Sunday, 11 July 2010

China: (I) - Investment Strategy and lessons for Ireland

Paul Sweeney: When the Chinese state becomes one of the biggest shareholders in Guinness’ parent, and Volvo is bought by an obscure Chinese carmaker, Geely, it is time to examine what Chinese companies and investors are up to. Guinness, of course, is synomous with Ireland. Guinness is seen as our national drink, foreigners tell you they have drunk it and you, a Paddy, are supposed to be pleased.

Guinness ceased to be an Irish company in the late 19th century when it was quoted in London, and only recently its parent, Diageo, even considered closing its plant in Dublin, but decided not to do so. Now the Chinese Investment Company (CIC) owns 1.1% of Diageo, making it the 9th largest shareholder. The CIC is a massive Sovereign Wealth Fund (SWF) owned by the Chinese government, which is buying up shares in companies all over the world.

Over a number of posts, I will examine the role of China under three different headings. First, I will examine how extensive is the investment in companies and in countries. It will be seen that it is massive! It will also be seen that it is quite strategic and mercantilist. Thus, it does not conform to liberal economic theory. I will also examine how Chinese state companies are taking shares, in varying amounts, in all kinds of companies worldwide, through stock markets, trade sales etc.

Secondly, investment in China by Western firms and unionisation will be briefly examined.

Thirdly, I will briefly look at the debate on whether China, through its vast investment policies in Africa, is a new colonial power (and in other emerging countries and also in many developed economies, but to much smaller degrees, proportionately). Or is it simply investing benignly to maintain access to resources for its hungry factories and consumers?

Fourthly, I will show that China, Asian, Russian and other major and increasingly important economies are not following the Western economic orthodoxy. These important economies are, to varying degrees, authoritarian and if they do not reject neo-liberal economic ideology outright, they are quite wary and perhaps scornful of it. This is a major challenge to liberal orthodoxy. Yet it is to be welcomed, with some caution, by progressives who have been critical of the free market fundamentalism which led to the Crash of 2008.

One such change in “free market” policy – or one aspect of it, that is, privatisation - should now be radically reviewed. In regard to our own state companies, we might see them differently - as assets with major development value. Thus, it will be argued that the Irish Government’s decision to undertake a “stock taking” of the remaining Irish commercial state companies is timely, provided it is strategic and not short-term fire sales for a few million euro. It will be argued that the Chinese pragmatism on its state companies may be one which has some lessons for Ireland and our state companies and our much diminished (used on the private banking sector bailout) Sovereign Wealth Fund, the NPRF.

Let us begin by looking at the extent of Chinese investments. These are not the biggest investments, nor is the list comprehensive.

In June 2009, when Morgan Stanley, the US bank under government support, sought private capital, CIC subscribed US$1.2bn. Back in 2007, the Chinese Investment Company (CIC) had purchased $5.6 billion in MS common stock, or 9.86% equity ownership in Morgan Stanley.

CIC purchased, for an aggregate purchase price of CAD $435 million, 5% of Canadian company Penn West. It also invested CAD $817 million for 45% interest in a partnership to develop Penn West’s bitumen assets located in the Peace River area of northern Alberta. 2009: CIC bought in 45% of the equity in Nobel Oil Group based in Russia in late 2009, investing €300m in shares and in development. Hong Kong’s Oriental Patron acquired a 5% equity stake and the original Russian shareholders maintain their 50% stake.

Canadian mining and processing company Teck Resources sold a 17.2% stake to CIC in July 2009. It is the largest diversified mining, mineral processing and metallurgical company in Canada. The company is a major player in the production of copper, metallurgical coal and zinc. It has interests in 15 mines in Canada, the US, Chile and Peru, as well as exploration activities in four continents. CIC told Teck that it is acquiring the shares to become "a long-term passive investor" (at least a year!).

