In the eyes of most Americans, China's investment environment is the worst of all, filled with widespread intellectual property theft, rule violations by government officials, and distorted regulations that suppress foreign investors and erode their interests. Given the fact that the Chinese officials are enthusiastic about attracting foreign direct investment, many people in Washington DC believe that the United States, with a bargaining power of over $5 trillion of direct investment abroad and total overseas investment assets of over $25 trillion, must show off its muscles to punish China's misconduct and force China to change routes.
If true, this sentiment has been simmering in Washington for a long time. Because of the reckless behavior and the emotional way American representatives mainly handle differences, it is expected on this side that sooner or later the boiling point will be reached. Now, thanks to the Trump administration's protectionist ideology with inherited American hegemonic behavior, this day has finally arrived with an accelerated pace. On Wednesday, April 4, 2018, the Trump administration announced 25 percent tariffs targeting about $50 billion in Chinese exports to the United States.
The move has several implications. First, it intends to punish China for the damage caused through entrenched theft of US intellectual property and forced technology transfers. Second, it also aims to hamper China's efforts to upgrade the manufacturing base. Third, there are indications that US trade authorities want to cause the global value chain to relocate from China as the scope of tariffs cover many typical global value chain goods such electronics, telecommunications, machinery and transportation equipment.
However, the situation worsened as China adopted an uncompromising approach to US aggression. No more than 11 hours later, China retaliated by slapping similar tariffs on some 106 US items with a value matching the $50 billion on Washington's list. Now the world is watching closely how the game is played by the two super trade powers. The US started the beggar thy neighbor approach while China quickly put both countries in a prisoner's dilemma. Next, it is time for the US to punish China for reacting and then China's turn to respond more aggressively. In response to China's reaction, Trump instructed the United States Trade Representative on April 5 to consider whether $100 billion of additional tariffs would be appropriate. The two countries have behaved as the game theory predicts. In this prisoner's dilemma game, both countries are forced with no good options, but to follow suit with each other. In fact, this game is not new, but simply a revival of the stupid trade wars by irresponsible governments during the Great Depression in the 1930s. In my opinion, misinformation has been a factor that made both countries emotionally charged.
I say "misinformation" because the US public has been misled by perceptions, not by truth about China's investment environment. From the data I have read, my immediate conclusion is China's investment environment isn't that unfavorable to US firms, though it is undoubtedly true that improvement is always needed.
Is China an important country for US direct investment abroad? If you look at the relative size of US direct investment in China, the answer is, not as important as expected. In fact, US direct investment in China is far behind countries such as the Netherlands, the UK, Luxemburg, Ireland and even Japan. By 2016, US total direct investment in China was only $93 billion with about 67,000 US firms in operation, similar to the size of US investments in Mexico. Meanwhile, in the Netherlands, the cumulative US direct investment amounted to $847 billion, and even in Ireland the amount was $387 billion. China is only the 15th largest recipient of US direct investments abroad.
Therefore, many people have concluded that US companies prefer to invest in European and developed economies rather than in China because they all have favorable environments to attract investors there. This may be an explanation for why China has not attracted enough direct investment from the US, due to fears of the country's economic system by the US investors. However, "seeing is believing" and "small is beautiful". Here, I will use a series of performance indicators to argue that instead of bad practices by China as accused by US trade officials, US direct investment in China has outperformed counterparts in any other overseas location and China is already a promising market for more US investors.
According to statistics from the US Bureau of Economic Analysis, the total sales of US firms operating in China amounted to $356 billion in 2015 and, ironically, this number is similar to the size of the US trade deficit with China, which was recorded as $335 billion that year. What implications does this sales figure have? In spite of the fact that US firms invested less in China than in the Netherlands, Luxemburg, Japan, Australia and Mexico, they have sold more goods in China than in these seemingly more favorable locations. If measured by total sales realized by US firms, China, being the 15th largest recipient country of US direct investment, ranks as the sixth most favorable location for US investors after the UK, Canada, Singapore, Ireland and Germany. Actually, China's position is closely similar to that of Germany as US firms sold about $357 billion goods in Germany in 2015.
