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China

Executive Summary

China is one of the top global foreign direct investment destinations due to its large consumer base and integrated supply chains.  China remains, however, a relatively restrictive investment environment for foreign investors due to restrictions in key economic sectors.  Obstacles to investment include ownership caps and requirements to form joint venture partnerships with local Chinese firms, as well as the requirement often imposed on U.S. firms to transfer technology as a prerequisite to gaining market access.  While China made modest openings in some sectors in 2018, such as financial services, insurance, new energy vehicles, and shipbuilding, China’s investment environment continues to be far more restrictive than those of its main trading partners, including the United States.

China relies on the Special Administrative Measures for Foreign Investment Access (known as the “nationwide negative list”) to categorize market access restrictions for foreign investors in defined economic sectors.  While China in 2018 reduced some restrictions, foreign participation in many industries important to U.S. investors remain restricted, including financial services, culture, media, telecommunications, vehicles, and transportation equipment.

Even in sectors “open” to foreign investment, foreign investors often face difficulty establishing an investment due to stringent and non-transparent approval processes to gain licenses and other needed approvals.  These restrictions shield inefficient and monopolistic Chinese enterprises in many industries – especially state-owned enterprises (SOEs) and other enterprises deemed “national champions” – from competition against private and foreign companies.  In addition, lack of transparency in the investment process and lack of rule of law in China’s regulatory and legal systems leave foreign investors vulnerable to discriminatory practices such as selective enforcement of regulations and interference by the Chinese Communist Party (CCP) in judicial proceedings.  Moreover, industrial policies such as Made in China 2025 (MIC 2025), insufficient protection and enforcement of intellectual property rights (IPR), requirements to transfer technology, and a systemic lack of rule of law are further impediments to successful foreign investments in China.

During the CCP 19th Party Congress held in October 2017, CCP leadership underscored Party Chairman Xi Jinping’s primacy by adding “Xi Jinping Thought on Socialism with Chinese Characteristics for the New Era” to the Party Charter.  In addition to significant personnel changes, the Party announced large-scale government and Party restructuring plans in early 2018 that further strengthened Xi’s leadership and expanded the role of the Party in all facets of Chinese life: cultural, social, military, and economic.  An increasingly assertive CCP has caused concern among the foreign business community about the ability of future foreign investors to make decisions based on commercial and profit considerations, rather than political dictates from the Party.

Although market access reform has been slow, the Chinese government has pledged greater market access and national treatment for foreign investors and has pointed to key announcements and new developments, which include:

  • On June 28, 2018 the National Development and Reform Commission (NDRC) and Ministry of Commerce (MOFCOM) jointly announced the release of Special Administrative Measures for Foreign Investment Access (i.e., “nationwide negative list”), which replaced the Foreign Investment Catalogue.  The negative list was reformatted to remove “encouraged” economic sectors and divided restrictions and prohibitions by industry.  Some of the liberalizations were previously announced, like financial services and insurance (November 2017) and automobile manufacturing and shipbuilding (April 2018).  A new version of the negative list is expected to be released in 2019.
  • On June 30, 2018 NDRC and MOFCOM jointly released the Special Administrative Measures for Foreign Investment Access in the Pilot Free Trade Zones (i.e., the Free Trade Zone, or FTZ, negative list).  The FTZ negative list matched the nationwide negative list with a few exceptions, including: foreign equity caps of 66 percent in the development of new varieties corn and wheat (the nationwide cap is 49 percent), removal of joint venture requirements on oil and gas exploration, and removal of the prohibition on radioactive mineral smelting and processing, including nuclear fuel production.
  • On December 25, 2018 the NDRC and MOFCOM jointly released The Market Access Negative List.  This negative list, unlike the nationwide negative list that applies only to foreign investors, defines prohibitions and restrictions to investment for all investors, both foreign and domestic.  This negative list attempted to unify guidance on allowable investments previously found in piecemeal laws and regulations that were often industry-specific. This list also highlighted what economic sectors are only open to state-owned investors.
  • On March 17, 2019 the National People’s Congress passed a Foreign Investment Law (FIL) that effectively replaced existing law governing foreign investment (i.e., the China-Foreign Joint Venture Law, the Contract Joint Venture Law, and the Wholly Foreign-Owned Enterprises Law).  As drafted, the FIL would address longstanding concerns of U.S. investors, including forced technology transfer and national treatment; however, due to lack of details and implementation guidelines, it is not clear how foreign investor rights would be protected.

