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Diplomacy in Action

2009 Investment Climate Statement - China


2009 Investment Climate Statement
Bureau of Economic, Energy and Business Affairs
February 2009
Report
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Openness to Foreign Investment

The growth rate of foreign direct investment (FDI) into China accelerated to 23% in 2008 to $92.3 billion, according to Ministry of Commerce statistics. American FDI in China grew more than 10% in 2008, the first year that U.S. investment in China rose since 2002. According to the United Nations Conference on Trade and Development (UNCTAD), in 2007, mainland China was the world’s sixth largest FDI recipient, after the United States, the United Kingdom, France, Canada, and the Netherlands. (Hong Kong was the world’s seventh largest FDI recipient. Together, the two economies would be ranked fourth.)

China also received the most votes in a 2007 UNCTAD poll of attractive investment destinations, followed by India, the United States, Russia, Brazil, and Vietnam. The American Chamber of Commerce has reported that American firms’ operations in China are more profitable than they are in the United States.

Outbound investment from China has recently increased significantly as China encourages leading domestic firms to acquire key technologies, brands, and access to natural resources abroad, although Chinese investment in U.S. financial institutions has lagged expectations.

While FDI in China shot higher, investors continued to face a range of potential problems that could expose them to risks in the future. Problems foreign investors face in China include lack of transparency, inconsistently enforced laws and regulations, weak IPR protection, corruption, industrial policies that protect and promote local firms, and an unreliable legal system.

In 2008, China continued to lay out a legal and regulatory framework granting it the authority to restrict foreign investment that it deems not to be in China’s national interest. In many ways, the new rules, which are outlined in more detail below, codify standards and practices that China was already employing in its existing, mandatory foreign investment approval process. Key terms and standards in the new regulations are undefined. In fact, China has told the United States that it wants to preserve flexibility for its regulators to approve or block foreign investment projects in response to changing circumstances. In practice, the potential restrictions that China may impose are much broader than those of most developed countries, including the national security review conducted by the Committee on Foreign Investment in the United States (CFIUS).

At the moment, China appears to be using the rules to restrict foreign investments that are:

  • intended to profit from currency speculation;
  • in sectors where the government is trying to tamp down aggregate capital inflows and inflation;
  • in sectors where China is seeking to cultivate “national champions;”
  • in sectors that have benefited historically from state-authorized monopolies or from a legacy of state investment;
  • in sectors deemed key to social stability, like foodstuffs and heavily polluting industries; and
  • nominally “foreign” investment that is actually Chinese capital that has been exported and re-imported to take advantage of preferential treatment accorded to foreigners.

Although it remains to be seen how many of these rules will be applied, they present several concerns to foreign investors. First, they appear to give regulators significant discretion to shield inefficient or monopolistic enterprises from foreign competition. They are also often applied in a manner that is not transparent. Finally, overall predictability for foreign investors has suffered because investors are less certain that China will approve proposed investment projects. The United States Government has raised its concerns about these laws and regulations and will continue to monitor developments closely in 2008.

At the end of 2008, in response to the weakening economy, China announced a stimulus package that includes fiscal stimulus, business tax cuts, and support for priority sectors that may present foreign investors with new opportunities. The United States is tracking the roll out of this plan and will seek to ensure it is applied in a manner that does not discriminate against foreign investors.

Investment Requirements

China has revised many laws and regulations to conform to WTO investment requirements. At the same time, Chinese industrial planners encourage investments that meet Beijing’s economic development goals. U.S. companies are concerned that encouragement may amount, in many cases, to WTO-prohibited requirements, particularly in light of the high degree of discretion provided to the Chinese officials who review investment applications.

Laws Governing Investment

In China, all commercial enterprises require a license from the government. There is no broad right to establish a business. The principle law governing establishment of an enterprise is China’s Administrative Permissions Law, which requires China to review proposed investments for conformity with Chinese laws and regulations, and is the legal basis for China’s complex approval system for foreign investment, described below.

Additional laws govern the forms of enterprises that can be established, which are described in more detail in Section F. Disposition of an enterprise is also tightly regulated. Apart from its legal regime, China makes liberal additional use of administrative regulations that restrict foreigners’ ability to establish investments in some sectors, as described below.

China’s Foreign Investment Review and Approval Process

The first step in securing approval for an investment project is application to China’s Environmental Protection Ministry and Land Resources Agency, which review projects for compliance with environmental and land use regulations. The next step is “project verification” by China’s National Development and Reform Commission (NDRC), which includes assessing the investment project’s compliance with China’s laws and regulations, its national security, and its economic development needs. Provincial DRC’s typically first pre-review investment projects before submitting them to the national DRC for “verification.” In some cases, NDRC also solicits the opinions of relevant Chinese industrial regulators and “consulting agencies,” which may include industry associations that represent domestic firms. The State Council also weighs in during the verification stage for “key projects.”

Once NDRC completes its review, the Ministry of Commerce (MOFCOM) conducts an “enterprise establishment verification,” which certifies that the contract establishing the foreign investment conforms to China’s laws and regulations. Foreign investors next apply for a business license from the State Administration of Industry and Commerce (SAIC), which allows the firm to operate. Once a license is obtained, the investor registers with China’s tax and foreign exchange agencies.

Investment Guidelines

While insisting it remains open to inward investment, China’s leadership has also stated that China is actively seeking to target investment in higher value-added sectors, including high technology research and development, advanced manufacturing, energy efficiency, and modern agriculture and services, rather than basic manufacturing. China would also seek to spread the benefits of foreign investment beyond China’s more wealthy coastal areas by encouraging multinationals to establish regional headquarters and operations in Central, Western, and Northeastern China.

Five Year Plan

China defines its broad economic goals through five-year macro-economic plans. The most significant of these for foreign investors is China’s Five-Year Plan for Foreign Investment. The most recent version was released in November 2006 and promised a greater scrutiny of foreign capital utilization. The plan calls for the realization of a “fundamental shift” from “quantity” to “quality” in foreign investment from 2006 to 2010.

According to the document, the focus of China’s investment policy should change from shoring up domestic capital and foreign exchange shortfalls to introducing advanced technology, management expertise, and talent. There should be more attention to ecology, environment, and energy efficiency. The document also demands tighter tax supervision of foreign enterprises, and seeks to restrict foreigners’ acquisition of “dragon head” enterprises (i.e., premier Chinese firms), prevent the “emergence or expansion of foreign capital monopolies,” protect national economic security, particularly “industry security,” and prevent “abuse of intellectual property.”

Foreign Investment Catalogue

China outlines its specific foreign investment objectives primarily through its Foreign Investment Catalogue. The most recent version went into effect December 1, 2007. The catalogue is revised every few years and supplemented by directives from various government agencies. According to Chinese officials, it is a static document, intended as a snapshot of policies in place at a given time, and thus may not fully reflect China’s foreign investment policy after it is published. In December 2008, China also released an updated version of its “Catalogue of Priority Industries for Foreign Investment in the Central-Western Region,” which outlines additional incentives to attract investment in targeted sectors to those parts of China.

The Foreign Investment Catalogue serves two functions. First, China intends for it to help foreign investors understand China's complex industrial policy by delineating sectors of the economy where foreign investment is encouraged, permitted, restricted, and prohibited. In addition, the catalogue spells out some more specific restrictions in various sectors, like caps on foreign ownership and permissible types of investment. In all restricted sectors, foreign firms wishing to invest must form a joint venture with a Chinese company, restricting their equity to a minority share. In addition, the release of an updated catalogue, with State Council blessing, sends a signal to other relevant agencies that they should adopt measures to implement the new guidelines.

Investment in sectors not listed in the catalogue is considered “permitted.” China “encourages” investment in sectors where it believes it benefits from foreign assistance or technology. Investment is “restricted” in sectors that do not meet “the needs of China’s national economic development.” China “prohibits” foreign investment in a limited number of sectors, such as news agencies, radio and TV transmission networks, film production, publication and importation of press and audio-visual products, compulsory basic education, mining and processing of certain minerals, processing of green and “special” tea using Chinese traditional crafts, and preparation of Chinese traditional medicine.

Since 2004, provincial governments have enjoyed expanded authority to directly approve many foreign investment projects. Currently, in “encouraged” and “permitted” sectors, only proposed investments valued above $500 million require National Development and Reform Commission (NDRC) review and State Council approval. Projects in “restricted” sectors valued above $50 million require central government review and approval. In targeted sectors, like high-technology industries, China uses a variety of incentives to encourage investment, which are described in Section E.

