China rolls out the welcome mat to foreign investors. As long as they’re the right sort.
Wind the clock back 15 years and foreign direct investment (FDI) in China was all about low-cost processing. Today, China is no longer a factory to the world. Backed by billions of dollars in investment from the state, Chinese corporations and overseas firms, the country is rapidly developing its service and advanced manufacturing sectors. As an increasingly mature economy, China is moving up the value chain.
Thanks to a combination of targeted government policy and market forces, FDI in China is reflecting this economic transition. Such investment is increasingly about leveraging a booming Chinese consumer market and satisfying Beijing’s desire to develop innovative, high-tech industries.
An investment imperative
China-bound FDI has reached a plateau in recent years. Commerce Ministry figures show that while 2016 saw FDI in China up 4.1 per cent year-on-year to US$118 billion, Beijing is keen to further ramp up investment levels. A period of economic opening is now likely to catalyse increased inflows, as the Chinese government looks to make resurgent FDI a pillar of the country’s new, consumption-led economy.
Stephen Olson, a research fellow at the Hinrich Foundation in Hong Kong, believes many people underestimate the importance of FDI to China, and its critical position in the Chinese government’s thinking on economic growth.
“From R&D centres and technological ‘spillover’ right through to the acquisition of world-class management skills by Chinese nationals, the impact of FDI in China continues to be huge,” Olson says. “Beijing will take whatever steps are necessary to keep FDI flowing.”
China’s low and middle income households are now demanding better jobs, better services and increasing salaries. Observers such as Richard Hoffmann, a partner and co-founder of legal and consulting firm Ecovis Beijing, believe these demands can only be met by higher productivity, technological innovation and higher quality service provision. He says without foreign investment, China will not be able to meet these requirements fast enough to guarantee social stability.
“China needs FDI for a variety of reasons,” says Hoffmann. “The country still lacks technological and managerial know-how. Chinese businesses are also expanding abroad. By relaxing restrictions at home, Beijing is hoping to avoid a backlash abroad, which could harm those companies.”
Beijing is well aware that a tightly controlled economy and currency impedes growth, and is now taking concrete steps to make China more accessible and attractive to FDI. The country’s 13th Five-Year Plan, a blueprint for the country’s social and economic development until 2020, encourages foreign investment in advanced manufacturing, high and new technologies, energy conservation and environmental protection, as well as a range of modern services.
Following up on the plan, China’s Ministry of Commerce and the National Development Reform Commission revised its 2015 Catalogue for the Guidance of Foreign Investment Industries, opening it up for public comment in January this year. The catalogue outlines measures to open up manufacturing, service and financial industries to FDI. Foreign businesses will also be encouraged to bid for infrastructure projects through local franchises, and provincial governments will be empowered to approve FDI proposals valued up to US$300 million.
Commentators such as Jake Parker, the vice president of China Operations at the US-China Business Council, have described these moves as superficial, decrying the ongoing restrictions that limit or prevent FDI in many of China’s industrial sectors. China’s “negative list” currently includes 96 items – such as online publishing – in the prohibited category and 232 items in the restricted category, including telecommunications.
Other observers, such as Hoffmann, believe the situation on the ground is more nuanced. He points to the growth of China’s service industry and the rapid development of high-tech sectors as areas where foreign businesses can leverage growth and accessibility.
“If we’re talking about social media or telecommunications software, then China has indeed tightened controls,” he says. “For most other sectors we’re seeing a more open attitude. In some areas, such as the automotive sector, there has even been talk of completely lifting caps on foreign ownership.”
As China’s FDI policy environment evolves, one thing is clear: those companies that can help Chinese economic development and establish world-class Chinese industries are likely to be the ones benefitting from greater access and support.
“Beijing is walking a tightrope when it comes to FDI,” says Olson. “It wants to take the cutting-edge benefits without ceding control. If you’re a manufacturer of low-quality plastic toys looking to set up a factory in Shanghai, don’t expect to be welcomed with open arms.”
According to China’s National Bureau of Statistics, China’s service sector accounted for 51.6 per cent of GDP in 2016, up 1.4 per cent year-on-year. The Chinese Government wants to get this number into the 70-80 per cent range, the norm for developed countries, Sara Hsu, assistant professor of economics at the State University of New York, wrote in Forbes.
The increasing consumption of services in China is driving growing levels of both domestic and foreign investment. Last year, total investment in the Chinese service sector increased 10.9 per cent year-on-year to US$5 trillion.
According to China’s Ministry of Commerce, 2016 saw FDI in China’s service industry rise 8.3 per cent year-on-year to US$83 billion, representing more than 70 per cent of total FDI. Investment in high-tech services was particularly strong, up 86 per cent year-on-year to US$13.8 billion.
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China’s shift toward services is increasingly driving investment flows across the Asia-Pacific region. From aged-care provider Aveo and medtech consultancy Ausbiotech, through to educational institutions such as Melbourne’s Haileybury College, a growing number of Australian businesses are now focusing their attention on developing Chinese trade and investment.
“Many Australian services businesses, for example those involved in education and aged care, are hoping that development of Chinese business will eventually lead into other Asian markets,” says Kristen Bondietti, principal trade consultant at Australian consultancy ITS Global.
