In the last few months, China has announced that it will open its doors wider to foreign investment. On the surface, this appears to be a response to the trade war rhetoric between the Xi and Trump governments. However, foreign investment reforms have been in the making for several years. In fact, it is part of a logical economic planning decision, as China moves towards an economy driven by higher quality growth based on innovation and high value-added production. Fewer investment restrictions will help domestic companies by providing better and cheaper inputs to drive the upgrade of production and potentially facilitate innovation.
Nonetheless, the actual coming impact on foreign investment is suspect. A number of facts suggest that, while on paper China will open up further to investment, the door may not actually widen that much overall. First, the Chinese government is demonstrably hesitant in its willingness to restrict the government’s hand in the economy. The only way for foreign companies to be on equal footing with domestic companies is for the government to reduce its protection of domestic industries. This often comes in the form of subsidization and preferential procurement policies with state-owned enterprises and government institutions.
Policy Moves on Foreign Investment
Pilot Free Trade Zones
China’s pilot free trade zones (FTZ) are a policy experiment to engage in broader investment reforms without bringing too much risk to the wider economy. Many industries that face joint venture requirements and other restrictions in China, face fewer requirements within the FTZ. Nevertheless, business in the free trade zones is not exactly “free”. The negative list, which represents existing restrictions on foreign investment in these zones, remains sizeable. The negative list for the Shanghai Free Trade Zone, which is by far the most liberalized economic zone country, shrunk considerably in 2017.
Financial Sector Liberalization
In April, the governor of the People’s Bank of China announced that the country would open up its financial sector to foreign investment by the end of 2018. Specifically, China will eliminate foreign equity restrictions on banks and asset managers. Foreign banks will also be allowed to freely set up branches and subsidiaries. The securities and insurance industry will still be subject to ownership restrictions but will now allow foreign ownership of up to 51%. China is eager to internationalize the Chinese currency, and it recognizes that liberalizing the financial sector is a critical step towards that goal.
Automotive Sector Liberalization
The announcement to liberalize China’s automotive industry is perhaps the most directly related to the ongoing trade conflict between the US and China. In some respects, China would continue to benefit from the restrictions as a way to increase the transfer of foreign know-how related to electric vehicles, batteries, and autonomous vehicles. The increasing role of high-technology in the automotive industry has made this issue highly contentious. Foreign automotive companies have long since been concerned that the joint-venture requirement will result in the loss of proprietary assets and will be used against these companies abroad. The recent measures will remove the ownership requirements on new energy vehicles by the end of 2018. Foreign ownership requirements on all vehicles will be fully phased out by 2022. In the coming years, foreign automotive companies will be able to open and fully own automotive factories in China.
Reason for Skepticism
Broken Promises on Reform
When Xi Jinping took over in 2012, China-watchers expected him to usher in a new era of pro-market economic reforms, the pace of which had been sluggish for many years prior. The Third Plenum in 2013 promised an ambitious set of economic reforms. Much to the surprise of spectators, implementation of that plan has, to this date, been minimal. Analysts have speculated that this may be due to vested interests in the bureaucracy and state-owned enterprises or the fear that further reforms may have politically destabilizing effects. Comprehensively opening the doors to foreign investment requires China to keep the ball of reform moving so that foreign and domestic companies can exist on a level playing field.
Threats from Abroad
If Chinese export-oriented industries are threatened by retaliatory trade measures from abroad, it could cause major disruptions to the Chinese economy. The Chinese government has reason to be concerned that engaging in further economic reform may harm its ability to weather these shocks. Economic reforms will sever key mechanisms for the government to guide the economy in its own interests and not permit economic decisions to be solely guided by profit-maximizing companies. If an export-oriented industry is brought to its knees overnight, the government will want to be able to intervene to prevent the situation from becoming politically destabilizing.
While Foreign investment is a critical aspect of China’s relationship with the global economy, it is, in fact, decreasing in importance in the Chinese economy. In 2016, FDI accounted for only 1.5% of national GDP compared with 4% in 2010, according to World Bank data. Before foreign companies eager to capitalize on the massive Chinese market get too excited about the announcements regarding foreign investment, they should consider China’s track record on reform follow-through as well as the remaining incentives for the government to favor domestic companies and retain control of the economy.