Problems with the Foreign Investment Catalogue

Foreign investors have expressed frustration that China does not publicly seek input before updating to the catalogue and offers no rationale for changes. In addition, Chinese regulators are not bound to follow the catalogue and instead maintain the flexibility to discard its guidance and restrict or approve foreign investment for other reasons. Part of the problem is that the catalogue is intended only as a general guideline, not a fully exhaustive list of restrictions. Even in encouraged and permitted sectors, regulations apart from the Catalogue often specify restrictions on the specific forms of investment that are allowed. China may also adopt new regulations or make unannounced policy decisions that supercede the most recent published edition of the catalogue. Chinese officials have told the United States Government that China is not able to exhaustively catalogue all existing investment restrictions and requirements.

Contradictions between the catalogue and other measures, some of which are outlined below, have also confused investors and added to the perception that investment guidelines do not provide a stable basis for business planning. Uncertainty as to which industries are being promoted and how long such designations will be valid undermines confidence in the stability and predictability of the investment climate. As an example, China is now concurrently putting into place a set of regulations governing foreign mergers with and acquisitions of Chinese firms (M&A) and regulations that stipulate state control over “key sectors” of the economy. The relationship between these rules and the investment catalogue is not clear. As a consequence, the practical implications of listing a sector in a given category are uncertain.

New Investment Restrictions in “Key Fields”

Starting in 2006, China began to release a set of regulations that together outline restrictions on foreign investment in “key fields.” While China has never officially defined the term, in practice, it appears to refer to sectors of the economy that are key to China’s industrial development and political stability. The scope of these interests may well be broader than many U.S. investors might assume. For example, China has recently indicated that food processing is critical to China’s security. In 2008, China explained that its rationale for imposing new restrictions on foreign investment in soy processing was driven by concern that foreign invested firms controlled too high a share of the oil seed processing market and that domestic firms were unable to compete. If foreign-invested firms were to wipe out their domestic competition, the officials explained, then China would become dependent on foreign firms to supply this key domestic food staple.

Review of Foreign Mergers and Acquisitions

In August 2006, the Ministry of Commerce (MOFCOM) and five other government agencies issued the first of a series of regulations to put in place restrictions on foreign investment in key fields. Specifically, China revised the rules that govern foreign mergers and acquisitions to establish an “economic security review” that can block deals. Under the new rules, foreign acquisitions that would result in “actual control” of a domestic enterprise in a “key industry” with “potential impact on national economic security” or altering control of a “prominent Chinese old brand” must be reported to MOFCOM for approval and certification that the target has been accurately valued.

Chinese officials have claimed that these regulations are broadly based on and equivalent to the U.S. interagency Committee on Foreign Investment in the United States (CFIUS) process, which is in fact a much more narrowly focused review of the national security implications of foreign acquisitions of U.S. firms. Although the implementing regulations for the M&A review process have never been released and may not be complete, foreign investors have reported that they face greater difficulties purchasing controlling stakes in prominent firms and several prominent proposed deals are stalled.

State Enterprise Restructuring

Subsequently, in December 2006, China’s State Council issued a decree drafted by the State-owned Assets Supervision and Administration Commission (SASAC) which concretely outlines a broad set of “key sectors” where the state should retain or expand its control. The Guiding Opinion Concerning the Advancement of Adjustments of State Capital and the Restructuring of State-Owned Enterprises calls on China to “enhance the state-owned economy's controlling power,” “prevent the loss of state-owned assets,” encourage “state-owned capital to concentrate in major industries and key fields relating to national security and national economic lifelines and accelerate the formation of a batch of predominant enterprises with independent intellectual property rights, famous brands, and strong international competitiveness.”

The document defines “major industries and key fields” as those related to national security, major infrastructure and mineral resources, industries that provide essential public goods and services, and key enterprises in pillar industries and high-tech industries. The measure explains that “pillar” and “backbone” industries such as automotive, chemical, construction, electronic information, equipment manufacturing, iron and steel, nonferrous metal, science and technology, and survey and design must maintain relatively strong state control. SASAC also identified seven strategic sectors where state capital must play a “leading role”: aviation, coal, defense, electric power and grid, oil and petrochemicals, shipping, and telecommunications.

Anti-Monopoly Law

In August 2007, China's National People’s Congress passed an Anti-Monopoly Law (AML) that took effect in August 2008. While U.S. experts say the law's core antitrust provisions meet international standards, it is important to note that these international standards can differ from U.S. practice and may allow considerable discretion for Chinese regulators to pursue cases that benefit local firms at the expense of international competitors. Specifically, while the United States tends to promote a competition regime that enhances consumer welfare, as measured by lower prices, other states pursue competition policies that seek to balance that goal with limits on “unfair” or “excessive” competition that harms specific competitors, even if consumers benefited from such competition.

China’s adoption a regime to manage “excessive” competition poses specific problems in China’s state-led economic development system. Specifically, competition regulators may find themselves responsible for both limiting excessive competition and promoting the development of state-backed companies. This can turn competition policy into a tool to protect and promote local companies at the expense of foreign firms. In order to avoid this problem, the United States has advised China that it should separate the competition and industrial policy functions of its regulatory system. Competition regulators should not be concerned with promoting domestic companies.

Some observers fear that China intends to use the AML as just such a tool to restrict foreign firms’ business activities or their access to markets, especially in the “key sectors” outlined above. Part of the reason for this suspicion is that passage of the law in 2007 was accompanied by a public debate about the risks posed to China’s development and independence by foreign dominance in key sectors. In addition, the text of the law notes China will protect the “lawful activities” of state-regulated monopolies and does not clearly resolve whether SOEs are otherwise subject to the law’s competition provisions.

In sum, the law appears to create a legal authority for the Chinese government to restrict the business activities of both foreign and domestic firms that harm national interests by restricting competition. This authority could be directed at foreign firms and at state-owned enterprises that abuse the monopoly power granted to them by the state. The law can thus be seen as another flexible economic management tool that China can adapt to changing circumstances and perceived needs. China is currently drafting implementing regulations for the law that, together with the resolution of specific cases, will likely clarify how it intends to use the AML.

National Security Review of Foreign Investment

Article 31 of the AML also calls on China to establish a "national security" review of foreign investment. In August 2008, China announced the formation of a “joint meeting of ministries for security reviews of foreign M&A,” headed by Vice Premier Wang Qishan. To date, China has declined invitations to brief the U.S. government on the work of the committee, most recently at the December 2008 meeting of the U.S.-China Investment Forum.

State Assets Law

In October 2008, China’s National People’s Congress passed a State Assets Law. The purpose of the law is to safeguard China's “fundamental economic system” and its SOE assets and claims, promote the “socialist market economy,” fortify and develop the “SOE economy,” and enable SOEs to play a dominant role, especially in “key sectors.” The law requires China to adopt policies to encourage SOE concentration in industries vital to the national economy and pertinent to national security in an effort to strengthen SOE dominance in these fields. This is similar to provisions in both the State Council's 12/06 Opinions on SOE restructuring and the AML. The law also stipulates that transfer of state assets to foreigners should follow government policies and shall not hurt national security or public interest.

Problems with Laws and Regulations Restricting Foreign Investment in “Key Fields”

One key issue that remains to be clarified is the degree to which these regulations restrict foreign investment in sectors identified for state dominance, control, or influence. While China encourages state-backed firms to concentrate on these sectors, it is not clear if the regulations prohibit foreign investment in them. Chinese officials have stated that the rules are intended as guidelines. When foreign investment in an identified sector becomes too high, future investment will be restricted. That is, foreign investment would be allowed so long as it does not lead to foreign dominance.

As a consequence, we believe proposed investments in key sectors are evaluated on a case-by-case basis. This allows significant discretion on the part of Chinese regulators to impose unexplained restrictions on new investment projects, regardless of a given sector’s designation in the foreign investment catalogue, and taking into account the interests of domestic competitors. Together, these new rules diminish the transparency of China’s inward investment regulations and contribute to anxiety among foreign investors by limiting their ability to predict whether proposed investments will be approved.

Additional Regulations that Could Restrict Foreign Investment

Apart from the measures outlined above, China has also adopted policies in specific sectors that appear designed to restrict foreign participation. For example, the State Council’s June 2006 Opinions on the Revitalization of the Industrial Machinery Manufacturing Industries calls for China to expand the market share of domestic companies in 16 equipment manufacturing fields. Policy supports include preferential import duties on parts needed for research and development, encouraging domestic procurement of major technical equipment, a dedicated capital market financing fund for domestic firms, and a strict review of imports. The measure suggests China will implement controls on foreign investments in the sector, including requiring approval when foreign entities seek majority ownership or control of leading domestic firms.