While Chinese pronouncements of greater market access and fair treatment of foreign investment is welcome, details are needed on how these policies will address longstanding problems foreign investors have faced in the Chinese market, including  being subject to inconsistent regulations, licensing and registration problems, insufficient IPR protections, and various forms of Chinese protectionism that have created an unpredictable and discriminatory business climate.

Table 1: Key Metrics and Rankings

Measure Year Index/Rank Website Address
Transparency International’s Corruption Perceptions Index 2018 87 of 180 http://www.transparency.org/research/cpi/overview 
World Bank’s Doing Business Report 2018 46 of 190 http://www.doingbusiness.org/en/rankings
Global Innovation Index 2018 17 of 126 https://www.globalinnovationindex.org/analysis-indicator 
U.S. FDI in partner country ($M USD, stock positions) 2017 $107,556   http://www.bea.gov/international/factsheet/ 
World Bank GNI per capita 2018 $8,690 http://data.worldbank.org/indicator/NY.GNP.PCAP.CD 

4. Industrial Policies

Investment Incentives

To attract foreign investment, different provinces and municipalities offer preferential packages like a temporary reduction in taxes, resources and land use benefits, reduction in import and/or export duties, special treatment in obtaining basic infrastructure services, streamlined government approvals, research and development subsidies, and funding for initial startups.  Often, these packages stipulate that foreign investors must meet certain benchmarks for exports, local content, technology transfer, and other requirements.  Preferential treatment often occurs in specific sectors that the government has identified for policy support, like technology and advanced manufacturing, and will be specific to a geographic location like a special economic zone (like FTZs), development zone, or a science park.  The Chinese government has also prioritized foreign investment in inland China by providing incentives to invest in seven new FTZs located in inland regions (2017) and offering more liberalizations to foreign investment through its Catalogue of Priority Industries for Foreign Investment in Central and Western China that provides greater market access to foreign investors willing to invest in less developed areas in Central and Western China.

While state subsidies has long been an area that foreign investors have criticized for distorting competition in certain industries, Chinese officials have publicly pledged that foreign investors willing to manufacture products in China can equally participate in the research and development programs financed by the Chinese government.  The Chinese government has also said foreign investors have equal access to preferential policies under initiatives like Made in China 2025 and Strategic Emerging Industries that seek to transform China’s economy into an innovation-based economy that becomes a global leader in future growth sectors.  In these high-tech and advanced manufacturing sectors, China needs foreign investment because it lacks the capacity, expertise, and technological know-how to conduct advanced research or manufacture advanced technology on par with other developed economies.  Announced in 2015, China’s MIC 2025 roadmap has prioritized the following industries: new-generation information technology, advanced numerical-control machine tools and robotics, aerospace equipment, maritime engineering equipment and vessels, advanced rail, new-energy vehicles, energy equipment, agricultural equipment, new materials, and biopharmaceuticals and medical equipment.  While mentions of MIC 2025 have all but disappeared from public discourse, a raft of policy announcements at the national and sub-national level indicate China’s continued commitment to developing these sectors.  Foreign investment plays an important role in helping China move up the manufacturing value chain.  However, there are a large number of economic sectors that China deems sensitive due to broadly defined national security concerns, including “economic security,” which can effectively close off foreign investment to those sectors.

