Playing risk: Chinese foreign direct investment in Cambodia.

• Author: O'Neill, Daniel
• Position: Essay

Multinational firms must go to the place with what they seek--whether natural resources, markets, labour or assets--is located and, more importantly where what they seek is available. Due both to the location of what they seek and their status as latecomers to globalization, Chinese firms frequently operate in developing countries where they are confronted by factors found to deter foreign direct investment (FDI), which seeks a controlling interest in a business enterprise in a foreign country. These factors include weak rule of law, high corruption and high political risk, each of which is characteristic of Cambodia's investment environment. Both theory and empirical studies suggest that foreign direct investors prefer states with political and legal institutions that protect property rights and constrain the government's executive leadership. (1) In Cambodia, where the institutions creating such conditions are weak, foreign investors must find alternative means of protecting their investments.

Chinese outward FDI--not only to Cambodia but also more generally--defies findings that poor property rights, corruption and political risk deter inflows of foreign investment. Surprisingly, Peter Buckley and his co-authors find Chinese outbound FDI to be positively correlated with political risk. (2) Similarly, Ivar Kolstad and Arne Wiig conclude that Chinese outward FDI is attracted to countries with "poor institutions", using an index that includes "control of corruption" and "political stability". (3) K.C. Fung and Alicia Garcia-Herrero compare Chinese and Indian outward FDI and suggest "Chinese investment seems to be attracted to more corrupt countries, while India is attracted to less corrupt economies with better rule of law." (4) Yin-Wong Cheung and Xingwang Qian also find that Chinese FDI is not deterred by corruption, poor law and order or a lack of democratic accountability. (5)

This article analyses Chinese investment in Cambodia, which has risen dramatically since the turn of the century despite the difficulties faced by foreign investors in the Cambodian political economy. Chinese FDI in Cambodia is worth studying for several reasons. The first is precisely because Cambodia lacks the characteristics that have been found to attract foreign investment and is abundant in those found to deter it. Second, there is important variation in the ownership type of Chinese investments in Cambodia, with Chinese state owned enterprises (SOEs) dominating the hydropower sector and private firms investing in the garment industry. Finally, there is also variation in these investments' asset specificity, the degree to which assets invested can be switched to other uses or moved out of the country. The garment industry, in which assets consist mostly of small sewing machines, is highly mobile. Hydropower assets, on the other hand, are not so easily shifted out of the country. These differences are important should the Cambodian government change policies in a way that negatively impacts a foreign investment or should domestic partners renege on their contracts. Investors with mobile assets can always credibly threaten to move their investments elsewhere. (6)

I hypothesize that Chinese government support is the key variable allowing Chinese firms to invest successfully in difficult investment environments. Testing this hypothesis against the Cambodia case, I find that China's bilateral policies, particularly financial assistance to the Cambodian government, are sometimes essential to gaining approval for and protection of Chinese investments. It is the factors mentioned above, ownership type (public or private) and asset specificity, along with size of the investment, that determine whether Chinese government support is a necessary condition for successful investment in Cambodia. Successful investment is a two-stage process. First, in order to obtain approval for the investment, the establishment of the enterprise in the foreign country must be perceived as beneficial by political elites in that country. Second, the continuing operation of the enterprise under foreign ownership must offer benefits to local political elites that outweigh other options, such as confiscating the firm's assets or preventing the firm from repatriating profits.

In the Cambodian garment industry--which is comprised of relatively small private enterprises--Chinese firms act much like those from other countries. Chinese government intervention in support of these firms does not appear to be a necessary condition for their entry into the market, nor for their ability to overcome weak legal protections and engage in business profitably. Through the actions of the primary industry lobbying group, the Garment Manufacturers of Cambodia (GMAC), firms owned by ethnic Chinese from throughout Asia use cultural and linguistic ties to overcome collective action difficulties and work with ethnic Chinese Cambodians in the domestic political economy to strike a balance with the government between providing rents and making profits. (7) These firms' mobility provides them with a credible threat to leave Cambodia should government policies threaten the success of their investments. The relatively small size of the investments means they are not reliant on funding from Chinese state banks. High cost, less mobile investments by Chinese SOEs, such as those in the hydropower sector, however, require other means of financing and protection.

In these cases, it is Chinese government policies, namely foreign aid and loans to the Cambodian government, that provide incentives for Cambodia's leadership both to approve and protect investments by China's SOEs. Unlike much "Western" financial assistance, Chinese funding comes without strings attached for political or economic reform; it thus enhances rather than threatens the political survival of the leadership in the receiving state, in this case Cambodia. In order not to jeopardize future inflows of such resources, the foreign leadership is likely to approve and protect Chinese investments. While corruption in the FDI receiving state usually deters foreign investors, it is Cambodia's corrupt and non-transparent environment that allows the Chinese government and SOEs to pursue this strategy by providing avenues through which the influence of key figures in the Cambodian political economy can be obtained out of the public eye.

The coverage of this "protection" for Chinese investments in Cambodia ranges from traditional investor concerns, such as expropriation and currency exchange risk, to Cambodian government guarantees of profits for Chinese hydropower firms, to security provided by elements of the Cambodian military for Chinese firms involved in controversial land deals. The gains to political elites on both sides of the bilateral economic relationship create a status quo in which Chinese firms are encouraged by their government to invest in Cambodia, and the Cambodian leadership is willing to offer protection for Chinese firms in order to maintain financial flows from China in the form of investment, aid and loans. In this way, state owned Chinese firms are able to invest successfully in an environment in which political institutions do not make government commitments to property rights and contractual agreements credible.

In order to examine this process of creating de facto Chinese government insurance for outward investments, the following section presents a theory of how three factors in the home (sending) state--a lack of democratic accountability, government support for outward investment and state ownership of outward investing firms--can provide protection for investments in a foreign state. I then provide data on levels of Chinese investment and loans to Cambodia, as well as consider the contested nature of Chinese "aid" to Cambodia. After brief overviews of Cambodia's semi-authoritarian political institutions and poor investment environment, I investigate the importance of Chinese government assistance in two cases: investments by Chinese SOEs in Cambodia's hydropower sector and private Chinese investment in Cambodia's garment industry. I then examine instances of Chinese firms securing protection for major investments in land and resources by partnering with a politically connected Cambodian stakeholder. I conclude by highlighting the original findings in this study.

Theory: Overcoming the Obsolescing Bargain

One reason that credible commitment to property rights and contractual agreements is vital to foreign investors is that, once on the ground, the bargaining power of these investors diminishes. Raymond Vernon's obsolescing bargain theory suggests that foreign firms begin with greater bargaining power relative to host (FDI receiving) states competing for investments, but that power diminishes after the investment is initiated and costs are sunk. (8) The obsolescing bargaining ability of foreign firms is particularly severe in markets, like Cambodia's, which lack institutional protections, such as well-established rule of law. In addition, since there are relatively few veto players in such autocratic states, foreign investment agreements are more easily approved but also more easily reneged on; (9) at the extreme, a dictator can single-handedly approve an investment but also later independently decide to expropriate it. Thus, where the institutions that protect foreign investors are less well developed, in other words where rule of man trumps rule of law, foreign investors must find other means to secure their investments. To do so requires gaining the protection of those who rule, since their preferences outweigh the laws and regulations of the state.

There are three factors in the home state, from which the investment originates, that affect the degree of investment protection in the foreign host country: democratic accountability, government support for outward investment and state ownership...