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Trade & Investment

EU competing with China in Latin America

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German Chancellor Angela Merkel and other EU leaders have become increasingly concerned that China’s continued rise in Latin America could squeeze out European business. China has not only increased the quantity of its exports to Latin America, but also used its economic resources to expand into the high-tech market, long considered German industry’s strong suit.

EU & German Latin America Strategy

EU strategy in the region has long focused on establishing free trade agreements (FTAs), and in 2011 and 2012 the EU signed FTAs with Colombia, Peru, and six Central American states. At least another dozen deals of varying types were already in place, though negotiations with the region’s biggest economy Brazil have dragged on since 1999.1 Consistent with this strategy, when Chancellor Merkel attended the most recent meeting of EU and regional leaders, the EU-CELAC summit, this year in Chile, she expounded on the evils of protectionism.

As far as meeting the China challenge, Germany focuses on those areas where it has historically had a comparative advantage. For example, German programs seek to boost the scientific and technical levels of regional states to create demand for Germany’s higher-tech and higher-quality manufacturing. However, Germany is already playing catch up in the region for reasons having nothing to do with China’s challenge there. Export business with the region by Germany’s small- and medium-sized manufacturers, a mainstay of its economy, lags behind its potential, and a push is on to improve matters. This is largely because in the 1990s German small-to-medium-sized firms were more interested in expanding to new markets in Eastern Europe and former East Germany. German financiers and large manufacturers also took little advantage of sweeping privatizations by Latin American states during the 90s, whereas Spain did and is now by far the largest EU participant in Latin American and Caribbean (LAC) economies.

Are German Efforts any Match for Chinese Competition?

German and EU domestic growth has long been stuck in the doldrums. Yet, according to a recent German government strategy paper, while overall German foreign trade grew by only 4.7 percent between 2005 and 2009, foreign trade with Latin America rose by 16.3 percent in the same period.2 So it is no wonder Merkel worries that China’s more rapidly growing trade with and investment in the region could squeeze German and EU businesses out.

But do EU and German strategies meet the China challenge in the LAC region?

The Old and New “China Challenge”

Looking at data on China’s trade and investment relationship with Latin America over the past decade, one sees first the familiar pattern of China’s commodity seeking. (It bears mentioning here that data on Chinese investments, loans, and trade in Latin America are both scarce and obscure.) Whatever challenge China presented to German interests in this phase, and whatever opportunities Germany may have missed, the consequences may be minor compared to the impact of China’s most recent phase. In this new phase China’s trade activity in Latin America has progressed into qualitatively new areas, where it had long seemed Germany would face little competition.

Old: China’s Quest for Basic Commodities

Beijing began sending its companies abroad in the mid-1990s primarily to acquire commodities, particularly energy resources. These have been essential to sustain both China’s rapid internal growth and its export-focused domestic manufacturing sector – a sector characterized by low labor costs and low-to-mid-range technology. China was then consuming such large percentages of the global output of raw materials as to inflate global prices significantly. In Latin America it found a huge potential for not only energy resources, but also raw minerals and agricultural products as well.

Figure 1: Total Chinese external investments by region of over million each from 2005-2012, separated into energy and non-energy

Figure 1: Total Chinese external investments by region of over million each from 2005-2012, separated into energy and non-energy

Figure 1 shows the distribution of China’s total overseas investments from 2005 to 2012 by world region, each separated into energy and non-energy categories. Reliable Chinese data on its overseas investments are not available; a database maintained by Derek Scissors of the Heritage Foundation in Washington, however, was used here. China has not neglected any corner of the globe, and its investments from 2005 to 2012 in both Latin America’s energy ($43 billion) and non-energy sectors ($47 billion) are second only to those in North America.