Also in 2007, some measures the government used to cool economic activity specifically targeted foreign investors, while measures introduced in 2008 to boost economic activity appeared tilted toward benefiting domestic firms. For example, in 2007, China applied residency requirements for foreigners seeking to buy real estate. Also, China’s steel policy requires foreign investors to possess proprietary technology or intellectual property in steel processing. Given that foreign investors are not allowed to have a controlling share in steel and iron enterprises in China, this requirement constitutes a de facto technology transfer requirement, in apparent conflict with China’s WTO accession agreement obligations. The policy also prescribes the number and size of steel producers in China, their location, the types of products that will and will not be produced, and the technology that will be used.

This high degree of government direction and decision-making regarding the allocation of resources in China’s steel industry raises concerns because China committed in its WTO accession agreement to refrain from influencing, directly or indirectly, commercial decisions on the part of state-owned or state-invested enterprises.

Laws Governing Business Operations

In March 2007, the National People’s Congress passed a new Corporate Income Tax Law, which eliminated many of the tax advantages that had been enjoyed by foreign investors. The law, which took effect January 1, 2008, fixed corporate tax rates for both foreign and domestic firms at 25 percent, following a transitional adjustment period. However, it maintained two exceptions to the flat rate: one for qualified small-scale and thin profit companies, which will pay 20%, and another to encourage investment by high-tech companies, which will pay 15%. Current preferential tax treatment will apply to investments in agriculture, forestry, animal husbandry, fisheries, and infrastructure. Although the law could result in narrower margins for FIEs, it provides new incentives to enterprises with high-wage labor costs. Under the new law, financial services, securities, consulting, and other high-wage professional services firms will be able to deduct all wage outlays from their taxable income, which had previously been limited to RMB 1,600 per month, per employee.

China's Contract Law encourages contractual compliance by providing legal recourse, although enforcement of judgments continues to be a problem. Most contracts must be registered with the government. Contracts establishing a Foreign Invested Enterprise (FIE), governing some technology imports, and relating to infrastructure projects require government approval.

The Government Procurement Law establishes rudimentary criteria to qualify domestic and foreign suppliers and various categories of procurement, as well as broad standards for publicity, notification, bid scheduling, sealed bidding and bid evaluation. Foreign reactions to the law have been mixed. The law clarifies that purchases by SOE’s do not constitute government procurement, thereby removing the bulk of commercial value from this procurement system. The legislation mandates domestic procurement unless the goods or services are unavailable at reasonable commercial terms in China.

The Securities Law, which was amended in 2005, codifies and strengthens administrative regulations governing the underwriting and trading of corporate shares, as well as the activities of China's stock exchanges in Shanghai and Shenzhen. No wholly foreign enterprises have yet issued shares on a Chinese exchange, though the Chinese regulator has voiced support for this in the future. See Section I for information on investing in China’s capital markets.

Additional relevant laws include: the Insurance Law, Foreign Trade Law, Law on Import and Export of Goods, Arbitration Law, Labor Contract Law (described in Section N of this report), and other laws. Regulations and updates on China's investment laws, projects, and conditions can be found on the websites of the Chinese Ministry of Commerce, at http://www.mofcom.gov.cn and http://www.fdi.gov.cn. MOFCOM also publishes a comprehensive summary of foreign investment laws, including the complete Guidance Catalogue for Foreign Investment Industries, in a regularly updated 100-page booklet, known as the “China Investment Guide.”

Distribution of Foreign Investment

The vast majority of foreign investment is concentrated in China's more prosperous coastal areas, including Guangdong, Jiangsu, Fujian, and Shandong provinces, and Shanghai. Foreign investment in most service sectors lags manufacturing, mainly due to government-imposed restrictions. China is committed to gradually phasing out barriers in many service industries, but progress has been slow.

Policies on Conversion and Transfer of Foreign Exchange

China has gradually loosened the foreign exchange regulations facing foreign-invested firms. While China permits foreign investors liberal access to foreign exchange for current account transactions such as repatriating profits, capital account transactions (financial investment) are tightly restricted. Investors can also purchase foreign-currency denominated Chinese bonds.

However, recently, in response to its large trade surplus and capital inflows, Chinese authorities have tightened restrictions on capital inflows, while easing restrictions on capital outflows. Chinese authorities have also reduced foreign banks’ quotas to borrow foreign currency and several foreign firms have noted increased difficulties in getting approval to bring in foreign capital to expand their businesses.

Authorities have also begun to liberalize the exchange rate regime and operation of exchange rate markets. Recent regulations permitting greater capital outflow and China’s encouragement of domestic firms to invest abroad appear to be motivated by Chinese desire to better balance the massive capital inflows that China has recently experienced.

To open and maintain foreign exchange accounts, foreign-invested enterprises apply to China's State Administration of Foreign Exchange (SAFE). SAFE determines the amount of foreign exchange the firm needs. Deposits above the limit SAFE sets must be converted to local currency. Enterprises authorized to conduct current account transactions can also retain foreign exchange equal to 50 percent of export earnings.

Foreign exchange transactions on China’s capital account require a case-by-case review and approvals are tightly regulated. These barriers to capital market access are not addressed in China’s WTO accession agreement and Chinese firms face even more onerous restrictions than foreign-invested enterprises. Most major firms reinvest their profits in the Chinese market.

The Chinese government registers all commercial foreign debt and limits the foreign firms’ accumulated medium and long term debt from abroad to the difference between total investment and registered capital. Foreign firms must also report their foreign exchange balance twice per year.

Expropriation and Compensation

Chinese law prohibits nationalization of foreign-invested enterprises, including investments from Hong Kong, Taiwan, and Macau, except under “special” circumstances. Officials claim these circumstances include national security and obstacles to large civil engineering projects, but the law does not define the term. Chinese law requires compensation of expropriated foreign investments, but does not describe the calculation. Foreign investors have reported disappointment with compensation offers. The United States has not formally determined that China has expropriated any investments since reforms began in 1979, though the Department of State has notified Congress of several cases of concern.

Dispute Settlement

Foreign firms report inconsistent results with all of China’s dispute settlement mechanisms, none of which are independent of the government. The government often intervenes in disputes. Corruption may also influence local court decisions and local officials may disregard the judgments of domestic courts. Well-connected local business people are often in a better position to win court cases than are foreign investors and it is possible that they may use their connections to avoid prosecution for taking illegal actions against their former foreign partners. China’s legal system rarely enforces foreign court judgments.

As the economy has slowed, there have been anecdotal reports of local governments singling out foreign investors, clients, and partners of Chinese businesses to repay debts incurred by local businesses.

Commercial disputes are heard in economic courts within China's Supreme People’s Court and at three levels in the provincial court system. These economic courts have jurisdiction over contract and commercial disputes involving foreign parties; trade, maritime, intellectual property and insurance; and economic crimes, like theft and tax evasion. Foreign lawyers cannot act as attorneys in Chinese courts, but may observe proceedings. China also has an extensive administrative legal system, which adjudicates minor criminal offenses. China uses this system extensively to address intellectual property infringements, with limited results, as described in Section G.

Chinese officials typically urge firms to resolve disputes through informal conciliation. If a formal mediation is necessary, Chinese parties and the authorities promote arbitration over litigation. Most foreign investors consider arbitration a last resort, as they generally find it time consuming and unreliable.

Most contracts propose arbitration by the China International Economic and Trade Arbitration Commission (CIETAC). Some foreign parties have obtained favorable rulings from CIETAC, but difficulties in other cases have led other participants and panelists to question CIETAC's procedures and effectiveness. In CIETAC arbitration involving at least one purely foreign entity, a panel with a foreign arbitrator is possible. (Foreign joint ventures are considered Chinese legal persons.) Provinces and municipalities also have their own arbitration institutions. For contracts involving at least one foreign party, offshore arbitration may be adopted. Contracts stipulating foreign arbitration should name the arbitration body. China is a member of the International Center for the Settlement of Investment Disputes (ICSID) and has ratified the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards, the “New York Convention.”

In August 2006, China adopted an Enterprise Bankruptcy Law, which extended bankruptcy to private companies, including financial firms, whereas earlier laws covered only state-owned firms. The law stipulates that all insolvent enterprises will pay creditors first, and use only assets not earmarked as credit guarantees to pay laid-off workers.

