Recent trends in Chinese direct investment in Europe point to an increase in flows and a shift in destination countries and sectors.

Despite a public image of increasing activity, inflows of Chinese outbound direct investment (ODI) have been low in Europe. Existing pockets of Chinese investment are too small and fragmented to be seen as either a threat or part of a grand strategy. Indeed, China’s investment to non-Asian countries as a whole has been only a small part of its gradual expansion of investment abroad.

But there are signs that this trend may be changing. China’s interest in developed markets, such as the EU member states, is growing in line with the general shift in the sectoral composition of Chinese ODI, as Chinese investors focus more on services and consumer markets. The share of Chinese ODI in Europe and other advanced economies expanded from 10.7 percent of total Chinese ODI flows in 2003 to 13.6 percent in 2007. Advanced countries’ share of total Chinese ODI looks set to continue to rise over the coming years as Chinese investment grows from a low base.

Chinese investors move north, into new sectors

Chinese investment in Europe remains low compared with international foreign direct investment (FDI) flows. Despite rapid growth in recent years, this fact will take time to change. Of the $4.5 billion estimated stock of Chinese investment in Europe in 2007, less than $3 billion was invested in the European Union—Russia received the remaining share (see Table 1). The same is true for recent flows; only $1 billion of Chinese ODI went to EU member states in 2007.

Some marked changes are appearing in China’s investment in the European Union, however. In 2007, the United Kingdom surpassed Germany for the first time as the most popular European destination for Chinese investment in terms of the value of stock and flow of projects undertaken, according to MOFCOM statistics and data collected independently by Ernst and Young’s European Investment Monitor in 2008. Countries that in recent years received a large share of China’s EU investments (albeit at much lower levels for total ODI)—such as France, Italy, and Spain—received much smaller shares in 2007, largely because investment in northern Europe soared (see Table 2). In contrast, new EU member states from Eastern Europe, and northern European states such as the Netherlands and Sweden, now rank higher as the new wave of Chinese investment targets electronics more heavily, and as Chinese companies aim to establish marketing and logistics operations related to China’s exports.

Recent changes in the scale of flows and type of operation set up have especially benefited the United Kingdom, which many Chinese companies seem to view as the most convenient gateway to the rest of Europe. Financial and business services received roughly 17 percent of all Chinese direct investment in the United Kingdom between 1997 and 2007, and this share has been rising steadily. The most recent Chinese entrants, in particular, have focused heavily on import and sales activities, according to a 2007 study published by Adam Cross and Hinrich Voss of Leeds University Business School. These investments aim to strengthen the market presence and profile of Chinese companies and help them tap into the UK and other EU markets more effectively.

The United Kingdom is also well-positioned to take advantage of the new surge in service-related Chinese ODI. As a center for services and innovation in Europe, it has a unique appeal to Chinese companies looking to internationalize. The combination of the global financial center of London, open and transparent investment procedures, technology, and the language all make the United Kingdom a prime location for Chinese companies in Europe, according to the UK Trade & Investment’s UK Inward Investment 2007/2008 report. Services industries are a relative strength of the UK economy, and rising investments by Chinese enterprises in finance, information technology, and other business services have benefited the UK economy, which is the leading recipient of all FDI into Europe. Though Chinese investments in the UK services sector are still relatively small and the level of overall 2009 investment may even fall given the current economic climate, the long-term rising trend will resume once a global recovery is under way.

To some degree, China’s focus on the United Kingdom reflects changes in investor priorities as they move away from earlier interests in Europe’s key centers for textiles and other household goods. In the run-up to China’s accession to the World Trade Organization in 2001 and immediately afterward, Chinese companies were concerned about the threat from stiffer competition in domestic and export markets. They invested in Europe to establish themselves and closely examine key competitors and products. Such investments were defensive and offensive market-seeking strategies, but Chinese companies may consider such activities less important today given China’s successful economy and export performance. With China moving rapidly up the value chain, and investments overseas increasingly focusing on industries such as telecom, electronics, and information and communication technologies, the share of ODI going to France and Italy seems to be shrinking.

Previous successes and failures will also play a role in guiding where Chinese companies invest next in Europe. For example, low interest in France may reflect the relatively poor performance of recent Chinese ventures there. (China National Bluestar [Group] Corp. and Hebei Hongye Machinery Co., Ltd. invested in ailing industries or partner firms as a way to enter overseas markets and improve their international competitiveness, but these businesses have since struggled.) Chinese investment may also have peaked in Italy, where Chinese firms have become significant players in the Italian home appliances sector, often working as subcontractors in the early stages to improve their own capabilities and technology before becoming established players in China’s domestic market and abroad.

Rossi table 1

Following in their neighbors’ footsteps?

Recent shifts in Chinese ODI patterns in Europe not only reflect how changing sectoral strategies influence where investment will go, they also suggest that Chinese investment in Europe is driven by commercial motivations rather than political considerations. Like companies from Japan, South Korea, and Taiwan before them, Chinese firms are now establishing business operations in key export markets and developing their global brands, creating firm-specific advantages and competitive positions. Over time, this trend will further reduce China’s historic emphasis on resources investment.

Though current levels of Chinese ODI in Europe may still be much too small to attract the attention of large multinational corporations, the establishment of a strong network of Chinese business operations in key markets will ultimately enable more Chinese companies to form direct links with buyers and sellers. FDI into China has contributed to rapid growth in its exports over the past 20 years. Chinese companies are now gearing up for a more direct approach that will offer them greater control over their marketing, sales, and supply chains abroad. This long-term strategy may contrast with their approach just after China joined the WTO, when some Chinese companies were anxious about their survival and rushed to buy foreign brands.

The global recession may temporarily freeze some of these developments, though to what extent will remain unclear until data becomes available. Despite the downturn, however, China’s ODI will grow rapidly and almost certainly change radically over the next decade. This shift will likely continue to favor northern Europe, especially the United Kingdom. The relatively modest inflows to date could foreshadow much greater changes to come in the next decade.

Rossie table 2

[author]Vanessa Rossi is senior research fellow, and Nora Burghart was research assistant for September 2008-July 2009, at the International Economics Program, Chatham House. This paper is based on a collaborative research project between Chatham House and the Center of Advanced Studies on Contemporary China, University of Turin. The authors would like to acknowledge Compagnia di San Paolo for its support. For more information, see[/author]

Posted by Vanessa Rossi and Nora Burghart