CONTEMPORARY CHINA AND CHINESE CULTURE

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Opening the Door to Foreign Investment

After Chairman Mao Ze Dong died, Deng Xiaoping gained more authority in the late
1970s. Deng never held the top government job, but he primarily wielded the power.
Deng wanted to modernize China by introducing faster reforms, saying about
capitalism versus communism, “Black cat or white cat, either will do as long as it
catches mice.”

Deng and his comrades created the Open Door Policy, which allowed foreign
investment into China for the first time since the founding of the People’s Republic of
China. Deng saw the need for China to modernize and to open to the outside world
after too many years of isolation. In the early 1980s, China opened its first Special
Economic Zones (SEZs), mainly in coastal cities, which allowed for more flexible and
capitalist policies. Foreign money began rushing into the SEZs — mostly in
manufacturing. The SEZ experiment was a huge success, and the government began
relaxing its control of the economy. The government then started to let private
(initially mainly Chinese) investors buy state-owned companies (more commonly
called state-owned enterprises, or SOEs) and even created stock exchanges.

Deng Xiaoping called this system socialism with Chinese characteristics, which is
now China’s official term to describe its economy. Some other people describe it as
market socialism. China’s mixed economy allows private and state-owned businesses
to compete in the marketplace. But socialism isn’t fading away altogether; after all,
China is a party-state government.

China has made remarkable progress over the past decade. Its share of global GDP
has risen from 4.4% in 2002 to around 10% in 2011. Currently, China is the world’s
largest exporter and its second-largest importer, and holder of the biggest foreign
currency reserves. And despite China’s slowdown in growth, it is expected to overtake
the US as the world’s largest economy (measured by GDP at purchasing power parity)
as early as 2018, according to PwC estimates.

China’s Foreign Direct Investment (FDI) Policies

For the last 25 years, China has aggressively shaped a relatively complete range of
laws and regulations governing foreign investment. They include the Law of the
People’s Republic of China upon Foreign Wholly Owned Enterprises, Law of the
People’s Republic of China upon Sino-Foreign Joint Ventures, Law of the People’s
Republic of China upon Sino-Foreign Cooperative Enterprises, and the Guiding
Directory on Industries Open to Foreign Investment. China’s laws and regulations on
FDI also include related preferential policies and stipulations for special economic
zones in the country.
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In a nutshell, China encourages favorable FDI policies. Therefore, FIEs enjoy

preferential treatment when compared to domestic enterprises. In fact, FIEs are
entitled to markedly different treatments depending on the region and industry, and
this different treatment is outlined by policies. Furthermore, the Chinese government
has stipulated different FDI performance requirements depending on these
distinctions.

China has designated certain parts of the country as special economic areas and each
is governed by different policies. China has also enforced two policies called Develop
China’s West at Full Blast and Strategy of Reviving Rusty Industrial Bases to
encourage FDI into its western and northeast regions. Therefore, FDI policies in
China’s western region entitle foreign enterprises to even more preferential treatment
than in other regions of the country.

The Chinese government pays much attention to industrial guidance on FDI. In June
1995, China first promulgated the Provisional Regulations upon Guidance for Foreign
Investment Orientations and the Guiding Directory on Industries Open to Foreign
Investment. Furthermore, the different preferential treatments granted to enterprises in
various industries have mainly been determined under the Guiding Directory. This
Guiding Directory was revised first in December 1997, and then again in April 2002
because of China’s accession to the WTO. The Guiding Directory is important
because it divides FDI-involved projects into four categories: projects that were
encouraged, allowed, restricted, and prohibited. These categories are then subdivided
even further. For instance, 262 types of encouraged projects, 75 types of restricted
projects, and 34 types of prohibited projects exist.

China currently encourages FDI for the purposes of

◼ transforming traditional agriculture, developing modern agriculture, and

promoting the industrialization of agriculture;

◼ producing transportation infrastructure, energy sources, and raw materials, and

other basic industries;

◼ tapping into cutting-edge, technology-oriented industries such as electronic

information, bioengineering, new materials, and aviation and aerospace, as well
as establishing local R&D centers;

◼ encouraging foreign businesses to utilize advanced and applicable techniques to

transform traditional industries such as machinery, textiles, and consumption
goods manufacturing industries as well as to upgrade their equipment and
facilities;
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◼ using raw and renewable resources comprehensively, initiating environmental

protection projects, and modernizing public utilities;

◼ encouraging export-oriented FDI projects; and

◼ building up the industries in China’s western region.

