China’s Drop in FDI Signals Shift in the Global Supply Chain

April 23, 2013 Posted by China Briefing Reading Time: 5 minutes

Export manufacturing moves on while sales-driven structures move in

Op-Ed Commentary: Chris Devonshire-Ellis

Apr. 23 – The 2012 drop in foreign direct investment in China is pointing out that manufacturing capacity is being rethought by MNCs considering global trade as a whole. The drop – some 4 percent from FDI figures in 2011 – is down to a number of issues, not least the emergence of competing destinations elsewhere in Asia for the same FDI dollars. However, it’s not indicative of any particularly bad news on the China front as the country still attracted US$111.7 billion in FDI in 2012 after a record US$116 billion in 2011, and the country remains one of the top destinations for corporate expansion. It should also be noted that China’s exports last year hit US$2 trillion in a sign that the world’s second largest economy continues, for the time being at least, to be the world’s manufacturer of choice.

Yet that decline in FDI does demonstrate that China is beginning to face some issues. For one, it aptly indicates that the country needs another catalyst to drive FDI inflows now that the massive increase from joining the World Trade Organization has hit a natural plateau.

“We will see FDI bouncing around US$110 billion to US$120 billion for some years,” said Tim Condon, an economist with ING in Singapore. “Hopefully, the current administration is going to intensify reform efforts, such as opening of the capital account. That could be momentous, in terms of attracting more FDI.”

Condon’s comments aside, opening China’s capital account will not be easy. While FDI would increase as a result, money would also flow out creating a situation that terrifies the government. It would also likely lead to a collapse of China’s housing bubble where a one-bedroom apartment in Guangzhou now costs the same as the four-bedroom detached house I recently purchased near Lake Ontario. Allowing capital flows into and out of China will be a gradual process of reforms, and not one that will happen overnight.

The decline of FDI into China came mainly from Europe, but tellingly also from existing Asia-based businesses. The European problems are well known, however the Asian figures point to a resurgence of interest in investing in other Asian countries as opposed to China. In fact, while China declined in FDI terms, countries such as Singapore, Vietnam, Myanmar, Indonesia, Bangladesh and the Philippines were sharply up. With the exception of Bangladesh (which is not a member of ASEAN), the answer to where foreign investment seems to be heading is simple – towards ASEAN and its free trade agreements. This a subject we covered in detail in a recent issue of our Asia Briefing Magazine “Are You Ready For ASEAN 2015?”

The impact ASEAN is having on Asian trade flows is an evolving issue, yet one that will have a dramatic impact over the shape of FDI into China over the course of the next decade. It is in fact Asia, not China, that is being called upon to produce the world’s growing consumer hunger for cheap produce. While it is true that some manufacturing units in countries such as Cambodia and even Vietnam are not yet as productive as China’s factories, the increasing costs of Chinese labor set against the improvements in infrastructure and productivity across alternative Asian nations will mean that FDI will continue to be attracted to these alternative markets. These matters are given, and will not change. China’s drop in FDI attraction is indicating that capacity is not being added to existing manufacturing plants in China, and that the financial demographics now make investing in alternative Asian destinations a suitable hedge against an increasingly expensive China.

China’s free trade agreements with ASEAN are already in force affecting some 7,000 different products which can be traded duty free across those borders. It makes more sense to pay factory wages in Vietnam that are 30 percent less than a factory in China even if you lose that 30 percent through inefficiencies in Vietnamese production – because the Vietnam’s production and infrastructure is improving, and China’s costs will only increase. It is this phenomenon that is now showing up in China’s FDI decline and is subsequently translating into the rise of FDI into ASEAN. In the case of Vietnam, their policy towards attracting even more FDI is becoming quite aggressive, and a reduction in corporate income tax from 25 percent to 23 percent is expected to kick in from January 1, 2014 (China’s corporate income tax rate is 25 percent). Clearly, the bean counters are, and will continue to be, taking note.

But this doesn’t mean that China will cease to be an attractive place for investment. Interestingly, American investment into China is increasing and FDI flows from the U.S. into China went up by 4.5 percent last year. Having spent much of the last month lecturing across the United States, I believe the reason is clear – middle market American businesses are now seeing opportunities to sell their products to China. This means that the nature of FDI into China is changing. Export manufacturing is giving way, slowly, to marketing, sales and distribution channels for foreign goods now to compete with domestic brands across the country. I have also discussed the rise of the amount of wealth the average Chinese consumer has in “The Rise of One Billion Consumers.”

China itself has also responded to its own changing demographics and the type of FDI it is looking for. A few weeks ago, and again published here on China Briefing, the Central Government issued guidelines for attracting foreign investment. I also discussed this in the article, “The Key National People’s Congress Takeaway – Developing China’s Domestic Consumption Is Vital for Growth.”

The heart of the matter is that export-manufacturing in China is on the move and countries such as Vietnam, Malaysia, and Indonesia are seeing increased investments as a result. Understanding the composition of FDI is the key, and it is clear that as manufacturing moves away from China, the global supply chain will dance around Asia instead. However, FDI into China will be fine as foreign businesses move into the market with the aim to sell to the country’s abundant, and increasingly wealthy, consumers. The increasing choruses I hear from investors interested in China is this: “How do I get my sales and distribution networks in position?”

Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates – a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia.

For further details or to contact the firm, please email china@dezshira.com, visit www.dezshira.com, or download the company brochure.

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