Minmetals deal unfairly funded

This is the second of two parts taken from a paper titled China Minmetals and Noranda: A Backdoor Nationalization Process of Canada’s Natural Resources? Part one was published in the Dec. 10-16 issue of The Northern Miner. The paper was written and published by the office of David Kilgour, Liberal member of Parliament for Mill Woods-Beaumont (Edmonton).

Some have said that the takeover of Noranda would be of great benefit to Canada by creating opportunities for Canadian companies in China. The thinking being that if China is encouraged to make foreign investments in Canada, it will reciprocate by granting our companies greater access to their markets. This, however, is not the reality of the matter. China’s policy has been to protect its enterprises at home while simultaneously encouraging those companies to go out and conquer foreign markets.

The asymmetrical nature of China’s trade policy becomes especially evident in light of the Chinese Ministry of Commerce’s recent easing of its overseas investment rules. As it now wants to promote foreign investment, the government will no longer judge the viability of overseas investments and will leave such decisions to the companies involved. If a foreign firm wants to make any type of investment in China, especially an equity investment, official approval is required. Obtaining approval takes considerable effort and is not merely a formality.

China has very strict guidelines for Foreign Direct Investment (FDI). All investment proposals are carefully examined and classified by industry sector in one of four categories. They can be classified as “encouraged,” “permitted,” “restricted” or “prohibited.” It is far easier for the Chinese to invest in Canada than it is for Canadians to invest in China. If a Canadian company wanted to acquire a company of comparable size and scope to Noranda in China, it would most likely be a state-owned enterprise (SOE). However, China currently forbids foreign companies from directly operating businesses in the Middle Kingdom. A Canadian company seeking to purchase an entire company in China would have to register itself in China and then attempt to purchase the target Chinese company. However, even after a company had done all this, it would still be impossible, according to current Chinese regulations to purchase a SOE and what purchases such a company could make are heavily regulated. The difficulty foreign entities encounter in acquiring Chinese companies, or merging with them, is clear when one looks at what percentage of China’s FDI that such activity accounts for. Of all the FDI China has received this year, only about 10% has been in the form of mergers and acquisitions.

It is necessary to examine the source of the funds Minmetals will use to buy Noranda. These come from China’s ballooning foreign reserves, which stood at US$514.5 billion in September. These funds are made available to state enterprises for their use in diversifying their businesses globally and represent a distinctly unfair competitive advantage that is enjoyed by SOEs. While SOEs have access to China’s foreign reserves for their use, Canadian companies operating in China, or competing with Chinese companies in any other arena, are bound by the constraints of the market.

In comparison, Canada’s state corporations are today confined to a handful of industry sectors and are not actively seeking foreign acquisitions utilizing public funds. Chinese SOEs are active in many industrial sectors and are aggressively trying to acquire foreign enterprises. They are using access to state funds to make investment decisions that would otherwise be fiscally impossible. They essentially have no cost of capital and enjoy easy access to capital in the form of China’s foreign reserves that continue to grow larger and larger. If Canada were to start funding its corporations to make acquisitions in China, would the Chinese government find this acceptable? Clearly, there is an issue of reciprocity that exists here which demands close examination because it has the potential to impact Canadian corporations in a very negative way.

The growth in China’s foreign reserves has been fuelled by its ever-widening trade surplus, which continues to grow due to ever-increasing demand for cheap imports. Looking specifically at Canada’s trade situation with China, Canadians import three and a half times as much as we export to China. The trade deficit with China for the current year (January to August 2004) stands at $10.58 billion dollars. It continues to grow as more and more Canadian companies seek to profit or remain in business by reducing their manufacturing expenses through out-sourcing manufacturing operations to China and importing goods cheaply from China. A large part of the reason for China’s cost advantage is its cheap labour, which relies on paying exploitative wages. The portion of China’s foreign reserves which is generated as a result of trade and foreign investment in China seeking to take advantage of lower labour costs, could be considered unfair gains in part since they have been accrued through the exploitation of Chinese workers. The $7 billion that Minmetals intends to use to purchase Noranda would involve the use of a pool of funds that has been garnered partly through exploitation and allowing the purchase of Noranda utilizing such funds could be taken as an action that rewards China’s poor labour practices.

Another reason that China has such large foreign exchange reserves is that its central bank has intentionally kept the yuan pegged to the U.S. dollar such that is undervalued. This has been done in order to make Chinese imports more attractive than they would be if the yuan were a stronger currency. It has resulted in a growing trade surplus for China, which has translated into increasingly large foreign exchange reserves. In essence, the undervaluation of the Chinese yuan has resulted in products coming into Canada from China at far lower prices than they would have if the yuan’s value reflected global demand for it. This has had a negative impact on our manufacturers who have been unable to compete with the unfairly low prices of Chinese imports and have thus been forced to cut jobs and outsource some of their labour or go bankrupt. Ironically, in being forced to outsource their labour, Canadian manufacturers end up exporting jobs to low cost producers such as China. In allowing Minmetals to purchase Noranda, China would benefit from the fruits of its unfair trade practices and thus have no incentive to change them.

In spite of all the aforementioned concerns, there are still arguments being made that the Noranda acquisition must be allowed to proceed in the name of “constructive engagement.” However, allowing China to buy Noranda is completely antithetical to free market principles. It does not in any way encourage China to promote private enterprise and the freedoms it must necessarily accord its citizens such that they may engage in private enterprise. Therefore, it cannot be justified as any kind of “constructive engagement”; in fact, it is deconstructive engagement in the sense that China will feel that it can trade with rest of the world freely without allowing its own citizens to do so.

In light of all the known and unknown circumstances related to whether or not Minmetals uses forced labour, the proposed deal to acquire Noranda certainly deserves a thorough review. The natural resources of Canada belong to all Canadians and are held in trust on their behalf by the government. If Minmetals is allowed to take over Noranda, what are the implications with regard to this trusteeship?

The implications of the deal go far beyond the particular transaction at hand and will in fact be precedent setting as Canada enters into a new kind of economic relationship with China. It will be necessary to carefully examine what China’s new policy strategy means for Canada. Thus, the most prudent policy would be to block the proposed sale of Noranda to China Minmetals at least temporarily until all the implications for Canada have been carefully considered.