Foreign Trade Zones/Free Ports/Trade Facilitation

China has customs-bonded areas in Shanghai, Tianjin, Shantou, Guangzhou, Dalian, Xiamen, Ningbo, Zhuhai, Fuzhou, and parts of Shenzhen.  In addition to these official duty-free zones identified by China’s State Council, there are also numerous economic development zones and “open cities” that offer preferential treatment and benefits to investors, including foreign investors.

In September 2013, the State Council in conjunction with the Shanghai municipal government, announced the Shanghai Pilot Free Trade Zone that consolidated the geographical area of four previous bonded areas into a single FTZ.  In April 2015, the State Council expanded the pilot to include new FTZs in Tianjin, Guangdong, and Fujian. In March 2017, the State Council approved seven new FTZs in Chongqing, Henan, Hubei, Liaoning, Shaanxi, Sichuan, and Zhejiang, with the stated purpose to integrate these areas more closely with the OBOR initiative – the Chinese government’s plan to enhance global economic interconnectivity through joint infrastructure and investment projects that connect China’s inland and border regions to the rest of the world.  In October 2018, the Chinese government rolled out plans to convert the entire island province of Hainan into an FTZ that will take effect in 2020. This FTZ aims to provide a more open and high-standard trade and investment hub focused on improved rule of law and financial services. In addition to encourage tourism development, the Hainan FTZ will also seek to develop high-tech industries while preserving the ecology of the island. The goal of all China’s FTZs is to provide a trial ground for trade and investment liberalization measures and to introduce service sector reforms, especially in financial services, that China expects eventually to introduce in other parts of the domestic economy.

The FTZs should offer foreign investors “national treatment” for the market access phase of an investment in industries and sectors not listed on the FTZ “negative list,” or on the list of industries and economic sectors restricted or prohibited for foreign investment.  The State Council published an updated FTZ negative list in June 2018 that reduced the number of restrictions and prohibitions on foreign investment from 95 items down to 45. The most recent negative list did not remove many commercially significant restrictions or prohibitions compared to the nationwide negative list also released in June 2018.

Although the FTZ negative list in theory provides greater market access for foreign investment in the FTZs, many foreign firms have reported that in practice, the degree of liberalization in the FTZs is comparable to other opportunities in other parts of China.  According to Chinese officials, over 18,000 entities have registered in the FTZs. The municipal and central governments have released a number of administrative and sector-specific regulations and circulars that outline the procedures and regulations in the zones.

Performance and Data Localization Requirements

As part of China’s WTO accession agreement, China promised to revise its foreign investment laws to eliminate sections that imposed export performance, local content, balanced foreign exchange through trade, technology transfer, and create research and development center requirements on foreign investors as a prerequisite to enter China’s market.  As part of these revisions, China committed to only enforce technology transfer requirements that do not violate WTO standards on IP and trade-related investment measures. In practice, however, China has not completely lived up to these promises with some U.S. businesses reporting that local officials and regulators sometimes only accept investments with “voluntary” performance requirements or technology transfer that helps develop certain domestic industries and support the local job market.  Provincial and municipal governments will sometimes restrict access to local markets, government procurement, and public works projects even for foreign firms that have already invested in the province or municipality. In addition, Chinese regulators have reportedly pressured foreign firms in some sectors to disclose IP content or provide IP licenses to Chinese firms, often at below market rates. These practices not only run contrary to WTO principles but hurt the competitive position of foreign investors.

China also called to restrict the ability of both domestic and foreign operators of “critical information infrastructure” to transfer personal data and important information outside of China while also requiring those same operators to only store data physically in China.  These potential restrictions have prompted many firms to review how their networks manage data. Foreign firms also fear that calls for use of “secure and controllable,” “secure and trustworthy,” etc. technologies will curtail sales opportunities for foreign firms or that foreign companies may be pressured to disclose source code and other proprietary information, putting IP at risk.  In addition, prescriptive technology adoption requirements, often in the form of domestic standards that diverge from global norms, in effect gives preference to domestic firms and their technology. These requirements not only hinder operational effectiveness but also potentially puts in jeopardy IP protection and overall competitiveness of foreign firms operating in China.