Performance Requirements and Incentives

China has committed to eliminate export performance, trade and foreign exchange balancing, and local content requirements in most sectors. China has also committed to enforce only technology transfer rules that do not violate WTO standards on intellectual property and trade-related investment measures.

In practice, however, local officials and some regulators prefer investments that increase exports, develop industry, and support the local job market. Local authorities also operate with great autonomy from the central government. In addition, foreigners seeking to invest in “key sectors” which the government views as important to its economic development or national security face an array of often opaque regulations that limit their operations and may have the effect of imposing performance requirements. For example, Chinese regulators have pressured foreign firms in these sectors to disclose intellectual property content or license it to competitors, sometimes at below market rates. In sectors where foreign investment is restricted, Chinese nationals must own a majority of the enterprise.

China offers investors a complex system of incentives at the national, regional, and local levels. The Special Economic Zones (SEZ’s) of Shenzhen, Shantou, Zhuhai, Xiamen and Hainan, 14 coastal cities, hundreds of development zones and designated inland cities all court foreign investors with unique packages of reduced national and local income taxes, land use fees, and import/export duties, as well as priority treatment in obtaining basic infrastructure services. Many locales offer high-level support and services to businesses, including streamlined government approvals. Chinese authorities have also established a number of free ports and bonded zones. China offers preferences for investments in sectors it seeks to develop, including transportation, communications, energy, metallurgy, construction materials, machinery, chemicals, pharmaceuticals, medical equipment, environmental protection, energy conservation, and electronics. Finally, China boasts numerous national science parks, many focused on commercializing research developed in Chinese universities. The parks provide infrastructure, management and funding support for start-ups across a variety of industries, and welcome foreign firms.

In the past, foreign-invested enterprises benefited from preferential tax rates and could obtain a rebate of 40% of taxes paid on income if profits were reinvested in China for five years. Where profits are reinvested in high technology or export-oriented enterprises, a foreign investor could receive a full tax rebate. However, in March 2007, the National People’s Congress passed a new Corporate Income Tax Law that eliminated many of the tax advantages that had been enjoyed by foreign investors. This law is described in more detail in Section A.

Foreign investors often must negotiate directly with authorities as benefits may not be conferred automatically. These packages also often stipulate export, local content, technology transfer, and other requirements. The 54 national-level SEZ’s accounted for over 23.16% of total realized FDI in 2007. To achieve a unified national trade regime, as required by its WTO accession, China has indicated that it will decrease SEZ investment incentives over time. By late 2006, China had reduced the number of SEZ’s, at the national and sub-national levels, to 1568.

Together, these incentives amount to an ad hoc system. In November 2007, China agreed to terminate subsidies that had benefited Chinese exporters and domestic suppliers that competed with importers in a range of industrial sectors which the United States had alleged were illegal under WTO rules.

Chinese visas, legal residency, and work permits are tightly regulated, and may inhibit investors’ mobility. Foreign investors working through established law firms typically are able to meet the requirements.

Right to Private Ownership and Establishment

In China, all commercial enterprises require a license from the government. Disposition of an enterprise is also tightly regulated. The main laws that describe the form that a foreign investment can take are the Partnership Enterprise Law (2007), the Company Law (revised in 2005), the Law on Chinese-Foreign Equity Joint Ventures (2001), the Law for Wholly-Foreign Funded Enterprises (2000), and the Law on Chinese-Foreign Contractual Joint Ventures (2000).

In addition, the Administrative Permission Law (2003) is the basis for China’s complex approval system for foreign investment. The Anti-Monopoly Law (2007) governs foreign mergers and acquisitions and the State Assets Law (2008) authorizes the state to maintain control over key assets.

These laws define several permissible legal structures for foreign investments. The most important category is the Foreign-Invested Enterprise, or FIE. If foreigners own at least 25% of a firm, China considers it an FIE, which qualifies the firm for foreign investment incentives. Enterprises with foreign ownership between 10 and 25% can register as “enterprises with foreign investment below 25%” and do not qualify for incentives aimed at FIE’s.

Foreign-invested enterprises exist in many forms. The most popular is the Wholly Foreign Owned Enterprise, or WFOE. Under the amended WFOE Law, China may reject an application to establish a WFOE for five reasons: danger to China's national security; violation of China's laws and regulations; detriment to China's sovereignty or public interest; nonconformity with the requirements of the development of China's national economy; and danger of environmental pollution.

In the past, China had encouraged the formation of Equity Joint Ventures, or EJV’s, as a means of rescuing poorly performing state-owned industries. This structure has since fallen out of favor as some foreign investors have experienced disagreements with local partners about board of director decisions, capital formation, dividend distribution, and other matters. This led China to loosen restrictions on WFOE’s.

Contractual Joint Ventures (CJV’s) resemble legal partnerships and often mandate proportional investment, return on capital, governance, and dividend distributions. CJV’s have never been as popular as EJV’s, in part because of investors' unfamiliarity with the structure. Another type of CJV involves infrastructure projects, in which the foreign investor is allowed an early return on capital in return for relinquishing any claim to residual assets upon expiration of the CJV's term.

Foreign-Invested Companies Limited by Shares (FICLS) are shareholdings in which foreign investors hold at least 25% of the equity. In the past, they have been difficult to organize because of demanding regulatory preconditions and required Ministry of Commerce approval. This structure may become more popular as Chinese share companies have established a market presence.

Foreign investors with multiple investments may also be eligible to establish a Foreign- Invested Holding Company. Minimum capital requirements normally make this suitable only for corporations with several sizeable investments. Holding companies may manage human resources across their affiliates and provide market research and other services. Foreign firms commonly complain that China’s administrative rules governing holding companies prevent consolidation of accounts of subsidiaries for tax purposes, limit joint import businesses, and hamper the performance of true central treasury functions.

Wholly foreign-invested Venture Capital Companies may fund high-technology and new technology startups in industries open to foreign investment. Regulations introduced in 2003 lowered capital requirements, allowed firms to manage funds from overseas, and permitted investors to form venture capital firms organized like limited partnerships.

These firms face significant operating restrictions. In particular, China bars securities firms operating in China from the domestic private equity business and limits foreign private equity firms’ investment exit options. NDRC adopted new rules in 2008 that encourage foreign venture capital and private equity companies to exit investments through a listing on the Shanghai Stock Exchange. To facilitate the rule, the China Securities Regulatory Commission (CSRC) established an expedited process to complete the listing of new shares within a one year timeframe. However, this exit option remains effectively closed off because CSRC is not now approving any new listings as a consequence of the depressed levels of the Chinese stock markets. China’s State Administration of Foreign Exchange since 2006 has also barred the listing of shares in domestic enterprises on foreign exchanges and also restricted the transfer of assets to offshore special purpose vehicles.

China’s Company Law also allows foreign firms to establish Branch Offices. In practice, only foreign commercial banks and non-life insurance financial firms are permitted to do so. Foreign firms may establish Representative Offices, but these are prohibited from engaging in profit-making activities. Foreign law firms, however, are only allowed to incorporate as representative offices and are exempted from the profit-making prohibition.

In 2007, a revised Partnership Enterprise Law came into effect which aims to encourage both venture capital investment and the development of the professional services sector. The Partnership Enterprise Law applies to both China’s domestic and foreign-invested enterprises. However, there are reports that cities have retained the ability to impose unequal corporate income tax rates and rebate schemes, which favor domestic partnerships.

Protection of Property Rights

The Chinese legal system mediates acquisition and disposition of property, as outlined in Section D – Dispute Settlement. Besides the weaknesses of Chinese courts outlined above, which have an inconsistent record in protecting the legal rights of foreigners, there are two additional significant limits on property rights in China – land and intellectual property ownership.

Land and Property Ownership

First, all land in China is owned by the State, state-controlled entities, or rural collectives. Individuals and firms, including foreigners, however, can own and transfer long-term leases for land use, as well as structures and personal property, subject to many restrictions. To obtain land-use rights, the land user must sign a land-grant contract with the local land authority and pay a land-grant fee up front. The grantee will enjoy a fixed land-grant term and must use the land for the purpose specified in the land-grant contract. The maximum term of a land grant ranges from 40 years for commercial usage, to 50 years for industrial purposes, to 70 years for residential use. China’s Property Law, passed in 2007, stipulates that residential property rights will be automatically renewed while commercial and industrial grants should be renewed absent a conflicting public interest.

