US-China trade

Rising challenges for foreign firms in China

Michael Enright

Enright Rising Challenges For Foreign Firms In China

Published 10 September 2024

China’s business environment is becoming increasingly complex, with heightened regulations on data, national security, sanctions, and Communist Party influence, alongside massive state support aimed at displacing foreign firms. The evolving Chinese policies, economic headwinds, and geopolitical tensions demand a deep rethink by foreign companies of their China strategy.

China remains critical for multinational firms. It is the world’s second-largest economy and its largest manufacturing location and trading nation. China is also among the world’s greatest beneficiaries of foreign direct investment (FDI). As of the mid-2010s, approximately a third of China’s GDP could be traced to foreign-invested enterprises (FIEs), their supply chains, and the consumer spending of related employees. However, the evolution of Chinese policies, slower economic growth, changing consumer behavior, and geopolitical tensions require a rethinking of China strategy for many foreign companies.

The policy environment

Foreign firms have always found China’s policy environment challenging.¹ China reserves a substantial portion of its economy for the state or state-owned enterprises (SOEs) through a Negative List for Market Access.² China further restricts access to foreign companies through its Special Administrative Measures (Negative List) for Foreign Investment Access, while the financial sector has its own restrictions.³ While the number of sectors from which foreign firms are excluded has been substantially reduced over time, China is still among the most restrictive of the world’s large economies.

China’s industrial policies increasingly aim to shift the balance in favor of Chinese firms. The "Made in China 2025" (MIC25) program announced in 2015 included targets for Chinese firms to displace foreign firms in domestic and international markets across 10 key technology areas.⁴ Further support in these areas is embedded in China’s 14^th Five-Year Plan (2021-2025). They enhance longstanding industrial policy including subsidies for Chinese companies in R&D, training, specialized industrial parks, foreign asset acquisitions, as well as preferential access to finance and government procurement. The policies reinforce signals to the banking sector, investors, entrepreneurs, and others as to which sectors they should support. Meanwhile, China continues to force foreign firms to share technology to access the China market.⁵ The lack of IP protection in China has cost foreign companies hundreds of billions of dollars in lost revenues, and Chinese theft of IP may have cost trillions more.⁶ The stronger local capabilities and increasing assertiveness of these policies make them more of a concern for foreign investors than ever before.

While many aspects of China’s Cybersecurity Law, Personal Information Protection Law, and Data Security Law are similar to those found in other countries, limits on cross-border data transfers and related requirements on source codes, rights for government access, and for companies to keep data within servers located in China have been described as "paradigm-shifting"⁷ and "unprecedented."⁸ China’s expansion of its National Security Law and raids on foreign consulting companies have raised fears that even normal business analysis could be subject to arbitrary enforcement.⁹ The Anti-Foreign Sanctions Law passed in June 2021, a week after the Biden administration banned investment in 59 Chinese companies for aiding China’s military and security forces, allows China to seize assets from companies that comply with foreign sanctions on China and to take action against senior managers of such firms – and their family members.¹⁰

China requires firms over a certain size to have Chinese Communist Party cells. By 2018, an estimated 73% of private companies in China had set up such cells, including more than 100,000 such cells in foreign-invested companies. The extension of control by China’s party-state over all aspects of the Chinese nation has been a hallmark of the Xi administration. In 2016, President Xi Jinping called for the Party to integrate Party leadership "into all aspects of corporate governance."¹¹ This includes the private economy, both domestic and foreign companies.¹²

Recent developments have combined to worsen the pressure and uncertainty faced by foreign firms operating in China.

The economic and business environment

The size and growth of the China market has long been the main attraction for foreign companies. However, slower economic growth, a graying demographic, and an imploding property sector have changed the "China story." China’s 14^th Five-Year Plan (2021-2025) claimed the goal of overcoming abject poverty and providing a middle-income standard of living had been achieved and relegated headline economic growth in favor of development of key technologies, self-sufficiency, and national security. Given these forces, many analysts believe China’s growth will decline from historical rates of around 7% to 3%-4% per year.¹³

The competitive environment has also changed. While foreign companies were once technology and quality leaders in China, this is often no longer the case. China has become an innovation leader in artificial intelligence, high-speed rail, e-commerce, and e-marketing. Chinese companies have become a global force in electric vehicles, consumer electronics, telecommunications equipment, solar panels, and many other industries, competing not only in the low end, but increasingly in premium segments and industries as well.¹⁴ Localization and Chinese cultural branding are becoming more important, particularly to younger Chinese, and Chinese consumers have taken to e-marketing and e-commerce to a greater extent than anywhere else in the world.

The slower domestic growth and increased competitive pressures have made the China investment story less compelling.

