China FDI: The Glass is Half Empty

China lawyer

Clara Muriel Ruano wrote an article for the Asia Pacific Forum, Media Perception of China: Myth vs. Reality, {link no longer exists] contending there is no reason to worry about foreign investment in China and blaming the media for our believing otherwise.
I disagree.

Ruano starts out by noting how there has been “plenty of media coverage on the deterioration of the business environment for foreign companies in China, but then seeks to entirely counter that with one inconclusive American Chamber of Commerce in Shanghai survey on China’s business climate.

Ruano sets out the following key findings from that survey to support the claim that nothing has changed for foreign investment in China:

  • 90 percent of companies feel their business either has improved or stayed the same in the last six months.
  • 78 percent of companies feel the business environment either has improved or stayed the same over the past six months
  • Even within the 22 percent that perceives the situation to have worsened, 69 percent still feels that their business has improved or stayed the same!
  • 63 percent of companies have not changed their company’s plans in the last six months.
  • Out of the 37 percent that changed their plans, more than 80 percent actually were increasing their activity in China (investment, manufacturing, procurement, R&D, etc.).

Ruano then asks why “if companies sound undeniably positive, the perception we get from the media is so unmistakably negative” and proceeds to list out the following as reasons:

There are plenty of some issues of concern, including a series of government announcements that have potential investors uneasy:

  • New regulations on foreign investment with its emphasis on welcome versus unwanted investments.
  • Tighter regulations affecting the creation of representative offices.
  • Tax increases for representative offices.
  • China’s Indigenous Innovation policy, which would discriminate in favor of Chinese technology when competing to access government procurement business.

Ruano then knocks down this “straw man” by noting how there “already have been previous announcements on favored investment industries; ROs may be further restricted, but WFOEs (Wholly Foreign Owned Enterprises) are easier and cheaper to set up than just a few years ago; and the Indigenous Innovation policy already has been modified to improve the access of foreign companies to government procurement business (updates on the Indigenous Innovation Policy draft).”

Wrong, wrong, wrong.

First off, the statistics on foreign companies doing fine in China and wanting to expand are completely irrelevant. These companies could be doing fine in China and wanting to expand not because China is making things easier for them, but because China’s economy is booming and because China has 1.3  billion people. The more interesting statistic is that 22 percent of those surveyed see the situation as having worsened, which is actually a much higher number than one might initially have expected.

And here’s why.

Take the Google and Rio Tinto kerfuffles. My view on those is that they will have little to no impact on the vast majority of my firm’s clients. I say this because the vast majority of my firm’s clients are neither in internet search companies nor do they plan to engage in bribery. In other words, enforcement of a particular law or a change in a particular law will usually not impact all that many companies.

Ruano does not cite any real evidence for the proposition that things are fine in China nor for her contention that setting up a WFOE is easier and cheaper now than just a few years ago. In fact, the countless experiences of the China business lawyers at my law firm and the countless discussions we have with other international lawyers actively engaged in seeking to advance the legal interests of their foreign clients in China tell us the opposite.

We see the following concrete examples of how China is making things tougher on foreign investment:

— China’s local governments are more often delaying or denying applications for wholly foreign owned enterprises (WFOEs) and joint ventures. Chinese officials have come right out and said they no longer care whether foreign businesses come to China.
— Registration of technology licenses is more often being prohibited or restricted. The idea seems to be that Chinese businesses should not be required to pay for access to foreign technology.
— Visas for foreign workers are increasingly being delayed, denied or restricted. The view on this is that Chinese workers are available to do any job.
— China is greatly stepping up enforcement of its tax laws against foreign companies.

Now let’s just focus on forming WFOEs in China. I know of absolutely nothing that has happened in the last few years that would have made forming a WFOE any cheaper or easier in China, but my firm’s own personal experiences are saying that about 25% of the time in seeking to form a WFOE, we are being asked to provide documents that are nowhere required in the law and that we have not once been asked to provide in the previous five years. In the end, the officials have always granted the WFOE formation, but these sorts of things cause delays and increase attorney time. My firm charges a flat fee on WFOE formation so we have “eaten” the extra time, but if this sort of thing continues (and I expect it will), we will need to reexamine our fee structure to account for it. Firms that charge by the hour are no doubt charging more in these circumstances. I have talked with a slew of other lawyers (both Chinese and foreign) who have told me they are experiencing the same thing.

Few if any of the companies already in China would have sought to form a WFOE in the last few months and those are the companies AmCham surveyed.

China is tightening the reins on foreign business and it is doing so in very small drips and I think you would be hard pressed to find a lawyer representing foreign companies in China who would tell you otherwise.

The fact that it still makes complete sense for foreign companies to “play through” these drips and move forward in China as though they do not exist does not mean they are not there, as they are.

The Wall Street Journal read the same AmCham report and concluded things are getting worse for foreign investment in China and in their article, U.S. Businesses Wary About Protectionism In China their lead paragraph was on how China’s protectionist policies threaten their long term future:

A new survey from the American Chamber of Commerce in China indicated that concern is growing among U.S. businesses in the country that protectionist policies are threatening their long-term future in a key market, even while they remain optimistic about an economy that has rebounded strongly from the global recession.