China’s Security Law defines debtor and guarantor rights and allows mortgages of certain types of property and other tangible assets, including long-term leases as described above. Important areas of the law remain unclear – such as how to effect transfer of property under foreclosure. Chinese commercial banks have successfully repossessed vehicles from delinquent borrowers and a December 2005 policy update enabled banks to foreclose on owner-occupied residences. Foreigners can buy non-performing debt through state-owned asset management firms, but bureaucratic hurdles limiting their ability to liquidate assets have dampened investor interest.

Limited Intellectual Property Rights

China remains a top intellectual property enforcement priority for the United States. The United States in 2007 requested WTO dispute settlement consultations with China on IPR protection and enforcement issues. The WTO panel found in favor of the United States in January 2009 on two of three U.S. claims that China’s IPR regime is inconsistent with China’s obligations under the Trade-Related Aspects of Intellectual Property Rights (TRIPS Agreement). Any U.S. company or individual encountering or anticipating encountering problems arising from IPR protection in China should consider an appropriate strategy to minimize the risks and actual losses it faces. Some assistance can be found at the “IPR Toolkit” hosted at the website of the U.S. Embassy in Beijing: http://www.usembassy-china.org.cn/ipr/. Additional information can be found in the third chapter of the Country Commercial Guide for China, at http://www.buyusa.gov/china/en/ccg.html.

China remains a very challenging environment for IPR protection and enforcement. Industry associations representing software, entertainment, and consumer goods continue to report high levels of piracy. The Business Software Alliance estimates that 82% of the business software that was used in China in 2007 was pirated, the same levels found in a 2006 study. At the same time, because business software use grew faster than the rate of piracy declined, the value of the pirated software used in China grew from $5.4 billion to $6.6 billion over the same period, according to BSA statistics. Consumer goods companies report that as much as 20% of their products in Chinese markets are counterfeits. Online copyright violations are pervasive. Further, Chinese-origin infringing goods are also found throughout the world.

In general, criminal penalties for infringement are seldom applied, while administrative sanctions are typically non-transparent and so weak as to lack deterrent effect. Civil sanctions also tend to be of limited effect. Trademark and copyright violations are blatant and widespread. There are widespread technology transfer practices that are often predatory in nature. Chinese companies are increasingly found “squatting” on the trademarks, company names, and design patents of well-established companies, even companies with household names. Such “squatting” practices, while unethical, may often be legal, particularly when they occur where a company has declined to obtain registration of its rights in China in a timely fashion.

Significant regional differences exist in infringement and enforcement, with some areas showing higher levels of protection of IPR, and others apparently offering safe harbors to local counterfeiters and pirates. While many Chinese officials are increasing enforcement efforts, violations also generally continue to outpace enforcement. Lack of coordination among various government agencies also continues to hamper many enforcement efforts.

Despite these great challenges, China has made efforts to improve intellectual property rights protection. China acceded to the World Intellectual Property Organization (WIPO) Copyright Treaty and the WIPO Performances and Phonograms Treaty in 2007. Apart from its membership in WIPO, China is also a member of the Paris Convention for the Protection of Industrial Property, Berne Convention for the Protection of Literary and Artistic Works, Madrid Trademark Convention, Universal Copyright Convention, and Geneva Phonograms Convention, among other conventions.

China has also updated laws and regulations to comply with the Agreement on Trade-Related Aspects of Intellectual Property (TRIPS), as required by its WTO membership. The country’s newly amended Patent Law will come into effect on October 1, 2009. One significant amendment is a new stipulation on mandatory patent licensing. Article 49 of the new Patent Law allows compulsory licensing if, after three years from the grant of a patent or four years from the filing of a patent application, the patent holder, “without proper justification,” is found not to have “exploited” the patent “sufficiently,” or if the patent use is found to restrict competition. While China previously had government rules on compulsory licensing, this is the first time the compulsory licensing has been legislated.

Industry officials report improved cooperation with enforcement agencies on raids. China has stepped up coordination with foreign enforcement agencies in cases involving international organized crime, and in 2008 Chinese courts successfully prosecuted several major counterfeiters caught as a result of joint international enforcement efforts. China established IPR law centers at Beijing University, Tsinghua University, and People's University, among other institutions, and dispatched Chinese IPR policymakers, enforcement officials, and legal professionals to study other countries’ intellectual property enforcement techniques. China began establishing specialized IPR complaint centers in provincial capitals and other large cities in the spring of 2006, and now operates a national network of 50 such centers.

Improving protection of intellectual property rights is one of the U.S. Government’s highest priorities in its economic relationship with China. To that end, the U.S. Ambassador to China has sponsored annual roundtables on intellectual property attended by hundreds of U.S. investors, in addition to other activities related to IPR and innovation. For further information on the roundtable and other USG IPR programs contact: usptochina@mail.doc.gov.

Transparency of the Regulatory System

Though improving, China's legal and regulatory system remains complex, contradictory, and lacking in consistent enforcement. Foreign investors rank inconsistent and arbitrary regulatory enforcement and lack of transparency among the major problems in China's market. The situation tends to be worse outside of coastal regions. No prospective foreign investor should venture into China without professional advice.

The State Council's Legislative Affairs Office (SCLAO) has reiterated instructions to Chinese agencies to publish all foreign trade and investment related laws, regulations, rules, and policy measures in the MOFCOM Gazette, in accordance with China’s WTO accession commitment. China said it would also help WTO members and enterprises understand its rules. However, foreign investors report that Chinese regulators at times rely on unpublished internal guidelines that impact their businesses.

At the fourth meeting of the U.S.-China Strategic Economic Dialogue, China further agreed to publish at least 30 days in advance for public comment all trade and economic-related administrative regulations and departmental rules that are proposed for adoption on the SCLAO website (www.chinalaw.gov.cn). The SCLAO has posted a number of draft administrative regulations (which are issued by the State Council and have nearly the legal force of laws passed by the National People’s Congress) on this site over the past few months, as well as some draft departmental regulations, but nowhere near “all trade and economic-related departmental rules” are posted there.

That said, Chinese agencies have increased the number of draft trade and economic-related departmental rules made available on their own ministry websites for public comment, including from foreign parties. But comment periods can be extremely brief, and the impact of public comments on final regulations is not clear, as some rules are published for comment in final form. Some agencies release draft regulations only to certain favored enterprises, usually domestic enterprises, or have allowed enterprises to read but not retain drafts. Comments do not become part of a public record.

Efficient Capital Markets and Portfolio Investment

China has continued to slowly and steadily modernize its financial sector. Bank reforms and recapitalizations in 2003 led to expanded minority participation by foreign strategic investors, the appointment of independent directors, and listings on overseas and domestic stock exchanges. Together this has led to more modern corporate governance and risk-based credit decisions. The ratio of non-performing loans (NPLs) has dropped steadily. NPLs system-wide dropped to about 2.5% by December 2008 from 8% in 2006, according to People’s Bank of China (PBOC) statistics. According to the China Banking Regulatory Commission (CBRC), the provision coverage ratio for major commercial banks has risen from 41% in 2007 to 115% in 2008.

Bank loans continue to provide the vast majority of credit, accounting for roughly 80% of formal financial sector financing. Nevertheless, with the development of capital markets, venture capital and private equity, that percentage has fallen from 85% in 2007. The PBOC, China’s central bank, continues to maintain a floor on lending rates that is 2-3 percentage points above the ceiling on deposit rates, thereby maintaining a healthy profit margin on bank loans. This raises borrowing costs for the most creditworthy borrowers, which are usually large firms, both state and foreign-owned. Commercial banks are increasingly being urged by regulators to limit financing to projects that are not in compliance with environmental regulations. The lack of adequate credit information on borrowers also contributes to inefficient credit allocation, and small- and medium-sized firms experience the most difficulty obtaining bank financing.

Non-bank financing has expanded over the last few years. Regulators increasingly support the listing on domestic exchanges of shares in both state-owned and private Chinese firms. However, stock market declines have led regulators to limit the number of new issuances on China’s stock markets in the second half of 2008; in total, only RMB 222 billion was raised on the A Share market in 2008, with just RMB 73 billion of this coming from initial public offerings compared to almost RMB 438 billion in 2007. In comparison, corporate bond issuance stood at over RMB 236 billion in 2008.

