China’s Evolving Economic Statecraft

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China’s Evolving Economic Statecraft

Beijing’s use of commercial actors to carry out Party-state objectives requires a coordinated response.

China’s Evolving Economic Statecraft

A statue of former Chinese leader Mao Zedong is seen in front of smoking chimneys at Wuhan Iron And Steel Corp in Wuhan, Hubei province (March 6, 2013).

Credit: Reuters

Chinese enterprises are going global, venturing overseas to acquire foreign companies, know-how, and technologies. While most of these activities reflect simple business decisions, others carefully and deliberately advance China’s strategic interests, perhaps against the interests of its trading partners. China’s state-owned enterprises (SOEs), as well as ostensibly private entities, serve on the front lines of Beijing’s economic statecraft. These companies’ activities increasingly signal political, not commercial, goals and are directed by the Communist Party of China (CPC), which rules China’s one-party state.

This effort is not being conducted in secret, but is clear to anyone tracking Beijing’s national economic, military, and industrial development policies. National policies such as “civil-military integration,” “Made in China 2025,” and “One Belt, One Road” leverage commercial actors to drive economic and military modernization, advance foreign policy objectives, and enhance Beijing’s power projection abroad.

Beijing’s ability to leverage economic tools and commercial actors to achieve Party-state aims — economic statecraft — will always face implementation challenges, as demonstrated by numerous examples of missteps and bad behavior by Chinese SOEs abroad. However, China appears to be enhancing its capabilities by consolidating Party control over SOEs, rolling-out techno-nationalist economic and military development strategies, and leveraging SOEs to advance military modernization and foreign policy objectives. Beijing’s increasingly sophisticated economic statecraft has already permitted it to achieve significant advances in a short period of time in several key industries including aerospace and energy.  Such successes pose a dual threat to U.S. security since they enable Chinese SOEs both to compete more effectively against Western companies and accelerate the pace of Chinese military modernization.

Consolidating Control

Chinese President Xi Jinping is currently overseeing the largest overhaul of SOEs since the 1990s to “strengthen, optimize, and enlarge” state firms. Since 2014, more than $1 trillion in state-directed mergers have taken place across the railway, metals and mining, and shipping sectors. Just this month, Caixin News reported that Beijing was merging its two state-owned nuclear energy companies and that plans for merging other SOEs are expected to be rolled out in the near future. At their core, these mergers are a key part of Beijing’s push to create globally competitive national champions.

While it is making SOEs the centerpiece of its overseas economic expansion, Beijing is also increasing the Communist Party’s control over them. In October 2016, Xi effectively defined the corporate missions of China’s SOEs, declaring that they should “become important forces to implement” the decisions of the Party to “enhance overall national power, economic and social development, and people’s wellbeing.” Xi’s pronouncement is having an immediate effect as the CPC moves to consolidate power over SOEs corporate operations. For example, a number of state-owned firms, including FAW Car Co. and Sinoma Science & Technology Co., are amending their articles of association to provide internal Party Committees a “central role” in corporate management. This includes requiring the board of directors to seek direction from the Party Committee before making “major decisions.” Many SOEs are also combining the role of company chairman and Party secretary, a policy reversal dashing any notion of separation between CPC and SOE corporate affairs. These policies and the elevation of Party Committees within SOEs reflect a coordinated and gradual reorientation of SOE reforms consolidating CPC control over core industries deemed vital to future prosperity and power.

Targeting Western Technology and Know-how

The commercial activities, including overseas M&A and investment, of Chinese state-owned or connected firms place Party-state directives and national interests above corporate interests. Robert Atkinson, president of the DC-based Information Technology and Innovation Foundation, reports that China’s national strategies specifically target Western defense and industrial technologies to advance military and economic modernization initiatives. Berlin-based MERICS has reached a similar conclusion.

These strategies — carried out by Chinese corporate actors — generate market distortions and operational risks to foreign companies while aggravating national security challenges confronting foreign governments. In January 2017, a White House advisory panel reported that China’s policies poured billions of dollars into its semiconductor industry, representing a direct threat to U.S. industry.

The White House’s findings are not new. Chinese state-owned and connected firms have successfully targeted Western companies to fill technology and knowledge gaps in domestic commercial and military development programs for years. These acquisitions often follow a government prescribed process of introducing, digesting, and assimilating foreign technologies that lead to re-innovated Chinese products (“IDAR”). According to Dr. Tai Ming Cheung, a foremost authority on Chinese technical innovation, IDAR policies encourage the “going out” of Chinese firms to gain access to foreign R&D and technology and aim to attract foreign companies to establish R&D facilities in China.

Many of the overseas investments of the state-owned Aviation Industry Corporation of China (AVIC), the country’s sole supplier of military aircraft, follow the IDAR model. Since 2008, AVIC has spent upwards of $4.5 billion acquiring high-tech U.S. and European aviation, automotive, and engineering firms. All of these firms, which include Cirrus Aircraft, Continental Motors, Barcelona-based Aritex, and Thielert Aircraft, provided AVIC advanced dual-use technologies and technical design and manufacturing expertise.