Room for growth
The China-Australia Free Trade Agreement (ChAFTA), which came into force at the end of 2015, provides Australian companies with far greater opportunity to invest in a diverse range of Chinese economic sectors, including services.
“As Australia’s largest trading partner, China is strategically critical for Australian companies that want to be globally competitive,” says a spokesperson from Austrade, the Australian Government’s trade, investment and education promotion agency. “Investment in China’s advanced manufacturing and service sectors can move such companies up the value chain.”
ChAFTA opened doors to many Australian companies – from Queensland-based Cox Rayner Architects through to aged-care provider Aveo – that may remain closed to their European and North American competitors for years to come. Financial services providers, for example, are well placed to gain from the growth and liberalisation of services and investment in China. They now enjoy substantial access to the Chinese market, second only to competitors based in Hong Kong and Macau.
“China’s highly developed coastal regions tend to be far more discriminating when it comes to investment than the hinterland.” Stephen Olson, Hinrich Foundation
China’s service sector reform in October 2016 saw the country’s regulations relaxed in the aged-care, private education and sports services sectors. Beijing’s aim is to facilitate the establishment of new aged-care institutions, permit private schools to set their own fees, support the use of recreational vehicles in tourism, and increase private investment in service businesses.
In a 2015 survey by the US Pew Research Center, 62 per cent of the 3649 Chinese respondents interviewed said healthcare was a concern. With its burgeoning middle class, ageing population, growing GDP and improving intellectual property protection laws, China presents Australian healthcare providers with a significant opportunity for revenue growth.
China could account for 42 to 47 per cent of Australia’s healthcare and social assistance service exports by 2025, up from 25 per cent today, according to the Australia China Business Council’s (ACBC) The Long Boom report.
“Health and aged-care services, as well as advisory, architecture and urban development need local presence to grow,” says the Austrade spokesperson. “This presents Australian companies with a great opportunity for continued expansion and investment.”
China’s FDI environment is not uniform across the country, with different regions keen to attract different types of investment. China’s central provinces are pulling in a growing proportion of FDI, as economic growth in this region is driven largely by domestic demand. The availability of relatively cheap labour and Beijing’s increasingly hands-off approach to provincial FDI approval are also underpinning this trend, according to various reports by The Economist Intelligence Unit and PwC.
“There is definitely a regional component to FDI,” says Olson. “China’s highly developed coastal regions tend to be far more discriminating when it comes to investment than the hinterland.”
The new Chinese economic model is not only underpinned by rising domestic consumption and higher value-added manufacturing, it is also based on outbound investment. President Xi Jinping’s ambitious One Belt, One Road (OBOR) initiative, which calls for the development of trade routes across Asia and beyond, and was reinforced in May, could offer Australian service companies lucrative opportunities in both China and third markets.
“A greater understanding of what OBOR actually means and a better analysis of the new free trade alliances Beijing is forging will be increasingly important for companies looking to invest in China,” says Chris Devonshire-Ellis, founder of China-based specialist FDI practice Dezan Shira and Associates.
Unrestricted market competition will always be a much stronger force for sustaining technological development and innovation than economic policy. Beijing is likely to open new FDI doors as they are needed, steadily diminishing its negative list and setting up more special trade zones and free trade agreements.
Many foreign companies have been busy adjusting to China’s volatile regulatory environment. Some have been slow to act on economic developments, such as the rapidly growing demand for electric cars and the rise of online payment technologies. With Chinese companies already leading the way in these fields, foreign firms need to invest in China now, if they want to profit from innovation and sector growth.
An increasingly mature Chinese economy is also reshaping the nature of foreign investment. Foreign multinationals no longer need to start a brand new company or factory in China, but can begin production over a shorter time frame by buying into (or out of) domestic enterprises. The flow of FDI into China through mergers and acquisitions, according to China’s Ministry of Commerce, increased from 6.3 per cent in 2014 to 14.1 per cent in 2015, and this upward trend is likely to continue.
“As the Chinese economy grows and China eases immediate ownership requirements, we’re seeing fewer and fewer companies investing in China through joint ventures,” says Eric Moraczewski, chief executive of cross-border consulting firm FDI Strategies.
Whenever and however they choose to make their move, foreign investors interested in China will need to scrutinise the market carefully beforehand. Those that give Beijing and the Chinese people what they want, when they want it, will be the major winners.
China is an increasingly influential driver of the global sharing economy. Its own sharing economy was valued at more than US$500 billion last year, according to the Beijing-based Sharing Economy Research Center, with about 60 million Chinese people providing services. A report from the National Information Center, a Chinese Government think tank, says the sharing economy is expected to grow at an annual rate of 40 per cent over the next five years. By that stage it will be worth 10 per cent of China’s GDP. Other movers in China’s sharing economy – such as Tujia, China’s version of Airbnb – are also growing and now making moves overseas.
Beijing has already made steps toward encouraging the sharing economy. The Commission on the Sharing Economy in China (CSE) was launched in 2015. Co-founded by ride-sharing service Didi Chuxing, internet giant Tencent, tech manufacturer Lenovo and LinkedIn China, the CSE is expected to play a key role in promoting the development of China’s sharing economy.