A more detailed analysis of Scissors’s data shows that up to about 2008 China succeeded mainly in acquiring mining stakes in Latin America. For various reasons its entry into the region’s energy sector was not as rapid; factors included a lack of technical capacity and of overseas business experience within China’s national energy firms (CNPC, Sinopec, and others) as well as the fact that Latin America is a region where energy policy is deeply involved in issues of national sovereignty and identity. However, the fact that all projections showed China’s demand for oil continuously rising into the future caused Beijing to take a long-term approach. Its patience and perseverance have paid off, bringing its energy investments into first place in the region.

Figure 2: Chinese oil and gas investments in Latin America and the Caribbean (hydroelectric, electric grid, etc. not included) by country and year

Figure 2: Chinese oil and gas investments in Latin America and the Caribbean (hydroelectric, electric grid, etc. not included) by country and year

Figure 2 breaks down these Chinese energy investments by country and year in order of decreasing total investment. The order of the top five is certainly not what Beijing had expected even as recently as 2008. Beijing fully expected to have in Venezuela “our largest overseas investments anywhere,” as a high-ranking Chinese diplomat told me at the time. As things turned out, even though Venezuela under Hugo Chavez was sitting on the world’s largest reserves of oil, the technical and managerial capacity of its state oil company, PDVSA, became a casualty of his revolution. Accordingly, China has had to moderate its short-to-medium-term energy production expectations there.

On the other hand, in Brazil the discovery of large offshore oil deposits, so-called “pre-salt” deposits, plus the superior technical and managerial capacity of its national oil company, Petrobras, has brought Chinese firms ample opportunity to invest in the Brazilian oil sector, as evident in Figure 2 – a reality largely unexpected in 2005 or even 2008.

China also made large energy investments in Argentina in 2010 with the aim of becoming a major player in that country’s newly discovered shale gas reserves in the Vaca Muerte region. This potential has only come to light with the development of fracking technology in the US that, again, was not in the cards in 2005 or 2008.

However, more in keeping with Beijing’s early expectations, its firms’ energy investments in Ecuador rapidly made China the biggest oil producer there. The openness of President Correa’s administration to Chinese energy firms has been greatly fostered by Beijing’s willingness to invest in and construct large hydroelectric projects in Ecuador.

German Absence From the Latin American Oil & Gas Sector

It is striking how little participation German firms have in the LAC energy sector, considering the size of the German economy. Unlike many of its EU15 and other European neighbors, Germany has no national energy champion or major oil-and-gas (O&G) exploration-and-production (E&P) firm to do business in the region. One can contrast this absence with the participation of Great Britain (BP), The Netherlands (Shell), Italy (ENI), Spain (Repsol), France (Total), Norway (Statoil), and, of course, Russia (with its various newer firms). There may be historical explanations for this German absence in energy exploration and production, but Germany also has no major energy technical service company in the LAC region. And although Germany is an electro-mechanical manufacturing powerhouse, Tokyo, for example, stands out in Latin America in contrast to Berlin in its use of Japanese development bank loans and in its diplomatic activity in the region to support deals for Japanese O&G equipment manufacturers (e.g., Mitsubishi).

All in all, in light of the relative lack of technical and manufacturing sophistication of Chinese firms in the energy sector as compared to their European and US competitors, it is remarkable how Beijing has so rapidly acquired large stakes in the LAC energy sector. The ability and willingness of the Chinese state to lubricate the process with generous infrastructure projects and loans to local states has been a key factor.

Infrastructure and Loans Facilitate China’s Access

Figure 3: Chinese non-energy investments in Latin America and the Caribbean by country and year. Note: To aid comparison, the scale is identical to Figure 2

Figure 3: Chinese non-energy investments in Latin America and the Caribbean by country and year. Note: To aid comparison, the scale is identical to Figure 2

Beijing has focused on two levers to facilitate access to LAC resources. The first is that Beijing extends financing and often does the construction for large infrastructure projects, and, secondly, it extends large loans – generally at reasonable rates – to states or national energy companies.

