Let the Market Check Beijing’s Ambitions

Not surprisingly, Chinese officials, businessmen, and observers have complained that Washington uses national security as a pretext for engaging in “China bashing” and protectionism. Prof. Wang Zhile, president of the Beijing New Century Academy on Transnational Corporation, regularly tells his American interlocutors that the U.S. government simply does not understand and underestimates the sophistication of China’s large SOEs, especially those that are publicly listed. He argues that Chinese companies must make a profit too and hence make their decisions about overseas acquisitions based on business needs, not just edicts from the government.

Certainly, powerful Chinese SOEs, spurred by the profit motive, do not just execute Beijing’'s every wish without question. The most powerful ones even throw their weight around to play hardball with the central government. For instance, the country’'s two largest state-owned oil giants, China National Petroleum Corp. and China Petroleum and Chemical Corporation, have, in the past, not been shy to manufacture diesel and gasoline shortages domestically -- creating long lines at the pump and fueling citizen discontent -- in order to force Beijing to loosen national price controls that impose huge losses for the oil companies.

Nevertheless, the linkages between China’'s strategic priorities and corporate activities are vast and convoluted, and neither politics nor the profit motive alone accounts for China'’s aggressive global business expansion. On the one hand, Chinese SOEs respond to business opportunities and compete fiercely for market share and profits, but on the other hand, their incentives and bottom lines are distorted by massive aid, preferences, and intrusion from Beijing. Notably, though top executives of state conglomerates jockey for power by demonstrating corporate success, they owe their appointments and promotions to the Communist Party.

Regardless, even China cannot escape the logic of markets. The vast state funds that give Chinese SOEs deep pockets also create incentives to overspend. A study byMckinsey & Company has found that between 1997 and 2005, Chinese acquirers overpaid in more than half of their foreign transactions, and that those transactions tended to fare not as well when compared to Western acquisitions. Additionally, as the Economist has reported, Chinese SOEs must secure government backing to fund a large overseas acquisition, and once they do, they risk political fallout at home if they fail, a problem that private companies do not have and a weakness that negotiators on the other side do not hesitate to take advantage of.

In recent years, notable examples of underperformance or outright failures of Chinese state-led investments have surfaced. In Australia, state-owned Citic Pacific has invested to build Sino Iron, the largest magnetite mining and processing operation in Western Australia. Publicly listed on the Hong Kong Stock Exchange and majority owned by the Citic Group, a state-owned financial and investment conglomerate, Citic Pacific boasts of becoming the first Chinese-owned company to ship iron ore products from Western Australia to China when the Sino Iron project is complete. Yet costs skyrocketed from a budget of $2.5 billion in 2006 to $7.8 billion in 2012, and the project has suffered from delays, lack of expertise, labor shortages, regulatory compliance issues, bad publicity, and new carbon and mining taxes introduced by the Australian government.

Clearly, even China’s massive financial might does not mean that its SOEs are immune to market incentives or punishments. Concerns about the national security risks and market distortions presented by China must be addressed, but when it comes to economic competition with China, Inc., U.S. policymakers should not brace for a losing battle and opt for protectionism or paranoia before considering the market’'s powers to check Beijing’s grand ambitions.