Why SOE’s shouldn’t be shunned - opinion

Author: | Published: 20 Nov 2012
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In recent years, overseas’ investment initiatives by state-owned enterprises (SOEs) – especially those based in China – have come under critical scrutiny by host governments in North America and Europe. For example, the Chinese National Overseas Oil Company’s (Cnooc) proposed acquisition of Unocal in 2002 faced strong opposition from US politicians. This year, the Canadian government rejected the proposed acquisition of a medium-sized Canadian oil and gas company by Petronas, a Malaysian SOE. All indications are that the government will also reject Cnooc’s pending acquisition of the large Canadian oil and gas explorer, Nexen. At the same time, legislation governing foreign direct investment in a number of developed countries, including the US and Canada, has been amended to incorporate provisions related to national security that are ostensibly aimed at making it more difficult for SOEs to acquire domestically owned companies.

Given the vast savings that can be mobilised in emerging markets for cinvestments in developed countries with relatively low savings rates – particularly the US – the unwelcoming attitude extended toward foreign investments by SOEs seems misguided, if not self-destructive. Moreover, while there is no shortage of justifications for discouraging or even blocking direct investments by foreign-based SOEs, the justifications are economically naïve and, often, simply unsupported by evidence.

The irrelevance of politics

Perhaps the strongest argument for blocking investments by SOEs is that the latter are motivated by political rather than economic considerations. This translates to a concern that SOEs will engage in actions that are inefficient or otherwise economically harmful to the host economy. For example, it has been alleged that SOEs in the oil and gas business will supply home country customers rather than host country customers, even if the latter are willing to pay more for oil produced by the SOEs. This preference to forego profits in favour of serving home government interests would presumably not characterise the behavior of for-profit firms. Whether or not SOEs act economically irrationally in deference to political mandates is a matter of speculation. There is little evidence to support or reject the practical relevance of the argument. In any case, if SOEs pay a fair market value for the host country assets that they acquire, speculation about the investment motives of SOEs is irrelevant. Competitive capital markets will ensure that SOEs pay full market value for foreign acquisitions. In this case, host country stakeholders, primarily shareholders, will not be harmed by unprofitable actions taken by SOEs subsequent to the latters’ investments. Rather, the explicit and implicit subsidies associated with politically motivated behaviour will be paid for by stakeholders in the home countries, including foreign governments and their sovereign wealth investment agencies.

Speculating over social responsibility

Another set of arguments against allowing SOE investments is that they do not act in a socially responsible manner. Further, that a lack of transparency makes it especially difficult for host governments to oversee and regulate their socially irresponsible behavior. The empirical evidence for or against the practical relevance of this argument is again quite limited. However, if there is a widespread worry about such behavior, SOEs should find it more costly and difficult to do business in host countries. This is because lenders, investors, suppliers, employees and other stakeholders will demand so-called protection against anticipated and difficult to monitor opportunistic behavior by SOE owners. This protection will take the form of higher costs of capital, wage rates and other input prices, as well as weaker demand for their products. A choice by SOEs to be opaque rather than transparent will again be paid for by the SOEs’ owners rather than host country residents.

In short, competitive markets rather than government regulation provide assurance that outward direct investment by SOEs will benefit host country residents. In this context, the hostility of host governments to such investment is likely to do more economic harm than good.

By Professor Steven Globerman of the Western Washington University College of Business and Economics

Related articles:

Cnooc, Petronas’s lessons for SOE investment in Canada http://www.iflr.com/Article/3118158/Search/Results/Cnooc-Petronass-lessons-for-SOE-investment-in-Canada.html

How Cnooc’s bid was structured for foreign investment approval http://www.iflr.com/Article/3091897/Search/Results/How-Cnoocs-bid-was-structured-for-foreign-investment.html

How to obtain ChinaCo/US merger approval http://www.iflr.com/Article/3110269/Search/Results/How-to-obtain-ChinaCoUS-merger-approval.html

Canada’s reformed merger review process http://www.iflr.com/Article/3039373/Search/Results/Analysis-of-Canadas-reformed-merger-review-process.html

The inflated concept of national security http://www.iflr.com/Article/3110255/Search/Results/Americas-The-inflated-concept-of-national-security.html