China: A Financing Opportunity for Latin America?

Javier Santiso, Director and Chief Development Economist, Organisation for Economic Co-operation and Development (OECD), Paris

China’s insertion in the global economy is an undisputed reality for academics, business people and policy makers today. With outstanding growth rates for three decades, mainly pulled by external demand, China has positioned itself at the core of the globalization process by supplying the rest of the world with manufacturing goods, technological components and, more recently, services. Latin America should benefit from this wake-up call, seizing the financing opportunity brought about by China’s rise.

Trade expansion has allowed China to accumulate significant revenues, mainly through international currency reserves. The recent creation of an important sovereign wealth fund, the China Investment Corporation (CIC), is a signal that the country’s capacity for exporting capital abroad is now clearer than ever. In the last months, the People’s Bank of China (PBOC) and the CIC have coordinated market operations mostly on conservative investments such as government bonds and banks securities. Nevertheless, China’s presence in other emerging regions like Latin America is expected to grow. Likewise, Foreign Direct Investment flows from China to the developing world have almost doubled between 2000 and 2006, according to the UNCTAD (from 3.8 to 6.4% of total flows), whereas FDI stocks have tripled (from 4.2 to 13.9% of total stock).

Although China has traditionally been regarded as a possible competitor for FDI with Latin America, our research at the OECD Development Centre, published in The Visible Hand of China in Latin America and the most recent Latin American Economic Outlook 2008, shows that such competition is not straightforward. Except for specific countries like Mexico and Colombia, with export structures closer to those of China, the most remarkable trend in terms of FDI flows is that Chinese investments are quickly gaining room in the continent. Moreover, Latin America and China differ significantly in the nature of the FDI they attract: whereas inflows of FDI in China are mostly the result of the wide availability of capital coupled with very high productivity growth levels, Latin America’s main interest for investors continues to be higher returns and natural resource availability.

In the absence of strong competition for investments with China, the main question is how Latin America can maximize the financing opportunities offered by growing Chinese investment abroad. In principle the region is well positioned, as the core of current Chinese FDI outflows goes to commodity sectors, with Latin America as an important receptor. However, if the region wants to avoid excessive specialization on natural resources, it will need to adapt new strategies to benefit from Chinese FDI. So far, Latin America has based its strategy in horizontal incentives, such as financial openness, deregulation and privatization. As remarked by ECLAC and OECD, these goals are necessary but insufficient. Other countries have had better experiences with more active policies orienting FDI towards long-term objectives, technology-transfers, human resources training and FDI-induced spill-overs on other sectors of the economy.

So far, Asian investment in Latin America has only focused on a small group of firms in specific sectors such as natural resources and, to some extent, textiles and electronics. More active policies on the host countries need to be introduced. In particular, the role of governments is crucial, as shown by the notable commercial insertion of some countries through the ratification of special agreements with China in recent years. Further steps need to be taken to identify other synergies and complementarities between the two, avoiding Latin America’s overspecialization in sectors with little processing and value added.

As stressed in the recent OECD and World Economic Forum paper "Adapting to the Rise of China: How Can Latin American Companies Succeed?", China offers not only a wake-up call, but also an opportunity for integration to Latin American firms. To make better use of Chinese capital and forge strategic investments in the region, they will need to capitalize on comparative advantages such as their proximity to key markets (United States) and the maximization of existing networks that facilitate market penetration.

A number of successful examples by Latin American companies highlight winning business adaptation strategies through the identification of industrial and commercial synergies with Chinese counterparts. In the basic and natural resource industries, companies like Vale, Aracruz, Gerdau and Codelco have consolidated themselves as worldwide leaders in their respective sectors of activity. In other sectors where the comparative advantage is not so clear, there are also some remarkable examples. One winning strategy is based on upstream value chain integration, as illustrated by Betametch, an IT and hardware Brazilian company that has become an innovation hub in the region by using China’s unique capacity to design and produce technology products and capturing its more downstream value.

A second strategy consists in focusing on a high value-added niche to achieve global scale; a good example is the Colombian home building firm Corona, which has integrated China’s unbeatable low-cost base into its value-chain and focused on innovations and scale in regional markets. Finally, a third strategy is based on a preference for product segments with high volatility of demand and high customization needs, to exploit geographical advantage; Koramsa, from Guatemala, is an example of firm adaptation to the new industrial landscape depicted by Chinese entry in the textile industry: it decided to focus on higher value-added garments in smaller batches with shorter lead times.

Responding to China’s challenges requires, therefore, continuous adaptation and innovative thinking. The emergence of other Asian giants, such as India, stresses the need for Latin American firms and governments to play a leading role at seizing the current financial opportunity posed by the changing global landscape. Besides flexibility and focus, business leaders need to think regionally, exploiting regional market networks and cultural advantages. A culture of collaboration and a greater variety of contracts to formalize relationships, like joint ventures with Chinese companies, will be very valuable in the future.