AVIC’s acquisition strategy targets advanced dual-use technologies, materials (e.g. composites), technical know-how, and manufacturing capabilities. In fact, both Western and Chinese military analysts report that AVIC, in coordination with state research institutes, diverted technologies acquired from overseas companies to achieve long-awaited breakthroughs in its domestic unmanned aerial vehicle program – a good example of Beijing’s “civil-military integration” strategy in action.

SOEs on the Front Lines of Beijing’s Territorial Disputes, Foreign Policy

In addition to traditional commercial activities, the CPC leverages commercial actors in irregular or “gray zone” activities to advance foreign policy objectives, modernize the country’s military, and even assert territorial claims in the South China Sea.

Chinese SOEs serve on the front lines alongside an irregular maritime militia asserting Beijing’s territorial claims in the South China Sea. Their activities aim to avoid the official involvement of Chinese military forces and the negative reactions that would ensue from neighboring countries. Andrew Erickson of the U.S. Naval War College highlights this symbiotic relationship, noting that in 2014 Beijing’s irregular maritime militia force escorted the China National Offshore Oil Corporation to protect its just-deployed HYSY-891 oil rig in the South China Sea. To date, at least 23 Chinese SOEs have participated in land reclamation and construction projects in the South China Sea.

With apparently little commercial justification behind such activities, Chinese SOEs engage in land reclamation or construction projects in the South China Sea to simply carry out Party-state directives. These activities blur the normal rules of engagement and present new challenges for foreign companies and policymakers evaluating the prospect of commercial joint ventures or acquisitions by Chinese companies.

Beijing Reaching into U.S. Courts

Beijing is also extending its reach in U.S. court proceedings involving state-owned firms in attempts to influence outcomes through political pressure. In at least two recent court proceedings — Chinese Drywall Litigation and the Vitamin C Antitrust Litigation — China’s Ministry of Foreign Affairs and the Ministry of Commerce sent letters to the U.S. Department of State expressing “strong discontent” with the courts’ decisions, going so far as to threaten negative repercussions to the U.S.-China economic and trade relationship.

In a series of U.S. legal cases, Chinese state owned firms are claiming sovereign immunity from U.S. courts, creating costly delays and legal fees that have a chilling effect on the cases of American plaintiffs. In addition, current U.S. law requires plaintiffs to prove a principal-agent or “alter ego” relationship between a Chinese state-owned parent and its overseas subsidiaries, despite the fact that current Chinese law enshrines this bond.

Toward a More Coordinated Response

How should the United States and its allies respond to the market distorting and security externalities of Chinese economic statecraft? Ensuring long-term American economic security requires developing a defensive response, at a minimum, though offensive action may be necessary. Yet broad protectionist trade policies are not the answer and are sure to harm the competitiveness of U.S. industry and its standing as the premier global destination for foreign investment.

First, the U.S. government should undertake a cross-agency effort to identify, catalogue, and understand the policies and strategies underpinning China’s economic statecraft. To be sure, Chinese investment can add needed financial strength to U.S. firms and create good jobs for Americans. However, any government review should evaluate the broader constellation of Beijing’s national strategies and ambitions, not just U.S. national security.

Second, Washington should adopt a foreign investment review process that insists on market-driven FDI and reciprocity that enables the U.S. government to more effectively distinguish between commercially motivated versus Party-state directed investment that could present risks to national economic or even security interests. In addition, such an approach could provide a much-needed lever for influencing the direction and pace of China’s economic reforms outside of existing intergovernmental trade organizations.

Third, lawmakers must ensure that Chinese firms operating in America respect and abide by rule of law. Congress must correct gaps or loopholes in the Foreign Sovereign Immunities Act that allow Chinese SOEs engaged in commercial activities to create costly delays in legal proceedings and skirt U.S. court rulings. U.S. laws should also respect the same singularity of centrally owned Chinese SOEs that China’s own laws enshrine.

Chinese SOEs should also be required to establish an agent for the receipt of legal service in the United States. Chinese secrecy laws and Beijing’s mixed interpretation of its obligations under the Hague Convention have long served as a “legal firewall” shielding state-owned companies and executives from U.S. legal and regulatory jurisdiction.

Finally, Washington and other like-minded economies should sustain a serious dialogue to understand China’s ambitions and begin coordinating policy responses. Governments in Tokyo, Taipei, and Seoul have effectively banned Chinese investment in core sectors of their economy. Australia, the United Kingdom, and Canada have already implemented more comprehensive investment review procedures in response to growing Chinese investment. Without a coordinated approach led by Washington, Chinese firms will continue “cherry-picking” foreign companies to carry-forward national strategies that may not be so “win-win” after all.

Greg Levesque is a managing director at Pointe Bello overseeing intelligence and analysis engagements. He concurrently serves as senior adviser to Dallas based Tang Energy Group, a clean energy development firm with more than 20 years of experience working with state-owned Chinese firms in the U.S. and China.