The annual AmCham-China survey of its members–a barometer of sentiment among U.S. investors in China — reflects worries that China’s three-decades-long push for open markets could be stalling, as the government increasingly seeks to favor state-owned domestic enterprises that have spearheaded the economic recovery.

The article goes on to note how for “the first time in the 12-year history of the surveys, regulation tops the list of concerns among member companies, displacing worries about rising salaries, and recruiting and retaining key staff” and how “The main grievance is that laws and regulations are inconsistently applied around China, the white paper says, a problem that adds to the cost of compliance and results, for example, in delays obtaining licenses and approvals.” It then describes how foreign companies face long delays in gaining approval for mergers and acquisitions while Chinese applications face “little, if any, review.” Environmental laws are applied more stringently against foreign companies.”

Bingo.

What are you seeing out there?

7 responses to “China FDI: The Glass is Half Empty”

  1. I work for a company formation company and this is exactly what I am seeing and I agree with you that this started changing last year. I think some who say everything is great in China and things are always getting better just say that so they can get more business.
    I think foreigners got so tired of this that the Chinese government started to realize that many companies might leave or just not come and so over the last few weeks they have been saying things to make everyone feel better about how they still do welcome foreign investment. We will see.

  2. Hi Dan, Just in reference to my post, which you mention here (ouch). I must start saying that I never gave that title to the article (it was changed after I sent it as a contribution article). So it was not meant to be about “media: myths and realities”, but on business environment in general and how the pessimism we get when we read media was not shared by companies already settled here (and given that this was my angle, the survey data from companies based here was more than relevant).
    I’m not saying the investment environment is not challenging (in the article I end up saying that it is challenging and, and it is not going to get easier when they less need us) but my “half full glass vision” about China is that it is still bigger news the opportunities this market still has to offer.

  3. Dan,
    Perhaps the problem is trying to discuss “business in China” using overly broad one sided perspectives.
    Where you do business in China is having a greater affect on your business equation. Business which are opening offices and factories in and around the major industrial/population centers are subject to more requirements than before, but if they were looking to invest in a second or third tier city they would find a different environment; which means different, not necessarily easier. Taking about China as a monolithic entity was only useful when the deals were being cut in Beijing but with hundreds of major market cities (cities with 500,000 or more people) that are interpreting central government policy and directives in their own ways it is no longer useful to use generalizations.
    Presenting issues in general ways from the western perspective is useful but limited. To do business anywhere you need to understand the people and environment. China’s cities are definitely becoming more discriminating consumers of FDI and there are reasons. FDI has provided jobs, revenues and technology but in some cases it left enduring scars on both the people and environment. Having had a mixed experience with the first crew, it is not surprising that those in charge are suspicious when the next group of economic buccaneers shows up at their door. Sometimes to understand the situation you need to reverse the circumstances. What would you and your country’s reaction be to a bunch of new outsiders knocking at your door because they want to join the economic bandwagon, especially if there had been some mixed reactions to the last set? I often finding it perplexing that people think they are entitled to do business in China or anywhere else, other than their home countries, for that matter. Last time I checked every country was trying to run its country for the benefit of its people not its guests.

  4. Dan, you are correct, and while it maybe a generalization, it is getting more difficult for foreign companies to enter the market.
    The challenge, however, for MNC’s, is in allowing for the possibility that the market may be relaxed in the future. The CEO of a major international insurance firm was telling me of his company’s on-going decision of whether to stay here in case a particular sector is opened to WFOE’s. They are currently spending a lot of money to maintain their presence, while their core business interests are closed. However, if they leave and the market is subsequently relaxed, they sustain enormous lost earnings.
    At the end of the day, it’s a gamble, and companies need to carefully conduct their cost-benefit analysis. Some will decide that it’s simply not worth it.

  5. Hello Ehtangen
    some very good comments but I must take issue when you say “with hundreds of major market cities (cities with 500,000 or more people) that are interpreting central government policy and directives in their own ways”
    In a previous firm I worked in it is exactly this kind of “creative” interpretation of policies than can lead to big headaches. We were advising a client in a western province where the local government was encouraging FDI. However their tax “breaks” turned out to be at odds with central government laws which meant that our client could have faced a rather large bill once they discovered this anomaly, possibly years down the line. Fortunately we discovered this in time.
    In discussing FDI in China is it not right therefore that focus is had on Central government policies even if this does lead to a certain amount of “inaccuracy” in specific regions?

  6. Dan: I agree with your observations, but not the conclusions. While it’s a lot harder than in the “free and easy” period a few years ago, it is still a lot easier than doing business in say, Japan or India or Russia. I see this tightening as market maturity. China isn’t just going to accept “any ol'” foreign investment anymore. Neither does Singapore. Nor should it. I think that the dream of China being completely open to investments like Hong Kong or parts of the US is unrealistic. China doesn’t have the regulatory or administrative chops to be able to ride herd over that kind of environment, and we would end up seeing a lot of bad social outcomes (such as increased pollution).
    As for preferences towards Chinese companies, even our dear US plays that game. Unocal, anyone?

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