Creating a More Attractive Investment Environment

By Tu Xinquan and Cao Hongyu

Along with the adjustment and upgrading of China"s industries, the structure of foreign investment has undergone profound changes.

C hina"s reform and opening up program is now in its 40th year. In the four decades since this pivotal program was launched, foreign capital has been an important factor in the rapid development of the economy and the dramatic rise in living standards.Through determined improvements in the level of market opening and the use of investment-friendly policies,China has become one of the major destinations for cross-border investment.

Foreign investment has not only fi lled China’s economy with much needed capital, it has promoted foreign trade,increased employment, and made important contributions to the expansion of China’s economy and the improvement of the quality of life. According to data released by the National Development and Reform Commission, foreign companies account for nearly half of combined imports and exports, one quarter of all industrial output, one- fi fth of tax payments and one-tenth of all employment in China. Foreign-funded enterprises have signi fi cant bene fi ts to the development of Chinese enterprises and industries. The competitiveness of China’s industry has been enhanced by the introduction of advanced production technologies as well as top grade management experience and high-quality talent. At the same time,the increasing sophistication of the manufacturing supply chain in China and the rapidly expanding domestic consumer market have provided a favorable operating environment for foreign companies. As a result, China and foreign companies have truly achieved win-win outcomes from investment in this country.

In the future, the door to China’s economy will not be closed. In fact,the degree of opening will become increasingly wider as China seeks to ensure an even more attractive foreign investment environment.

Changes in the Investment Environment

Different stages of the foreign investment program exhibited important differences. At the beginning of the reform and opening program,China hoped to use the opening policy to spur economic development by encouraging foreign investment.However, the results were limited.China was isolated from the outside world and foreign investors had little knowledge of the country’s business conditions. China’s economy was still undeveloped, with a limited degree of marketization and a weak industrial base. Infrastructure lagged and foreign investors still had many complaints about inconsistent and unnecessary regulation. After Deng Xiaoping’s groundbreaking southern tour in 1992- credited with kickstarting a stalled reform program -- China’s foreign investment environment began to change. Around the country there were new efforts to attract investment and create jobs as local and provincial governments competed for the chance to host foreign-invested factories. By vigorously pushing ahead with projects in transport, telecommunications and energy, local of fi cials made it clear that foreigners were welcome. At the same time, there were major changes in the legal framework, while regulatory and administrative reforms made considerable progress. Economic management also made steady gains.Regions around the country competed to offer favorable conditions to attract foreign investment, creating specially designated investment zones,bonded zones, high-tech zones, and development zones. Foreign-funded enterprises entering China could often enjoy special privileges. At the same time, however, there were substantial restrictions on foreign investors, such as requirements for the use of local components, the need to work with local partners and commit to the transfer of technology. It can be said that the introduction of foreign capital at that stage was mainly to achieve speci fi c economic development goals,such as increasing employment and developing foreign trade. The foreign investment environment was under strict state planning and regulation.

In 2001, China formally joined the World Trade Organization (WTO), and the country’s efforts to attract foreign investment entered a new phase that was marked by signi fi cant efforts to improve the investment environment.The areas open to foreign capital were expanded and the service sector showed particular gains. In terms of creating sound investment laws and policies,considerable efforts were made to clarify relevant policy measures and local supervision of foreign investment.Laws and regulations helped meet WTO commitments and made domestic investment governance practices consistent with the requirements under the WTO framework. At the same time,the preferential treatment policies for foreign investment were gradually withdrawn. Local authorities paid more attention to introducing foreign capital in a market-oriented manner. In recent years, through the establishment of free trade pilot zones and the negotiation of foreign investment agreements,China has actively promoted the principle of national treatment and a“negative list” management system whereby investment is permitted unless speci fi cally restricted. Bene fi ting from an increasingly stable and transparent foreign investment environment,in fl ows of foreign capital grew rapidly.Since 1992, China has led developing economies in terms of attracting foreign investment and it has been in the top three investment destinations for all economies since 2008.

China has improved the local investment environment by gradually enhancing local conditions while shifting from strict controls to a generally looser policy guidance. Capital in fl ows were initially directed at key cities and then expanded to regional and national levels. Preferential treatment was offered to investors in speci fi c industries. A generalized system of preferences eventually guided foreign investment in accordance with the needs of industrial development. The rules for governing foreign capital extended from areas within the nation’s borders to those on the border itself. Ultimately, the domestic and international investment markets became increasingly integrated.

The Investment Environment Still Needs Improvement

China has achieved signi fi cant results in improving the foreign investment environment by upgrading its infrastructure and institutional environment. The World Investment Report 2017 released by the United Nations Conference on Trade and Development (UNCTAD) shows that China is one of the most attractive investment markets in the world. The nation’s manufacturing eco-system and world class infrastructure have created signi fi cant advantages in attracting foreign capital. A large consumer market with the potential for strong growth have provided long-term momentum in capital in fl ows. And the attractiveness of the local market has been shifting from cost factors to a more comprehensive consideration of the nation’s advantages.

