Jack Mintz: China's state-owned enterprises will make us all weaker and poorer

Having more Chinese state-owned enterprises investing in Canada won't help, rather it would run the risk of creating a branch-plant economy

Canada's Prime Minister Justin Trudeau met with China's Premier Li Keqiang in December.

January 4, 2018

The plan for a Canadian trade treaty with China has gone off the rails for now, but when it rears its head again one of the most delicate issues won’t be exports and imports, but foreign direct investment. Rules that potentially open up markets to Canadian investment in foreign countries could be of obvious value to our own multinational companies. And usually, foreign direct investment into Canada brings benefits to us, too, providing new capital inflows, management and technology that can improve our prosperity.

But China’s different. Benefits to outbound and inbound foreign direct investment are minimized when it comes to a heavily state-managed economy like China’s. Canadian businesses already face much more stringent regulations when investing in China compared to what Chinese investors face when buying into western economies. And the biggest Chinese investors are state-owned enterprises (SOEs). The assets they buy tend to become worse performing, with the government using them to pursue political goals and unfair competition to seize global market share. The only terms that Canada should accept in a trade deal with China should require reciprocity and limits on SOE takeovers of Canadian industry. 

I was involved in numerous World Bank and IMF missions to developing countries over the years, including China, and one of my first orders of business was to read the reports put out by accounting and legal firms evaluating the ease of doing business in a particular place. Looking at the latest “doing business” reports from China, it’s clear that the country has done some things to reduce barriers to foreign direct investment, but investment regulations are still extraordinarily heavy.

RESTRICTIONS

Companies that want to set up shop in China need to create a special Chinese subsidiary whose licence to stay must be routinely renewed by the government. Foreign companies can also enter joint venture agreements with Chinese companies, but even those require approvals and are subject to a number of restrictions.

Certain industries are off limits, including power, oil, banking, tobacco and broadcasting. Certain capital transactions are still subject to official approval (although foreign exchange is more convertible than it used to be). And the biggest barrier to entry for foreign investment, of course, is that so much of the economy is dominated by China’s powerful and myriad SOEs. Those favoured firms are not ones that most investors see much hope in competing with.

Canada — despite having some barriers to foreign direct investment of our own — is nevertheless a much more open, competitive market. Most foreign acquisitions either are exempt from review, if they’re not too big, or are generally approved by Investment Canada through a net benefit test. The only really controversial ones involve Canadian “champions,” such as in the resource sector, or firms involved in national security.

RECIPROCITY

A successful trade deal with China requires a reciprocal bargain in foreign investment: the rules for Canadian investors over there must be no stricter than what Chinese firms face here, and vice versa. It’s only fair. Why would we negotiate an agreement that gives rights to another country but not your own? And the lack of reciprocity can fuel political opposition to trade deals, as a recent U.S. study to be published in the British Journal of Political Science reports.

Still, don’t count on China to agree to anything of the sort. Beijing talks like it’s open to trade and investment on a commercial basis. But its actions — protected markets, minimal intellectual property rights and heavily subsidized export industries — say otherwise. And its SOEs are key to China’s strategically unfair trade practices.

Here in Canada, China’s CCCC International Holdings is trying to buy infrastructure-builder Aecon, and is awaiting government approval. But CCCC’s state-owned parent company was blocked from World Bank projects for eight years after 2009 after engaging in fraudulent practices. Meanwhile, the Trudeau government was in such a hurry to help China’s state-owned Hytera Communications buy Canada’s Norsat — which sells satellite communication equipment to the U.S. military — that it didn’t even carry out a national security review. The Pentagon might soon be cancelling business with Norsat, leaving Canada worse off.

Productivity in Canada got huge boosts over the last three decades as Crown corporations were sold off and made more profitable, including Air Canada, Petro Canada, Canadian National Railway, Alberta Government Telephones, and the Saskatchewan Wheat Pool.

The last thing Canada should be doing is allowing foreign SOEs to renationalize our industry, making us poorer and weaker for it. Since 2010, Chinese fully owned SOEs, accounting for roughly two-fifths of industrial assets in China, have been earning annual average rates of return on capital of about four per cent — well below the return rate of China’s private companies at 13 per cent.

Others note that if China’s SOEs also had to pay market rates for the land and loans they get at discounts, or free, from the government, their already weak profitability would be at least halved. (Chinese President Xi Jinping is introducing reforms that create mixed enterprises with partial private ownership of shares, and put a wall between SOE managers and regulators, but neither will do much good. The performance of mixed enterprises is not much better than SOEs, and investors will find that governments won’t resist interfering in decisions for political reasons.)

Whether from China, Russia or elsewhere, more SOEs investing in Canada will not help the Canadian economy. Canada will become a branch-plant economy, much like the old days when America’s corporations dominated. At least those companies brought managerial and technology expertise to Canada. China’s SOEs have little to teach us.