Is China being beastly to foreign investors?

by Charles Grant

When I visited China a year ago, I was struck by the strong feeling among many foreign firms there that the business environment was getting tougher. Western businessmen complained, in particular, about discrimination against foreigners. On a recent trip to China, I found a more nuanced situation. In some sectors, notably those where intellectual property (IP) is important, there are growing complaints of unfair treatment. But in other sectors foreign companies are making good money, without grumbling much.


Western business leaders are certainly complaining more loudly than they used to. In July, the Financial Times reported Jeffrey Immelt, the chairman of General Electric, as saying that he was “really worried about China. I am not sure that in the end they want any of us to win, or any of us to be successful.” A few days later Jürgen Hambrecht, the CEO of BASF, told Wen Jiabao, the Chinese prime minister, that foreign firms were being forced to transfer know-how to Chinese companies, in return for market access. Hambrecht told him that this did “not exactly correspond to our views of a partnership”. At the same meeting Peter Löscher, the CEO of Siemens, urged Wen to ensure that foreign firms could compete fairly for government procurement contracts. (Like a lot of western business leaders, Löscher had previously taken the Chinese government’s side, as when he criticised German Chancellor Angela Merkel for meeting the Dalai Lama.)

One government measure that has provoked foreign business leaders is the regulation on ‘indigenous innovation’ that was published last November. This would, if enforced, exclude foreign firms from public procurement contracts unless they agreed to hand over IP. The regulation seems to have been driven by the Chinese Communist Party’s belief that market forces alone will not provide a high-tech economy, and that the state therefore needs to get hold of and control advanced technologies. The EU, the US and many other governments lobbied strongly against the measure.

Whether this regulation will bite remains unclear. The government announced a delay in implementation and Chen Deming, the minister of commerce, said the regulation would not affect firms that could prove they added value in China. Some western business lobbies fear that, despite recent reassurances, the regulation will in the long run take effect. If it is enforced, firms like IBM and Microsoft are likely to cut back on R&D in China. On Capitol Hill, Microsoft is now taking a hard line on IP issues in China; until recently, it tended to sympathise with the Chinese point of view. China can no longer assume that US business leaders will, as a bloc, support its interests in Washington.

A similar shift is evident among some European companies. According to the head of one large German firm in China: “They assume their market is so big, that foreigners will stay, and put up with losing IP. That’s a miscalculation. Most foreign investors think IP is very important and that they have a duty not to hand it over.” He thinks that enforcement of the indigenous innovation regulation would dampen FDI in China. Big western manufacturers would not pull out but would source more components to countries such as Vietnam, Taiwan, Malaysia, Indonesia and Singapore. China’s free trade agreements with these countries now make it easier to supply Chinese factories from them.

Within the past two years, some high-tech foreign firms have had to pay higher rates of tax, while new restrictions on representative offices – each is allowed only three non-Chinese staff – are proving irksome. Foreign firms involved in making wind turbines, such as GE, Siemens and Vestas, are particularly annoyed that, as they see it, procurement rules have been skewed to exclude them from the Chinese market (the largest in the world), to the benefit of local firms.

Two-fifths of European businesses in China surveyed by the EU Chamber of Commerce in June 2010 expected the regulatory environment to worsen in the next two years. The same proportion described the discriminatory application of laws and regulations as a ‘significant’ obstacle. The EU Chamber concluded: “Optimism in the overall economic climate has been dampened dramatically by concerns about regulatory interference and unpredictability in the market.”

Some of the shifting balance of power between foreign investors and the Chinese authorities is the inevitable result of the country’s development. A lot of Chinese companies are now stronger and better-equipped to compete with European or American rivals. Twenty years ago the Chinese needed western capital, skills and technology. Now they need the technology, but they have less need of the skills, and plenty of their own capital.

Another issue for foreign investors is that costs are rising, in part due to labour unrest that has been prevalent in the Pearl River Delta area. The emergence of free trade unions is an important and positive step for the country’s future development, signalling the emergence of a civil society that is not controlled by government or party. But many foreign businesses see the new trade unions merely as a source of growing costs.

Mining companies, energy firms, banks and insurers, among others, still face restrictions on their activities in China. Many of them nevertheless make money. That is the case for Shell and BP, which are significant investors, often through joint ventures, but would like to engage in a wider range of activities than they currently do. In many other sectors, such as retailing, advertising, hotels, pharmaceuticals and cars, companies report they are doing well without too much government interference. For example Tesco finds it easier to open stores than two years ago, as central government permission is no longer required; but Tesco says that Chinese retailers face less hassle from red tape than do foreign ones. WPP is allowed to own 100 per cent of local advertising agencies and says that as a foreign firm it faces no discrimination – except that it pays more tax than local competitors. Car companies are doing particularly well: BMW has doubled sales in China over the past year, and Daimler is forming a joint venture to develop electric vehicles.

Since the spring, the government has made an effort to appear friendly to foreign firms: Premier Wen met foreign business leaders to listen to their complaints; several ministries opened their doors to foreign investors in China and asked how they could help; and in July the government appeared to accept a compromise in its dispute with Google, with the result that Chinese citizens can search uncensored via Hong Kong. Chinese analysts point out that many local authorities still compete for FDI and therefore offer special deals (for example, on tax and utilities) to foreign firms.

When China joined the World Trade Organisation in 2002, it failed to sign the agreement on public procurement that prevents discrimination against foreign firms. In July China made new proposals for acceding to this agreement – but western governments think them inadequate (for example, China is not offering to open up local government procurement). Also in July, Chen Deming wrote in the Financial Times that China is “ever more open to business”. He is right that most of the formal rules applying to foreign investors are less restrictive than they were ten years ago. According to his figures, global FDI fell by nearly 40 per cent in 2009, but only by 2.6 per cent in China.

My conclusion is that China still welcomes FDI, but that it is becoming more insistent on setting the terms. For example, it wants to choose the location for big foreign industrial investments – often in the underdeveloped west of the country, where a lot of foreign firms would rather not go. The Chinese government is probably right to calculate that, for all their grumbling, most foreign firms will stay; China is just too big a market to ignore. In any case, despite the difficulties, many foreign investors in China claim that they are managing to hang on to their IP.

China’s strategy is to exploit foreigners’ desire for access to its markets as a means of gaining their technology. From China’s point of view that is a reasonable policy. If a lot of foreign investors clubbed together to speak with one voice and make credible threats to China, they might persuade its leadership to re-examine that strategy. But neither the big foreign companies in China, nor the European and American governments, are likely to get significantly tougher with China. So do not expect much change in China’s policies towards foreign investors.

Charles Grant is director of the Centre for European Reform