In the past, China’s FDI laws included some performance requirements. However, to
meet WTO membership requirements, within a year of its entry into the organization
China revised its three laws and removed the FDI requirements regarding such criteria
as export proportion, local contents, balance of foreign exchanges, technology transfer,
and creation of R&D centers. The remaining restriction limited ownership share on
projects falling in the “restricted” category. However, in practice, the Chinese partners
of some joint ventures or cooperatives privately require technology sharing or transfer
from FIE foreign investors.

The 2011 Foreign Investment Industrial Guidance Catalogue

The Foreign Investment Industrial Guidance Catalogue was originally adopted in

1997 to guide foreign investment away from discouraged and into encouraged sectors.
It had four revisions which made in 2002, 2005, 2007 and 2015. While the 2002
revision represented a major liberalization of the catalogues in line with commitments
entered into to secure China’s WTO accession in December 2001, the two subsequent
revisions were clearly aimed less at further opening up to foreign investment and
more towards adjusting the aspirational sectoral mix of inward direct investment.

In April 2015, Chinese National Development & Reform Commission (NDRC) and
the Ministry of Commerce (MOFCOM) co-published a new industrial guide for
foreign investment, which has repealed the 2011 version and established some new
rules for different sectors of foreign industries.

Generally speaking, foreign industries in China can be sorted into four categories: the
“encouraged”, the “restricted”, the “prohibited” and by implication the so-called
“permitted” (Industries that are not included in the catalogue). Different substantial
rules (e.g. tax), procedural rules and restrictions will apply to different categories of
industries so that an investor could understand whether the business that he is going to
carry out is encouraged or discouraged by Chinese government as well as which kind
of rules and regulations that he has to comply with.

In general, the 2015 catalogue stands for a trend that Chinese market is further
opening up to foreign companies. Compared to the 2011 version, the 2015 catalogue
includes 48 less items in total (now there are 432 items in total), which means the
scope of permitted industries has been enlarged. In addition, the 2015 catalogue also
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removes 41 industries (e.g. real estate, cross-border transportations, some mining
industries such as barites, diamonds, high-aluminum fireclay, and phosphorus mines)
from the restricted category (now there are 38 industries restricted in China). In
addition, there are also alterations to the industries that are encouraged by Chinese
government. The 2015 catalogue tries to encourage more foreign investors to invest in
modern agriculture, high technology, environment friendly industries and modern
service industry as well as new cleaning energy industries, etc. The category of
prohibited industries usually covers industries concerning national policy or public
security, such as gambling, on-line publishing, manufacture of tobacco products,
domestic courier service and Chinese law consultation service (except for those in
relation to the impact of Chinese legal environment), etc.

In terms of obstacles to foreign investment, the most common types of restrictions

include the “Sino-Foreign” joint venture (JV) only rule and the “majority Chinese
ownership or Chinese party controlling” rule. The “Sino-Foreign” JV only rule
requires a foreign investor to find a Chinese partner in order to create a JV if it wants
to carry out the selected business. However, the 2015 catalogue has decreased the
number of such industries from 43 to 15. It means foreign investors are able to create
wholly foreign owned companies in those adjusted industries via new set-ups or
merge and acquisition (M&A). The other type of restriction applies in a way that only
allows foreign investors to hold 50% or less than 50% shares in certain types of
industries, such as publishing industries, telecom business and railway
passenger-transportation, etc. On the other hand, the number of such industries has
been decreased from 44 to 35 and foreign investors are allowed to hold more than 50%
share in the selected items.

Compared to the 2011 version of the Foreign Direct Investment Policy, China is
getting more and more investor-friendly and is creating a more competitive
environment for foreign companies. However, foreign investors should still keep in
mind that their business plan should be in accordance with the above-mentioned
industry catalogue and make sure that their industries are not prohibited by Chinese
government. It is suggested that you should make a detailed long-term business plan
before you decide to set up in China.

Industries with Potential for Faster Growth in the Next Decade in China

Many of the industries with the highest growth potential in China over the next
decade are in the services sector, but not all. For example, energy and agriculture will
have segments with very rapid growth. Below is a very brief snapshot of where we
see opportunities.
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E-tailing. The online share of retail in China, at 8 percent in 2014, is higher than it is
in the United States and is not close to
reaching saturation. Increasingly, this is
conducted through mobile devices. The
payment system is in place, logistics are
improving, and online provides are trusted.
Many retailers will adapt, often with far
fewer physical locations. Malls will have to
become destinations for services beyond
retail.

