Victor Davis Hanson Private Papers

Chinese Foreign Investment: A Perspective

Please read the following editorial by my college James D. Jameson.

It is hard to understate the impact that foreign investment has played in transforming China into the world’s second largest economy.  While direct investment might have peaked, China is still moving toward opening its stock markets to draw in foreign capital.  Policymakers in Beijing hope that international investors might keep China economy from slowing and thereby avoiding the middle-income trap.

However, as China’s seeks to attract more foreign capital, one might wonder why wealthy individuals from China are ‘stashing’ their money abroad.  Chinese buyers have been snapping up real estate from Cyprus to Vancouver for the last decade, and Chinese firms go on exuberant buying sprees every time Beijing loosens controls of capital outflows. Why do rich, and even upper middle class, Chinese have different expectations about future outcomes of investing in China?

Most seasoned investors are aware of the risks of investing in China.  These risks include the possibility of corruption, fraud and outright expropriations.  However, most investors understanding these complications would find few recourses in a legal system with little claim to transparency or impartiality.  One such recourse is the fragile system of ‘guanxi,’ a mutual assurance of interests driven by political, social and familial relationships.

But what protections do investors have when “guanxi” goes south? I was one of the first investors in China’s e-commerce boom in 1998.  My Chinese partner had founded a grey market publisher working with state publishing houses to co publish business books – a niche that the state-owned houses overlooked. My ambitious and very entrepreneurial Chinese partner tracked the emergence Amazon.com. “We can do the same thing in China,” he and his new wife said.

The e-commerce company was a momentary hit.  It went public in 2010 on the NYSE with a market valuation of $1.2 billion.  For the shareholders, it was a great but temporary success.  The company’s stock price declined precipitously after the lock up period.  As a foreign investor who sold at the original IPO date, the transfer of our proceeds from the sale were temporarily blocked by the controlling Chinese shareholder who wished to extort a payment to cure past employee bonus awards, a company obligation and not a shareholder obligation.  A threatened lawsuit in USA courts against the Chinese controlling shareholder of this NYSE company unblocked the funds.  The US rule of law worked!

However, the group of early investors of which I was one came under a dispute with the company’s founders over the dissolution of predecessor publishing company. The board resolved to unwind the company which had a significant amount of cash on its balance sheet. As 30% minority shareholders, I watched our Chinese partners withdraw the cash for personal purposes and investments. These actions were a clear violation against the statutes of the company.

We filed a suit in the Chinese courts in Beijing for embezzlement.   In the United States or Europe, it would have been an open and shut case. Though the amount in dispute was small, we had a desire to test ‘rule of law’ in China. As we have found out over the past three years, the lack of appropriate rule of law has stymied us.  The Chinese legal system prevents discovery, subpoena, and enforcement of a legally filed shareholders’ agreement. Foreigner plaintiffs come last in line in the court docket and often find their causes stonewalled by these arcane prohibitions. There were times when the defendants never actually showed up before the judge in the court, an affront that would not have been taken lightly by a judge in the West.

So as China tries to draw in foreign capital, its legal system still offers few protections for investors. Those risks are likely well understood by the “smart” capital flowing out of China. Therefore, it would only be prudent for foreign investors to ask:  if insiders are selling and moving money out, should we be moving money in and buying?

James D. Jameson

Assistant Secretary of Commerce – Trade Development :  George HW Bush Administration

Ex Officio Member: Committee on Foreign Investment in the United States:  1992/3

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About Victor Davis Hanson

Victor Davis Hanson is the Martin and Illie Anderson Senior Fellow in Residence in Classics and Military History at the Hoover Institution, Stanford University, a professor of Classics Emeritus at California State University, Fresno, and a nationally syndicated columnist for Tribune Media Services. He is also the Wayne & Marcia Buske Distinguished Fellow in History, Hillsdale College, where he teaches each fall semester courses in military history and classical culture.

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