Foreign investors are fleeing China. Portfolio investment that flows into traded stocks and bonds has turned negative, and so has foreign direct investment, which goes into building plants and businesses.
Why have investors suddenly turned so negative on China? What impact will this have on the longer-term Chinese economy?
Whether investment in China or other investments, there isn’t one reason but rather a host of reasons that an investment is either made or rejected. Investors, whether hedge fund managers or multinational corporations building a plant, are motivated by money. For years, the Chinese market has been seen as an instant money maker, and the market is continually just out of reach.
Companies operating in China typically had to enter into joint ventures or turn over their competitive edge, such as technology, which many quickly found was siphoned off into other companies or competitors. Foreign banks and asset managers always anticipated the grand market opening that had never come, where they could compete for business. Chinese bureaucrats were skilled at offering just enough to keep businesses interested but rarely gave anything of substance. Foreign investors looking to invest in Chinese stocks have learned the hard way that Chinese stocks have been roughly flat for 20 years. The first problem China faces is that too many investors have been burned in China.
Politics has contributed to the outflows. Before Chinese leader Xi Jinping took office and even in the early years of his rule, foreign businesses operating in China made enough money to compensate for the risks and trade-offs necessary. However, to use a clean dividing line, with the fabricated detention of Canadians Michael Spavor and Michael Kovrig, the approach to foreigners and foreign business changed.
After the global financial crisis, a China posting by an ambitious junior multinational corporation executive was seen as a requirement for an aspiring senior executive. Coupled with the cushy pay packets, business and labor were anxious to take the first flight out. With businesses required to provide government access to pretty much all technology, internal emails and networks, draconian national security laws, and a highly protected market, the multitude of risks facing foreign businesses has driven many to say that the difficulties just aren’t worth the potential profits.
Chinese business faces the gravity constraints of the state: A Chinese business will remain a Chinese business. An international company deciding where to invest, source from, or build has many options, including Vietnam, India, Germany, and the United States. China now has to compete for international mobile capital; so far, it doesn’t appear to be interested in competing.
So what are the implications of foreign investment leaving China?
None of them are good for China or the rest of the world.
China benefited enormously from opening its markets. From the spillover effects it gained from local firms and workers competing against and working for foreign firms to the flow of technology and hard currency, China gained significant benefits from direct interaction with foreign business and trade.
With foreign business and investment looking for other destinations, there are a number of clear implications. First, companies will become less of an advocate for China. In reality, China outsources many of its quasi-lobbying efforts of democracies to companies and institutions in the country. It will be much harder for businesses to lobby their representatives or other companies when they go elsewhere.
Second, look for investment and trade to diversify away from China and into other countries. India and Vietnam, as well as other Southeast Asian destinations, are benefiting from companies leaving China. International trade and investment don’t vanish; they seek new destinations.
Third, expect China to become increasingly restrictive on existing business and investment, both domestic and international, whether it’s entering or leaving. The People’s Bank of China just recently announced verification measures for even state-owned enterprises making purchases of U.S. dollars more than $50 million. Though many expect China to reverse course and seek out international capital flows, this simply doesn’t grasp the nature of the situation in China.
Fourth, expect China to continue to experience weak productivity growth. Foreign enterprises, and even private Chinese enterprises, are the most productive and innovative businesses in China. With private enterprises and foreign businesses pulling down or facing sharp restrictions, this will hamper innovation and depress already low productivity growth rates. Don’t expect China to stop growing, however, neither should we expect a healthy, dynamic, competitive economy.
Fifth, as investors leave, expect Beijing to tighten restrictions on foreign exchange transactions. The Chinese are already utilizing various methods to help move U.S. dollars out of China or ensure that they never enter, causing headaches for the Chinese foreign exchange regulator. China desperately needs U.S. dollars to keep international trade flowing and money growing. This means that regulators will continue tightening up on trade and capital flows to ensure that they achieve their desired balance. If they aren’t getting as much from abroad, that means that they have to stop sending it abroad. That will only get worse.
Investors aren’t making money in China, and the politics just compounds the risks, which are unlikely to change any time soon. As money finds other destinations, expect more continued tightening and inefficiencies as China becomes more ossified.
