By Su Qingyi and Wang Ruiya

T he prolonged trade dispute between China and the US has raised concerns among foreign-invested enterprises. Foreign investors worry whether trade frictions will hurt China's economic growth, whether the business climate overall will deteriorate or whether China will impose retaliatory restrictions on American or other companies. Opinions vary widely on the extent of the impact from the trade row. The US argues that it will “impose tariffs to drive American companies out of China,” while the World Bank's Doing Business 2019, often seen as an investment bellwether, has stated that China's business environment has actually been improving. In the article below, the author concludes that despite the damage to Sino-US trade relations, foreign investors still regard China as an attractive place for investment.

Negative Impacts

The Sino-US trade dispute has had a mixed impact on foreign investment in China. In examining investment trends it is essential to look at investment stocks and flows. If foreign invested enterprises close down, reduce production, and shift investment to other countries, that will reduce the foreign investment stock. However, Sino-US trade friction is not the only reason for the withdrawal of some foreign capital from China. Some of the other factors can be seen below.

01 Rising costs are the root cause of the outbound migration of manufacturing. China is no longer attractive for some types of manufacturing, particularly in labor-intensive areas. To cut costs, some companies have been shifting their manufacturing base to lower cost countries. It is an inevitable phenomenon in economic and industrial development. For example, Nitto Denko, one of the world's top 500 companies, has closed its factory in Suzhou. Nikon, Fujitsu and Samsung have also moved their factories to Southeast Asia for cost reasons.

>>> A Chinese enterprise engaged in the processing trade, a type of business whereby some or all of the raw materials are imported for “processing.” Finished goods are then exported.

02 Some businesses have failed to keep pace with technological developments. Japan's Omron found its LCD panels were severely affected by OLED panels in applications such as smart phones, televisions and automobiles. It saw its market share decline and finally had to close its Suzhou LCD panel factory.

03 Intensifying competition from local rivals is another factor. Samsung closed its network equipment factory in Shenzhen in April 2018 and its mobile phone factory in Tianjin in August of the same year. After those closures, the company had only its Huizhou mobile phone factory still in operation in China. Samsung has come under great competitive pressure from local brands in China and that has figures in its decision to shut some operations.

04 Multinational companies have also found it difficult to adjust to market demand in the Chinese market at times. In the Chinese automobile market, for example, the bulk of the demand is for sport utility vehicles and cars with a large engine displacement. After years of trying to compete, Suzuki Motor, which focuses on the compact car market, eventually called it quits and exited the China market. Its decision reflected an inability to cater to local market demand.

05 Management missteps - as well as other external issues - have also contributed. Olympus, the Japanese optical giant, closed its Shenzhen factory in May 2018 because of aging equipment, a financial scandal and restrictions on its export business. Political friction and cultural missteps have also plagued some foreign companies. Korea's LOTTE Mart became embroiled in a political row over Korea's stance on the THAAD (Terminal High Altitude Area Defense) missile defense project. Dolce and Gabbana ran into a firestorm of opposition from Chinese consumers after an advertising video led to boycotts of its products.

Some foreign investors already in the China market have been hesitating in committing to further investments amid uncertainties in Sino-US trade relations. It is not clear how long the trade friction will continue, and this no doubt will cap growth in investment totals.

Positive Factors

China has been taking steps to offset these negative factors and ensure that the business environment is attractive. It has been relaxing its controls over market access. It plans to reduce the number of items on the “negative lists” which bar foreign investment in certain areas of the domestic economy. This applies to the nationwide negative list as well as a similar arrangement for the nation's free trade zones. Additionally, China is moving ahead with trial programs to open up the service sector. Moreover, China is trying to adjust the structure of foreign investment by encouraging the channeling of foreign capital into high-tech industries and the nation's less developed central and western regions. It has publicized guidelines for this redirecting of investment in its Proposed List of Industries for Foreign Investment and Catalogue of Priority Industries for Foreign Investment in Central and Western China.

