of any Chinese company and its motives will fester in America, and any acquisition of an American brand by even the biggest Chinese brand will encounter resistance.

Americans do not resist such acquisitions because China has a history of acquiring American firms, running them from Zhongnanhai, and undermining the U.S. economy for the PRC’s own nefarious purposes. Rather, American’s resist because of a not-entirely-unreasonable fear of the unknown and a dislike for past actions of the Chinese government.

China, in short, has an image problem in America, and it is not one that will be solved by propaganda and advertising campaigns alone. It must be solved by a fundamental change of behavior. Call me crazy, but that sounds like a brand problem.

Would Baidu or Tencent Be Any Different?

Elliott also suggests that a truly private Chinese enterprise would not face the same resistance as a large state-owned enterprise like CNOOC or Anshan Steel. I am skeptical.

Chinese companies are not well-known for their transparency in either accounting or governance. Among other issues, this calls into question of the role the government takes not only in the “guidance” of state-owned industrial giants, but in the leaders of China’s emerging private sector. All that would need happen would be for Mrs. Pelosi to raise this question in public and Robin Li, Jack Ma, or Li Ning would all find themselves in the unenviable position of having to prove a negative, that there is no government involvement in the management of their firms, and that there never will be.

The problem, then, afflicts or threatens every company in China, no matter its ownership or pedigree.

What About the Case of Japan?

Elliott suggested that one of the reasons several Japanese companies I mentioned managed to do well during the height of paranoia about Japan in the late 1980s was that they were private companies. Given that Japan did not possess state-owned enterprises in the 1980s as China does now, we cannot prove that either way. On the other hand, one could argue that Japan’s largest industrial combines (keiretsu) were actually informally but deeply integrated with the ruling Liberal Democratic Party (LDP) and the Ministry of International Trade and Industry, blurring the lines between national power and private enterprise. But leave that aside for a moment.

It is useful to note that until 1989 Japan held two cards that China does not today possess that gave Japanese companies a distinct advantage in acquiring U.S. firms. First, Japanese firms and trade associations undertook a collectively widespread and largely sophisticated lobbying effort in Washington that over time wore down resistance to Japanese foreign direct investment in the United States.

Second, until 1989 Japan enjoyed the position as America’s primary Asian redoubt against the Soviet Union, a position enhanced rather than lessened by the departure of American armed forces from Southeast Asia and later Taiwan in the 1970s. This strategic security relationship did much to prevent Capitol Hill from taking too much counsel of America’s Rising Sun fears.

None of this allowed Japanese companies to avoid often substantial resistance to direct investment, but these advantages were effective enough in the face of several other substantive challenges in the Japan-US relationship to allow many deals to go through. The ownership structure was irrelevant: it was, in the end, Japan’s carefully cultivated relationships in Washington, D.C., and in the U.S. states and towns in which it invested that opened the doors.

Here Come the State Capitalists

Finally, there is the issue of state or party ownership. Elliott and I agree that this is a core problem. Where I think we diverge is that Elliott sees this problem as intractable, while I see it as a matter of perception.

Americans are, as a whole, uncomfortable with the concept of state ownership. The evident discomfort with the issue of nationalization of banks and of GM is ample evidence of that fact, as is the manner in which the U.S. has kept its defense production base firmly in private hands even in times of national crisis, and the attention given to the CIA’s proprietary invesments. There is something subtly frightening to Americans about the mixture of government and business.

It is time to probe whether that fear has a basis in reason, or whether it is an ideological matter. State capitalism, whether acquisitive sovereign funds or expanding SOEs, looks to play a wider role as new economic powers emerge around the globe. Rather than forswear dealings with such players, we need to understand the various shades of state capital, to explore in detail our reservations, and take measured steps to ensure our worst fears do not come to pass.

And it is time for state capitalists of all flavors and nations to recognize that the burden of proof lies with them. If they seek to operate in the lucrative world of private enterprise, they must offer transparency, openness, and in some cases a willingness to fundamentally alter the way they operate.

That is the price of trust.

Elliott Ng

David, didn’t expect a lengthy reply to my comment, but highly appreciated.

I largely agree with all your points – that there is a Brand China issue for all companies – but a particular discomfort with state-owned enterprises – that I characterized as a “Team China” issue.

What would help me (and I think the Western public and their politicians) is some kind of typology of SOEs or degree of “SOEness.” Look forward to chatting with you more about this topic!

David Wolf

Hey Elliott, it was YOUR fault for asking such meaty questions in the comment. It begged for a post…