In the same time period, Chinese company, Sinopec, bought oil exploration company Addax Petroleum for $7.2 billion to develop oil sands. In June, Wuhan Iron and Steel Corp made a $400 million investment into Brazilian mining company MMX. Aluminum Corporation of China (Chinalco) took up its full entitlement in Rio Tinto's $15 billion rights offering. China expanded its interest in Mozambique’s natural resources, agreeing to invest $1bn in a coal project in June 2010.
The Chinese government invested $3 billion of its massive $1.2 trillion foreign reserves in the Blackstone Group, a major private equity fund. Blackstone is not a popular company, having been criticised as an asset stripper worldwide. It took a 12.5% stake in late 2008, and it was nodded through by the US Government because it was less than the threshold of 40% that it usually applied to prevent foreign takeovers of US corporations (so much for free markets, which, as most wise persons know, are seldom free). In contrast, in 2007, when the massive Chinese state oil company, CNOOC, sought to buy (all of the stock of) US oil company Unocal, it was stopped by the US government. Blackstone has bought up companies in China since, for example, pharmaceuticals firm Nufarm. China Investment Corp also invested €685m (£599m) into Apax Partners’ €11.2bn fund another private equity group in February 2010

Many of the major state-owned companies in China are now quoted on Stock Exchanges, and this means that they are now allowing in some private investors, but are included in international rankings of companies. It is estimated that of the top 500 global companies in the Fortune list, over 30 are Chinese state companies.
What is even more remarkable, from a policy perspective, is how many of the Fortune list of the top companies are former state-owned companies in many Western countries, and how many are still state owned, like France’s EDF, which owns much of the UK electricity industry.

In short, state companies have played a major role in developing some of the biggest enterprises of global scale throughout the world and continue to do so. Only the blind will ignore the role of state owned enterprises (SOEs) from a policy perspective. The proposed review of the Irish state owned companies must think in terms of developmental strategy, not of short term fire sales.

CIC, formed in September 2009, with RMB 1.55 trillion from the Chinese state, says that it selects investments based on economic and financial objectives, and an assessment of the commercial return and like any good Western capitalist, it seeks “to maximize shareholder value.” While it usually does not seek an active role in the companies in which it invests nor attempts to influence those companies’ operations, it may do so in certain circumstances. It seeks “long-term, stable, sustainable, and risk-adjusted returns.”

CIC states the “importance of operating responsibly – from how it runs itself and treats employees to how it selects investments. It is committed to operating responsibly and in full compliance of the laws and regulations in each of the jurisdictions in which it invests. CIC strives to contribute to the prosperity and development of local economies.”

As well as the sovereign wealth investment by the CIC, the many huge Chinese state companies are buying up stakes in private companies, taking over some outright, buying vast tracts of land for industrial type farming and buying financial assets all over the world. They are not just doing this to spread risk and diversify, as some Irish state companies like the ESB and DAA have done, but for national strategic reasons – to ensure adequate supply of minerals, oil, copper, etc., to the vast Chinese industrial complex. This is not the way of liberal economics.
In the next post, investment in China by Western firms and unionisation will be briefly examined. Meantime enjoy your Chinese part-owned pint of Guinness!

21 comments:

Paul Hunt said...

Since you seem determined to conflate the modern manifestation of the great liberal tradition with the neo-con free market fundamentalist frenzy, bonfire of financial regulation and international projection of US military might over the last 20 years, you may feel comfortable extolling the virtues of authoritarian, mercantilist regimes and proposing a replication of some their behaviour. Genuine liberalism is a continuous journey to seek an equitable and sustainable balance between the liberty of the individual and the collective needs of society and between the role of the state and the efficient operation of capitalist markets that will preserve the fragile thread of civilisation.

But rejecting this liberal tradition from JS Mill, through Beveridge (the real father of Britain's welfare state) and Keynes to the multitude of modern proponents and practitioners that include Sen, Krugman and Stiglitz is a dangerous path to follow.

China (and to an extent Russia) may feel scornful of, and take pleasure from, the inevitable implosion of the neo-con frenzy, but what they really fear is the genuine liberalism that is struggling to reassert itself in the developed mixed economies (and in Europe, succeeding to a considerable extent - much to the chagrin of the Left).

It is bad enough seeking to pose as a wary fellow-traveller of these regimes, but seeking to apply their mercantilist projection of economic power via their SOEs to the Irish semi-states is beyond the pale.