Beginning January 2009, listed Chinese banks were allowed again to trade exchange-listed bonds in an open-ended pilot program, whereas since 1997, they had been limited to trading in the interbank market. Moreover, following the December 2008 U.S.-China Strategic Dialogue (SED), Chinese regulators announced that foreign banks may underwrite and trade corporate bonds. Also as a result of the SED, Chinese authorities announced that they will allow foreign firms doing business in China to raise capital on China’s stock and bond markets, which will help U.S. firms to obtain financing despite restrictions on borrowing in foreign currencies. To date, no foreign companies have taken China up on the offer, although several foreign firms have expressed an interest in issuing depository receipts in China. Small- and medium-sized firms often face difficulties accessing credit through formal channels, and instead finance investment through retained earnings or informal channels.

Most foreign portfolio investment in Chinese companies occurs on foreign exchanges, where investors buy and sell shares in Chinese firms, primarily in New York (N-shares) and Hong Kong (H-shares). In addition, China permits limited access to renminbi-denominated A-share markets for portfolio investment by foreign institutional investors. Through its Qualified Foreign Institutional Investor (QFII) scheme, China had granted QFII status to 76 foreign firms through December 2008 and distributed over $12.86 billion of the $30 billion quota, which China raised from $10 billion at the May 2007 meeting of the U.S.-China Strategic Economic Dialogue.

Of note, China has also increased channels for domestic investors to invest in international capital markets through the Qualified Domestic Institutional Investor (QDII) program. While the QDII program exceeded $35 billion in its first six months after inception in July 2006, interest in the QDII program was tempered in 2007 and 2008 first by China’s roaring A-share market and expectations of continued appreciation of the renminbi, and then by sharp declines in overseas financial markets. Nevertheless, by May 2008, the QDII program totaled $48 billion. At the December 2007 meeting of the Strategic Economic Dialogue, CBRC announced an agreement in principle with the Securities Regulatory Commission to launch QDII investment in U.S. stock markets.

Political Violence

Violent but unconnected protests in areas throughout China continued in 2008. Protesters tend to target local officials and powerful business interests rather than the central government. Such “mass incidents” commonly involve, for example, rural residents with environmental concerns or protesting inadequate compensation for confiscated property. Other riots and protests, however, were sparked by specific events such as traffic accidents perceived to reflect abuse of power by local officials, especially corruption. Business disputes in China are not always handled through the courts. Sometimes the foreign partner has been held hostage, threatened with violence, or beaten up. For additional information on safety and security in China, please consult the State Department’s Consular Information Sheet on China at http://travel.state.gov.

Corruption

In 2008, China began a major probe into corruption in the foreign investment approval process. High-ranking officials at the Ministry of Commerce, the State Administration of Industry and Commerce, and at law firms that cater to foreign investors allegedly have been implicated. This followed the 2007 execution of China’s former top food and drug regulator for taking bribes to approve untested medicine and the 2006 sacking of the Shanghai Municipal Communist Party chief, who was a member of the Communist Party’s national Politburo.

Corruption remains endemic. Surveys show that concerns about corruption limit U.S. firms’ investment in China. Sectors requiring extensive government approval are most affected, including banking, finance, government procurement, and construction. The lack of an independent press as well as the fact that all bodies responsible for conducting corruption investigations are all controlled by the Communist Party together hamper anti-corruption efforts. Senior officials and family members are suspected of using connections to avoid investigation or prosecution for alleged misdeeds.

In China, giving or accepting a bribe is a serious crime. Offering a bribe merits five years’ punishment. For serious circumstances or “heavy losses” to state interests, the punishment can range up to 10 years. “Especially serious” circumstances lead to imprisonment from 10 years to life. Accepting a bribe of greater than RMB100,000 is punishable by 10 years to life in prison, or death in especially serious circumstances; accepting a RMB 50,000 to 100,000 bribe is punishable by five years to life; RMB 5,000 to 50,000 gets one to seven years; less than RMB 5,000 is punishable by up to two years.

It is not, however, a crime under Chinese law to bribe a foreign official. While a bribe denoted as such could not be deducted from taxes as a business expenses, practically speaking, a Chinese firm could mis-categorize a bribe and deduct it from revenues.

Three government bodies and one Communist Party organ are responsible for combating corruption. The Supreme People's Procuratorate and the Ministry of Public Security investigate criminal violations of anti-corruption laws, while the Ministry of Supervision and the Communist Party Discipline Inspection Committee enforce ethics guidelines and party discipline. Corrupt officials are first investigated by the Discipline Inspection Committee, which gathers evidence outside of the judicial process and strips the official of Party membership before deciding whether to hand the case over to the judicial system. Anti-corruption drives have not targeted foreign firms. China’s National Audit Office also inspects accounts of state-owned enterprises and government entities.

China ratified the UN Anti-Corruption Convention in 2005 and participates in APEC and OECD anti-corruption initiatives, but has not signed the OECD Convention on Combating Bribery.

The United States provides anti-corruption training to officials from the Ministries of Public Security and Supervision and the Supreme People's Procuratorate. Domestic scholars cooperate with foreign non-government organizations, like Transparency International, which is itself exploring opportunities to work with the government to reduce corruption.

In addition to Chinese laws and regulations, foreign investors in China should not violate the U.S. Foreign Corrupt Practices Act, details about which are available online at http://www.usdoj.gov/criminal/fraud/fcpa/.

Bilateral Investment Agreements

China has bilateral investment agreements with 121 countries, more than any other developing economy, according to UNCTAD. China’s bilateral investment partners include Japan, the United Kingdom, Germany, France, Italy, Spain, the Belgium-Luxembourg Economic Union, South Korea, Austria, and Thailand. China’s bilateral investment agreements cover expropriation, arbitration, most-favored-nation treatment, and repatriation of investment proceeds and are generally regarded as weaker than the investment treaties the United States seeks to negotiate.

China has also signed treaties to avoid double taxation with the United States and dozens of other economies. The United States and China signed an agreement on investment guaranties, which entered into force in 1980. In 2008, the United States and China began negotiation of a bilateral investment treaty.

Overseas Private Investment Corporation and Other Insurance Programs

The United States suspended OPIC programs in the aftermath of China’s violent crackdown on Tiananmen Square demonstrators in June 1989. OPIC honors outstanding political risk insurance contracts. The Multilateral Investment Guarantee Agency (MIGA), an organization affiliated with the World Bank, provides political risk insurance for investors in China. Some foreign commercial insurance companies also offer political risk insurance, as does the People's Insurance Company of China (PICC). Political risk insurers have experienced a decline in business in China.

Labor

Human resource constraints remain a major concern for American companies operating in China. Skilled managers and technical personnel are in high demand with employers often citing difficulty in locating appropriate skilled talent. Experienced managers at foreign firms typically command salaries far greater than their counterparts in Chinese enterprises. Foreign-invested and private sector employers have seen workers with high-demand qualifications move rapidly from job to job, and while talented and motivated university graduates are abundant, many firms find they must invest heavily in additional training. The global financial crisis has at least temporarily shifted the dynamics of the labor market in favor of employers, but there is still a structural shortage of skilled personnel familiar with international business practices.

Foreign firms are generally free to find and hire employees, although representative offices must hire local employees through a labor services agency. Foreign companies may offer local workers market-rate salary, hourly pay, or piecework wages, so long as the rate exceeds designated minimums. In addition, wages are typically supplemented by subsidized services, like medical care and housing, which China’s tax laws encourage. Local governments require contributions to pension and unemployment insurance funds that can also amount to over 20% of an enterprise's wage bill. Mandatory health, workplace injury and maternity insurance are additional labor costs. Some firms pay into a housing fund that amounts to as much as 10% of payroll. Regulations on non-wage compensation differ by locality. Chinese law limits, and requires premium compensation for, overtime work.

Labor regulations in general vary widely according to location, type, and size of enterprise. In response to the global economic crisis, many local governments have adopted new policies to deter large scale lay-offs. China’s 2008 Labor Contract Law also introduced new provisions regarding consultation with employees on company policies, on the use of contingent labor, and on procedures for terminating or laying-off employees. How these new provisions affect employers will depend in part on implementing regulations which are still under development. Terminating a worker for cause may require prior consultation with the local labor bureau and labor union.

Under China's labor contract system, foreign firms generally do not encounter problems releasing workers at the end of an initial short-term contract, however the Labor Contract Law favors the use of indefinite term employment contracts when contracts are renewed. Enterprises that hire workers from state-owned enterprises find it especially difficult to terminate employment, and large-scale layoffs at a variety of enterprises have created tensions and prompted demonstrations, and in some isolated cases, criminal acts of revenge or intimidation. With a view to minimizing job loss during the global financial crisis, the government has increased enforcement of regulations that govern lay-offs of 10% of the workforce or 20 or more workers (whichever is less.) At the same time, labor bureaus have worked with employers to find other means to reduce costs and preserve jobs. Some employers who have attempted to downsize their staff, or who have closed their doors, have encountered resistance from local trade union organizations, or faced strikes and other forms of protest.

