How changes in China's investment environment will impact the world

Japanese academic Toshiya Tsugami analyses China's recent trade and investment flows amid US-China rivalry, highlighting the EV and semiconductor sectors which have become key battlegrounds in the competition between China and the West. How will development plans for the Chinese market and the global business environment be affected?
Supporters await the arrival of Chinese President Xi Jinping in San Francisco, California, US, on 14 November 2023. (Jason Henry/AFP)
Supporters await the arrival of Chinese President Xi Jinping in San Francisco, California, US, on 14 November 2023. (Jason Henry/AFP)

Recently, there has been a series of negative news regarding the Chinese economy. The topic of foreign investment is no exception.

The Ministry of Commerce of China announced that the cumulative foreign investment from January to July 2023 was US$111.8 billion, down 9.7% year-on-year. Additionally, net direct investment debt (new investments less capital recovered due to exits and downsizing) announced by the State Administration of Foreign Exchange (SAFE) increased by US$15.5 billion in the first three quarters. However, this is a 90% decrease compared to US$152.4 billion in the same period last year. Looking at the third quarter alone, it was the first time since statistics began in 1998 that it recorded a minus of US$11.8 billion.

Deteriorating business environment for foreign firms

Firstly, a deteriorating business environment for foreign companies in China may be causing a decline in foreign direct investment.

As a result of the US-China conflict, the US imposed high tariffs and various trade restrictions on China. This made it difficult to export products from China to North America, and many assembly factories were relocated from China to ASEAN countries and Mexico. China is also tightening its grip on foreign companies through policies to promote the indigenisation of supply chains (production by Chinese companies) and anti-espionage laws for economic security, leading to a deterioration of the business environment for foreign companies. Above all, the slowdown in China’s economic growth is discouraging foreign companies that had pinned their dreams on the vast Chinese market.

... not only foreign companies but also domestic companies are moving their assembly factories overseas from China, following the general trend to avoid high tariffs and the impact of decoupling.

People wearing face masks wait at an intersection in Beijing, China, 1 November 2023. (Tingshu Wang/Reuters)
People wearing face masks wait at an intersection in Beijing, China, on 1 November 2023. (Tingshu Wang/Reuters)

These effects are reflected not only in direct investment but also in trade. The proportion of China’s exports to Western countries and regions such as the US, Europe and Japan was 51.3% in 2018, but it decreased by 6% to 45.3% in the first half of 2023. In particular, exports to the US alone decreased by 4.8% over five years.

This suggests that not only foreign companies but also domestic companies are moving their assembly factories overseas from China, following the general trend to avoid high tariffs and the impact of decoupling. As a result, there are growing concerns in China about the hollowing out of its industries, and some analysts in Western countries’ governments are cheering the move, stating “the economy’s dependence on China has decreased”.

Are foreign companies giving up on China?

However, if you look more closely, you will see a different picture. It is dangerous to simply assume that foreign companies are abandoning China.

It is true that foreign direct investment received by China has been negative since April 2023 compared to the same period last year. However, recently, investment from Hong Kong accounts for three-quarters of foreign direct investment, and a significant portion of this is U-turn investment by mainland companies. At the same time, the amount of domestic investment by mainland Chinese private companies has continued to decline by around 20% year-on-year since April 2023. What we can infer from this is that mainland Chinese companies have felt uncertain about the future and have been reducing investment since April 2023, which may also be contributing to the decline in foreign direct investment.

Western big businesses stay but smaller companies think twice 

So, does this mean that investment in China by foreign companies from Western countries and regions such as the US, Europe and Japan, other than Hong Kong, is not decreasing? The answer is yes and no.

Recently, the Chinese government has repeatedly pointed out that foreign investment by Western countries is increasing in size. “From 2019 to 2022, the average investment size per deal increased by 45% to reach US$4.91 million. Contract investment amounts of US$100 million or more will account for 53% of the total in 2022, or 6,535 million RMB. In addition, in January-March 2023, there was a quarterly increase of 223.3 billion RMB, an increase of 10.4%,” said Chinese media reports.

... there is a growing movement among smaller companies to downsize or withdraw from Chinese operations.

People walk at the venue of the China International Import Expo (CIIE) in Shanghai, China, 6 November 2023. (Casey Hall/Reuters)
People walk at the venue of the China International Import Expo (CIIE) in Shanghai, China, on 6 November 2023. (Casey Hall/Reuters)

It is presumably because Western big businesses have been making large-scale investments in China. Large global companies with annual sales of tens of billions of dollars or more in industries such as automobiles, IT, and pharmaceuticals remain strongly committed to the Chinese market.

On the other hand, there is a growing movement among smaller companies to downsize or withdraw from Chinese operations. Things have changed completely from 20 years ago, when small and medium-sized Western companies were setting up factories in China en masse. In other words, Western companies’ business in China is becoming polarised.

It is generally seen that the Western business community wants to value economic ties with China, but this reflects the hope of big business, which has a large voice and influence. “Other companies”, which outnumber both large companies and their employees, have lost their passion for China. This is one of the reasons why Western politics have recently taken a harsher stance toward China.

... even assembly factories that moved overseas (from China) out of concern for the US-China conflict continue to import machinery, parts and materials from China.

Deepening of economic relations between China and ASEAN continues 

I mentioned earlier that the proportion of China’s exports bound for Western destinations such as the US, Europe and Japan is decreasing, but behind the scenes, the trade and investment relationship between China and ASEAN is rapidly expanding and deepening. ASEAN has now become China’s largest trade partner destination, surpassing the US and EU.

