to procure raw materials might be exacerbating the problems associated with strong demand by locking up natural resource supplies, gaining preferential access to available output and extending control over the world’s extractive industries.
But Chinese investments in Africa, Latin America and elsewhere need not have this zero-sum effect; Chinese efforts to procure raw materials might help to solve the problems of strong demand. Positive outcomes for Chinese procurement arrangements depend upon whether these arrangements solidify a concentrated global supplier system (and enhance Chinese ownership or control within that system) or expand, diversify and make the global supplier system more competitive, using Chinese ownership or control as a lever for such expansion, diversification and enhanced competition.
Research on Chinese investments in the extractive sector has identified four basic types of procurement. In the first procurement arrangement, Chinese investors take an equity stake in a very large established producer so as to secure an equity-share of production on terms comparable to other co-owners. In the second type of arrangement, Chinese investors take an equity stake in an up-and-coming producer so as to secure an equity-share of production on terms comparable to other co-owners. In the third type, Chinese buyers and/or the Chinese government make a loan to a very large established producer in return for a purchase agreement to service the loan. And in the fourth type of procurement arrangement, Chinese buyers and/or the Chinese government make a loan to finance an up-and-coming producer in return for a purchase agreement to service the loan.
These four structures provide the basis for giving an operational definition to ‘tying up’ supplies. If the procurement arrangement simply solidifies a legal claim to a given structure of production, as in the first and third structures, ‘tying up’ or gaining ‘preferential access’ to supplies, has zero-sum implications for other consumers. But if the procurement arrangement expands and diversifies sources of output more rapidly than growth in world demand, as per the second and fourth structures, the zero-sum implication vanishes, as all consumers have easier access to a larger and more competitive global resource base.
Earlier Peterson Institute for International Economics (PIIE) research examined the 16 largest Chinese natural resource procurement arrangements around the world within these four categories. The results showed a few instances in which Chinese natural resource companies take an equity stake to create a ‘special relationship’ with a major producer. But the predominant pattern (13 out of 16 projects) is to take equity stakes and/or write long-term procurement contracts with the competitive fringe. A brief review of four smaller Chinese procurement arrangements undertaken at the same time suggests there is no significant selection-bias in looking at these 16 largest projects. Three projects in Australia, Myanmar and Canada present the characteristics of the second type of arrangement, where Chinese investors take an equity stake in an up-and-coming producer. One project in Indonesia, on the other hand, resembled the first type of arrangement more closely.
Building on the findings of this earlier report, a comprehensive examination of 34 Chinese natural resource investments and procurement arrangements in Latin America concluded that 25 of them help to diversify and boost the competitiveness of Latin American natural resources. This is a good outcome for host countries because it indicates that Chinese investors will be more willing to take on new frontier — or even fringe — projects that more-established oil and mining companies might pass by.
This is not a new strategy, as those who have examined the evolution of the Japanese approach to natural resource procurement know all too well. In the early resource struggles of the 1970s, the Japanese government entertained the idea of creating the country’s own major national champion resource companies as a strategy — based on the first and third procurement arrangements — to secure a special relationship with major resource companies and/or producer governments. But from the late 1970s through the 1980s there was a shift, and Japanese overseas investment increasingly targeted up-and-coming producers, as highlighted by the second and fourth types of procurement. Japanese procurement thus became a major force in enhancing the competitive structure of global extractive industries and diversifying the geography of production. Japan’s participation in Latin American mining projects today consists primarily of minority equity stakes in a large array of extractive projects, backed by purchase contracts for a portion of the output.
By multiplying and diversifying sources of supply for energy and minerals, Chinese investment — like Japanese investment in previous decades — continues to help solve demand-side problems by multiplying and diversifying sources of supply for energy and minerals.
Yet not all Chinese strategic manoeuvres to procure natural resources reflect the predominant trend towards making the supplier base more competitive: Chinese policies to exercise control over rare earth mining run in the opposite direction. Rare earth elements are crucial for a growing array of civilian and military products. In 2009–10 China’s Ministry of Industry and Information Technology took steps to control mining, by setting an export quota of 35,000 tons per year, with a potential ban on exports of at least five types of rare earth elements. At the same time, Chinese investors have sought to acquire equity stakes in new producers, particularly in Australia. Beyond the economic sphere, Chinese manipulation of rare earth elements exports has also played a role in geopolitical manoeuvres vis-à-vis Japan, with Chinese customs authorities temporarily refusing to issue export licenses for rare earths destined for Japan in 2010.