It is to the credit of the Chinese regime that it has sought to recycle some of its massive export surplus as productive investment (unlike the recyling of the German export surplus which fuelled asset bubbles and fiscal lunacy in the EZ periphery). But successive Irish governments, when funds were available, invested very little in the semi-states and nothing in the larger, more profitable, so-called 'self-financing' semi-states such as the ESB and BGE. But these are 'self-financing' only because they are, and have been able to, finance their activities and investments approx. 70:30, resp., from retained earnings and borrowings. And these retained earnings have been generated by Irish consumers paying excessively high prices set by the CER.

The Government doesn't have the funds to invest directly in these semi-states and regulators are probably coming to the end of the road as to how much more they can gouge from consumers. Investigatinmg the potential to sell some of these 'old' assets with a view to financing investment in 'new' assets is a perfectly rational response and long overdue.

EWI said...

Thirdly, I will briefly look at the debate on whether China, through its vast investment policies in Africa, is a new colonial power

Well, I think that they haven't been purchasing (at great cost and trouble of setting up elaborate fronts) decommissioned and never-completed Soviet aircraft carrier hulls, and investing great effort in reverse-engineering and rebuilding same, just for the hell of it.

Michael Burke said...

Paul S

I'll look forward to this series. One factor in the sharp divergence in the economic growth rates of the West and countries like China and, to a slightly lesser extent India is their very high rates of investment compared to Western investment.

http://ablog.typepad.com/key_trends_in_the_world_e/2010/01/india-and-china-refute-the-myth-of-overinvestment.html

In the OECD data as a whole the fall in gross fixed capital formation accounted for 93% of the entirety of the 'Great Recession' which is in fact a Great Investment Strike.

China and India's government massively increased their investment levels to replace the decline in private investment. They powered through the downturn, and, crucially, experienced a minimal rise in their budget deficits as a result, because of increased investment, not despite it. And, since investment and trade form the basis of long-tem prosperity they will also reap long-term rewards.

By contrast, in this economy, investment (GCFC) has fallen by €25.6bn and fell again in Q1, down 30% from a year ago. This is greater than the fall in GDP and represents 95% of the total decline in GNP.

The govt. has abetted this decline with its own cuts in capital spending, when the correct course was to increase investment. It is still the correct course.

paul sweeney said...

Paul, I take your point on the difference between the liberal tradition of JS Mill and the Neo con free market zealots who held sway for a while and who did so much damage. Yet most economists did appear to buy into the ideology.
On your last point - you are dimply wrong. Of course there is plenty of money for investment in state companies and for other capital spending. You said it yourself in your response. Most of the larger state companies are fully funded from own resources and can continue in this way and expand too.
Further if the Taoiseach can find €250m to woo foreign venture capitalists to sell their dubious wares from Ireland of course we can invest in solid and needed productive infrastructure. On the day (yesterday) Mr Cowan announced his bizarre idea to make Ireland the new Las Vegas of casino capitalism, ( I had thought Casino Capitalism had imploded) the Irish Times led with the report on the appalling mental health infrastructure in Ireland after 22 Boom years – 15 of which were years of real sustained economic progress. What missed opportunity! But mental health buildings are still very worthy investments now to help dig us out of the Crisis. I will be suggesting actively utilising state owned companies for productive investment.

Mack said...

Paul

Mr Cowan announced his bizarre idea to make Ireland the new Las Vegas of casino capitalism, ( I had thought Casino Capitalism had imploded)

Ah now. Starting any new venture is risky - whether it's the government doing it (as in the statist approaches advocated many times here) or private enterprise. Some group of people must bear the risk - taxpayers, investers, entrepreneurs - that a venture will fail in order to get it off the ground. To think otherwise is to deny reality. If there is an issue with this fund it is that taxpayers are taking on some of the risk, but not all the risk (as would be the case with a statist investment solution). At least some of the burden is shared with foreign investors. And they are making equity investments, rather than debt financing new companies. Given the state of our banks, surely this is a good thing?

Incidentally - this blog runs on Google's servers (funded by sequoia Capital) - how much of this wonderful tech infrastructure do you think we would have if it wasn't for Venture Capitalists willing to take risks with their money? (Cisco, Apple, HP, Dell, Google, Yahoo, Microsoft, Facebook, Intel etc.)