Figure 3 illustrates the extent of such “non-energy investments.” For example, the 2009 investment of $7.5 billion in Venezuela was used to build a railway in the remote Faja del Rio Orinoco region, where its untapped heavy-oil reserves are found. Beijing’s strategy here is obvious. Infrastructure projects like this railway and the Ecuadorian hydro mentioned earlier are not meant to turn a profit. Rather, they are intended to allow Chinese national energy companies to obtain contracts to produce oil. This is no big secret; Chinese officials have frankly explained this to me on more than one occasion. The non-energy investments shown in Figure 3 are of largely this type, but also include investments in minerals and agricultural lands.3

The other major lever used to facilitate energy access is loans from Chinese banks and the state. Here again, it is difficult to obtain systematic information from Chinese sources; however, data from a study by The Inter-American Dialogue in Washington, DC published in 2012 provides valuable insight.

Figure 4: Chinese loans to Latin America by country; totals from 2005-2011

Figure 4: Chinese loans to Latin America by country; totals from 2005-2011

Figure 4 shows the totals of Chinese loans to each of 12 Latin American and Caribbean states between 2005 and 2011. The lopsided total to Venezuela – nearly equal to all other loans combined – is mainly a loan-for-oil deal signed in 2010, where the national oil company pays with oil deliveries ramping up over several years.

Although Chinese firms have invested in oil production projects in Brazil, Brazil has at times rebuffed such investments, preferring to develop its fields as far as possible on its own, especially as Chinese firms lack Brazil’s expertise in deep offshore projects. So, although Chinese firms would prefer more opportunities to participate directly in producing oil in Brazil, Beijing has on occasion settled for making a large loan to be repaid in oil.

In the case of Argentina, China is now the major recipient of soy grown there, which has come to replace beef as Argentina’s main agricultural export.

These oil loans fulfill a dual purpose for China. Beijing’s loans ingratiate Chinese companies into the recipient state by providing important sources of financing for the local oil companies and/or state. In addition, developing new oil fields generally requires at least seven years lead time (and often longer in Latin America), so while Chinese national oil companies are working to develop new fields, receiving oil right now as payment for loans provides a jump start for these future flows.

Note, however, that three of the top four recipients of Chinese loans – Ecuador, Venezuela, and Argentina – are states that have either been cut off from traditional sources of international finance because of past defaults, or, as with Venezuela, suffer from very poor credit ratings and can otherwise only issue expensive “junk bonds” to raise cash abroad. Beijing has come to play a very special role for these states. Nevertheless, Chinese banks significantly reduce their risks of default by taking repayment in commodities.

These aspects of Chinese involvement in Latin America are not necessarily antithetical to German and EU interests. However, the problem with the scenario is that China’s role in the region is evolving. Data indicate that China’s export activity is already vigorously occupying niches where Germany formerly had a strong advantage.

New: China’s High-Tech Export Surge

Figure 5a: Total exports by selected exporters during selected years to Latin America and Caribbean 33 that comprise the Comunidad de Estados Latinoamericanos y Caribeños (CELAC). Data from the UN’s Economic Commission for Latin America and the Caribbean (ECLAC), 2013

Figure 5a: Total exports by selected exporters during selected years to Latin America and Caribbean 33 that comprise the Comunidad de Estados Latinoamericanos y Caribeños (CELAC). Data from the UN’s Economic Commission for Latin America and the Caribbean (ECLAC), 2013

It is clear that, even if the pie has been steadily growing in Latin America and with it EU and German exports that have been constantly increasing in absolute terms, viewed from a more competitive point of view (i.e., in terms of each player’s percentage increase) the vast bulk of this increase has gone to China. Figures 5a and 5b show this quite starkly. Using data from the UN’s Economic Commission on Latin America and the Caribbean (ECLAC), Figure 5a shows the total exports to 33 Latin American and Caribbean states – the “LatAm33.”4 It compares the US, China, the EU15-without-Germany, and Germany itself, taking snapshots every third year from 2003.

This shows that just 10 years ago China’s trade challenge did not look so daunting. In 2003 exports both by Germany alone and by the EU15 without Germany exceeded the total of all Chinese exports to the LatAm33. But by 2006 China’s total had exceeded Germany’s, although it was not more than that of the EU15 without Germany, and it was still not greater in 2009. However, by 2012 China’s total exports ($134 billion) exceeded the combined total of all the EU15.

