China realises it needs foreign companies

Investment from overseas is falling. That's a big problem

China is increasingly desperate for foreign investment. Yet foreign companies are less and less interested in what it has to offer. How this problem gets resolved may be one of the most important questions facing China’s economy.

After China joined the World Trade Organization, in 2001, overseas investors couldn’t wait to jump in. Foreign direct investment grew at an annualised rate of 10.8 per cent from 2000 to 2008. Enticed by China’s market size and development capacity, companies were willing to tolerate almost any kind of restriction. They turned over intellectual property; entered into joint ventures as junior partners, essentially training their eventual competitors; and accepted restricted access to wide swathes of the economy.

Since the financial crisis, however, things have changed. Wages in China have risen by an average of 11 per cent a year, making it less attractive for outsourcing. Despite years of complaints, intellectual property theft hasn’t abated (just ask Michael Jordan, who had to wage a four-year court battle to get ownership of his own name in China). Add in an increasingly hostile business environment, and it’s not surprising that overseas companies are losing enthusiasm.

Since 2008, utilised foreign direct investment has increased by an average rate of only four per cent a year. According to quarterly balance-of-payment data, foreign direct investment has amounted to only $55 billion this year through June. The last time China’s mid-year inflows were that low was in 2009, the year after the financial crisis.

This could have serious economic consequences. Due to shady invoicing — which many firms use to evade capital controls — the money flowing into China through its trade surplus has shrunk. From 2010 through 2014, banks reported net settlement inflows from goods trade of nearly $1.7 trillion. Since January 2015, net settlement by banks has amounted to only $278 billion, while the official trade surplus is $1.3 trillion. For a country that relies on capital accumulation to sustain growth, this is a significant problem.

Making matters worse, China maintains a quasi-pegged exchange rate, which requires balancing the inflow and outflow of capital. That means attracting foreign investment is a necessary precondition for investing abroad, which is China’s main method of advancing its foreign policy objectives. Without more foreign capital, China will have a difficult time keeping the yuan stable and pursuing its global investment goals, such as the Belt and Road infrastructure initiative.

At the root of all these problems is that foreign companies still don’t think there’s a level playing field in China. The European Union Chamber of Commerce in China has said that “European investment in China is simply being held back”. More than 80 per cent of American companies in China say it has become less welcoming to foreigners in recent years. The number saying China is a top investment priority has fallen accordingly, from 78 per cent in 2012 to 56 per cent this year.

China’s government at least seems to recognise these problems. It is adding more free-trade zones, for one thing. And it recently issued a revised and somewhat less restrictive “negative list” of industries that are off-limits to foreigners. These reforms represent progress. But an amazing number of industries remain restricted or off-limits. Reform needs to go further. 

© Bloomberg