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Why China’s new leaders will ignore foreign investors

January 10, 2013
China Law and Practice
Connie Carter

Following the customary once-in-a-decade power handover, China’s new leaders are set to face many tough challenges, but enticing foreign investors will not be one of them. Instead, President Xi Jinping and his team will be looking outwards, ensuring China’s rise as a global power and looking in, devising a more sustainable growth model. This will include reducing environmental degradation, curbing cronyism, corruption and inequality, and dealing with an aging population skewed by the one-child-policy. Above all, they will strive to ensure stability.

Such challenges call for a robust and visionary agenda, perhaps similar to the innovative opening-up policies introduced by Deng Xiaoping in 1978. These moved China from the societal model of the Cultural Revolution to a jural model of law, which lifted hundreds of millions of people out of poverty and kick-started the transformation making China today the second largest economy in the world.

Addressing corruption

To appreciate why foreign investors will be sidelined, one must understand how China got to where it is today. First, Deng Xiaoping’s policies gave birth to special economic zones (SEZs) and other policy tools which incentivised foreign investors and opened China to foreign trade and investment.

Second, for over three decades, foreign investors financed a multitude of special zones, powering China’s economic development. The initial vision was China as the factory of the world, supplying foreign investors with cheap labour to make products designed only for export. However, in recent years, as the Chinese demographics changed, wages have risen and the supply of cheap labour has become a wish. Many foreign investors have relocated to other Asian countries or have repatriated production. The 3.5% decline in foreign direct investment (FDI) during the first ten months of 2012 documents a trend that is set to accelerate. China’s previous leaders tried to adjust to reality by moving up the value chain. They have even parcelled out some of their own low-tech production to Chinese-led SEZs in African and other Asian countries. They have encouraged investment in research and development, clean technology and environmentally friendly production. But that is not nearly enough. The growth-at-all-costs mentality in the world’s factory remains largely unbridled and has caused severe damage to the environment. The result is so much chronic pollution of the air, land and water, that it now threatens human health and social stability.

Investment in the physical infrastructure has been huge and relatively successful, but the human infrastructure, populated mainly by Party members, is failing. As Xi warned in his coming-out speech in November 2012: “the problems among party members and cadres of corruption, taking bribes, being out of touch with the people, undue emphasis on formalities and bureaucracy must be addressed ”. The question arises as to whether Xi has the stomach for reforming the opaque authoritarian political system which is riddled with corruption. Apparently he has commissioned a report about how Singapore managed to become wealthy while retaining a system where one party dominates.

Challenges dictate change

The economic slowdown in the West has shrunken the world’s appetite for China’s manufacturing, so the new leaders can no longer rely on the export-driven model. They need to shift towards reliance on Chinese consumers. Xi might be thinking along these lines when he said: “Our people yearn for better education, stable jobs, more satisfactory income, greater social security, improved medical and healthcare, more comfortable living conditions, and a more beautiful environment”. To give the people what they yearn for, a new development model will be required. But that model is unlikely to rely on incoming FDI. China has been slow to open its market to the domestic-made goods and services of foreign investors and there are no signs that the new leaders will change this stance.

However, there is reason to believe that Xi will support China’s going-out policy, which forces Chinese companies to invest abroad. China’s outward FDI grew from an annual average of below $3 billion before 2005, when the going-out policy was introduced, to over $60 billion in 2010. China’s total global outward FDI was about $360 billion in 2011 and during the first 10 months of 2012, it rose 25.8% to US$ 58.2 billion. Pundits estimate that China will invest US$ 1 to 2 trillion globally during Xi’s tenure. This will dwarf China’s FDI inflows and put the interests of foreign investors on the back burner. Meanwhile, the rest of Asia and the world will struggle to find a way to pacify China’s territorial claims, while accepting its investments. And Xi will struggle to build credible roles for China as a responsible global power.

Connie Carter, Professor of Law & International Business, Royal Roads University, Canada