Clearly, throughout this period, each of these players increased its total exports to Latin America – largely due to Chinese demand for commodities – and the Panglossian assessment is that all exporters to the region have gotten consistently larger pieces of a growing pie.

Figure 5b: Percentage change in exports of selected countries or regions to Latin American and Caribbean 33 from 2003 to 2012. Data: ECLAC, 2013

Figure 5b: Percentage change in exports of selected countries or regions to Latin American and Caribbean 33 from 2003 to 2012. Data: ECLAC, 2013

However, this says little from the competitive angle. Figure 5b looks at the percentage change from 2003 to 2012 calculated from the total trade amounts shown in Figure 5A. Clearly not Germany, nor the remainder of the EU15, nor the USA – all of which grew about 200 percent each – saw their trade grow in percentage terms anywhere near China’s (over 1000 percent).

To see the full competitive implications we have to look at this trade growth according to technical categories. Following Adam Smith, one might argue that all is well so long as each exporter continues to export those goods in which its nation has a “comparative advantage.” For China this has always meant focusing on the export of cheap, low-tech goods, and for Germany the export of high-quality and higher-tech goods. If this is in fact the current situation, one might argue that Germany’s and the EU’s trade-promoting diplomatic strategies described above are not inappropriate.

Figure 6: Export growth in low-, medium-, and high-tech categories 2003-2012. Data: ECLAC, 2013

Figure 6: Export growth in low-, medium-, and high-tech categories 2003-2012. Data: ECLAC, 2013

However, a breakdown of exports to Latin America according to technology content shows that the aforementioned scenario – so engrained only a few years ago – has begun to collapse. Figure 6 breaks down from total trade three germane categories of manufactured exports: low-tech, medium-tech, and high-tech.

Not only have China’s low- and medium-tech exports grown phenomenally (about 1000 percent and 800 percent respectively), but its high-tech exports have also grown (by 1200 percent). This far exceeds the rate of German and the other states’ growth in these categories, all below 200 percent.

But, of course, China started from near zero exports in this category a decade ago. One needs to investigate the absolute amounts of trade in each category for these players. Figure 7 does this.

Without overemphasizing this, in absolute terms, China’s exports to Latin America in the low-, medium-, and even the high-tech categories were below those of Germany and the EU in 2003, but in 2012 they exceeded the combined totals of the EU15 in the medium-tech and even in the high-tech categories. The only place the EU15 surpasses China is, rather oddly, in the low-tech manufactured goods category.

Conclusion: implications for German Trade Policy

Figure 7: Exports by Tech Category every three years since 2003 for selected states to the 33 independent Latin American and Caribbean states. Data: ECLAC, 2013

Figure 7: Exports by Tech Category every three years since 2003 for selected states to the 33 independent Latin American and Caribbean states. Data: ECLAC, 2013

The new aspect of the “China challenge” to Germany in the LAC region is that China is now exporting more medium-tech and high-tech goods of all sorts to the region. Of course, Chinese quality in higher-tech equipment is still generally nowhere near that of similar German goods. There are often significant complaints by states and oil companies who import Chinese goods, and there is also widespread recognition that for certain critical equipment one has to go to European or American producers and not to cheaper Chinese producers (I myself have heard many such statements from O&G producers and importers who have been forced by the national oil company in Venezuela to accept Chinese equipment).

However, the central point here is that the nature of the Chinese challenge to German and EU export business in Latin America is evolving. Chinese competition is a moving target, and it has begun to undermine Germany’s (and the EU’s) traditional comparative advantage in LAC trade.

