China’s attractiveness as an investment destination is declining due to economic challenges, tighter government controls, and foreign policy issues. Companies are shifting production to Southeast Asia, Eastern Europe, and Mexico. Decoupling from China accelerated post-COVID, with foreign firms facing regulatory hurdles, rising costs, and a shrinking consumer base.
A combination of a poor economic outlook, tightening central government controls, and aggressive foreign policies is making China a less attractive investment destination.
Many foreign companies began reevaluating their presence in China in 2016 when then-President Trump started increasing tariffs on Chinese imports. President Biden continued with the tariffs while increasingly restricting investment and trade from China. At the same time, China’s strict lock downs during Covid-19 accelerated the process of foreign enterprises reducing their exposure in China.
Now, firms from the United States and the European Union are increasingly sourcing from Southeast Asia, Eastern Europe, and Mexico rather than China. Consequently, China’s manufacturing sector experienced contraction in October, accompanied by a further decline in exports through the end of the year. Notably, China experienced its first-ever quarterly deficit in foreign direct investment during July-September, and the capital outflows are ongoing. With roughly 30% of China’s exports being produced by foreign-invested firms, an exodus of investment also means a loss of jobs. Now that Christmas orders are already completed, some factories are cutting staff by as much as 50% or more.
The current gradual decoupling began slowly because companies wanted to believe they could earn extraordinary profits in China and were willing to overlook or rationalize away facts that made success in the China market less likely. Another issue was that western investment banks were overly optimistic in their predictions and outlooks for China’s future. Here, there was a bit of a conflict of interest, however, as these same banks earned money selling China investments to their clients.
Until very recently, foreign firms were willing to weather economic downturns in China, absorb rising labor costs, and navigate the growing bureaucracy, in exchange for access to one of the world’s largest consumer markets. However, the size and wealth of China’s consumer base are often overestimated. China has a tremendous wealth and sophistication gap. Consumers in Shanghai, for example, are wealthier and more sophisticated than roughly two-thirds of the rest of the country’s population. The hundreds of millions living in second and third-tier cities, as well as in the countryside, cannot afford and may not want foreign products. And with a general economic slowdown, even the first-tier, former buyers of foreign brands are increasingly turning to discount merchandise and domestic brands. As the potential rewards in the domestic market decrease, the enticement for foreign companies to manufacture in China would be lower costs, as they focus on exporting. However, government policies are complicating foreign investment.
In spite of the poor economic recovery from China’s draconian Covid-19 lock downs, Xi Jinping is strengthening regulations that further restrict the activities of foreign firms. The counterespionage law, the cybersecurity law, national intelligence law, national security law, and foreign relations law, as well as the cross-border data transfer law, have made it easy for well-meaning foreign firms to unwittingly commit a violation. The very real possibility of police raids, fines, or exit bans is transforming China from a golden goose to a poisoned pill for foreign companies.
In a survey conducted by the European Chamber of Commerce in China, about a third of the surveyed companies estimated that it would cost them “several million euros” to store their data in China, in compliance with the cross-border data transfer law. Compliance with other similar laws would increase costs, or in extreme cases, make it impossible to conduct business in China. Consulting firms, market research firms, and auditors are falling into this latter category, where conducting routine investigative activities, which are a crucial component of their core business, may now be illegal.
Not only Western companies but also Taiwanese firms are reducing their exposure to China. In 2022, Taiwan, for the first time, invested more money in Southeast Asia and South Asia, including India, than in China. As a result, the People’s Republic of China (PRC) has accused Taiwan of violating the bilateral Economic Cooperation Framework Agreement (ECFA) and has initiated an investigation. Alleging the implementation of trade barriers by Taiwan, China has threatened to revoke preferential treatment for Taiwanese imports on the mainland. Beijing has stated that the investigation findings will be disclosed a day before the election, raising concerns about the Chinese Communist Party’s (CCP) potential influence on Taiwan’s electoral process. Both major opposition parties, the TPP and the KMT, advocating for increased collaboration with China, have expressed caution, warning that China may cancel portions of the Economic Cooperation Framework Agreement (ECFA). The investigation is seen as a move to interfere in the Taiwanese election, a behavior the US has already cautioned Beijing against.
According to the Economist Intelligence Unit, China’s business environment has seen a notable decline this year compared to the previous year. In the latest rankings, China falls behind other markets such as Malaysia, Thailand, Vietnam, Mexico, and India, all of which are actively courting manufacturing investment relocation from China. Vietnam and Thailand, in particular, are capitalizing on the “China+1” strategy, which involves diversifying supply chains across both China and another Asian market to mitigate geopolitical risks. These countries are offering favorable conditions for foreign investors, contributing to China’s decreasing attractiveness for business operations.
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TNL Editor: Kim Chan (@thenewslensintl)
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