The political environment

Foreign companies in China are finding themselves caught up in global geopolitics to a greater extent than ever before. Several Korean companies found themselves frozen out of the Chinese market after the deployment of the US Terminal High-Altitude Area Defense, or THAAD, anti-missile system in 2017. Lotte, which once had extensive operations in China, has essentially exited.¹⁵ Samsung Electronics, once one of the largest investors in China, closed its last smartphone factory in China in 2019¹⁶ and its last personal computer and television factories in 2020.¹⁷ In a classic case of Beijing’s selective deployment of non-tariff barriers in service of its foreign policy, Norwegian firms and products were barred from China after the 2010 award of the Nobel Peace Prize to dissident author Liu Xiaobo. It took six years and a written apology from Oslo to normalize trade relations.¹⁸ Australia found itself in a similar position in 2020 after criticizing China for refusing to share more information tracing the outbreak of Covid-19. H&M had retail leases and online access blocked after the company said it wouldn’t source cotton from Xinjiang.¹⁹ An Australian Strategic Policy Institute (ASPI) report cited 152 times China used what ASPI called "coercive diplomacy" against foreign companies or governments between the years of 2010 and 2020, an era that largely corresponds to Xi’s ascendancy.²⁰

Despite press commentary, it was China that initiated "decoupling" around 2005.²¹ China’s "dual circulation" strategy, Xi’s formalization of longstanding trade dogma, aims to reduce China’s dependence on the rest of the world while making the rest of the world more dependent on China. This appears to have succeeded: McKinsey reported that the rest of the world’s exposure to China tripled from 2000 to 2017 while China’s exposure to the rest of the world decreased by a quarter.²² China’s Belt and Road Initiative (BRI) is designed to "decouple" BRI countries from the West and Western institutions and couple them with China. The China International Payments System (CIPS), Beidou geolocation system, and "Digital Silk Road" are designed to do the same. It was the MIC25 program that galvanized a bipartisan and bicameral American answer, elevating an economic conflict that coalesced in kind around the Trump, and later Biden, administrations’ policy responses.²³

These growing geopolitical tensions, and China’s increased willingness to sanction companies officially or unofficially for acts or statements made anywhere in the world, further complicate matters for foreign firms. They dramatically increase the chances that companies will be caught in the tangle of public sentiment and political interests between China and their home countries.

Navigating the terrain

China is therefore increasingly complex for foreign firms. While restrictions on foreign investment have long been a fact of life in China, laws and regulations on data and cybersecurity, national security, sanctions, and Communist Party cells are new, have been expanded, or are being enforced to an unprecedented extent. China has always had aggressive industrial policies, but the scope, level of support, and attempts to displace foreign firms through massive state support are unprecedented in scale and scope.

Coupled with a Five-Year Plan that emphasizes self-sufficiency over headline economic growth, the rapidly developing capabilities of Chinese firms, and the emergence of a consumer market that increasingly favors local companies and brands, these factors represent a challenge of enormous proportions for foreign firms. This is particularly true as China’s economy slows, the market opportunity for some firms diminishes, and the potential to get caught up in geopolitical tensions grows.

While some foreign firms have exited China, most have stayed. In 2024, European companies were most concerned with China’s slowing economy, with an historically low percentage looking to expand in China.²⁴ On the other hand, East-West tensions represented the leading concern among American companies operating in China.²⁵ The situation is challenging, but China remains the world’s second-largest economy, contributes to a substantial portion of global growth, and is home to competitors and customers that may change the nature of industries globally, giving companies a strategic reason to face them in China.

For firms that continue to invest in China, it has become clear that they must think a lot harder about a lot more questions: Is their sector open or closed to FDI? Is it of strategic importance to China? Is it targeted by industrial policy? Are they a known leader by productive capability? Are they able and willing to transfer technology and expertise? Are they willing to support China’s key priorities? The nationality of the company matters. As a result, in addition to their traditional market, competitor, and consumer analysis, foreign companies now must assess the changing policy, business, economic, and geopolitical environment in China. They must ask how much of a role China plays in their global strategies. And ultimately, they must ask themselves what their appetite is for competing – and perhaps failing – in one of the world’s most important and challenging economies.