Additionally, China is trying to improve other aspects of the overall business environment. The Foreign Investment Law has already been promulgated. Authorities are also working on improving the central and local foreign investment complaint resolution mechanism to foster a “cordial, secure and profitable” business environment for all foreign investors. The government is also putting greater emphasis on intellectual property protection. It will implement a national strategy on intellectual property protection to guarantee the lawful rights and interests of foreign companies, enhance the credibility and efficiency of intellectual property examination, and be resolute in punishing infringements on the lawful rights and interests of foreign investors, particularly in the area of intellectual property. It also is putting in place a punitive compensation system to significantly raise the cost for offenders.

Trade Related Data

According to the World Investment Report 2019 released by the United Nations Conference on Trade and Development, global foreign direct investment (FDI) fell 13% in 2018, for the third consecutive annual decline. But China remained one of the global bright spots as foreign direct investment was up 4% to a record US$139 billion in 2018, accounting for more than 10% of the global total. It was the world's second largest recipient of foreign investment and the largest developing economy recipient. Actual use of foreign capital in the manufacturing sector increased 20.1% per year, 4.8 percentage points higher than the previous year. Investment in the high-tech manufacturing sector rose 35.1%. Actual use of foreign capital in the less developed central and western regions of China had a year-on-year growth of 15.4% and 18.5%, respectively. According to the Ministry of Commerce, China's actual use of foreign capital in the first five months of the year in domestic currency terms was 369.06 billion yuan, up 6.8% from the previous year. Foreign capital used in manufacturing increased 12.4% and investment in hightech manufacturing and high-tech services gained 23.2% and 68.9%, respectively.

In 2017 the US launched a Section 301 investigation against China and the two countries imposed tariffs on imports of each other's products. There were trade negotiations continuing into 2019, but there was no significant impact on China's actual use of foreign capital as shown in chart 1 (monthly and aggregate figures). As seen in chart 2, although there was a slight decline in utilized foreign investment in 2017, the figure went up in 2018, when Sino-US relations were more tense. Therefore, it can be seen that trade friction has had a limited impact on China's attractiveness for foreign direct investment.

Foreign direct investments in services and high-tech manufacturing have risen rapidly. From 2015 to 2018, foreign investments were mainly concentrated in tertiary industries. Viewed from the perspective of industry structure, manufacturing has been the most attractive sector for foreign investments. In 2018, the utilization of foreign investment in manufacturing rebounded significantly for the first time after years of contraction, rising 22.9% to US$41.2 billion, accounting for over 30% of China's total foreign investment in that year. This tells us that China is still the “world's

factory.”

The top 10 regions as sources of investment increased their share of the total from 94.2% in 2014 to 95.2% in 2018. Asia accounted for the bulk of the funds, with China's Special Administrative Region of Hong Kong far out in front. It is worth noting that foreign direct investment from developed economies showed significant growth in 2018. According to the Ministry of Commerce, direct investments from the UK rose 150.1%, Germany 79.3%, Korea 24.1% and Japan 13.6%. Ironically, direct investment from the United States, which has been the source of so much friction, also increased by 7.7%.

Chart 1: China's actual use of foreign capital from January 2019 to April 2019 (billions of dollars)

Chart 2: China's FDI stocks and flows from 2009 to 2018 (billions of dollars)

Over the last five years, the US has slipped in the rankings of the top sources of foreign investment. Nonetheless, there has still been a moderate rise in total US investments. The US policy of “imposing tariffs to drive American companies out of China” has proven to be ineffective. This also means that even with the ongoing trade frictions, enterprises around the world, including the US, still consider China as sufficiently attractive to look for new investment opportunities.

Future Trends in Attracting Foreign Capital

With the continued deepening of China's economic reforms, the development of the national economy and the upgrading of the industrial structure, foreign investment will undergo major changes in the future. This is positive for China's own development, and indirectly is also conducive to addressing Sino-US trade frictions.

First, China's foreign investments will shift from incremental expansion to higher quality and greater efficiency. Second, it will gradually shift from lower end manufacturing to high-end manufacturing and services. Third, the proportion of investments from developed countries will continue to rise.