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Speeches and Papers

How China Can Break Down America’s Wall

by David M. Marchick, Covington & Burling
and Edward M. Graham, Peterson Institute for International Economics

Article in the Far Eastern Economic Review
July-August 2006

© Far Eastern Economic Review

As the Japanese swallowed up American companies and assets during the 1980s, members of Congress, union leaders, and business executives began proclaiming with anxiety “The Japanese are coming!” Although foreign investors had played an important role in the development of the US economy—especially during the late industrial revolution from the 1870s to 1914—critics warned that, when it came to Japan, something was different. Some, including Lester Thurow, then Dean of the MIT Sloan School of Management, and Steve Forbes, publisher and later presidential candidate, worried that growing Japanese economic clout might seriously threaten the future wealth and power of the United States. “Some people seem to worry that they will pick up the phone,” observed MIT economist Rudiger Dornbusch in 1988, “and the guy at the other end of the line will be saying ‘Moshi! Moshi!’”

Now, 20 years later, similar arguments are being applied to investments from China. Despite the fact that both Republican and Democratic administrations have long encouraged China to liberalize its markets, there is growing anxiety in Congress about increased Chinese investment into the United States.

But what lessons can Chinese investors glean from the Japanese experience? Should Chinese investment in the United States be treated any differently than investments from other countries?

In response to growing hostility, Japanese corporations in the 1980s implemented various strategies to gain acceptance in America. Since most official criticism came from Congress and not from the state or local level, many Japanese companies, including Nikon, Sony, Panasonic and Toshiba, set up or expanded offices in Washington to foster a more positive image for their companies. Today, 37 Japanese corporations operate such offices in Washington, making Japan the third most represented foreign country in the US capital.

For cultural reasons, however, Japanese companies have been less aggressive than US companies in their outreach strategies. Instead, they try to shape opinion in Washington by working with third parties such as think tanks, journalists and former government officials. In particular, Washington think tanks began in the middle 1980s to host forums on Japanese investment, producing studies demonstrating its economic benefits. Japanese companies in many cases contributed to these studies, both by helping directly to fund the think-tank activities, and by cooperating with the scholars performing these studies. This practice continues to this day.

Thus Japanese firms were able to show that, contrary to the fears of many, Japanese companies investing in the United States often hired Americans in top executive positions and, moreover, bought inputs from US producers. In 2002, the Bureau of Economic Analysis reported that Japanese companies had created over 834,000 jobs in the United States. Automaker Honda alone employs over 27,500 Americans and has an annual payroll of $1.69 billion; since 1982, the company has increased its number of US suppliers to over 550 from 40. And it’s not alone: Toyota’s purchases of parts and materials from North American suppliers now exceeds $11 billion.

Japanese companies also worked to build support at the local level. Though warmly received by many state governors, such as former Governor of Tennessee Lamar Alexander (now a senator), who successfully courted investments from both Nissan and Komatsu during the 1980s, Japanese companies nevertheless worked to integrate themselves into countless local communities. Following the mantra, “produce where you sell,” Japanese companies helped ease fears that their investments were simply conduits for imported goods. For example, Honda’s engine plant in Ohio is the company’s largest in the world, producing more than one million engines per year; and Toyota’s West Virginia plant became the first outside Japan to build Toyota’s automatic transmissions in 2001. Responding to Toyota’s investment of over $220 million in a V8 engine plant in Huntsville, Alabama, Governor Don Siegelman proclaimed in 2001 that the “partnership between Toyota and Alabama provides hope and dreams of a better quality of life to Alabama families.”

In San Antonio, Texas, where Toyota opened a large plant, the firm donated over $500,000 to local foundations, including the San Antonio Economic Development Foundation and the San Antonio Education Partnership. Similarly, Sony Pictures Entertainment partnered with Culver City Schools in California to provide new educational equipment, faculty training and student mentoring. Sony employees themselves planted trees, painted murals and created a butterfly garden for the sixth grade science program. “Thanks to our partnership with Sony Pictures Entertainment,” said Dr. Laura McGaughey, superintendent, Culver City Unified District, “the Culver Academy [of Visual and Performing Arts] has become a leader in arts education and a place where students can pursue their dreams.”

These stories are not unique. Throughout the United States, many Japanese companies have contributed to local community development. They have donated millions of dollars to local organizations ranging from little league baseball teams to pediatric cancer research centers. In doing so, Japanese companies were in fact emulating the strategies of US companies—invest, build community support, court local politicians and broaden the economic benefits associated with their investment.