5. Protection of Property Rights

Real Property

Foreign companies have long complained that the Chinese legal system, responsible for mediating acquisition and disposition of property, has inconsistently protected the legal real property rights of foreigners.

Urban land is entirely owned by the State.  The State can issue long-term land leases to individuals and companies, including foreigners, subject to many restrictions.  China’s Property Law stipulates that residential property rights will renew automatically, while commercial and industrial grants shall be renewed if the renewal does not conflict with other public interest claims.  A number of foreign investors have reported that their land use rights were revoked and given to developers to build neighborhoods designated for building projects by government officials. Investors often complain that compensation in these cases has been nominal.

In rural China, collectively-owned land use rights are more complicated.  The registration system chronically suffers from unclear ownership lines and disputed border claims, often at the expense of local farmers who are excluded from the process by village leaders making “handshake deals” with commercial interests.  The central government announced in 2016, and reiterated in 2017 and 2018, plans to reform the rural land registration system so as to put more control in the hands of farmers, but some experts remain skeptical that changes will be properly implemented and enforced.

China’s Securities Law defines debtor and guarantor rights, including rights to mortgage certain types of property and other tangible assets, including long-term leases.  Chinese law does not prohibit foreigners from buying non-performing debt, which can only be acquired through state-owned asset management firms. However, in practice, Chinese official often use bureaucratic hurdles that limit foreigners’ ability to liquidate assets, further discouraging foreign purchase of non-performing debt.

Intellectual Property Rights

Following WTO accession, China updated many laws and regulations to comply with the WTO Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) and other international agreements.  However, despite the changes to China’s legal and regulatory regime, some aspects of China’s IP protection regime fall short of international best practices.  In addition, enforcement ineffectiveness of Chinese laws and regulations remains a significant challenge for foreign investors trying to protect their IPR.

Major impediments to effective IP enforcement include the unavailability of deterrent-level penalties for infringement, a lack of transparency, unclear standards for establishing criminal investigations, the absence of evidence production methods to compel evidence from infringers, and local protectionism, among others.  Chinese government officials tout the success of China’s specialized IP courts – including the establishment of a new appellate tribunal within the SPC – as evidence of its commitment to IP protection; however, while this shows a growing awareness of IPR in China’s legal system, civil litigation against IP infringement will remain an option with limited effect until there is an increase in the amount of damages an infringer pays for IP violations.

Chinese-based companies remain the largest IP infringers of U.S. products.  Goods shipped from China (including those transshipped through Hong Kong) accounted for an estimated 87 percent of IPR-infringing goods seized at U.S. borders.  (Note: This U.S.  Customs statistic does not specify where the fake goods were made.)  China imposes requirements that U.S. firms develop their IP in China or transfer their IP to Chinese entities as a condition to accessing the Chinese market, or to obtain tax and other preferential benefits available to domestic companies.  Chinese policies can effectively require U.S. firms to localize research and development activities, practices documented in the March 2018 Section 301 Report released by the Office of the U.S. Trade Representative (USTR).  China remained on the Priority Watch List in the 2019 USTR Special 301 Report, and several Chinese physical and online markets were included in the 2018 USTR Notorious Markets Report.  For detailed information on China’s environment for IPR protection and enforcement, please see the following reports:

For additional information about national laws and points of contact at local intellectual property offices, please see the World Intellectual Property Organization’s country profiles at http://www.wipo.int/directory/en  

7. State-Owned Enterprises

China has approximately 150,000 SOEs which are wholly owned by the state.  Around 50,000 (33 percent) are owned by the central government and the remainder by local governments.  The central government directly controls and manages 96 strategic SOEs through the State-owned Assets Supervision and Administration Commission (SASAC), of which around 60 are listed on stock exchanges domestically and/or internationally.  SOEs, both central and local, account for 30 to 40 percent of total GDP and about 20 percent of China’s total employment.  SOEs can be found in all sectors of the economy, from tourism to heavy industries.