While you criticize it (Venture Capital) as casino capitalism, remember that the bursting of an equity driven investment bubble (should one come about) is relatively mild compared to the bursting of a debt bubble. I.e. the investors will lose their own money, not yours and mine..

Paul Hunt said...

@Paul Sweeney,

Many thanks for taking the time and effort to engage. I, in turn, take your point about the extent to which much of the economics profession seemed to be mesmerised by the neocon frenzy. But the challenge is to secure that precious middle ground both to repair the damage caused by the neocons and to guard against the inroads of nationalist, mercantilist authoritarianism.

Wrt your second point, it never ceases to baffle and amaze me that there is so little understanding of what "fully funded from own resurces" actually means. When one considers the scale of the investment in the ESB networks over the last decade - which is now close to trebling the asset value of the networks in that time (almost €6 billion investment added to an initial €3 billion of assets) - it must surely encourage some curiosity about how this massive investment could be funded from own resources.

Successive government haven't contributed a cent; indeed they have extracted dividends. Up to 2004 there was a limit on how much the ESB could borrow which was raised via emergency legislation. However, the ESB maintained its consolidated gearing low (<30%) and is only recently being compelled to raise it.

As a result over 70% of the up-front financing of this huge investment came customer capital contributions and from excessively high revenues set by the CER - which fed into high final prices.

This is the reality of "fully funded from own resources" and is evidenced by the CER's 5-year network price revies and the ESB's Summary Regulstory Accounts.

Of course, consumers should contribute to the financing of investment as they benefit, but 30% (rather than 70%) would be efficient. Regulated network businesses elsewhere can manage a gearing of up to 70%. And a responsible shareholder would have provided new equity. But this didn;t happen and consumers were gouged - and continue to be gouged - instead.

And yet you continue to advance this model and even to propose extension and expansion.

You may find that the CER is approaching the limit of its ability to gouge consumers to provide cheap finance for the ESB - and this is beginning to happen in other regulated areas as well.

This flawed model has run its course.

Rory O'Farrell said...

I think something that separates Ireland from some other countries is that here the state acted as an entrepreneur. The state didn't just nationalise companies but created new companies for everything from peat briquettes to cable television.

In China state companies also act as entrepreneurs, something that has decreased a lot in Ireland.

EWI said...

@ Mack

Incidentally - this blog runs on Google's servers (funded by sequoia Capital) - how much of this wonderful tech infrastructure do you think we would have if it wasn't for Venture Capitalists willing to take risks with their money? (Cisco, Apple, HP, Dell, Google, Yahoo, Microsoft, Facebook, Intel etc.)

Google, famously, was born out of the (publicly-funded) US educational system, as were most of the others as well (and staffed by graduates of same). Silicon Valley itself, of course, was born out of massive, sustained US state investment in the middle of the last century. Try something else...?

EWI said...

@ Mack

Incidentally - this blog runs on Google's servers (funded by sequoia Capital) - how much of this wonderful tech infrastructure do you think we would have if it wasn't for Venture Capitalists willing to take risks with their money? (Cisco, Apple, HP, Dell, Google, Yahoo, Microsoft, Facebook, Intel etc.)

Google, famously, was born out of the (publicly-funded) US educational system, as were most of the others as well (and staffed by graduates of same). Silicon Valley itself, of course, was born out of massive, sustained US state investment in the middle of the last century. Try something else...?

hughgreen said...

Some group of people must bear the risk - taxpayers, investers, entrepreneurs - that a venture will fail in order to get it off the ground.

It might be helpful at this point in your argument to give a shout out to the wage labourers and their families who bear the risks of longer working hours, greater workloads, stress, ill health, unemployment, crumbling schools, hospitals etc etc in order that investors can direct surpluses accruing from capitalist innovation (usually, through lower labour costs) in those directions the state-educated entrepreneurial geniuses buoyed by state-financed technological innovation see fit.

Paul Hunt said...

@Rory O'Farrell,

Your comment evokes George W Bush's alleged observation that the French have no word for entrepreneur. Data published by the CER and the ESB show that, over the last decade, the CER gouged over €4 billion from consumers to finance network investment. €2.4 billion of this should have come from borrowings and new equity. Add another €1+ billion extracted in a similar manner from gas consumers and the hundreds of millions spent creating this optical illusion of competition and guaranteeing high prices for new entrants and one isn't far short of €5 billion.

