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In November, China reported a negative foreign direct investment balance of $11.8 billion for the first time since it opened its economy to the world in 1998.
Ordinarily, this news would be bad enough but the timing could not be worse.
China’s economy is already struggling because of a real estate debt crisis and the government is giving out special loans to try to save collapsing real estate companies. But it still might not be enough to avert disaster.
So far the crisis has been exacerbated by foreign investors quickly losing faith in China as the cracks in this Asian powerhouse economy are revealed.
On top of this, multinational companies are starting to halt operations in China due to a mix of economic sanctions, geopolitical tensions, and uncompromising Chinese policy.
This brings up some questions, like why are investors and businesses leaving China? And what does that mean for the future of the world’s second largest economy?
China Loses Foreign Investment
China’s foreign investment outflows exceeded its inflows, resulting in a negative balance of $11.8 billion FDI in the country’s balance of payments for the first time since monthly figures were made available.
No one would have believed this was possible at the start of this year. In fact, global investors began the year by putting $25.05 billion in Chinese investments during just the first five months of the year. This number is really significant since it is a whopping 293% increase from the entire FDI in 2022.
The huge increase can be explained by the positive economic data coming out of China in early 2023 which led foreign investors to become particularly bullish on the country as its harsh Zero-Covid policies eased.
As a result of its zero-covid policies, China experienced a 3.9% loss in GDP in 2022. While this was a major economic shock, it looked like the situation in 2023 would improve as Chinese stocks became among the best-performing globally. However, this was more a reflection of investors’ expectations for an economic recovery than the reality.
When the recovery failed to arrive in due time and the Chinese market underperformed, foreign investors began selling their Chinese shares at an alarming rate. In April, $659 million were withdrawn from Chinese markets, shares worth $1.71 billion were sold just a month later, and in just the first 14 days of August, $3.7 billion was pulled out of Chinese stocks.
It wasn’t just foreign investors taking their money out of China. Multiple multinational companies were also moving profits made in China out of the country, refusing to reinvest them in their operations.
Those foreign companies, especially the ones that operate in the tech industry, decided to either cease their manufacturing activities in China or limit them as much as possible in order to build a more diverse supply chain that doesn’t depend on one country.
What Went Wrong?
The Trade War
The problems began to show when the U.S. and China got into a trade war in 2018, with both countries imposing extensive tariffs on commodities traded between them.
The U.S. started the trade war to stop state-owned Chinese companies from extorting patents and rights to intellectual property from American tech companies operating in China. America’s dedication to this cause is still strong after five years, announcing tighter restrictions on investments in important technology such as chip manufacturing and AI in China back in August.
In response to the escalating tensions between the two countries and the pressure the U.S. government put on American companies that manufacture in China, many tech companies started downsizing their operations in China.
A good example for this is Dell Technologies, which moved its production and supply chains and made a plan to shift up to 30% of its notebook production out of China. In addition to that, the company announced that it will reduce the amount of Chinese suppliers it works with, and that it will stop using Chinese-made chips. This shift came shortly after the Biden Administration limited the export of American semiconductor chips to China.
Evidently, the sanctions the U.S. put on China greatly impacted the foreign investment in the semiconductor sector, with China’s share greatly decreasing from 48% in 2018 to 1% in 2022.
In contrast, the U.S. share increased from zero to 37%.
The Economic Slowdown
Despite the U.S.-China tensions being a big reason for foreign companies to move out of China, with 66% of companies in AmCham China listing it as their biggest concern for the future of corporate investment in China, there are many other reasons why foreign investors no longer want to stay in China.
The biggest of all is the country’s slowing economy, caused by an ongoing real estate crisis and deflation. Chinese people have preferred for a long time to invest in housing instead of the stock market, so they lost money and were discouraged from spending when massive real estate companies defaulted on their debts in quick succession.
Besides the problems in the property sector, the rising unemployment rate of people aged from 16 to 24 years old also discouraged spending, increasing from 15.3% to 21.3% from 2022 to 2023. This demographic was especially stressful to Chinese families that were affected by the one child policy, causing parents and their children to worry about future financial security.
It’s also important to note that the lack of foreign investment directly affects the unemployment rate, as foreign investment generated around 40 million jobs in China, equal to 10% of the workforce.
But the Chinese government chose to follow its trends of opaque policies and moves, and decided to stop publishing unemployment figures instead of addressing the issue.
Manufacturers’ Problems With China
China’s economic slowdown might affect retailers, but for manufacturers it could be an opportunity for cheaper costs, but even manufacturing companies have reasons to leave China.
China is trying to move from having an economy that depends on exporting to one that depends on consumption and emerging new sectors. So, it started making its own technology devices and automobiles while encouraging Chinese consumers to buy Chinese products by reducing the costs associated with the purchase. This led to increased competition in markets that were once completely owned by foreign companies, like the automobile market.
This is why the Japanese company Mitsubishi decided to stop its operations in China after years of slow sales and losing money, stating that the competition in the local market wasn’t something it could keep up with. This probably has to do with the fact that Mitsubishi was late to adopt the trend of electric cars, and found itself falling behind.
The impact of the competition in this market was global, with China surpassing Japan as the top automobile exporter in the first six months of 2023.
China’s Counter-Espionage Laws
Lastly, business people and investors in China have been on a constant edge since China updated its counter-espionage laws and made them stricter, leading to government raids on foreign companies accompanied by accusations of spying and leaking sensitive information multiple foreign employees getting arrested and detained for hours.
With all of this in mind, the government of China developed a plan that would help bring more foreign investment in key industries, such as healthcare and green technology, into the country in August of 2023.
The plan proposes easier ways for acquiring visas and residency for employees of foreign companies, and increased financial and tax support for businesses and research and development centers.
What’s Next For China?
To sum everything up, foreign investment and foreign companies pulling their money out of China is hurting the country whose economy is already struggling with various domestic issues, such as the real estate crisis, youth unemployment and elevated debt.
All of this is hurting China’s growth prospects for the future, according to the World Bank, which cut China’s GDP forecast for 2024 from 4.8% to 4.4%.
China’s troubles aren’t exclusive to the country either, and a weakened Chinese economy would mean a global economic slowdown, a natural consequence when China has been the source of more than 40% of global economic growth in the past decade.
So the Chinese government must take every measure to bring back foreign investment and encourage foreign companies to operate in China again, but it can’t expect that investors would be swayed only with easier visas, when what investors are concerned about is getting insurance for the political risks associated with China. What it should do is adjust the policies that keep pushing global investors away.
Until that happens, China will remain a country that puts ideology over economic growth in the eyes of global investors.
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