SASAC regulated SOEs: http://www.sasac.gov.cn/n2588035/n2641579/n2641645/c4451749/content.html  .

China’s leading SOEs benefit from preferential government policies aimed at developing bigger and stronger “national champions.”  SOEs enjoy favored access to essential economic inputs (land, hydrocarbons, finance, telecoms, and electricity) and exercise considerable power in markets like steel and minerals.  SOEs have long enjoyed preferential access to credit and the ability to issue publicly traded equity and debt.

During the November 2013 Third Plenum of the 18th Party Congress – a hallmark session that announced economic reforms, including calling for the market to play a more decisive role in the allocation of resources – President Xi Jinping called for broad SOE reforms.  Cautioning that SOEs still will remain a key part of China’s economic system, Xi emphasized improved SOE operational transparency and legal reforms that would subject SOEs to greater competition by opening up more industry sectors to domestic and foreign competitors and by reducing provincial and central government preferential treatment of SOEs.  The Third Plenum also called for “mixed ownership” economic structures, providing greater economic balance between private and state-owned businesses in certain industries, including equal access to factors of production, competition on a level playing field, and equal legal protection.

At the 2018 Central Economic Work Conference, Chinese leaders said in 2019 they will promote a greater role for the market, as well as renewed efforts on reforming SOEs – to include mixed ownership reform.  In delivering the 2019 Government Work Report, Premier Li Keqiang pledged to improve corporate governance, including allowing SOE company boards, rather than SASAC, to appoint senior leadership. 

OECD Guidelines on Corporate Governance

SASAC participates in the OECD Working Party on State Ownership and Privatization Practices (WPSOPP).  Chinese officials have indicated China intends to utilize OECD SOE guidelines to improve the professionalism and independence of SOEs, including relying on Boards of Directors that are independent from political influence.  However, despite China’s Third Plenum commitments in 2013 (i.e., to foster “market-oriented” reforms in China’s state sectors), Chinese officials and SASAC have made minimal progress in fundamentally changing the regulation and business conduct of SOEs.  China has also committed to implement the G-20/OECD Principles of Corporate Governance, which apply to all publicly-listed companies, including listed SOEs.

Chinese law lacks unified guidelines or a governance code for SOEs, especially among provincial or locally-controlled SOEs.  Among central SOEs managed by SASAC, senior management positions are mainly filled by senior CCP members who report directly to the CCP, and double as the company’s Party secretary

The lack of management independence and the controlling ownership interest of the State make SOEs de facto arms of the government, subject to government direction and interference.  SOEs are rarely the defendant in legal disputes, and when they are, they almost always prevail, presumably due to the close relationship with the CCP.  U.S. companies often complain about the lack of transparency and objectivity in commercial disputes with SOEs.  In addition, SOEs enjoy preferential access to a disproportionate share of available capital, whether in the form of loans or equity.

In its September 2015 Guiding Opinions on Deepening the Reform of State-Owned Enterprises, the State Council instituted a system for classifying SOEs as “public service” or “commercial enterprises.”  Some commercial enterprise SOEs were further sub-classified into “strategic” or “critically important” sectors (i.e., with strong national economic or security importance).  SASAC has said the new classification system would allow the government to reduce support for commercial enterprises competing with private firms and instead channel resources toward public service SOEs.

Other recent reforms have included salary caps, limits on employee benefits, and attempts to create stock incentive programs for managers that have produced mixed results.  However, analysts believe minor reforms will be ineffective as long as SOE administration and government policy are intertwined.

A major stumbling block to SOE reform is that SOE regulators are outranked in the CCP party structure by SOE executives, which minimizes SASAC and other government regulators’ effectiveness at implementing reforms.  In addition, SOE executives are often promoted to high-ranking positions in the CCP or local government, further complicating the work of regulators.

