China Realizes It Needs Foreign Companies

(Bloomberg View) -- 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 annualized rate of 10.8 percent from 2000 to 2008. Enticed by China's market size and development capacity, companies were willing 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 percent 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, utilized foreign direct investment has increased by an average rate of only 4 percent a year. According to quarterly balance-of-payment data, FDI 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 percent 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 percent in 2012 to 56 percent this year.

China's government at least seems to recognize 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 do represent progress. But an amazing number of industries remain restricted or off-limits -- "performing arts groups" and foreign life-insurance firms, for instance, are still limited to junior-partner status.

Reform needs to go further. When China joined the WTO, it agreed to adhere to the "national treatment" principle, or the idea that foreign goods and services -- once they've entered a market -- should be treated equally to those produced by local firms. It reiterated this commitment when it published its revised negative list. But it has never really followed through, as overseas firms well know. Finally making good on that commitment would not only allow China to lure more foreign businesses, it would also make domestic ones more competitive.

China remains a fundamentally attractive place to invest, with a burgeoning tech scene, top-notch infrastructure and rapidly growing consumer class. It shouldn't take much to revive the interest of foreign companies. Leveling the playing field would be a good start.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Christopher Balding is an associate professor of business and economics at the HSBC Business School in Shenzhen and author of "Sovereign Wealth Funds: The New Intersection of Money and Power."

To contact the author of this story: Christopher Balding at cbalding@phbs.pku.edu.cn.

To contact the editor responsible for this story: Timothy Lavin at tlavin1@bloomberg.net.

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