Drew Bernstein
By Drew Bernstein
In just a few decades, China produced the second largest population of wealthy and ultra-wealthy in the world. Today, China ranks a fast-rising #2 in both the number of millionaires (2.4 million vs. 7.1 million in the U.S.)* and billionaires (213 vs. 536 in the U.S.) ** globally. China’s top 1% own over one-third of total assets, quite astonishing in a putatively socialist country where most of the largest companies are still state owned enterprises.
While Deng Xiaoping may have never actually uttered the words, “To get rich is glorious,” the Chinese elites fervently embraced it as their mantra. For the past few decades, the interests of business people, government officials, and banks converged to drive economic development and personal enrichment. Business erected housing, factories, and infrastructure at a furious pace. Officials supplied discounted land and special perks. And banks fueled the building binge with cheap credit.
But recently, the wealthy have learned that to get rich is also dangerous. For one thing, the old economic model based on real estate development and export manufacturing has run out of steam. Most traditional industries are plagued with overcapacity. And real estate prices, which for many years were a one-way bet, have softened and begun to decline.
More importantly, the anti-corruption campaigns promulgated by China’s president Xi Jinping have served to remind the wealthy class that their riches can be taken away at any time. Given how closely intertwined business success and official favor were during China’s boom years, very few members of the elite have spotless hands. Hence, all are vulnerable.
As a result nearly half of China’s millionaires intend to leave the country, according to a poll conducted by Barclays last year, in which 47% of those with $1.5 million or more in assets said they planned to emigrate, while another 20% said they were considering it.
If only a fraction of these Chinese citizens act on their intent, it would represent the largest outflow of wealth in human history.
Massive Capital Outflows
There are signs such a migration is beginning. In the fourth quarter of 2014, China reported a capital account deficit of $91 billion, the largest since 1998. Official statistics may capture only a fraction of the real number, since often capital outflows are buried in false invoicing from offshore suppliers or payments to the millions of offshore subsidiaries that Chinese companies have set up.
A recent report by Orient Capital estimated that false service invoicing alone was used to channel $200 billion of capital out of China in 2014, a number that could rise to $400 billion in 2015.
The United States is uniquely positioned to benefit from this infusion of capital and entrepreneurial energy. Our commitment to rule of law, stable currency, and cultural openness makes the U.S. a safe refuge for investment. And the long-standing business and cultural ties between the U.S. and China provide a sense of familiarity. Many wealthy Chinese already send their children to study at American universities, sell products to American customers, and own second homes in America. Cities like New York, Los Angeles, and Seattle have become happy hunting grounds for Chinese real estate investors.
Rather than fearing the coming Chinese invasion, America should constructively encourage it. Chinese capital has the potential to generate new jobs and economic activity, while helping to compensate for our persistent trade deficits with China. Tighter business and personal ties with China’s elite are an effective way to export America’s legal and political norms and reduce the chances for future political conflict.
Needed Expansion and Reform of EB-5 Program
One way to do this is to expand and reform the EB-5 visa program to accommodate the surge in Chinese demand. Under the EB-5 program, foreign nationals can earn a green card and get on the path to citizenship if they make an investment of $500,000 to $1 million that creates at least 10 new jobs. Last year, Chinese citizens accounted for 85% of EB-5 investments before the U.S. government cut off further applications from China. In 2015, the allotted 10,700 visas are expected to be used up by the middle of the year, according to Savills Studley.
Congress, which needs to reauthorize the program in September, should expand the number of EB-5 slots to meet Chinese demand. But the program also needs better oversight and reporting to provide transparency on the track record of the various EB-5 investment opportunities, and increase the follow up to make sure that the intended jobs are indeed being created.
In addition, U.S. deal makers will need to become more attuned to the growing number of potential Chinese buyers and their particular appetites and negotiating styles. Chinese direct investments in the U.S. have grown from less than $1 billion in 2009 to $12 billion in 2014 with information technology, real estate, pharmaceuticals and automotive among the top sectors, according to Rhodium Group.
China has arrived as a major player in cross-border M&A.
Whereas in the past overseas acquisitions were led by large state-owned enterprises (SOEs), the private sector now accounts for over 80% of deals. Leading Chinese tech companies like Alibaba and Tencent are making venture investments in Silicon Valley to import innovation. Chinese private equity and financial institutions shopping for U.S. assets to diversify their portfolios.
The sale of the Waldorf Astoria hotel to Anbang Insurance Company for $1.95 billion is one prominent example.
Keys to Negotiating Deals with Chinese Buyers
But doing business with Chinese rich is different. For one thing, no major move will take place until the chairman or chairwoman decides. That person often speaks no English, relies significantly on the input of a few people within his or her circle of trust, and may value assets in a very different way than Wall Street norms. Both sides need to have patience and a willingness to learn for deals to close.
The Chinese government recently significantly reduced the level of government approval required to make overseas investments and streamlined the process to obtain foreign exchange. The U.S. and China are in the process of negotiating a Bilateral Investment Treaty that is being billed as a way to open up China’s consumer and services markets to U.S. companies. But it will also free Chinese investors to shift more of their assets to the U.S.
China’s new wealthy class has already reshaped global luxury retailing and tourism. As China’s economy slows and its political system becomes less predictable the migration rich Chinese may well transform global investment flows. This will create enormous opportunities for service providers that can understand the needs of Chinese investors and for communities that badly need their investment capital and entrepreneurial grit.
It is a very rare occurrence in human history that nearly half of a nation’s most resourceful, prosperous, and energetic citizens wish to emigrate en masse. America should play to all of our natural advantages to attract and productively channel what China’s rich have to offer.
*Boston Consulting Group, Global Wealth 2014
**Forbes Billionaires List 2015
About the author
Drew Bernstein is the Co-Managing Partner of Marcum Bernstein & Pinchuk (MarcumBP), and a recognized expert in issues related to doing business in China, accounting and financial due diligence, and cross-border M&A. MarcumBP provides a range of services to both Chinese companies looking to expand overseas and U.S. companies with operations in China, including audit, financial due diligence, internal controls, risk management, international tax strategy, and transactional support services.