Logistics. Modernization of supply chains is a key enabler of increasing productivity

in many sectors in China today. Until recently, most goods were carried by individual
truck owner–operators. As express parcels become a $100 billion industry on the back
of e-tailing, e-commerce companies themselves are investing billions in modern
warehouses and trucks. Alibaba alone is
committed to spending billions of dollars on
its own logistics. Third-party carriers such as
SF Express are rapidly becoming regional
leaders on the back of growth in China. Even
in agriculture, massive investment is under
way in cold storage and cold carriage to
reduce waste and provide higher-quality food
products to China’s middle class.

Education. Nearly two-thirds of registered kindergartens in China are privately

owned. Private universities are expanding. Traditional and online vocational learning
schools are publicly listed multibillion-dollar businesses. Niche businesses, such as
preparing children to apply to US, UK, and Australian high schools and universities,
are also flourishing. The amount the Chinese are willing to spend on tutoring and
support for their children is almost unlimited. As the middle class becomes wealthier,
the increased ability to spend will drive market growth.

Healthcare. More than 1,500 new private hospitals opened in China in 2013, a
number of which are 100 percent foreign
owned. The shortcomings of the
mainstream public healthcare system in
China are not likely to be overcome
quickly. Patients are looking for solutions
where both cost and quality are more
certain, and private and foreign companies
are being encouraged to deliver. There is a
related boom in supplying equipment to
these new facilities.
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Tourism. Available hotel rooms in China have tripled over the last decade. Four
million mainland Chinese visited South Korea in 2013; four million visited Thailand.
China’s middle class expects to take three to four weeks of vacation each year and no
longer accepts visiting the overcrowded, overexploited traditional domestic
destinations. Disneyland’s opening in Shanghai in 2015 could trigger a new wave of
investment to create higher-caliber resorts.

Wealth management. China represents more than 50 percent of Asia ex-Japan growth,
with high-net-worth assets expected to reach $16
trillion by 2016. The more than one million
high-net-worth individuals in China remain
generally unsophisticated as investors, seeking
advice on how to broaden their investment
portfolio both onshore and offshore.

Entertainment. China is the second-largest movie box office market in the world,
despite the fact that tickets cost upward of $10 and DVDs are still available for $1. In
2013, more than 1,000 new theaters opened, yet admissions per capita are less than
one-fifth of South Korea’s.

IT Services. Finding the chief information

officer in a Chinese company if often hard,
especially in a state-owned enterprise.
Historically regarded as simply a support role
for the business, CIOs were pushed three to
four levels down in the organization and
attracted little talent (which instead went to
Internet start-ups). Atypical Chinese company
spends only 2 percent of revenue on IT versus
international benchmarks of around 4 percent.
As these companies struggle to bring technology into the core of their operations, they
need massive amounts of help to do so. The cost of good IT talent is already soaring.
Most Chinese companies will be unable to solve their technology challenges for
themselves.

Clean energy. China already produces 60 percent of solar panels and wind turbines.
Increasingly, it is consuming this output domestically. For example, 11 gigawatts were
installed in large-scale solar farms in 2013, and this will grow an additional 30
percent in 2014. China is also investing heavily to exploit its shale-gas assets and
develop cleaner coal technologies.
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Agriculture. China does not feed itself today—certainly
not with the kind of quality and value-added products
that the middle class seeks—but it will be challenged to
do so in the future. Continual food-safety crises
illustrate the challenge. For many successful technology
investors, such as Legend Holdings, agriculture is the
new Internet. Chinese companies are investing in
agriculture outside of China at scale, from Chile to the
Ukraine, for China. They also invest in China,
especially in value-added products—such as fruit and
the production of frozen ready meals.

References

Wenqing Liao, China’s new Foreign Direct Investment Policy – Investing in China,
http://spiegeler.com/chinas-new-foreign-direct-investment-policy-investing-in-china/
Ken Davies, China Investment Policy, OECD publishing, 2013
Guoqiang Long, China’s Policies on FDI: Review and Evaluation
Gordon Orr, A Pocket Guide to Doing Business in China, McKinsey & Company,
2014(3)