The impact of Chinese procurement arrangements on the structure of natural resource industries is only one dimension of the geopolitical challenges surrounding these endeavours. Other dimensions are much more problematic. The fact that Chinese natural resource investments flow to problematic states and regions such as Iran, Sudan and Myanmar is one example. Host countries in the developing world may be exposed to ‘resource curse’ practices, including illicit payments, graft and corruption, plus poor worker treatment and lax environmental standards. The link between transnational corporations, extractive industries and development is discussed at length in UNCTAD’S World Investment Report 2007. This report agreed with other authoritative sources that non-OECD investors — most prominently Chinese investors operating under the officially sanctioned doctrine of ‘non-interference in domestic affairs’ — have often undermined hard-won governance standards observed by multinational corporations. These governance standards include home country legislation that conforms to the OECD Convention on Combating Bribery.
To investigate how Chinese investors in the extractive sector compare to their OECD counterparts, a team of researchers from the PIIE undertook structured comparisons in Peru between two OECD-owned mining companies and two Chinese mining investments.
Of the two OECD-owned mining investments studied, Newmont’s Yanacocha gold mine was accused of bribing officials in the Fujimori regime in the mid-1990s, and was fined for a serious mercury spill in 2000. By 2008, however, Yanacocha had cleaned up its act to the point that its environmental practices received ISO 14001 certification. The company pays wages that are 24 times higher than the national average. The other mine, Antamina, pays even higher wages — the highest in Peru’s mining industry. Antamina became ISO 14001 compliant in environmental practices in 2009. The parent companies of both mines (Newmont Mining, BHP Billiton, Xstrata, Teck and the Mitsubishi Corporation) support the Extractive Industries Transparency Initiative or EITI — a coalition of governments, companies and other stakeholders that has developed international standards for the systematic reporting and auditing of payments by resource extracting companies. And both Yanacocha and Antamina are members of corporate groups devoted to identifying best practices in mining and community fora, such as the Grupo Diálogo Perú, which are concerned with the environment and sustainable development.
As for non-OECD investors, the Shougang Corporation was the first Chinese firm to invest in a Peruvian mine, arriving in 1992. At the time it was established, Shougang Hierro Peru brought in Chinese labourers and reduced the local labour work force from 3000 to 1700. Wages at the mine are among the lowest in Peru’s mining industry (less than half the national average), with repeated bouts of contentious strikes. Shougang has been fined repeatedly for breaches of health, safety and environmental practices. But there are grounds to expect improvement because its current expansion program is being financed by external creditors, including Citibank, BCP, HSBC and Santander, which may be held accountable for violations of globally accepted standards. The second Chinese investor, Chinalco Toromocho, has not yet launched operations but already faces a major challenge in having to pay US$100 million to relocate a town of 3400 inhabitants away from the site where the mine will operate.
Neither Chinese company supports EITI or international industrial bodies; neither participates in Grupo Diálogo Perú. But one major difference between Shougang and Toromocho is that the latter’s parent company, Chinalco, has secured large financial support from the China Export-Import Bank. Since 2007 this financial institution has instructed loan recipients to follow host country laws and regulations and to carry out social and environmental assessments for overseas projects, which explains Chinalco’s more recent efforts to meet international standards. Even before starting operations, Chinalco established a social fund and it will invest US$20 million in infrastructure for the local community. An environmental impact study has been conducted, and Chinalco has convened public hearings with the local community as part of these proceedings.
The evidence thus suggests that Chinese companies are beginning to respond to local and international pressure. They are being pushed away from a longstanding neglect of social and environmental issues and being urged instead to adopt standards of behaviour that are similar to their OECD-country counterparts.
Professor Theodore H. Moran holds the Marcus Wallenberg Chair in International Business and Finance at the School of Foreign Service, Georgetown University, and is a senior fellow at the Peterson Institute for International Economics.
Barbara Kotschwar is a research associate at the Peterson Institute for International Economics.
Julia Muir is a research analyst at the Peterson Institute for International Economics.
This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘China’s Investment Abroad’.