Resource-seeking ODI is directed to exploit local factor endowments such as oil, gas, minerals, timber and other natural resources. The abundance of natural resources in the host country is the key determinant of this type of ODI.
In many cases strategic asset-seeking ODI is concerned with securing foreign technology. Technology-seeking ODI is directed to destinations that either have already developed advanced technologies or are in the process of developing them. Investing firms that pursue this strategy tap the knowledge pool either directly, by cooperating with local companies, or indirectly, through spillover and demonstration effects. Other strategic asset-seeking ODI is driven to acquire brand names and obtain improved access to distribution channels. These tacit assets are typically sought because they will help the acquirer fulfil long-term strategic objectives.
The potential impact of resource-seeking ODI for upgrading China’s economy is mixed. On the one hand, effective resource-seeking ODI would help ease current resource bottlenecks. This would allow investing firms to focus on other factors affecting their competitiveness, such as product and process innovation. On the other hand, successful resource-seeking ODI could diminish incentives to develop resource-conserving, environmentally friendly technologies. This could result in the wasteful use of resources and be detrimental to the quality of growth. This is important in the context of the Twelfth Five-Year Plan, which calls for China’s economic development model to be transformed and identifies resource conservation and care for the environment as top priorities. But without institutional reforms, including a more liberalised market for production factors, this kind of investment could result in a heavier use of resources, greater externalities in the form of carbon emissions and other pollution, and a deteriorating economic structure.
Upgrading the Chinese economy through strategic asset-seeking ODI is preferable. Acquiring technology and brand names can enhance a firm’s competitive edge by rationalising production, by transitioning the firm toward producing higher value-added goods or services, and by allowing the firm to explore new functions with higher profits. Improved access to distribution channels gives investing firms access to larger markets and higher sales. These are all important aspects of industrial upgrading.
Two conditions must be satisfied for strategic asset-seeking ODI to be effective. The first requirement is that investing firms must possess the technology transfer skills necessary for managing acquired strategic assets (including absorbing any spillovers) and transferring benefits back to the country where the investment originates. The second requirement is that investing firms must have the capacity and commercial culture required to bear short-term losses, while the advantages of newly acquired strategic assets come into effect. In the absence of this second condition the eventual returns will not justify the enormous upfront expenses required to purchase the assets.
Chinese firms that engage in strategic asset-seeking ODI frequently meet both requirements: they have come to possess the degree of technological capability required to assimilate acquired strategic assets, and are also predominantly from industries with lower competition and higher profit margins. This gives them the necessary fiscal buffer against possible losses in the short term, allowing those strategic assets to come online and become profitable.
Despite such positive signs, Chinese ODI faces varied challenges. Cultures at the national and corporate levels need to be reconciled and both must learn to engage with foreign regulators, unions and local communities, all which are unfamiliar territory. Firms also need to continue building the corporate governance and management skills needed to effectively consolidate, absorb and operate foreign assets.
ODI can play a significant role in China’s ongoing economic development by channelling international knowledge diffusion from investing firms to host countries. This is possible provided ODI is conducted sensibly. Three factors are important here.
First, the investment destination matters. Firms investing in a host country with a relatively high level of technology are more likely to receive technology spillovers and benefit from productivity gains.
Second, the motivation for investment matters. Firms undertaking international knowledge-sourcing ODI are found to enjoy substantially higher productivity growth.
Finally, the capabilities of the investing firm matter. Successfully realising reverse knowledge transfer depends on the investing firm’s productivity, absorptive capacity and technology transfer skills. Only when these factors are present are investing firms able to absorb and transfer spillovers, allowing the entire company — rather than just foreign subsidiaries — to benefit from the external knowledge.
Chinese ODI is still small, but its global importance is growing fast. If properly managed, ODI might help upgrade China’s economy and facilitate deeper reforms of state owned enterprises, improve corporate governance, strengthen the notion of corporate social responsibility and, eventually, create a better and more orderly economic and business environment in China.
Bijun Wang is a doctoral candidate at the China Centre for Economic Research, Peking University.
Bijun Wang’s research was presented at China Update 2012. The annual China Update conference is hosted by the China Economy Program in collaboration with the East Asia Forum at the ANU in July. This article is a digest of Ms Wang’s chapter in Huw McKay and Ligang Song (eds), Rebalancing and Sustaining Growth in China (ANU E Press, 2012), available in pdf here. This book is the latest publication in the China Update Book Series, launched at the China Update conference every year.