Policies Towards Foreign Direct Investment
China continues to be one of the largest recipients of global FDI due to a relatively high economic growth rate, growing middle class, and an expanding consumer base that demands diverse, high quality products. FDI has historically played an essential role in China’s economic development. In recent years, due to stagnant FDI growth and gaps in China’s domestic technology and labor capabilities, Chinese government officials have prioritized promoting relatively friendly FDI policies promising market access expansion and national treatment for foreign enterprises through general improvements to the business environment. They also have made efforts to strengthen China’s legal and regulatory framework to enhance broader market-based competition. Despite these efforts, the on-the-ground reality for foreign investors in China is that the operating environment still remains closed to many foreign investments across a wide range of industries.
In 2018, China issued the nationwide negative list that opened up a few new sectors to foreign investment and promised future improvements to the investment climate, such as leveling the playing field and providing equal treatment to foreign enterprises. However, despite these reforms, FDI to China has remained relatively stagnant in the past few years. According to MOFCOM, total FDI flows to China slightly increased from about USD126 billion in 2017 to just over USD135 billion in 2018, signaling that modest market openings have been insufficient to generate significant foreign investor interest in the market. Rather, foreign investors have continued to perceive that the playing field is tilted towards domestic companies. Foreign investors have continued to express frustration that China, despite continued promises of providing national treatment for foreign investors, has continued to selectively apply administrative approvals and licenses and broadly employ industrial policies to protect domestic firms through subsidies, preferential financing, and selective legal and regulatory enforcement. They also have continued to express frustration over China’s weak protection and enforcement of IPR; corruption; discriminatory and non-transparent anti-monopoly enforcement that forces foreign companies to license technology at below-market prices; excessive cybersecurity and personal data-related requirements; increased emphasis on requirements to include CCP cells in foreign enterprises; and an unreliable legal system lacking in both transparency and rule of law.
China seeks to support inbound FDI through the MOFCOM “Invest in China” website (www.fdi.gov.cn ). MOFCOM publishes on this site laws and regulations, economic statistics, investment projects, news articles, and other relevant information about investing in China. In addition, each province has a provincial-level investment promotion agency that operates under the guidance of local-level commerce departments.
Limits on Foreign Control and Right to Private Ownership and Establishment
In June 2018, the Chinese government issued the nationwide negative list for foreign investment that replaced the Foreign Investment Catalogue. The negative list identifies industries and economic sectors restricted or prohibited to foreign investment. Unlike the previous catalogue that used a “positive list” approach for foreign investment, the negative list removed “encouraged” investment categories and restructured the document to group restrictions and prohibitions by industry and economic sector. Foreign investors wanting to invest in industries not on the negative list are no longer required to obtain pre-approval from MOFCOM and only need to register their investment.
The 2018 foreign investment negative list made minor modifications to some industries, reducing the number of restrictions and prohibitions from 63 to 48 sectors. Changes included: some openings in automobile manufacturing and financial services; removal of restrictions on seed production (except for wheat and corn) and wholesale merchandizing of rice, wheat, and corn; removal of Chinese control requirements for power grids, building rail trunk lines, and operating passenger rail services; removal of joint venture requirements for rare earth processing and international shipping; removal of control requirements for international shipping agencies and surveying firms; and removal of the prohibition on internet cafés. While market openings are always welcomed by U.S. businesses, many foreign investors remain underwhelmed and disappointed by Chinese government’s lack of ambition and refusal to provide more significant liberalization. Foreign investors continue to point out these openings should have happened years ago and now have occurred mainly in industries that domestic Chinese companies already dominate.
The Chinese language version of the 2018 Nationwide Negative List: http://www.ndrc.gov.cn/zcfb/zcfbl/201806/W020180628640822720353.pdf .
