By Saul Estrin
Professor Saul Estrin examines China’s growth as a global leader, and its growing global reach resulting from Foreign Direct Investment. As well as attracting inbound investment from abroad China is now becoming a major global player in outbound investment, teaching us valuable lesson about global foreign direct investment.
As Programme Director for the Executive Global Master’s in Management programme at LSE, I made the decision to relocate to Beijing this year to teach my students about foreign direct investment. My students travel to carefully chosen locations across the world for classroom modules on a series of different business topics, and we try to select the most appropriate places to provide practical ‘on location’ learning about the topics taught in each module. China is now a well-established global leader in attracting inbound investment from other countries (in fact China has been ranked as the largest host economy for inward FDI amongst emerging markets every year for the past decade). But more recently it has also become a new global player in outbound foreign direct investment, with Chinese firms rapidly extending their reach into profitable markets across the world. I could no longer ignore the fact that China can teach my students, and the rest of the world in general, valuable lessons on outbound FDI.
FDI remains one of the most important indicators of the process of globalisation, as it highlights the the division of labour across the world. It has been dramatically increasing on a global scale in recent years, reaching $1.45 trillion in 2013 (up 9% on the previous year). The stock of capital owned by firms operating outside of their home country has also accumulated to a remarkable $25.5 trillion. There is no sign that the pace is slackening – the United Nations (UNCTAD) predicts that by 2016, the total global FDI inflow could reach as much as $1.8 trillion.
As the middle of this decade approached, a new global trend emerged. For the first time an entirely new form of FDI has caught the world’s attention: “South > North” and “South > South” investments.
The pattern of global FDI has also changed over time, from “North > North” investments between American and European firms in the 1960s-1990s, to the inclusion of Japanese firms in the 1970s, and “North > South” investments into developing countries, for example to exploit natural resources. From 1990 onward the “North > South” trend expanded on a huge scale, in an era of increasing emphasis on ‘emerging markets’ (particularly concentrated in large economies like the BRICs – Brazil, Russia, India and China). In 2010, the flow of FDI into developing countries for the first time exceeded the flow into developed countries.
However as the middle of this decade approached, a new global trend emerged. For the first time an entirely new form of FDI has caught the world’s attention: “South > North” and “South > South” investments. In reverse to the previous trend, we are now seeing increasing investments by firms in increasingly wealthy and mature emerging markets into both developed and developing economies, reflecting increasing levels of wealth and maturity in emerging markets. For example Chinese multinationals are increasingly pouring investment into Brazil and African countries, as well as being active in mergers and acquisitions in Europe and North America. China has become a global leader in this trend, and it is fundamentally changing our understanding of FDI.
While the scale of FDI flowing outward from emerging markets remains relatively small in comparison with “North > North” and “North > South” investments, it is growing rapidly. Developing economies invested around $553 billion abroad in 2013, comprising approximately 39% of all global outward FDI flows, as compared with 10% at the start of the millennium.
China is the best place to observe and understand this new phenomenon. Outward FDI by Chinese firms is growing at an astonishing rate. In 2007 the flow had reached $26 billion, and last year it exceeded $100 billion for the first time. Chinese firms now have increasing significance in the global economy. There were no Chinese firms in Fortune’s Global 500 in 1990, and only 10 in 2000, but we have seen a massive shift in the one-and-a-half decades since the millennium. In 2014 there were 95 Chinese firms in the top 500, catching up rapidly with the 128 from the US and 121 from Europe. These new Chinese giants include large state-owned banks and smokestack industrial firms, as well as global players in technology and electronics like Huawei, Lenovo and Haier. Savvy investors also know a lot about rising stars like Baidu (internet search on a domestic scale to challenge Google), Sina (owner of Weibo, which entered the world’s top 10 largest social networks in 2013), and of course e-commerce colossus Alibaba, whose flotation on the New York Stock Exchange in 2014 was the largest Western markets have ever seen.
The rise of FDI in emerging markets meant that firms also needed to develop a better understanding of the risks and opportunities in business environments, which can be less sophisticated and more prone to political and social disruptions.
The latest analysis speculates that Chinese firms are following what is known as a springboard strategy, seeking strategic assets abroad to strengthen the firm’s capabilities not only in the local market, but also in its global operations. For example, thousands of small- and-middle sized manufacturing firms owning key manufacturing capabilities or technologies have been purchased by Chinese suitors, especially in Germany. This has given the acquirers access to advanced technologies and international brand names, which have strengthened their competitive position back home in their domestic markets in China.
So what can the rest of the world learn from China? Emerging market multinationals like these Chinese giants are changing the way we think about FDI, and changing the issues for which teachers like me need to prepare the next generation of managers and leaders. FDI strategies in the past focused on the development of resources (e.g. technologies, brands, human resource capabilities) that could be exploited profitably by a firm in a range of markets. The rise of FDI in emerging markets meant that firms also needed to develop a better understanding of the risks and opportunities in business environments which can be less sophisticated and more prone to political and social disruptions.
But now with the reverse flow of FDI from emerging markets into developed economies, the underlying motivations and strategies are less clear. Emerging market multinationals do not usually have special assets or technologies which they can exploit globally – instead their challenge is to develop those assets. This poses two significant strategic questions; the first one for emerging market firms, and the second one for their Western competitors.
The first is the profound question of how emerging market firms can bridge cultural gaps and successfully bring capabilities and resources back from their European and American acquisitions. Western firms tend to be flat and innovation-focused, whereas Chinese firms have traditionally been strongly hierarchical. For example, a Chinese firm which has purchased a German or Scandinavian high-tech company to obtain access to its technology and innovative capability, must successfully integrate the new highly qualified and highly autonomy-minded staff into the hierarchical Chinese organisation. Chinese firms are now, by necessity, at the forefront in solving these issues. They are also rapidly learning to find ways to make their organisational structures workable with other types of institutions in democratic and decentralised economies, such as trade unions and regulators.
The second question is how Western multinationals should respond to the recent seismic changes in the business landscape. At the moment, many Western firms do not view Chinese companies, even very large ones, as important competitors on the global stage – but instead take the view that the strength of Chinese firms lies in high-volume mass-market operations, rather than premium market segments where Western brands and prestige dominate. However Chinese firms are increasingly utilising the acquisition of foreign resources to bolster their strategic position in their domestic and overseas markets, and are rapidly learning how to move up the value chain and effectively strengthen their competitive stance across all market segments to challenge Western firms. While this development will not be instant, it is highly likely to occur in many markets – perhaps more quickly than is now appreciated in many Western boardrooms.
When I travel to Beijing with my students later this year, we will be grappling with these pressing questions and challenges which the managers of tomorrow will be facing in firms across the world – and I am confident that China will be teaching us some very valuable lessons.
About the Author
Saul Estrin is Professor of Management in the LSE Department of Management. He is an expert on global foreign direct investment, and Programme Director and founder of the Executive Global Master’s in Management, LSE’s innovative alter-native to an MBA.