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Economy

How Will China Stabilize Foreign Investment?

Jun 09 , 2020
  • Zhang Monan

    Senior Fellow, China Center for International Economic Exchanges

Whether foreign investments will be systematically withdrawn is now a most eye-catching topic in China, but it is not new. Since the 2008 financial crisis, concerns have grown over whether the Chinese economy had passed the Lewis turning point. These, plus the global manufacturing contraction, have led to fears of a massive withdrawal of foreign investments from China. However, developments in recent years have shown that’s unlikely.

In recent years, global overseas investment has been in a slump due to a contraction in global demand and the restrictive investment policies of many countries. According to UNCTAD, the primary United Nations body dealing with trade, investment and development, global FDI in 2019 was $1,394 billion, down 1.3 percent from 2018. In the same period, FDI in China was $140 billion, up 0.7 percent, and its share in global FDI rose to 10 percent. Actual use of foreign capital has decreased since the beginning of this year from the same period last year because of the COVID-19 pandemic. But with an 8.6 percent increase since April, China has been one of the few countries seeing positive year-on-year growth in FDI.

Basically, any enterprise attempting to reshape its global industrial chain will encounter a complex process requiring enormous amounts of time and money. Therefore, corporations tend not to change their long-term strategic decisions merely for the reimbursement of relocation expenses by the government. Proximity to product markets, high-quality factors of production, supporting facilities along the industrial chain and a friendly business environment are important factors to be considered in most investment decisions.

It is hardly deniable that China now faces a more complex and uncertain domestic and international situation, and that this poses a huge challenge as it tries to attract and stabilize foreign investment.

First, post-pandemic competition in the international market will become more intense. UNCTAD predicts that the pandemic and the global recession it has triggered could cut global FDI by as much as 40 percent this year. Shrinkage of the overseas market will further intensify competition in the game of attracting foreign investment.

Second, the institutional environment for doing business has become increasingly important. With demographic and other traditional dividends declining and combined costs increasing in recent years, China’s comparative cost advantage has been greatly reduced. Therefore, there is an urgent need to reconstruct new competitive advantages in terms of the commercial system, the regulatory system and the facilitation of trade and investment.

Third, China’s foreign investment law, which is the basic government instrument for foreign investment, must be continuously improved. Problems exist in the whole process, from drafting and enactment to implementation and adjustment. Conflicts between the general law and the special law, the national law and local laws, the new law and the old may exist within the current legal system and must be addressed. A balance must be struck between supporting local enterprises and implementing an open foreign investment regime. And a win-win situation must be achieved in promoting domestic economic development and advancing international economic cooperation. All of these will be very challenging.

Fourth, it is imperative to carry out a new round of institutional opening-up, starting with free trade zones. China still lacks a high-level of openness to the rest of the world. It has few internationally advanced free trade zones because of the many obstacles to free flow in the financial and regulatory systems, which results in a low degree of liberalization.

In particular, existing free trade zones operate like bonded zones, with export tax rebates, bonded processing and other similar preferential policies. In other words, their value proposition is not sufficiently attractive to foreign investors. Compared with the “zero tariff rate, low tax rate and simple tax system” of high-level free trade ports like Singapore, Hong Kong and Dubai, the Chinese mainland has a higher tax burden and lacks encouraging policies. For example, Singapore has tax relief for selected encouraged industries and businesses.

Finally, China faces increasing pressure from external rules. Since 2018, cross-regional FTAs of very large scale, such as the CPTPP, Japan-EU Economic Partnership Agreement and USMCA, have entered the stage. They are omnidirectional and feature high standards, wide coverage and exclusivity. These mega FTAs not only have deepened measures on traditional topics — tariff reductions and exemptions, along with trade and investment facilitation — but also have control over new topics, such as rules of origin, IPR protection, access to the service sector, digital trade, competition policy and state-owned enterprises. If China does not intensify its reforms in the spheres of these new rules, it will inevitably be encircled by rules or even be excluded from the newly emerging international system.

Future global competition will ultimately amount to a battle over the rules. Stabilizing foreign investment is not about short-term policy incentives. It will need more vigorous reform and opening-up — and some external pressure might be useful. The implementation of the foreign investment law and its supporting regulations is a good opportunity to introduce the “competition neutrality” principle. For example, deeper reforms should be conducted in the licensing system, IPR protection, technology transfer, industrial policy, competition policy, SOE reforms and the business environment with a view toward developing a basic system of institutions and regulatory models aligned with the prevailing international investment and trade rules and more transparent policy implementation mechanisms.

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