An employee works on a wind turbine tower at a factory in Lianyungang, Jiangsu province, China on 7 October 2023. (AFP)
An employee works on a wind turbine tower at a factory in Lianyungang, Jiangsu province, China, on 7 October 2023. (AFP)

This is because even assembly factories that moved overseas (from China) out of concern for the US-China conflict continue to import machinery, parts and materials from China. The proportion of China’s exports to ASEAN countries was 12.8% in 2018, but it increased by 3% to 15.8% in the first half of 2023.

Looking at the breakdown of export items, the export share of smartphones and personal computers whose assemblies are low-value-added is decreasing, while the share of machinery, parts and materials, etc. is increasing. This confirms this change. The US-China conflict and growing awareness of “economic security” are leading to the hollowing out of China’s assembly industries, while increasing exports of their upstream industries.

China is becoming equipped with a technological level and supply capacity that surpasses other countries when it comes to the key components of EVs, including batteries.

Impact of China’s EV breakthrough

It is not just parts and materials that China is increasing its exports of. Electric vehicles (EVs) have been attracting a lot of attention recently. China’s automobile exports, mainly EVs, totalled 4.24 million units from January to October 2023, an increase of 62% year-on-year, overtaking Japan to become the world’s largest automobile exporting country. In addition to exports, domestically produced cars, mainly EVs, are showing rapid growth in China, pushing out foreign brand internal-combustion engine vehicles.

There are three possible reasons for the rapid evolution and growth of Chinese EVs. First, the performance of EVs, centred on batteries, is rapidly improving. The second is that China implemented a new industrial policy that replaced the method that had failed in the past (subsidising companies on the supply side) by subsidising purchases on the demand side, leaving the supply side to competition. The third factor is the strong supply power that China’s manufacturing and software industries have developed.

People visit various booths at the Auto Shanghai show, in Shanghai, China, 19 April 2023. (Aly Song/Reuters)
People visit various booths at the Auto Shanghai show, in Shanghai, China, on 19 April 2023. (Aly Song/Reuters)

China is becoming equipped with a technological level and supply capacity that surpasses other countries when it comes to the key components of EVs, including batteries. This move is in line with the policy of “making the world dependent on China’s supply chains” advocated by President Xi Jinping in 2020. With this policy, Chinese companies are trying to build an uninterrupted supply chain, from upstream mining in overseas mines to downstream assembly of finished vehicles.

... if Chinese EVs show momentum in displacing Western automakers in the global south market, the economic conflict between Western countries and China will increase significantly.

Automobiles and semiconductors will be key battlegrounds 

Automobiles are a uniquely important industry in that they have vast supply chains and provide jobs for many people, making it a unique product whose ups and downs can easily become political issues. In particular, the automobile industry has been a pillar of support for Western countries’ business in China. Recently, Japan’s Mitsubishi Motors announced that it would be withdrawing from China. What would happen if foreign brand cars were driven out of China one after another?

Not only automakers but also foreign financial and professional services ecosystems that have developed and prospered around them will start to decline, potentially leading to a decline in Western countries’ business in China as a whole. Furthermore, if Chinese EVs show momentum in displacing Western automakers in the global south market, the economic conflict between Western countries and China will increase significantly.

Semiconductors are becoming more politically charged products than automobiles, as they are directly linked to national security, and is another industry sector that could have a major impact on the entire economic relationship between China and the West.

The restrictions imposed on semiconductor trade introduced by the US in October 2022 have dealt a huge blow to China. However, China appears to have succeeded in producing 7-nanometre semiconductors using manufacturing equipment that is not subject to regulations and a method that uses its own technological ingenuity. The US has had to reconcile national security demands with the economic interests of its semiconductor industry.

The US has been advocating a “small yard, high fence” policy that limits the scope of regulations to the necessary minimum and prevents China’s acquisition of semiconductors and technology as much as possible. However, if they decide that the current regulations are insufficient, they may try to expand the “yard”. This would further hinder the evolution and growth of Chinese semiconductors, but would also harm the commercial interests of the Western semiconductor industry.

... the globalisation movement is accelerating in reverse, and business risks and costs are rising everywhere.

An employee works on the production line of a semiconductor chip company in Suqian, Jiangsu province, China, 28 February 2023. (China Daily via Reuters)
An employee works on the production line of a semiconductor chip company in Suqian, Jiangsu province, China, on 28 February 2023. (China Daily via Reuters)

On the other hand, from the standpoint of ensuring economic security, China is also trying to reduce its dependence on foreign semiconductors by promoting the domestic production of so-called “legacy semiconductors”, whose technology is several generations old and is no longer subject to regulation.

China accounts for 30% of the world’s demand for semiconductors for use in home appliances, IT equipment, automobiles, etc., and is the largest and most important market for the semiconductor and manufacturing equipment industries in the US, Japan and Europe. Being kicked out of this market would not only be a huge blow to them, but it would also significantly deepen the economic conflict between the West and China.

Reversal of globalisation will lead to global economic stagnation

What these events suggest is that as mutual distrust between China and the West grows, the globalisation movement is accelerating in reverse, and business risks and costs are rising everywhere. Maintaining free trade between countries that distrust each other is inherently difficult.

This is not a surprising development, but in the not-too-distant future businessmen will be nostalgic, both in the West and in China. “It was easy to do business in the early 21st century [when the US ruled the world and the free trade order prevailed].”

Related: Third quarter figures up: Does China’s economy still need strong medicine? | [Big read] Why China will not be the next Japan | Is China’s development losing steam?