And this gouging hasn't been restricted to the semi-states; the private sheltered sectors have proved equally adept. So there should be no surprise that the price level for private consumption was more than 20% above the EZ average when the financial tsunami hit - and the subsequent decline has been patchy. It's bad enough that the private sheltered sector indulges in this gouging - it's simply their instinct when they're allowed to do it, but it is truly criminal when it is authorised by the state and its agencies.

This is about as far as you can get from the concept of an entrepreneur.

Mack said...

EWI -

I don't know where you are getting the idea that I am an anarchist from?


Without investment capital the company would not exist. That investment capital could have come from the government. But, in this case it didn't. If it had, there would have been just as much risk of the venture failing as if it had come from private capital. It came in the first instance from small time private investors (including Page and Brin's supervisors own savings) and then further injects from venture capitalists.

In the case dismissed out of hand by Paul above, the state and VC funds are making joint ventures. As funding any venture is risky, I can't see why one form of equity based funding is casino capitalism, and another virtuous. Especially seeing as the VC funds are risking their money, not ours.

Mack said...

Also, on the publicly funded arguement -

Stanford charges it's students hefty fees you know! And Phd programs are often funded by businesses and philanthropists. Never mind that the exchequer is also funded from the activities of private enterprise itself. Short of being communist (?), I can't see why anyone would object to that?

In fairness, in this particular instance Page and Brin were part-funded by the National Science Foundation (around €10k each) for their PhD studies - which is a government body. They weren't funded AFAIK, by the state in setting up the business. But grants, subsidies & tax breaks to new business from government are hardly unknown either.

Mack said...

Hugh -

Google pays pretty good salaries you know! When bonuses, stock grants, stock options & benefits (pension contributions, free food - 3 meals a day) are factored in they even pay well above market rates..

hughgreen said...

Mack,

There is a big difference between wage labourers in general, since your comments were about risk-bearing in relation to Venture Capital investment in general, and Google employees in particular. VC in general is not produced by Google employees.

Mack said...

Fair enough Hugh, I imagine venture capital is built up from previous successful exits, and run down by failed companies. It is possible some of those companies were f*&!rs to their employees.

In general though, high-tech startups in Ireland, part funded by the state, should create well paid jobs in *Ireland*, the more good jobs there are here, the more competition for workers - the higher the wages and the better the conditions.

EWI said...

Without investment capital the company would not exist.

Without the publicly-funded general research so derided by IBEC et al (but not by any good startups with real tech), there'd be nothing there for the VCs to gamble their money on.

Unless you think that a VC (with at most, what, an MBA?) is capable of creating a Google or Intergraph out of thin air?

Mack said...

EWI -

No of course not. It doesn't particularly matter where the investment capital comes from (the state, angel investors, existing tech companies, VC's etc) - just as long as the companies who need it, get it when they need it (otherwise they won't be able to grow). It's the entrepreneurs - putting in the work, that actually build the company. The investment capital is just money.

It depends on the VC's - how qualified / experienced / good they are - read Paul Graham's blog for a good overview. Most suck. He reckons the ones in Silicon Valley are better than the ones in Boston. They're more willing to take risks and invest early. Because they've got more experience in doing it. They can spot what works a little bit quicker and are more willing to take a chance (thinking they'll make up any loses on risky bets gone wrong, with risks gone right). The Boston VC's are much more conservative, and more likely to stall / prevaricate etc.

Having something like the company he set up (Y combinator) here - an early stage incubator, would probably also be very useful.

The other big advantage silicon valley has is a lot of the investors (particularly early stage, before VC's would come in) have worked in the industry. They're technologists, or entrepreneur themselves. They have that kind of conveyor belt system. Where people who have successfully built tech companies help and mentor the next generation coming through. That they have all this infrastructure (including world class comp sci Universities) is why it's such a hot-bed of innovation..

paul sweeney said...