The foreign investment negative list restricts investments in certain industries by requiring foreign companies enter into joint ventures with a Chinese partner, imposing control requirements to ensure control is maintained by a Chinese national, and applying specific equity caps. Below are just a few examples of these investment restrictions:
Examples of foreign investments that require an equity joint venture or cooperative joint venture for foreign investment include:
- Exploration and development of oil and natural gas;
- Printing publications;
- Foreign invested automobile companies are limited to two or fewer JVs for the same type of vehicle;
- Market research;
- Preschool, general high school, and higher education institutes (which are also required to be led by a Chinese partner);
- General Aviation;
- Companies for forestry, agriculture, and fisheries;
- Establishment of medical institutions; and
- Commercial and passenger vehicle manufacturing.
Examples of foreign investments requiring Chinese control include:
- Selective breeding and seed production for new varieties of wheat and corn;
- Construction and operation of nuclear power plants;
- The construction and operation of the city gas, heat, and water supply and drainage pipe networks in cities with a population of more than 500,000;
- Water transport companies (domestic);
- Domestic shipping agencies;
- General aviation companies;
- The construction and operation of civilian airports;
- The establishment and operation of cinemas;
- Basic telecommunication services;
- Radio and television listenership and viewership market research; and
- Performance agencies.
Examples of foreign investment equity caps include:
- 50 percent in automobile manufacturing (except special and new energy vehicles);
- 50 percent in value-added telecom services (excepting e-commerce);
- 51 percent in life insurance firms;
- 51 percent in securities companies;
- 51 percent futures companies;
- 51 percent in security investment fund management companies; and
- 50 percent in manufacturing of commercial and passenger vehicles.
Investment restrictions that require Chinese control or force a U.S. company to form a joint venture partnership with a Chinese counterpart are often used as a pretext to compel foreign investors to transfer technology against the threat of forfeiting the opportunity to participate in China’s market. Foreign companies have reported these dictates and decisions often are not made in writing but rather behind closed doors and are thus difficult to attribute as official Chinese government policy. Establishing a foreign investment requires passing through an extensive and non-transparent approval process to gain licensing and other necessary approvals, which gives broad discretion to Chinese authorities to impose deal-specific conditions beyond written legal requirements in a blatant effort to support industrial policy goals that bolster the technological capabilities of local competitors. Foreign investors are also often deterred from publicly raising instances of technology coercion for fear of retaliation by the Chinese government.
Other Investment Policy Reviews
Organization for Economic Cooperation and Development (OECD)
China is not a member of the OECD. The OECD Council decided to establish a country program of dialogue and co-operation with China in October 1995. The most recent OECD Investment Policy Review for China was completed in 2008 and a new review is currently underway.
OECD 2008 report: http://www.oecd.org/daf/inv/investment-policy/oecdinvestmentpolicyreviews-china2008encouragingresponsiblebusinessconduct.htm .
In 2013, the OECD published a working paper entitled “China Investment Policy: An Update,” which provided updates on China’s investment policy since the publication of the 2008 Investment Policy Review.
World Trade Organization (WTO)
China became a member of the WTO in 2001. WTO membership boosted China’s economic growth and advanced its legal and governmental reforms. The sixth and most recent WTO Investment Trade Review for China was completed in 2018. The report highlighted that China continues to be one of the largest destinations for FDI with inflows mainly in manufacturing, real-estate, leasing and business services, and wholesale and retail trade. The report noted changes to China’s foreign investment regime that now relies on the nationwide negative list and also noted that pilot FTZs use a less restrictive negative list as a testbed for reform and opening.
China made progress in the World Bank’s Ease of Doing Business Survey by moving from 78th in 2017 up to 46th place in 2018 out of 190 economies. This was accomplished through regulatory reforms that helped streamline some business processes including improvements related to cross-border trading, setting up electricity, electronic tax payments, and land registration. This ranking, while highlighting business registration improvements that benefit both domestic and foreign companies, does not account for major challenges U.S. businesses face in China like IPR protection and forced technology transfer.
The Government Enterprise Registration (GER), an initiative of the United Nations Conference on Trade and Development (UNCTAD), gave China a low score of 1.5 out of 10 on its website for registering and obtaining a business license. In previous years, the State Administration for Industry and Commerce (SAIC) was responsible for business license approval. In March 2018, the Chinese government announced a major restructuring of government agencies and created the State Administration for Market Regulation (SAMR) that is now responsible for business registration processes. According to GER, SAMR’s Chinese website lacks even basic information, such as what registrations are required and how they are to be conducted.