THOMAS W. O’DONNELL is an expert in the political economy and geopolitics of the global energy sector, specifically petroleum. He is a part-time faculty member in Graduate International Affairs at the New School University in New York City.
1. The EU’s legal framework for economic and trade agreement with Latin American states and groups of states includes: EU Association Agreements, EU Free Trade Agreements, EU Cooperation Agreements, and Economic Partnership Agreements. “The typological classification of the agreements derives from the legal basis, although their actual title and content may transcend this frame of reference.” See: “Germany, Latin America and the Caribbean: A Strategy Paper by the German Government.” Auswärtiges Amt, 2010, p.55, www.auswaertiges-amt.de.
2. http://www.auswaertiges-amt.de/cae/servlet/contentblob/479872/publicatio… “Germany, Latin America and the Caribbean: A Strategy Paper by the German Government – 2010.”
3. A detailed breakdown is beyond our present discussion.
4. The LatAm33 include all Western Hemisphere states with the exception of the USA and Canada and possessions or dependencies of European states, i.e., Great Britain, The Netherlands, and France. These same 33 states comprise the CELAC, a group founded in 2001 in Caracas, and whose annual summit with German Chancellor Merkel and other EU leaders have repeatedly led to further trade relations, the most recent of which was January 2013 in Santiago de Chile (see the German Federal Chancellor’s website: http://www.bundeskanzlerin.de/Content/EN/Reiseberichte/2013/2013-01-25-c…).
Originally published: IP Journal – Competing with China in Latin America

About Tom ODonnell

[This bio with hotlinks is at: http://www.umich.edu/~twod/bio/ ] Dr. Thomas Wilfred O’Donnell is an international academic, expert analyst and writer working on energy and international affairs, particularly the global oil and gas systems. Regions of interest include the USA, EU (especially Germany), Russia, China and the OPEC states of the Middle-East and Latin-American (especially Venezuela, Iran and Saudi Arabia). He teaches graduate seminars in Berlin at Hertie School of Governance and undergrads at Freie Universitӓt’s FU-BEST (European Studies Program). He previously taught at The University of Michigan (Ann Arbor) and The New School University (NYC). O’Donnell blogs at GlobalBarrel.com and has recently written for Berlin Policy Journal (Berlin), King’s College European Centre for Energy and Resource Security (London), Americas Quarterly (NYC/DC),Petroguía (Caracas & Latin America), AICGS (DC); reprinted in Natural Gas World, and is often interviewed by the international press. In Spring of 2015, Dr. O’Donnell was a fellow of The American Institute of Contemporary German Studies (AICGS) & The German Academic Exchange Service (DAAD) in Washington, DC interviewing US energy experts on German and EU energy vulnerabilities. He spent two full years, 2008-09, as a US Fulbright Scholar and Visiting Professor in Caracas at the Center for the Study of Development of the Central University of Venezuela (CENDES/UCV), returning several times since. He consults on energy, geopolitical and market/tech matters and is Senior Energy Desk Analyst at Wikistrat, O'Donnell's award-winning PhD thesis is in experimental nuclear physics (U. Michigan, Ann Arbor, 2000), which included research in several national and university laboratories. He is author or co-author of about 40 peer-reviewed physics papers. While doing post-doctoral physics and complex-systems research at U. Michigan, he taught social-science-focused courses in Science Technology & Society (STS) on historical technological change drawing on his industrial/scientific experience and also taught on issues of oil and geopolitics in Middle East and North African (MENA) Studies, as well as courses on the “Information Era” and “Energy and Environment,” and spent several semesters teaching in the Physics Department’s “Advanced Physics Laboratories” encompassing several subtopics. After his university studies, he spent 10+ years during the mid-1970’s to mid-1980’s working in U.S. automobile manufacturing, railways, and energy engineering, while writing and gaining a reputation in the US Midwest as an analyst and organizer of labor and social-political movements, developing extensive ties with activists and others in minority and immigrant working-class communities. This followed his initial (undergraduate) university years focused on political science and China Studies, where he had been an activist and organizer within political protest movements of the day. O’Donnell speaks English (native), Spanish (fluent) and functional German; he is fluent in various programming languages and computing environments. He resides in Berlin, accompanied by family; and maintains close professional and other ties to the USA.

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