During the Third Plenum of the CCP’s 18th Central Committee, in 2013, the CCP leadership announced that the market would play a “decisive role” in economic decision making and emphasized that SOEs needed to focus resources in areas that “serve state strategic objectives.”  However, experts point out that despite these new SOE distinctions, SOEs continue to hold dominant shares in their respective industries, regardless of whether they are strategic, which may further restrain private investment in the economy.  Moreover, the application of China’s Anti-Monopoly Law, together with other industrial policies and practices that are selectively enforced by the authorities, protects SOEs from private sector competition.

China is not a party to the Government Procurement Agreement (GPA) within the framework of the WTO, although Hong Kong is listed.  During China’s WTO accession negotiations, Beijing signaled its intention to join GPA.  And, in April 2018, President Xi announced his intent to join GPA, but no timeline has been given for accession.

Investment Restrictions in “Vital Industries and Key Fields”

The intended purpose of China’s State Assets Law is to safeguard and protect China’s economic system, promoting “socialist market economy” principles that fortify and develop a strong, state-owned economy.  A key component of the State Assets Law is enabling SOEs to play the leading role in China’s economic development, especially in “vital industries and key fields.”  To accomplish this, the law encourages Chinese regulators to adopt policies that consolidate SOE concentrations to ensure dominance in industries deemed vital to “national security” and “national economic security.” This principle is further reinforced by the December 2006 State Council announcement of the Guiding Opinions Concerning the Advancement of Adjustments of State Capital and the Restructuring of State-Owned Enterprises, which called for more SOE consolidation to advance the development of the state-owned economy, including enhancing and expanding the role of the State in controlling and influencing “vital industries and key fields relating to national security and national economic lifelines.”  These guidelines defined “vital industries and key fields” as “industries concerning national security, major infrastructure and important mineral resources, industries that provide essential public goods and services, and key enterprises in pillar industries and high-tech industries.”

Around the time the guidelines were published, the SASAC Chairman also listed industries where the State should maintain “absolute control” (e.g., aviation, coal, defense, electric power and the state grid, oil and petrochemicals, shipping, and telecommunications) and “relative control” (e.g., automotive, chemical, construction, exploration and design, electronic information, equipment manufacturing, iron and steel, nonferrous metal, and science and technology).  China has said these lists do not reflect its official policy on SOEs.  In fact, in some cases, regulators have allowed for more than 50 percent private ownership in some of the listed industries on a case-by-case basis, especially in industries where Chinese firms lack expertise and capabilities in a given technology Chinese officials deemed important at the time.

Parts of the agricultural sector have traditionally been dominated by SOEs.  Current agriculture trade rules, regulations, and limitations placed on foreign investment severely restrict the contributions of U.S. agricultural companies, depriving China’s consumers of the many potential benefits additional foreign investment could provide.  These investment restrictions in the agricultural sectors are at odds with China’s objective of shifting more resources to agriculture and food production in order to improve Chinese lives, food security, and food safety.

Privatization Program

At the November 2013 Third Plenum, the Chinese government announced reforms to SOEs that included selling shares of SOEs to outside investors.  This approach is an effort to improve SOE management structures, emphasize the use of financial benchmarks, and gradually take steps that will bring private capital into some sectors traditionally monopolized by SOEs like energy, telecommunications, and finance.  In practice, these reforms have been gradual, as the Chinese government has struggled to implement its SOE reform vision and often opted to utilize a preferred SOE consolidation approach. In the past few years, the Chinese government has listed several large SOEs and their assets on the Hong Kong stock exchange, subjecting SOEs to greater transparency requirements and heightened regulatory scrutiny.  This approach is a possible mechanism to improve SOE corporate governance and transparency. Starting in 2017, the government began pushing the mixed ownership model, in which private companies invest in SOEs and outside managers are hired, as a possible solution, although analysts note that ultimately the government (and therefore the CCP) remains in full control regardless of the private share percentage.  Over the last year, President Xi and other senior leaders have increasingly focused reform efforts on strengthening the role of the State as an investor or owner of capital, instead of the old SOE model in which the state was more directly involved in managing operations.

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