Many thanks to you all and a few comments. Mack, I do agree that venture capitalists do play a positive role in the economy in the main. From memory, I can think of two companies where they did so here - C&C and Smurfit Kappa. They also are very helpful in taking risk for new start ups which is very important. However, in some instances, they have been cold hearted and anonymous asset strippers who have also been subsidised by the taxpayer (on interest deductions on huge borrowings). I cite Eircom here and there are many more abroad. We need to be wary of them and also not subsidise them any longer. Mr Cowan seems to be upping the ante on the level of state subsidies to this class of entity.

Anyway, in my innocent youth I had thought right-wing economists were against state intervention in the economy. I realised that this is utterly untrue, provided the subsidies were rolling in to private firms. When I opposed the vast array of subsidies to property firms and others during the domestic boom, I was excoriated by the commentariat of the right. There are many honorable exceptions but they tended to remain silent. A pity – NAMA!

Many contributors argue for targeted stimulus packages to deal with rapidly declining demand. So far all we have got from government is money for what appears to be ephemeral venture capitalism – and it appears to be matching funds – 50:50 and a spend of €100m on two ships for our naval service, to stimulate the Scottish economy and even more dubious “investment” of our tax money in the so called smart economy, whatever that is.

On Paul Hunt’s point of the ESB and its regulator. I think we agree that the Irish system of electricity regulation is bizarre. There is a need to ensure that monopolies do not gold plate investments as Paul appears to be implying on ESB networks, but I do know that the opposite happened for many years. ESB was not allowed to invest in transmission and networks in order to keep prices down when it was directly regulated by the Dept. Good for consumers then (and better for Government?) but not so later.

Mack said...

Paul -

I can see the source of your worries.

While some firms probably do engage in both, we should be able to draw a distinction between firms that are primarily Private Equity firms (like Babcock & Brown), that purchase large existing companies to break them up, strip them of their most valuable assets and Venture Capital firms that specialise in scaling startups (like http://www.sequoiacap.com).

I would expect (given the size of the fund) & hope it's the latter rather than the former the government are doing deals with.

Paul Hunt said...

@Paul Sweeney,

Many thanks for attempting to close the loops your extensive post opened up.

Just a few observations. First, I am pleased that you see an important role for private entreprise and that risk-taking should be rewarded appropriately. Your strictures on private equity asset strippers are fully justified. Many infrastructure and utility businesses have had their balance sheets hollowed out (there are plenty of Eircoms in the US and the UK) so that they are not in a position to finance investment to address a looming infrastructure deficit. But that should not be used to deny the existence of responsible long-term investors who can provide finance to free up the state to apply its scarce resources where markets/regulation work poorly or not at all.

Secondly, you may recognise it, but the extent to which the private sector will seek, and expend effort and resources to secure, public subsidy is not widely acknowledged. You may find the following by Dieter Helm of Oxford University:http://www.dieterhelm.co.uk/sites/default/files/Rent-seeking_OXREP_26_1.pdf
of some interest in this context.

Thirdly, you may find the current electricity and gas situation 'bizarre'; I would say dysfunctional. You are correct in that governments held down electricity and gas prices below the economic cost of supply - the ESB and BGE had 'price freezes' during the late '90s and into the early 2000s. Apart from attracting big, electricity-intensive IT MNCs and making consumers temporarily happy, one intent was to reduce ESB staff and pay levels by squeezing cash flow and profits. The effect was to massively increase the demand for electricity and investment in the system while starving the ESB of the cash to finance it. However, successive governments failed to contribute a cent to finance this huge investment back-log and the ESB (and BGE) preferred to use their borrowing capability to finance empire-building in other areas. As a result the CER was compelled to gouge most of the finance up-front from consumers driving final electricity and gas prices to eye-watering levels.

And to drive prices even higher successive governments (using the mantra of 'more competition and better regulation')overdid the application of the EU's deeply flawed model for electricity and gas market liberalistion.

And finally, I recognise the requirement for some form of targeted stimulus, but it may be financed only by accepting some measure of assets sales to convert 'old' assets into 'new' assets.

However, the more pressing problem is deflation and holding some state administered prices high while others fall is merely going to prolong the agony. A one-off significant reduction in these prices would boost real wages and incomes, reduce the costs of doing business, boost demand and would restore normal expectations of inflation that would fuel the demand for credit to finance business and investment.