The State Council, which is China’s chief administrative authority, in recent years has reduced red tape by eliminating hundreds of administrative licenses and delegating administrative approval power across a range of sectors. The number of investment projects subject to central government approval has reportedly dropped significantly. The State Council also has set up a website in English, which is more user-friendly than SAMR’s website, to help foreign investors looking to do business in China.
The State Council Information on Doing Business in China: http://english.gov.cn/services/doingbusiness
The Department of Foreign Investment Administration within MOFCOM is responsible for foreign investment promotion in China, including promotion activities, coordinating with investment promotion agencies at the provincial and municipal levels, engaging with international economic organizations and business associations, and conducting research related to FDI into China. MOFCOM also maintains the “Invest in China” website.
MOFCOM “Invest in China” Information: http://www.fdi.gov.cn/1800000121_10000041_8.html
Despite recent efforts by the Chinese government to streamline business registration procedures, foreign companies still complain about the challenges they face when setting up a business. In addition, U.S. companies complain they are treated differently from domestic companies when setting up an investment, which is an added market access barrier for U.S. companies. Numerous companies offer consulting, legal, and accounting services for establishing wholly foreign-owned enterprises, partnership enterprises, joint ventures, and representative offices in China. The differences among these corporate entities are significant, and investors should review their options carefully with an experienced advisor before choosing a particular Chinese corporate entity or investment vehicle.
Since 2001, China has initiated a “going-out” investment policy that has evolved over the past two decades. At first, the Chinese government mainly encouraged SOEs to go abroad and acquire primarily energy investments to facilitate greater market access for Chinese exports in certain foreign markets. As Chinese investors gained experience, and as China’s economy grew and diversified, China’s investments also have diversified with both state and private enterprise investments in all industries and economic sectors. While China’s outbound investment levels in 2018 were significantly less than the record-setting investments levels in 2016, China was still one of the largest global outbound investors in the world. According to MOFCOM outbound investment data, 2018 total outbound direct investment (ODI) increased less than one percent compared to 2017 figures. There was a significant drop in Chinese outbound investment to the United States and other North American countries that traditionally have accounted for a significant portion of China’s ODI. In some European countries, especially the United Kingdom, ODI generally increased. In One Belt, One Road (OBOR) countries, there has been a general increase in investment activity; however, OBOR investment deals were generally relatively small dollar amounts and constituted only a small percentage of overall Chinese ODI.
In August 2017, in reaction to concerns about capital outflows and exchange rate volatility, the Chinese government issued guidance to curb what it deemed to be “irrational” outbound investments and created “encouraged,” “restricted,” and “prohibited” outbound investment categories to guide Chinese investors. The guidelines restricted Chinese outbound investment in sectors like property, hotels, cinemas, entertainment, sports teams, and “financial investments that create funds that are not tied to specific investment projects.” The guidance encouraged outbound investment in sectors that supported Chinese industrial policy, such as Strategic Emerging Industries (SEI) and MIC 2025, by acquiring advanced manufacturing and high-technology assets. MIC 2025’s main aim is to transform China into an innovation-based economy that can better compete against – and eventually outperform – advanced economies in 10 key high-tech sectors, including: new energy vehicles, next-generation IT, biotechnology, new materials, aerospace, oceans engineering and ships, railway, robotics, power equipment, and agriculture machinery. Chinese firms in MIC 2025 industries often receive preferential treatment in the form of preferred financing, subsidies, and access to an opaque network of investors to promote and provide incentives for outbound investment in key sectors. The outbound investment guidance also encourages investments that promote China’s OBOR development strategy, which seeks to create connectivity and cooperation agreements between China and countries along the Chinese-designated “Silk Road Economic Belt and the 21st-century Maritime Silk Road” through an expansion of infrastructure investment, construction materials, real estate, power grids, etc.
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.
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.