Title

Will Investment in China Grow or Shrink?

A ChinaFile Conversation

Donald Clarke:

I don’t have the answer as to whether investment in China will grow or shrink, but I do have a few suggestions for how to think about the question. First, we have to clarify why we want to know the answer to this question: what do we think it will tell us? This means we have to clarify whether we are talking about domestic investment, foreign investment, or both. We also have to clarify whether we are talking about an absolute decline in investment or merely a decline relative to total GDP.

Why do these things matter? Scholars have long posited a relationship between the quality of domestic legal institutions, investments, and growth. Indeed, it seems intuitively plausible that people will not invest, and the economy will not grow, when legal institutions—or at least some institution somewhere—cannot guarantee that they will enjoy the fruits of their investment. It has long been argued by the foreign business community that China needs to improve its legal system in order to continue to attract foreign investment, and it is certainly true that in the post-Mao era, increased foreign investment has gone hand in hand with the construction of China’s legal system.

Recently it has been cogently argued that China’s commitment to increasing legalization is essentially over; that we see a “turn against law” and a search for a different path that explicitly privileges politics and official discretion. Suppose we now observe a decline (relative or absolute) in investment. Case proved?
Not necessarily. Remember that at this moment China faces a major problem: the need to rebalance its economy and change from an investment-driven growth model to a consumption-driven one. If the government succeeds in doing so, we will see investment as a share of GDP go down. But this is a good thing, not a bad thing, and doesn’t necessarily tell us anything about incentives to invest. Thus, although we have recently seen many news stories about the difficulties faced by foreign firms in their China operations, it’s important to remember that we have to be very careful about drawing conclusions simply from rising or falling numbers.

Comments

After discussing company investments and new staff assignments to ‘perfect our arrangements’ and operations in Shanghai, Hong Kong, Beijing and Tianjin, the annual report from Reuters in the year 1900, added: ‘Although China is politically important, it is not a remunerative field for us, and it will be some time before we reap the fruits of our enterprise.’

Well over a century later, that’s a sentence that many foreign companies equally could—and do—write.
Hope, expectation and the logic of size drive the ambition; realities frustrate and disappoint.

I think foreign investment in China will be bounded by two factors. The bottom will always be protected because China remains too big and important and too filled with promise to ignore. The top will be bounded because turning a real return continues to be difficult, and there are places that are simply easier and more remunerative to operate.
As China rebalances its economy to spur domestic consumption, as the world’s greatest-ever experiment in rapid urbanization continues apace, as China’s population changes its demands, and as the sheer size and importance of the economy asserts itself, the shape of China’s own domestic investment will mature and change. The lure for foreign companies seeing the promise and opportunity will only continue.

The trick will be for that upward bound to be expanded—or even removed. True level playing fields, confidence in legal safeguards, transparency, an end to corruption—these are some of the things that would lift that upper barrier. And make the promise much more realisable.