Evolving economy changes nature of investment

China's attention is expected to shift to more developed markets, particularly in infrastructure

China's economic outlook remains fairly solid despite the slowdown in the pace of growth that we have seen across a number of economic metrics in recent months. Looking ahead, our forecasts see growth slowing gently in the coming years, but also becoming more sustainable and less dependent on manufacturing and exports.

This process of transformation from a middle-income market to an advanced one with a greater role for consumption and services in the economy is also expected to affect China's decision of where to direct its foreign direct investment.

So far China has invested heavily in emerging and resource-rich economies where the returns - but also the risks - tend to be generally higher than in developed markets. Sub-Saharan Africa, for example, attracted the lion's share of Chinese FDI between 2005 and 2014, with a total of $150 billion (129 billion euros) or roughly a fifth of the total.

Many of these were in infrastructure, with deals such as China Railway Construction's $5.6 billion investment in railways in Chad and by China National Petroleum Corp's $4.2 billion investment in Mozambique. This phase of big infrastructure investment in Africa coincided with a period of low costs for the developing Chinese manufacturing sector, with China's advantage in manufacturing and construction giving it a comparative advantage in securing infrastructure contracts in Africa. On the other hand, Europe and the US have been less successful in attracting Chinese FDI over the same period.

But China is expected to increasingly shift its attention to more developed markets. Factors such as the quality of the business environment and the extent to which the recipient country is innovative and rich in know-how are expected to be crucial in attracting FDI from China as it seeks to improve productivity at home and raise the value-added of what it produces through learning from industry partners in these markets. We are already witnessing a shift: so far last year, Chinese foreign direct investment in Sub-Saharan Africa is $6 billion, compared with $16 billion in Europe.

As for investment in infrastructure in particular, an obvious factor to determine attractiveness for Chinese funds is whether an economy needs such investment - something that will determine whether there is the potential for big projects that will interest Chinese investors. The International Monetary Fund and the Organization for Economic Cooperation and Development have recently called for European economies to invest more in their infrastructure as a way of ensuring higher and more sustainable growth. Investment in infrastructure is an important driver of economic development. Energy, transport links, communications and water infrastructure are all essential inputs to a well-functioning economy as they help elevate the productivity of other factors such as land, capital and labor.

However, despite these clear benefits of investment in infrastructure, such projects are not usually pursued to a sufficient scale. This is because of high upfront costs that increase the risks, and because the benefits tend to be realized many years after the projects are completed and as such do not accrue to the politicians who included them in their agendas. This has left many European countries, especially the UK, with a huge infrastructure deficit that needs to be filled.

The need for high investment in infrastructure, in combination with Chinese investors' appetite for long-term and stable returns in a lower-risk environment as their economy matures are expected to drive an increasing share of investment in Europe, and the UK in particular, which enjoys a stable political outlook compared with the uncertainty clouding many eurozone economies, a strong rule of law, and openness to foreign investment.

Another key reason behind Chinese infrastructure investment expansion overseas is the overheated domestic economy, with too much infrastructure investment already. This crowding of the domestic economy combined with China's large reserves has many firms searching for international opportunities.

In recent research by the Centre for Economics and Business Research and the global law firm Pinsent Masons LLP we estimated that China's outward foreign direct investment will record a sixfold increase in the next decade from $100 billion in 2013 to almost $600 billion in 2025, while the stock of FDI is expected to stand at $4 trillion in 2025, more than six times as high as the $600 billion of 2013. As China's outbound infrastructure investment continues to grow, Chinese companies will also continue to seek knowledge of good technology and know-how on infrastructure projects.

So far, notable examples of Chinese investment in Europe's infrastructure projects include China Investment Corp buying minority stakes in infrastructure including the UK's Heathrow Airport Holdings and Thames Water Utilities Ltd. China Three Gorges Corp bought 21 percent of Portuguese power company EDP-Energias de Portugal SA. This trend is expected to continue as Chinese outbound investment grows and Europe's infrastructure remains unfulfilled.

China is also expected to use its vast domestic manufacturing capability and capacity to export equipment and materials for its foreign infrastructure investments. This development is expected to considerably change the infrastructure industry in the UK and other European markets as the Chinese enter the supply chain over the next 10 years.

The author is an economist at the Centre for Economics and Business Research, a think tank in London.