Monday, July 13, 2009

FDI, Regulation, and Shifting Power Centers: China and Rio Tinto

. Monday, July 13, 2009

On July 5th, without warning or explanation, Chinese officials arrested four Rio Tinto employees, one of them an executive and Australian citizen.  Later, China's state run media reported the arrests were connected with allegations that Rio Tinto obtained confidential documents revealing China's bargaining strategy for negotiating iron ore prices with the multinational mining firm.  Australian officials are particularly concerned since the detainees were given no access to outside communication and Chinese officials did not divulge any information about their whereabouts or the charges they face to Rio Tinto or the Australian government.

The ensuing diplomatic breakdown between China and Australia illustrates two points about the nature of foreign direct investment (FDI) today.

1) Power asymmetries are shifting.  

Most academic work on FDI treats developed (read OECD) countries as price makers and developing countries as price takers.  In other words, highly developed countries act on behalf of their multinationals by securing legal protection for multinationals' FDI in other countries.  This is mainly done through the use of Bilateral Investment Treaties (BITs).  The literature treats developing countries (China included) as grateful for whatever FDI they can get, and therefore willing to submit to OECD standards of legal protection for businesses.  
The problem with this view is that FDI sourcing patterns are shifting.  As the Chinese economy can support regional trade and FDI growth as well as export FDI to Africa and elsewhere, China doesn't need to cower to western demands for business protection.  Indeed, China never really has.  
Bottom line: predictions of convergence towards one standard of FDI legal protections depends upon the preferred regulatory level of key players.  China's rise underscores the possibility of multiple and competing regulatory regimes.

2)  The link between home country and multinational must be tested:

The focus on regulatory regimes like BITs assumes that home countries act as agents for their multinationals and that home countries discriminate against multinationals based on the multinational's home countries.  Talk that the recent events in China will lead to a backlash against Chinese multinationals looking to directly invest abroad depends upon the idea that countries will retaliate against Chinese-owned firms as well as the Chinese government.  And, the Chinese experience is an easy test of this link because many Chinese firms are in part owned by the Chinese government.  It is not entirely clear that this link holds more generally or consistently.


Alex Parets said...

I guess I just don't understand what your argument is for point #1. All I see is developing countries taking the best (read: cheapest) investment that they can get, the same as it was before. The only difference now is that China has resources available to spend in other developing countries, so there set of options has increased. They're still taking whatever they can get, starting with the best deal.

The "price-taking" argument as far as developing countries go is still firmly intact.

China's entry has simply added an extra FDI player into the mix. They have a market advantage in that they don't tie their FDI to certain legalistic protections and standards so developing countries may be more inclined to take their FDI first. But this may also not be true. There may be other benefits to Western FDI that go beyond the simple cash flow. Western multinationals may be more dependable, may re-invest profits into the local economy, etc. Don't know if any empirical work has been done.

Has the story really changed? I may be wrong so set me straight if I am!

Alex Parets said...

I like where you're going in #2. It's a really interesting topic.

A couple other interesting cases to take a look at are leftist populist movements in Latin America and nationalizing certain industries once they assume power. I'm thinking of Chavez in Venezuela and Morales in Ecuador.

There is constant talk about the backlash from the FDI-sending country when businesses are nationalized. Certain countries may retaliate and withdraw their business. But it seems like there is always another MNC ready to invest when that company leaves. It's as if they recognize the risk and factor it into their expenditures and operations as a "cost of doing business" in that country, much like corruption is factored in.

Does retaliation actually take place, as you put forward in your post? It's possible under certain circumstances. If you're China, it would be hard for these countries to retaliate against your businesses in Australia or the US. But if your Ecuador, it would be a lot easier. The retaliating country may lose a lot by retaliating against China, but substantially less with the same policy towards Ecuador. So size may matter.

Interesting stuff Sarah.

Thomas Oatley said...

I don't understand your point about BITs. Their purpose is to provide a common legal framework in the absence of a common sovereign. They thus specify how disputes between firm and host government will be managed; specify compensation for expropriation; tend to require MFN treatment, and other such things. Thus, I don't understand what you mean when you relate BITs to "home countries as agents" or retaliation.

Nor do I really understand the broader point here. An authoritarian state "disappears" four people they allege have engaged in corporate espionage. Why is this surprising? What surprises me is that anyone would place fixed assets in China and the ridiculous infrequency with which we observe government behavior of this sort. The fact that China is the single largest recipient of FDI and rarely engages in such behavior thus speaks volumes about the perceived effectiveness of BITs in restraining arbitrary behavior.

So, this episode seems interesting only if what it illustrates is an emergent Chinese policy to hold people hostage in order to extract lower raw material prices. I don't think that is that what you are suggesting, is it?

Sarah Bauerle Danzman said...

Happy my post is generating so much commentary. I think I was a little unclear about my points, so I'll try to clarify:

Alex: My first point is that as different countries become large FDI exporters, they may have different preferences in regards to the types of rules they include in BITs. So, for example, China's ability to export FDI in large amounts means that they can set the rules they want for BITs between them and countries they want to export FDI to. When there is more than one regulatory regime (read: Western vs. Chinese), then developing countries can choose which type of BIT they would rather sign (or at least to the extent that Western FDI and Chinese FDI are complements, which may be the case in certain industries but not in others). This suggests the emergence of competing regulatory regimes.

Alex and Thomas: the NY Times piece talks about the potential for retaliation, namely countries refusing to accept FDI from Chinese firms. My point is that it is not really clear whether or not countries punish firms for the actions of those firms' home countries.

Thomas: per your second paragraph - I am responding to the literature on BITs which seems to equate the proliferation of such agreements as proof that countries are converging to one common domestic regulation of MNEs. China's decision to go its own way seems to undermine that argument, at least in part. More broadly, China's actions show that the desire to attract foreign firms is not always stronger than the desire to flex sovereign muscle. It goes back to the argument that elites do not always desire what is welfare improving (eg - Acemolgu and Robinson).

I hope that's clearer. I find some of this difficult to articulate succinctly.

Thomas Oatley said...

Which literature mistakes BITs for domestic regulation? These are completely different things. And as almost all BITs are based on the US model, there is a clear convergence toward a single model for legal obligations arising from or connected to issues associated with FDI.

As for China, I don't understand the assertion that they have "decided to go their own way" or are flexing sovereign muscle. You seem to rule out for no reason the quite reasonable alternative that the four people in question did indeed engage in corporate espionage, in which case China did what the U.S. would have done and was fully within its rights to have done so. Nothing in BITs grants immunity from local law to foreign investors. So, what exactly has China done that is in contravention of an obligation they have accepted?

Sarah Bauerle Danzman said...

Well, there are actually a lot of disparities between BITs based on source country. I spoke with Jason Yackee about this earlier this year. While the literature often treats BITs as basically carbon copies (here I'm thinking specifically about Elkins et. al), BITs vary widely on the amount of protection they afford foreign investors. US BITs can often be particularly invasive in terms of granting immunity from local law. Often, these BITs require that any disputes or charges of unlawful behavior must be adjudicated by dispute settlement procedures rather than through local judiciaries. And, given that China arrested the four people without giving them a chance to contact relatives and without a specific charge (at first) and without access to legal council, there is plenty of reason to bring up the effectiveness as well as the future of BITs. BITs are supposed to foster FDI through the causal mechanism of providing transparent and fair (sometimes preferential) treatment under the law, and regardless of guilt, that didn't happen in the case of the four Rio Tinto employees.

FDI, Regulation, and Shifting Power Centers: China and Rio Tinto




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