Image Makeover

These strategies employed by Japanese companies to weave themselves into the fabric of the United States can provide useful lessons for Chinese corporations as they attempt to navigate the same waters as Japanese companies did 20 years ago. As with Japan in the 1980s, Congress and the administration are concerned with the growing competitive position of China, the huge bilateral trade imbalances and China’s export-led growth strategy.

At the same time, there are important differences between the Japanese and Chinese investment trends. For example, one of the main criticisms of Japanese investment was that the Japanese economy was closed to foreign investment. By contrast, while significant problems remain, China is not closed; rather, it is the second largest recipient of foreign investment in the world. US investment alone in China at the end of 2004 exceeded $15.4 billion, and this almost surely understates the true amount.

Further, most US concerns with Japanese investment in the 1980s focused on economics, whereas concerns with Chinese investment are based on a mixture of economic and national security-based issues. Of America’s top 10 trading partners, only China is not considered a strategic and political ally. The other nine are either members of NATO, have US troops on the ground, enjoy a free trade agreement with the United States or are recipients of American arms exports.

And whereas Japanese investors in the United States were privately owned, the Chinese government owns or controls most of the Chinese companies with the wherewithal to invest abroad. A recent study estimates that of approximately 1,300 publicly listed companies in China in 2004, only about 20 were genuinely private; the rest were all ultimately controlled by the state.

Government ownership of companies often raises questions of whether they will make decisions based on commercial interests or national interest. Given America’s strategic concerns with Beijing, the fact that so many Chinese companies are controlled by the state will result in exacting scrutiny of Chinese investments under the US government process for reviewing the national security implications of foreign investments. This process, conducted by the 12-agency Committee on Foreign Investment in the United States (CFIUS), was created in 1988 at precisely the time when Congress was concerned about growing investments from Japan.

But government ownership is not the only factor likely lead to extra scrutiny by CFIUS. The possibility of sensitive, export-controlled technology being transferred to other countries is a factor in virtually all reviews by the committee, regardless of the home country of the acquirer. It is a concern in the case of Chinese acquisitions largely because of a series of high-profile breaches of US export-control laws and regulations by Chinese companies in the late 1990s and early 2000s. China’s espionage activities have become a concern to US counterintelligence agencies, including the Department of Justice, Defense, and Homeland Security, as well as the Federal Bureau of Investigation. These agencies are worried that certain Chinese companies might be used as covers for intelligence operations. So long as the Pentagon views China suspiciously, CFIUS will likely assess Chinese acquisitions of US companies in part on their impact on China’s military strength.

Chinese acquisitions may also present different economic issues for US policy makers to consider. For example, whereas a significant number of Japanese investments flowed into the US manufacturing sector as greenfield investments, Chinese companies have many comparative advantages, including low labor costs, in manufacturing and already have significant access to the US market. Chinese companies may be less interested in establishing a manufacturing base in the United States than in developing globally competitive management skills and global brand names. Moreover, Chinese companies are keenly interested in acquisitions in strategic sectors, including energy—precisely those sectors that may raise political or national security issues in the United States.

Even so, most Chinese investments in the United States would not trigger CFIUS reviews, required mainly when foreign investments are made in sectors that potentially implicate US national security interests. When the Chinese company Haier considered purchasing US white goods manufacturer Maytag during the summer of 2005, for instance, Haier did not have to submit the acquisition for CFIUS approval. Similarly, most Chinese investments in the retail, real estate or auto sectors would not require national-security reviews.

But no matter what sector they operate in, Chinese companies will need to become more sophisticated in addressing the potential political opposition that may arise if they wish to be successful in their efforts to enter the US market. They will need to demonstrate their commitment to creating jobs, complying with US laws and regulations, and being good employers. They will need to become involved in their communities in the same way that the best American companies do. Chinese companies would benefit from gaining experience in investing in the United States by investing in sectors that would not be seen as sensitive from a national security perspective. To maximize their chances of earning satisfactory returns in America, Chinese companies should concentrate on investing in activities where they have demonstrable intangible assets—e.g., better product or process technologies—that local rivals do not possess (as did the most successful Japanese firms).

For its part, the United States should continue to support China’s integration into the global economy, and Chinese outward foreign investment should be viewed as a natural and positive step in China’s economic development. A US policy that encourages American companies to invest in China but frowns upon Chinese investment in the United States is neither sustainable nor sound from an economic or national interest perspective. The United States should simultaneously encourage China to continue to allow FDI to flow into its own economy and in parallel welcome Chinese investment in the United States. By doing so, the United States itself will benefit, as will China.


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