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A palpable shift in sentiment
The first fall in foreign funds this decade is a sign that foreign companies are taking a more hard-headed approach by Lionel Barber
For 20 years, ever since Deng Xiaoping's "Open Door" policy heralded market liberalisation, foreign investors have looked at China as a mouth-watering commercial opportunity.
Today, many of those same investors are taking a harder-nosed attitude towards the land of a billion consumers. Not all are in retreat, but there is a palpable mood of retrenchment among those staying.
The shift in sentiment reflects the difficulties of doing business in an economy struggling to escape the shackles of deflation, the impact of the Asian financial crisis, and worries over the stability of the currency. But it also points to a loss of patience with an economy where sustained profits have proved more elusive than imagined.
Foreign direct investment has fallen by 10 per cent in the first seven months of this year. Although officials in Beijing and Shanghai predict there will be a slight pick-up in the second half, the total figure is expected to reveal a decline for the first time in this decade.
In some respects, the new realism among the foreign investment community is a healthy sign. It shows, says one western lawyer in Shanghai, that investors are treating China like any normal country rather than a developing country making the transition from a command economy to a social market economy.
But he adds: "There is no doubt that a lot of people are frustrated right now."
The slowdown has profound implications for the government, both in its management of the economy and its relations with the west. Foreign direct investment has created much-needed jobs, particularly in eastern China and the coastal regions, where state-owned companies are laying off workers. If foreign investment dries up, it will be a further drag on the economy and could exacerbate unemployment and labour unrest.
Last year, for example, foreign direct investment (FDI) in China was $45.6bn. This makes China the largest recipient of foreign investment after the US, and easily the largest among developing countries. Dai Xianglong, governor of the People's Bank of China, the central bank, tentatively predicts a total of $35bn for the full year.
Foreign investment in China has sharpened competition, improved social welfare and the distribution of resources and spread the use of new technology. Total output of foreign invested enterprises accounted for 17 per cent of the total industrial output in 1997, according to Hu Angang, a leading Chinese economist and author of a recent paper on the foreign direct investment policy orientation in China.
Yet FDI is a double-edged sword. Mr Hu notes that the past few years have witnessed unseemly bidding wars between regions and provinces for the favours of foreign investors. A succession of tax breaks and other incentives have resulted in significant tax losses for the government.
Despite these costs, officials leave little doubt that they are determined to court more foreign investment, albeit on their terms. Wang Ande, responsible for attracting investment in Shanghai's Pudong district, rolls out the names of foreign companies with relish: GM, NEC, Sharp Hitachi, Siemens, BASF, and Pilkington, each with hundreds of millions of dollars at stake.
Yet a small but growing number of companies have been folding their tents. Royal Bank of Canada has pulled out of China, worried about the health of the financial sector. South Western Bell withdrew from a telecommunications joint venture because of regulatory obstacles and Fosters, the Australian brewer, is selling the bulk of its Chinese operations after failing to make a profit.
In some cases, the Chinese blame events beyond their control such as the wave of international mergers which has forced companies to rationalise their Chinese operations or representative offices; but elsewhere it is plain that head offices of multinationals have ordered new projects to be put on hold until the Chinese operations are either streamlined or the joint ventures are scrapped in favour of management structures which offering greater degree of control.
One example of new corporate thinking about doing business in China is Eastman Kodak's purchase last year of three state-owned photographic film enterprises. The deal suggested that foreign companies were becoming more leery of pouring large sums and lots of corporate energy into making a greenfield operation work, and were prepared to bide their time until they could buy into established Chinese ventures.
The next step, says Mr Hu, is to develop a rules-based system for FDI which seeks to attract regional headquarters of foreign companies, improve the quality of exports, and continue the search for high-value, high-tech projects. In others words, second generation reform.
For the moment, however, the atmosphere is more sober. The gold-rush mentality has gone.