Chinese labor law allows for collective contracts that specify wage levels, hours, working conditions, insurance and welfare. Collective contracts can cover individual enterprises, geographical regions, or specific industries within geographical regions. Most contract consultations do not rise to the level of negotiations, in part because local Communist Party committees or regional trade union bodies, rather than workers, control the selection of workers' representatives. However, in light of the Labor Contract Law's provisions on consulting with employees, some local governments and trade unions or ad hoc employee organizations have showing a growing interest in collective bargaining.

Independent trade unions are illegal in China. Officially sanctioned trade unions must affiliate with the All-China Federation of Trade Unions (ACFTU), which is an arm of the Communist Party. It is illegal for employers to oppose efforts to establish ACFTU unions. The Trade Union law requires enterprises with ACFTU unions to contribute 2% of their wage bill to the union, which is shared between the union in the enterprise and the ACFTU organization all the way to the national level. Since mid-2006, the ACFTU has engaged in a centralized campaign to organize chapters in foreign firms. Some foreign firms also often host worker organizations that perform union functions, like organizing social and charitable activities.

China has not ratified core International Labor Organization conventions on freedom of association and collective bargaining, but has ratified conventions prohibiting child labor and employment discrimination. Apart from banning independent unions, Chinese labor laws meet international labor standards, and the Chinese Government is in the process of implementing new legislation to improve workers' rights protection. However, enforcement of existing labor regulations is poor. Some multinational companies have suffered negative publicity arising from labor disputes related to the business practices of their suppliers in China.

Foreign-Trade Zones/Free Ports

China's principal duty-free import/export zones are in Dalian, Guangzhou, Shanghai, Tianjin, and Hainan. Besides these official duty-free zones, numerous free trade and economic development zones and “open cities” offer similar privileges and benefits to foreign investors. In 2008, China also actively promoted economic development outside its relatively wealthy coastal area by encouraging multinationals to establish regional headquarters and operations in Central, Western, and Northeast China. Some analysts speculate that China will eventually grant full trading and distribution rights nationwide.

China's General Administration of Customs claims to successfully control duty-free imports into the zones, but the lack of physical barriers between the duty free zones and surrounding areas makes it difficult to control the outbound flow of untaxed items. More information on investment incentives available in SEZ’s is provided in Section E.

Investment Trends and Statistics

The top sources of FDI in China in 2008 were: Hong Kong, the British Virgin Islands, Singapore, Japan, the Cayman Islands, South Korea, the United States, Western Samoa, and Taiwan. Of note, some mainland companies utilize “roundtrip” investment via subsidiaries in the Special Administrative Regions (SAR’s) of Hong Kong and Macau in order to obtain incentives available only to foreign investors. Analysts have estimated that mainland Chinese funds flowing through Hong Kong may account for 10-30% of Hong Kong's total realized direct investment in China. Hong Kong and Macau statistics are further skewed because many Taiwan firms invest through them to avoid scrutiny from Taiwan authorities. Indeed, some observers estimate accumulated stock of FDI inflows from Taiwan is actually two to three times the amount formally recorded.

The past few years have seen an upsurge in investment from tax-havens like the British Virgin Islands and Cayman Islands. Anecdotal information suggests these funds originate from companies based in Organization for Economic Cooperation and Development (OECD) economies, Taiwan, and even China itself. Some researchers estimate that as much as one-third of nominally “foreign” investment in China is really of Chinese origin. That is, Chinese investors find ways to send money out of the country so that they can then re-enter as a “foreign investor,” taking advantage of policies that offer foreign investors preferential treatment. The elimination of certain tax benefits for foreign investors, described in Section E, may lead to a drop in “round trip” investment.

U.S. direct investment abroad is increasingly concentrated in developed countries, reflecting a focus on high-tech and financial services and a move away from basic manufacturing and extractive industries. U.S. direct investment in China had fallen in line with this trend from 2002 to 2007, but U.S. investment in China grew in 2008. While China's processing trade exports to the United States are booming, U.S. retailers often buy goods from enterprises whose source of investment is not American, thus de-linking this trend from U.S. direct investment abroad statistics. Also, it is important to note that Chinese data on foreign direct investment do not include much of the high-dollar value minority equity stakes that American financial services firms have taken in major Chinese lenders. Finally, American-invested enterprises in China may fund their continued growth by reinvesting locally-generated profits in China. China does not classify this as new investment.

Notes on Statistics

Most of the data below is provided by the Ministry of Commerce. Statistics on utilized investment are based on FIEs’ required reports of committed capital. Cumulative values are totals of the data collected each year, are not adjusted for inflation, and do not account for divestment. More sophisticated data on investment in China is not now available. Yearly figures do not sum exactly to total due to rounding.

Table 1 -- Utilized Foreign Direct Investment in China (1979-2008)
(in $ Millions)

YearUtilized FDI
1979-843,060
19851,658
19862,244
19872,314
19883,194
19893,392
19903,487
19914,366
199211,008
199327,515
199433,767
199537,521
199641,726
199745,257
199845,463
199940,319
200040,714
200146,878
200252,743
200353,505
200460,630
200560,325 (72,410)
200663,020 (69,470)
200774,768 (82,658)
200892,395
Total851,269

Source: Ministry of Commerce
Note: Excludes investment in the financial services sector. (Numbers in parentheses do include financial sector investment.)

Table 2 -- Utilized Foreign Direct Investment (in non-financial sectors) from the United States in China (1979-2008) (in $ millions)

YearUtilized FDI
1979-84274
1985357
1986326
1987263
1988236
1989284
1990456
1991323
1992511
19932,063
19942,491
19953,083
19963,443
19973,239
19983,898
19994,216
20004,384
20014,433
20025,424
20034,199
20043,941
20053,061
20062,865
20072,616
20082,944
Total59,515

Source: Ministry of Commerce

Table 3 -- China's Utilized and Cumulative Foreign Direct Investment (in non-financial sectors) by Selected Source Economy as of 2008 (in $ millions)

Utilized FDICumulative FDI
Hong Kong41,036349,569
Virgin Islands15,95490,100
Singapore4,43537,826
Japan3,65265,376
Cayman Islands3,14516,507
Korea3,13541,910
United States2,94459,650
Western Samoa2,54912,314
Taiwan1,89847,659
Total (All Sources)92,395883,142

Source: China Commerce Yearbook 2008, published by MOFCOM

Table 4 -- China's Utilized Foreign Direct Investment by Sector, in 2007 (in $ millions) (2008 data not yet available)

2007 Realized
FDI amount

Change from
2006 (%)

Agriculture, Forestry, Animal Husbandry & Fisheries92454%
Mining4896%
Manufacturing40,8652%
Electricity, gas and water supply1,073-16%
Construction434-37%
Transport, Warehousing2,0071%
Information Transmission, Computer Service and Software1,48539%
Wholesaling and Retail2,67750%
Hotels and Restaurants*1,04226%
Banking and Insurance9,01034%
Real Estate Management17,089108%
Leasing and Business Service4,019-5%
Scientific Research and Polytechnic Services91782%
Water conservation, environment, and public facility management27340%
Social Services72343%
Health Care, Social Security, and Welfare12-20%
Education3210%
Culture, Sports and Entertainment45187%
Public management and social organizations------

Source: China Commerce Year Book 2008

Table 5 -- Role of FDI in China's Economy (In $ millions) (2007 Average 1USD= 7.604RMB)

% Change

% of National Figures

2007 FIE-generated industrial output1,644,35724.4%30.9%
2008 FIE-generated exports790,62013.7%55.3%
2008 FIE-generated imports619,95610.8%54.7%
2007 FIE-g tax revenues131,14925.02%20.17%
2007 FDI inflows/GDP--2.3%
2007 FDI stock/GDP--23.1%
2007 FDI share of total fixed investment--4.6%

Source: Ministry of Commerce and China Customs statistics.
Note: "Stock" is actually a cumulative total of historical inflows, not necessarily current stocks.

