Bears in a China Shop: AmCham China's Latest Survey Shows Growing Worries

The American Chamber of Commerce in China (AmCham China) on Wednesday released the results of its latest annual membership survey. Although there were a few notable bright spots, American firms increasingly feel like unwelcome guests who face unclear prospects for future growth. As a result, companies are limiting their expansion plans, and China is becoming less central to some firms' global business plans.

Although American companies account for less than 5% of all foreign investment in China, they represent a who's who of global industry titans, and their opinion is a solid barometer of how the foreign business sector in China feels more generally. This year's survey yielded a much higher response rate than in the past -- 477 valid responses compared to 365 in 2013 -- which lends these findings even more weight. Moreover, with the results being issued in mid-February, before the annual National People's Congress conclave, rather than the traditional release time in April, the results are sure to receive even greater attention than in years past.

A Few Reasons for Being Bullish

Companies are in business to make money, and American firms in China are no exception. The proportion of highly profitable U.S. firms has fallen, but the percentage of respondents making at least some profit has held steady at over 70% for the past few years. A slight plurality of firms (42%) are making profit margins that are higher than a year ago, compared to those whose income has remained the same (41%) or fallen (17%). Firms in consumer- and service-oriented sectors are the most positive about their current business and future opportunities. 43% of firms in services see the environment as improving, which is 10-15% points higher than firms in any other sector. Localization of products and services is now a dominant approach for most of AmCham China's members. Finally, theft of intellectual property (IP), one of the thorniest problems over the last few decades, has receded as a concern. Although members report that IP theft is a bigger problem in China than in other markets, a whopping 86% of respondents report that China's IP environment has improved over the last five years.

A Bear Run

Despite those positive signs, the broader picture is of a deteriorating environment akin to Beijing's soupy smog of a skyline. Some of the pessimism is a result of the broader downturn in China's economy. Slow growth in China, abetted by low commodity prices globally, has hurt everyone's bottom line. This cyclical economic correction is made more challenging by problems that have gradually become more severe. The number one problem firms face is rising labor costs, with a shortage of qualified employees and quality managers also among companies' top five worries. And for the first time ever, China's poor air quality is an impediment to recruiting expats for a majority of firms (53%), up from only 19% in 2010. Wages in China are destined to continue rising, and sufficient top-level domestic talent will only emerge as China's educational system is reformed. And heaven knows when the skies and rivers will clear. The last type of problem firms face is growing protectionism. The Xi Administration has made reforming China's economic development model a top priority, and has announced and rolled out a slew of positive policy changes. But at the operational level, the daily trickle of reform measures is being swamped out by what feels like a larger wave of aggressive bureaucratic actions, including a spate of antimonopoly cases and growing constraints on the Internet and IT firms. Fully 47% of all respondents believe foreign firms are less welcome in China than in the past, with the largest dissatisfaction levels (53%) coming from firms in R&D-intensive industries, resources, and manufacturing.

Not Heading for the Exits - Yet

The problematic environment is having several effects on business behavior. First, China is no longer the top priority for firms' global investment plans. It still ranks among the top three for 44% of firms (down from 58% in 2012), but 27% of firms see China as just "one among many destinations," up from only 15% in 2012. The unbridled enthusiasm of years past is over. As a result, a majority of respondents plan either to not expand investment at all or by no more than 10%. And in what perhaps should be more worrying for Chinese authorities, 15% of all those polled (and 23% of those in resources and manufacturing) report that their company has or will move capacity outside China as a result of rising labor costs. Had AmCham not included the labor-cost qualifier, the percentage would no doubt have been higher.

Despite the uptick in offshoring some China production, at this point we are unlikely to see a massive run for the exits. A large majority of firms are still profitable, and most are focused on China for its domestic market, not as an export platform for the rest of their global business. China's consumer economy may be stunted, but it is still growing at a relatively rapid pace and could potentially expand much more rapidly if reforms take hold in health care, education, and financial services.

Equally important is the limited existence of alternative investment options. For all of its many problems, China's business environment has improved substantially over time and is on par with most of the other likely alternative destinations for foreign investment in Asia. According to the World Bank's "Doing Business" project, China ranks a middling 90th out of 189 countries in its business environment. While far below some of its neighbors, most notably Malaysia (18), the PRC's environment is similar to that of Vietnam (78) and Indonesia (114), and much better than that of India (142). The U.S. International Trade Commission recently completed its own survey of American firms in India, and the results were more disheartening than AmCham China's report card for the PRC. And while foreign direct investment is heavily affected by a country's overall business climate, it is also substantially shaped by the absolute size of the economy.

China's mammoth size means that most investment bears will put up with a wintery climate for some time as long as they have some chance to find sustenance. Of course, the American business community will continue to point to problems and identify potential solutions, many of which are in China's own self-interest. But given the inherent attractiveness of the Chinese market for foreign firms and the authorities' commitment to give as a great a boost to Chinese industry as possible, we should not expect the Chinese government to simply rollover and fully acquiesce to these arguments in the near term. That focus on domestic industry is not surprising when one remembers that although foreign investors often represent the cream of the crop, foreign investment accounts for only 0.9% of all fixed asset investment in China.

The rhythm of China's engagement with the global economy -- massive yet gradual, incremental, zig-zag -- shows no signs of abating. As a result, we should expect to see a similar mix of progress and concerns when AmCham takes the pulse of its members next year.

Scott Kennedy is deputy director of the Freeman Chair in China Studies and director of the Project on Chinese Business and Political Economy at the Center for Strategic and International Studies in Washington D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Scott Kennedy
Senior Adviser and Trustee Chair in Chinese Business and Economics