New China FDI rules put focus on ascent
By Benjamin Shobert
Jan 24, 2012
Nervous eyes around the world have set their gaze on China as 2012 gets off to a start. Even without the looming leadership transition planned for later this year, questions remain about whether China’s economy is on solid ground, and how to interpret the direction of China’s economic reforms.
The direction of reforms are viewed by many in Washington as an important indicator not only of whether China will continue opening its economy to foreign investment and competition, but also as a signal of Beijing’s willingness to let both economic and political reforms advance. The prevailing notion of engagement with China continues to be that economic reforms will ultimately trigger political ones, a linkage that has come under fire in recent years.
The prevailing wisdom in Washington is that much of the stalled political reform and the heavy-handed suppression of dissenting voices that have occurred over the last 18 months reflect real concerns about the China’s social stability, both in general and more specifically in advance of the change of leadership. This makes interpreting Beijing’s economic reform policies that much more important.
Consequently, the late December release of the 2011 revised Catalog for Guidance for Foreign Investment by the National Development and Reform Commission (NDRC) sheds essential light on China’s plans for further economic reform.
Steven Dickinson, a China-based lawyer and Principal at Harris & Moure, a well-respected law firm with offices in the United States and China, believes the 2011 Catalog reflects what he calls a “continued openness” to outside investment. Perhaps more importantly, Dickinson said the Catalog also shows a desire on China’s part to continue to open the economy to outside investment and competition.
As he put it, “The basic numbers reflect this. Three items were added to the encouraged category, while seven items were removed from the restricted category and one item was removed from the prohibited category.” He goes on that, “In addition, where joint ventures are required, the required Chinese share was reduced in eleven cases and was not increased in any case.”
These moves are hardly consistent with the version of China being popularized by some in Washington policy circles. While the 2011 Catalog certainly shows China continues to pursue a state-sponsored, state-crafted and state-centric economic development and planning model, it equally shows that the country is systematically removing barriers to outside participation in the domestic economy. These moves stand in stark contrast with other emerging economies, namely India, whose late 2011 moves to restrict FDI show what a stalled process of economic reform really looks like.
Critics of this more generous interpretation as to China’s economic reform process will be quick to point out that the 2011 Catalog does not have any impact on the country’s government procurement practices and the notorious Indigenous Innovation policies that have drawn the ire of various congressional committees, the US-China Economic and Security Review Commission (USCC) specifically.
This leaves open the possibility that the 2011 Catalog and other facets of Beijing’s economic plans may run counter to policies and practices of openness. As has always been the case in the past, and will likely be the case in the foreseeable future, certain discontinuities are to be expected, which will make local municipal-level interpretation and engagement by foreign investors key to success.
Chris Devonshire Ellis, a Principal and Founding Partner at Hong Kong based Dezan Shira & Associates, agrees with Dickinson’s analysis. According to Ellis, “various new products and technologies in the textile, chemical and mechanical manufacturing industries have been added to the encouraged category in the 2011 Catalogue.” Beyond these sectors, Ellis emphasized that the 2011 Catalog is, “more hi-tech focused.”
The Catalog also puts additional emphasis on China’s service sector, with a focus that includes “motor vehicle charging stations, venture capital enterprises, intellectual property rights services, marine oil pollution clean-up technical services, [and] vocational skills training.”
International investors focused on China’s exploding healthcare market will be pleased to note that the 2011 Catalog encourages investment in these areas. Specifically, as Ellis points out, “Foreign-invested medical institutions have been moved from the restricted to the permitted category, while biotechnology, biomedicines, new vaccines, and advanced medical equipment have all been categorized as strategic sectors and investments to be encouraged.”
David Dai, an attorney and Partner in Shanghai at MWE China Law, echoed Ellis’ view of what the 2011 Catalog means for foreign investors in China’s healthcare market: “Foreign invested healthcare services are removed from the restricted category and there is no longer any restriction on foreign investment proportion in this sector. The above liberalization is applicable to the whole health-care sector.” China’s willingness to allow foreign investment in these areas is, as Ellis points out, large a recognition of “the needs of China’s aging population demographics.”
The 2011 Catalog does present a handful of sectors where prohibitions either will be in kept in place or expanded. According to Dai, restricted areas include “large-scale agricultural products, wholesale market and processing of rice and flour are included in the restricted category. [In addition,] sectors like domestic express delivery business of mails and construction and operation of villas are also added into the prohibited category for the first time.” Ellis adds that “whole vehicle manufacturing has been removed from the encouraged category, while to suppress over production and redundant construction in certain industries, poly-silicone and coal chemical products have also been removed from the encouraged category.”
Beyond these areas where Beijing is signaling it either wants more or less foreign investment, the 2011 Catalog also provides an insight into two other features that characterize the challenges facing the country as its economy evolves. As Dickinson puts it, “Foreign investment is intended to support China’s manufacturing sector by providing access to modern advanced technology.
There is no longer a focus on job creation and there is little interest in foreign investment in any sector outside those areas which will help China modernize.” This is an important insight: while China recognizes the need for its economy to grow, it no longer is chasing shear job creation as the goal of inbound FDI. Rather, it is seeking those technologies that will enable it to move up the value chain and compete internationally as something more than the world’s factory floor.
The second feature the 2011 Catalog offers beyond which sectors the government desires investment within is the geography of where it wants these investments to occur. Ellis points out “investment is being further encouraged geographically in the Central and Western regions of China.”
According to him, this reflects awareness by the Chinese government of rising wages along the eastern seaboard that drives a “renewed interest in the more inland regions – as long as China can get its cost of transportation infrastructure right.” Whether the lower costs in these areas will offset increased transportation expenses or the additional lead-time related to moving in-land remain largely unknown.
The 2011 Catalog formerly goes into effect at the end of January. The document cannot be understood or interpreted without looking at other plans and statements put forward by the Party, most important of which is undoubtedly the much-focused-on Five-Year Plan. However, the 2011 Catalog is the central planning document used by the Chinese government to guide investment decisions, and as such, it is important and influential.
The Catalog’s centrality to Beijing’s stated economic objectives should give critics of China’s economic reform process pause, and advocates reason to believe that all is not lost relative to China’s liberalization. After all, as Dickinson’s comments show, the overwhelming direction of China’s foreign investment is towards increased openness and increased accommodation of foreign participation in the Chinese economy. While there may well be other reasons for concern over China’s process of reform, the 2011 Catalog makes an important statement about the country’s ongoing pursuit of Western capital, ideas, and guidance.
Benjamin A Shobert is the managing director of Rubicon Strategy Group, a consulting firm specialized in strategy analysis for companies looking to enter emerging economies. He is the author of the upcoming book Blame China and can be followed at www.CrossTheRubiconBlog.com.