If measured by value added produced by US firms, China's investment environment is more competitive. US firms produced $68 billion valued added in China in 2015. To the surprise of many people, this would put China together with the UK, Canada and Germany in the club of the world's top four value-added producing countries for US firms. Further to this argument, if China is a country of intellectual property theft everywhere and if US firms were unable to protect their trade secrets in the absence of US government interventions, US firms should cease their R&D activities in China. What is the truth? In fact, US firms have performed more R&D activities in China than the countries highly valued by the US public such as the Netherlands, Luxemburg, Ireland, Australia, France, Singapore and Japan, not to mention Mexico! In 2015, the R&D activities performed by US firms in China were equivalent to $31 billion and this placed China in the rank of the top four locations (along with Germany, the UK and Canada) for US firms to conduct their R&D activities.
To the disappointment of many who have been preoccupied with "China bashing", the Netherlands, one of the most innovative countries in the world, hosted only 40 percent of the R&D activities done in China by US multinationals. If one looks at the records in Luxemburg, Brazil, Mexico, France and Japan, it is hard for you to believe that the Chinese market is a misfortune for US multinationals. US firms actually conducted very little R&D activities in Luxemburg and Mexico, and those performed in Japan were about 23 percent below the level in China. Meanwhile, Singapore could only reach 50 percent of the performance by US firms in China.
Economists do not like to use absolute values as these numbers do not reflect efficiency or effectiveness. The implications would be stronger if we use efficiency indicators to describe the situation. If you look at average sales of per dollar investment (equivalent to average return of investment in economics) US firms in China are the most successful among all the favored locations by the US public and each dollar invested by US firms in China could generate $4.7 sales in 2014 and $4.2 sales in 2015, whereas in the UK a dollar invested could only generate $0.99 sales, in Canada $1.6, in Ireland $1.1 and in Luxemburg the number was unbelievably lowb only $0.12 in 2015.
I know that it is still far away from convincing those who base their judgment of China's investment environment on various talks and narrow-view analysis. Let's look at other indicators. What is the profitability ranking of US firms in China relative to other locations? I use net income from each dollar invested as a measure of profitability. In 2014, US firms enjoyed the highest profitability in Ireland for their investments and an average of each dollar invested by US firms in Ireland could receive $0.42 of profits in 2014. I think everyone in this world may be surprised to hear that the second most profitable location after Ireland for US direct investment is China. In comparison with Ireland, US firms in China have a slightly lower rate of return at $0.35 per dollar invested. But it is significantly higher than Canada at $0.19, the UK at $0.13, the Netherlands at $0.20 and Japan at $0.19.
It is not sufficient for you to give up your long-held belief now. Look at more indicators. What about the effectiveness of value added and investment income generated by US firms for each invested dollar? It is incredible that US firms in China have topped all the other host countries in these two indicators. For example, US firms generated an average of $0.92 value added for each invested dollar in China, while the average of seven major locations for US direct investment -- Canada, the UK, Ireland, the Netherlands, Germany, France and Japan -- was only $0.41. US firms received the highest investment income from each dollar of investment in China. In 2014, US investors in China received an average of $0.15, 200 percent higher than that in Germany and 67 percent higher than in Japan during the same period.
What about R&D activities, a topic that the US public is most concerned about? The fact is that US overseas investment has basically used two countries, Germany and China, as the most important platforms to perform R&D activities. The latest figures show that an average of $0.08 for each invested dollar was used for R&D activities in Germany, and in China the share was $0.04. If you compare these numbers with those in other favored locations, you will see a striking difference. In the UK, only $0.01 of each invested dollar was devoted to R&D activities by US firms and in the Netherlands the share was even lower at $0.002. While Luxemburg is among the most favored locations for US direct investment, US firms performed the least R&D activities and an average of $0.0004 of each dollar invested was allocated to R&D activities. It is up to US multinationals and policymakers to find out why the number is so low for Luxemburg.
Now, we can draw two main conclusions from these facts. First, like it or not, US firms in China have outperformed their peers in most of the locations favored by US investors. Viewed by sales, net income, value added, investment income and R&D activities, the outstanding performance of US firms in China cannot justify the accusations made by some US officials that China's unfair practices have caused substantial damage to US business interests and thus, compensation worth $50 billion should be paid. Second, with its market size and vast pool of skilled labor and engineers, China is a market characterized by high rate of return on investment. The Chinese market is a mercy rather than a nightmare to US investors as it is providing highly profitable opportunities for US firms.
Let me quote Adam Smith in his great book The Wealth of Nations to end this short article: "Man is an animal that makes bargains: no other animal does this - no dog exchanges bones with another."
The author is the chief economist with the Academy of China Open Economy Studies at the University of International Business and Economics.
If you have any problems with this article, please contact us at app@chinadaily.com.cn and we'll immediately get back to you.