However, in other respects, there is much work to be done. According to the World Bank’s latest Doing Business 2018, which measures the business environment of 190 economies around the world, China’s business environment ranks just 78th. In this assessment, China lags far behind the United States and other Western economies, as well as Japan and South Korea. It also trails less developed economies such as Indonesia and Ukraine, and there has been little improvement in recent years under this kind of measurement. In this survey,supply costs of production factors such as land and energy are relatively high,while policies regarding taxation and protection for small-and-medium sized companies lag behind those of other large countries. In addition, many foreignfunded enterprises have complained about the opacity of relevant policies as well as discriminatory treatment.The 2017 AmCham China White Paper:American Business in China, published by the American Chamber of Commerce in China, noted that the biggest challenge faced by American companies operating in China is an unstable and opaque policy and regulatory environment. The European Union Chamber of Commerce in China, in its Business in China Position Paper 2017/2018, cited ambiguous laws and regulations and excessive administrative measures as signi fi cant obstacles to foreign-funded enterprises. It also noted unequal treatment of foreign companies as compared with local competitors and pointed to considerable room for improvement in China’s foreign investment environment.

In recent years, along with the adjustment and upgrading of China’s industries, the structure of foreign investment has undergone profound changes. China is considerably less attractive for labor-intensive manufacturing operations because of rising labor costs. This type of manufacturing has shifted to other lower cost economies in Southeast Asia and elsewhere. Capital- and technology-intensive industries have become the key source of foreign investment. In the future, China will need to obtain more high-quality foreign investment to correspond with its development goals,and this will mean new requirements for attracting foreign investment.

A Multi-Pronged Approach

China has taken a proactive approach to meeting the needs of its economy. It has made a multipronged effort to accelerate the opening of the domestic market and improve the investment environment.At the opening ceremony of the 2018 annual Boao Forum for Asia,President Xi Jinping outlined reform measures, such as strengthening links with international economic and trade rules, completing the revision of the negative list for foreign investment,and fully implementing the “pre-entry national treatment” and negative list management system. He stated that only “fresh air” would attract more foreign capital, a description that was meant to be both fi gurative and literal.In the past few years, China has made great achievements in air pollution control, for example. There is good reason to believe that the determination of the Chinese government will result in further progress in that area in the future.

In order to create a fairer, friendlier and more transparent foreign investment environment, China should take the following steps.

First, it is necessary to address ideological rigidity. The introduction of foreign capital is aimed at allocating resources from a global perspective and giving more room for market-based decisions. In the supervision of foreign capital, China must broaden its horizons and establish a clear and complete framework for opening up its industries in a manner that re fl ects national conditions. China must pay attention to foreign investment in new technology by making long-term plans based on the objectives of sustainable development,such as environmental protection and the optimization of resource utilization.

Second, it is necessary to improve the investment environment in some regions and in speci fi c industrial sectors to promote more coordinated development.China’s eastern coastal region is at the forefront in terms of development while the central and western regions have relatively weak infrastructure. The manufacturing sector is on the whole open to investment but there are still segments of high-tech manufacturing and the service sector where there is less openness. For the eastern regions that have received large amounts of foreign investment for a relatively long time, the next step is to attract highend manufacturing and providers of modern services. In the central and western regions where the investment environment is relatively lagging,infrastructure needs to be improved. At the same time, such regions should enjoy some preferential policies in order to help them narrow the gap with the east. In terms of industry sectors, it is necessary to further expand the scope of foreign investment, provide more investment opportunities, and comprehensively and effectively implement the system of preentry national treatment combined with negative list management so that foreign capital can better serve China’s industrial transformation.

Third, it is necessary to reform and improve foreign investment management practices and institutional settings,in order to provide a more businessfriendly institutional environment. It is necessary to strengthen transparency and openness, improve administrative ef fi ciency, treat all domestic and foreign-funded enterprises equally and eliminate the dissatisfaction of foreignfunded enterprises stemming from unfair treatment. At the same time, it is necessary to strengthen the protection of intellectual property rights, improve relevant legislation and tighten law enforcement.

Fourth, it is necessary to make economic and trade practices conform more closely to international norms and improve investment governance. In terms of domestic rules and practices,China must actively develop innovative practices, such as free ports, to cultivate and improve the overall management of foreign investment, and explore the establishment of a system of rule-of-law that matches the highest international standards. At the same time, China must follow the new guidelines of the 21st century, such as competition neutrality,expanded data fl ows, and new views on investment dispute resolution. With greater integration between domestic regulations and international rules, the foreign investment environment can be upgraded and fully optimized.

At present, cross-border investment faces many challenges as an antiglobalization trend gathers pace.Some developed countries, led by the United States, have begun to retreat from free trade principles and adopt more protectionist measures to close their own markets and exclude foreign competition. Such moves are not in the interest of global economic development and are extremely irresponsible. Under these circumstances, China has always upheld the banner of opening up, and has personally integrated itself into the globalization framework. China welcomes foreign capital and this will result in new opportunities and greater bene fi ts for all. By shouldering its responsibilities as a great global economic power, China will stick to its reform and opening policies.

The authors are from the China Institute for WTO Studies, the University of International Business and Economics