Table 6 -- Chinese Direct Investment Abroad Outward Flows and Stock in non-financial sectors, 2000-2007 (In $ billions)

YearOutflowOutward Stock
20000.9227.77
20016.8934.65
20022.5237.17
2003-0.1537.03
20041.8138.83
200511.3146.31
200617.6375.03
200718.7293.75

Source: MOFCOM (2008 data not yet available)

Major U.S. Investments in China

This following is a snapshot of U.S. investment in China as reported by firms and the media. Some companies declined to provide information about their investment plans. A rough estimate of total investment is noted in parentheses, where available.

Intel (under $4 billion) – Includes a $500 million assembly/testing facility in Pudong and a $450 million chip testing plant in Chengdu. In 2006, Intel Capital invested in several technology firms. In March 2007, Intel announced its $2.5 billion investment in a new wafer fabrication facility in Dalian. In 2008, Intel Capital also announced three new China investments in clean technology and healthcare and established a new US$500 million fund to make investments in China. Intel's previous China fund invested US$200 million in more than 28 companies.

Motorola ($3.6 billion) – Motorola is one of the largest foreign investors in China’s electronics industry with more than 9,000 employees in China. Motorola’s investment includes $800 million in research and development (R&D). In 2007, Motorola opened a new R&D complex in Beijing, consolidating several other R&D facilities. This coincides with Motorola’s 20th anniversary in China.

General Motors ($2-3 billion) – In 2007, GM announced plans to invest up to $5 billion in China through 2012. As of December 2008, GM planned to continue its investments in China. In December 2008, GM and Shanghai Automotive Industry Corporation (SAIC) launched Beisheng Joint Venture Automobile Company in Shenyang, following a total investment of $390.6 million. In March 2008, GM announced the establishment of the GM Research Center at Shanghai Jiaotong University, where it plans to invest $4 million over the next 5 years. GM also maintains a $1 billion stake in Shanghai GM, a $472 million investment in Shanghai GM Dong Yue Automotive Powertrain, $282 million in Shanghai GM (Shenyang) Norsom Motors, $257 million in Shanghai GM Dong Yue Motors, $54 million in Pan Asia Technical Automotive Center, and $10 million in SAIC-GM-Wuling joint venture operations. GM currently employs over 20,000 people in China. In October 2007, GM announced plans to build an advanced hybrid technology research center in China. GM also plans to build a $250 million corporate campus with research facilities.

Wal-Mart (over $2 billion) – In 2007, Wal-Mart acquired local hypermarket chain Trustmart for $1 billion. As of September 2008, Wal-Mart operated 108 stores in China under its Supercenter, SAM’S CLUB and Neighborhood Market brands. Wal-Mart employs more than 40,000 associates in China. Wal-Mart plans to open more stores in 2009.

Anheuser-Busch ($1.9 billion) – Anheuser-Busch planned in 2008 to complete a new $63 million plant in Guangdong province and begin first phase construction of another plant in Tanshan at a cost of $US 49 million. Other investments in China include a 27 percent stake in Tsingtao Brewery, China's largest beermaker; ownership of Harbin Brewery Group Ltd., the country's fifth-largest brewer; and a 97 percent equity interest in the Budweiser Wuhan International Brewing Co. Ltd. joint venture, which produces Budweiser brand beer. In 2008, Anheuser-Busch was acquired by Belgium-based Inbev. The acquisition was the first case reviewed under China’s anti-monopoly law. After imposing several restrictions on future acquisitions by the combined company, China cleared the transaction.

General Electric ($1.5 billion) – GE has established 50 JV and WFOE entities, including medical equipment, plastics, lighting, power generation, silicones, special materials, industrial equipment, aircraft engines and leasing, capital services, transportation systems, and an R&D center in Shanghai. In 2007, GE Commercial Finance invested $50 million in China’s Credit Orienwise Group Limited. In 2008, GE Water and Process Technologies launched an expanded manufacturing facility in Wuxi New Zone, representing an investment of nearly US $9 million. According to UNCTAD, GE has more overseas investments than any other multinational company in the world.

Kodak ($1.5 billion) – Kodak has sensitizing facilities and facilities to manufacture digital cameras, medical and commercial imaging equipment, and photochemicals. In 2007, Kodak invested $50 million in a new printing plate manufacturing facility in Xiamen.

Coca-Cola ($1.3-3.7 billion) – Coca-Cola operates 35 bottling plants throughout China and one of the largest sales and distribution systems in China with over 700 sales centers, 30,000 distributors, and 1.3 million retailers. In 2008, Coca-Cola offered US$2.4 billion to acquire China Huiyuan Juice Group, China’s largest juice and nectar bottler, which is listed in Hong Kong. The deal would be Coca Cola’s largest ever overseas acquisition and is currently under review by China’s Anti-monopoly authorities. In 2007, Coca-Cola launched a new global research center and headquarters in Shanghai, an investment of $80 million.

ExxonMobil ($1-5 billion) – The bulk of Exxon Mobil’s investment is in production-sharing contracts for upstream oil exploration, as well as chemical and lubricant blending plants. In 2007, China approved a $5 billion joint venture between ExxonMobil, Sinopec, and Saudi Aramco, to operate 750 service stations and expand a petrochemical refinery run by Sinopec and the Fujian Province. ExxonMobil has a 22.5% stake in the project. ExxonMobil expects investments in China to reach $5 billion by 2010.

Ford ($1 billion) – Ford is close to completing a $1 billion expansion in China, which includes stakes in: Changan Ford Mazda Automobile, with plants in Chongqing and Nanjing producing Mazda and Volvo brand vehicles, Changan Ford Mazda Engine in Nanjing, a stake in the publicly listed Jiangling Motors Co., and Ford Automotive Financial Co. in Shanghai. In October 2007, Ford opened a $28 million engine R&D center. In September 2007, Ford announced that its China-based joint venture, Changan Ford Mazda Automobile Co, began making small cars under the Ford and Mazda brands at a new Nanjing-based assembly plant, following investment of $510 million.

Alcoa ($1 billion) – In 2008, Alcoa together with the Aluminum Corporation of China (Chinalco) jointly acquired a 12% stake in Australia-based Rio Tinto for $14 billion in the largest ever overseas investment by a Chinese enterprise. This followed Alcoa’s 2007 divestiture of its 7% stake in Chinalco, which it had acquired years earlier for $200 million. In 2006, Alcoa invested $95 million for a 70% stake as the managing partner in a joint venture with Shanxi Yuncheng Engraving Group to produce aluminum brazing sheets at a plant outside Shanghai. Alcoa has close to 20 operating locations in China.

United Technologies (UTC) ($1 billion, including Hong Kong) – Several of UTC's subsidiaries have operations in China, including Otis Elevator, Carrier, UT Automotive, Turbo Power Systems, Pratt and Whitney, and the New Training Center, near Beijing Capital International Airport. UTC has over 35 joint venture and wholly-foreign owned enterprises with over 14,000 employees in 293 offices in 73 Chinese cities. They also maintain 16 factories and two research centers.

DuPont (over $700 million) – DuPont has 37 wholly-owned/joint ventures in China. Its facilities manufacture a wide range of products including nylon, polyester, fibers and non-woven fabrics. In 2008, DuPont announced it will begin construction of a Hong Kong-based R&D center and a manufacturing facility in Shenzhen, and that it will contribute $2 million to support graduate student research and education in plant breeding through university fellowships and a competitive fellowship program. In December 2006, DuPont announced a joint venture with Dunhuang Seed Co., one of China’s largest seed production companies, to market new hybrid corn products.

IBM (more than $400 million) – In 2008, IBM announced it will establish a branch of its Worldwide Banking Center of Excellence in Shanghai. IBM also took a stake of approximately 20 percent in Hisense TransTech Company Ltd. (HTT) and announced it will establish the first Cloud Computing center for software companies in Wuxi. IBM also has a $300 million organic chip packaging base in Shanghai and an $18 million investment in Beijing Jinchangke International Electronics Co., together with Great Wall Computer Shareholding Corp.

Cummins ($200-500 million) – Cummins plans to invest $300 million in China through 2010. In April 2008, Cummins announced the opening of its first fuel systems manufacturing site outside of North America, the Cummins Fuel Systems Wuhan Plant following an initial investment of US$10 million. Cummins has established factories and R&D centers producing nine engine families, turbochargers, filters, exhaust systems, alternators, and gensets. Cummins also located its East Asia regional headquarters in Beijing, managing Cummins operations in mainland China, Taiwan, Hong Kong, Macao and Mongolia.

Microsoft ($100-500 million) – In November 2008, Microsoft announced that it plans to spend more than $1 billion in China on R&D over the next three years. Microsoft has already established several R&D centers in China.



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