Numerous media reports noted last week that foreign investment into China was down 80 percent last year compared to 2022 and was at its lowest level in 30 years. That is a statement about inflows, not about the total stock of foreign investment in China, which remains high. Investment tends to fluctuate from year to year, and there is always the question of whether a new data point represents a blip or a trend. In this case, it is beginning to look like a trend. So, for the sake of argument, let’s assume that and take a look at why it is happening and what it might mean, keeping in mind that I’m not a professional economist. If you get really excited about this stuff, you should consult one of those. There is no shortage of economists commenting on China right now.
There is rarely a single cause for big events, and this case is no exception. The Chinese economy is going through a period of significant difficulty right now. The rate of growth is declining, though still positive, and unemployment appears to be up, though the government stopped reporting some data. The real estate bubble appears to have burst, which is dragging down the rest of the economy. Overall, it looks like demand is not growing fast enough, and supply continues to grow too fast, making the threat of deflation an additional problem. China is keeping interest rates low in order to stimulate growth and demand, while rates in the United States remain high, at least for the time being. These are all factors that tell foreign investors that now is not a good time to invest in China and the United States is currently a better option.
There are also political factors. The Chinese Communist Party (CCP) under Xi Jinping has continued to tighten its control over the population and the economy, including Western investors. Companies are being raided and employees detained. The CCP is clearly more interested in control than growth. This has directly influenced foreign investment because of Chinese efforts to close and otherwise harass companies that undertake due diligence services for foreign investors. It is standard procedure throughout the world for investors to retain professionals to investigate potential investment targets, but China seems more concerned about preventing the gathering and transmission of information to foreign sources. That has come back to bite them as investors turn away since they can no longer get the information they need to make an investment decision.
More difficulties are looming since it is beginning to appear that China’s leaders will once again attempt to solve the country’s domestic economic problems by exporting its way out of them. They have done this repeatedly in the past, but this time it may catch up with them, as more countries besides the United States have seen this movie before and are more willing than ever to take action. Treasury Secretary Janet Yellen was in China last week, and the issue of overcapacity of manufactured goods was at the top of her list of complaints. This is a chronic problem in China. When credit is allocated by the state rather than the market, you inevitably get overinvestment in favored sectors, which produces overcapacity, which leads to overproduction, which is then dumped on the rest of the world. Think steel, aluminum, wind turbines, solar panels, and, soon, electric vehicles (EVs).
The market economist’s solution to that is to open up the economy, reduce the role of state-owned enterprises (SOEs), and work harder to grow domestic demand in order to soak up the excess supply. Chinese economists, trained in Marxism-Leninism, seem more focused on further growing supply. They also know that advocating reducing the role of SOEs would not be a good career move as long as Xi Jinping is in charge.
Foreign responses to Chinese overcapacity have been to use existing trade tools, primarily antidumping and countervailing duty laws, to slap tariffs on dumped or subsidized imports. Those laws are now being criticized as too little, too late. They take a year or more to investigate and provide relief, and they often do not deal effectively with Chinese strategies to circumvent the tariffs, as we have seen most recently with solar panels coming through four Southeast Asian countries. There now appears to be growing interest in taking defensive actions more quickly and decisively. The European Commission launched an investigation into Chinese EV imports that will most likely result in tariffs being imposed this summer. Members of Congress are calling for preemptive duties on Chinese EVs (and legacy chips) to prevent the same thing from happening here, and the administration appears to be considering them. Those tools can work, but this is still a whack-a-mole problem, with new cases appearing every time an old one is addressed. The better solution is for China to change its policy. Secretary Yellen is working hard to convince China that further capacity building is not in their interest nor in anybody else’s, and the latest investment data is an important talking point for her. If China is serious about attracting the investment it says it wants, it needs to make significant changes in economic policy and in its practice of making life difficult for foreign companies and businesspeople.
William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.