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[1] Michael J. Enright, Developing China: The Remarkable Impact of Foreign Direct Investment, Routledge, 2017.
[2] See Dezan Shira & Associates, "China’s 2022 Negative List for Market Access: Restrictions Cut, Financial Sector Opening," China Briefing, April 12, 2022, https://www.china-briefing.com/news/chinas-2022-negative-list-for-market-access-restrictions-cut-financial-sector-opening/ accessed August 17, 2024.
[3] See Dezan Shira & Associates, "China’s Negative List for Foreign Investment Access (New Edition): English Version Available," China Briefing, December 28, 2021, https://www.china-briefing.com/news/chinas-foreign-investment-negative-list-2021-edition-english-version/ accessed August 17, 2024.
[4] For foreign reactions to the Made in China 2025 Program, see European Chamber of Commerce in China, China Manufacturing 2025: Putting Industrial Policy Ahead of Market Forces, March 7, 2017, https://www.europeanchamber.com.cn/en/press-releases/2532 accessed August 17, 2024 and U.S. Chamber of Commerce, Made in China 2025: Global Ambitions Built on Local Protections, March 16, 2017, https://www.uschamber.com/international/made-china-2025-global-ambitions-built-local-protections-0 accessed August 17, 2024.
[5] Julie Wernau, "Forced Tech Transfers Are on the Rise in China, European Firms Say," The Wall Street Journal, May 19, 2020, https://www.wsj.com/articles/forced-tech-transfers-are-on-the-rise-in-china-european-firms-say-11558344240 accessed August 18, 2024.
[6] Nicole Sganga, "Chinese hackers took trillions in intellectual property from about 30 multinational companies," CBS News, May 4, 2022, https://www.cbsnews.com/news/chinese-hackers-took-trillions-in-intellectual-property-from-about-30-multinational-companies/, accessed August 17, 2024.
[7] Reed Smith, China’s Cybersecurity Law, January 2018, accessed August 18, 2024.
[8] Mike Orcutt, "China’s Unprecedented Cyber Law Signals Its Intent to Protect a Precious Commodity: Data," MIT Technology Review, June 1, 2017, https://www.technologyreview.com/2017/06/01/105843/chinas-unprecedented-cyber-law-signals-its-intent-to-protect-a-precious-commodity-data/ accessed August 18, 2024.
[9] Jill Goldenziel, "China’s Anti-Espionage Law Raises Foreign Business Risk," Forbes, July 3, 2023, https://www.forbes.com/sites/jillgoldenziel/2023/07/03/chinas-anti-espionage-law-raises-foreign-business-risk/, accessed August 18, 2024.
[10] Narayanan Somasundaram, "China anti-sanctions law to put squeeze on foreign companies," Nikkei Asia, June 11, 2021, https://asia.nikkei.com/Politics/China-anti-sanctions-law-to-put-squeeze-on-foreign-companies accessed August 20, 2024.
[11] Matthew Brooker, "Communist Party Cells? Nothing to See Here," Bloomberg, July 28, 2022, https://www.bloomberg.com/opinion/articles/2022-07-28/communist-party-cells-at-your-company-s-office-in-china-nothing-to-see-here accessed August 18, 2024.
[12] Dennis Kwok and Sam Goodman, "Chinese Communist Cells in Western Firms?," The Wall Street Journal, July 11, 2022, https://www.wsj.com/articles/communist-cells-in-western-firms-business-investment-returns-xi-jinping-11657552354 accessed August 18, 2024.
[13] Spencer Feingold, "Where is China’s economy headed?," World Economic Forum, June 27, 2024, https://www.weforum.org/agenda/2024/06/china-economic-outlook-growth-trade/, accessed August 18, 2024.
[14] See, for example, Bain and Company, China FMCG: Navigating through Turbulent Times, June 23, 2022, https://www.bain.com/insights/china-shopper-report-2022/ accessed August 18, 2024.
[15] "South Korea's Lotte seeks to exit China after investing $[SGD]9.6 billion, as Thaad fallout ensues" The Straits Times, March 13, 2019, https://www.straitstimes.com/asia/east-asia/south-koreas-lotte-seeks-to-exit-china-after-investing-96-billion accessed January 16, 2023 and "Lotte pulls out of China and focuses on Southeast Asia," Retail in Asia, May 27, 2022, https://retailinasia.com/featured/lotte-pulls-out-china-southeast-asia/ accessed August 18, 2024.
[16] Ju-min Park, "Samsung ends mobile phone production in China," Reuters, October 2, 2019, https://www.reuters.com/article/us-samsung-elec-china-idUSKBN1WH0LR accessed August 20, 2024.
[17] "Samsung Electronics to halt production at its last computer factory in China," Reuters, August 1, 2020, https://www.reuters.com/article/us-samsung-elec-china-pc-idUSKBN24X3K4 accessed August 20, 2024.
[18] Arwa Mahdawi, "Norway criticised over snub to Dalai Lama during Nobel committee visit," The Guardian, May 6, 2014, https://www.theguardian.com/world/2014/may/06/norway-snub-dalai-lama-nobel-visit accessed August 18, 2024.
[19] "China Canceled H&M. Every Other Brand Needs to Understand Why," Bloomberg News, March 14, 2022, https://www.bloomberg.com/graphics/2022-china-canceled-hm/, accessed August 20, 2024.
[20] Michael Walsh, "Norway once felt China's wrath – what can Australia learn from them?," ABD [Australia] News, September 3, 2020, https://www.abc.net.au/news/2020-09-04/norway-once-felt-chinas-wrath-what-can-australia-learn-from-them/12621056 accessed August 18, 2024 and Tasha Wibawa, "Australia and China's relationship has been turbulent. Here are some recent key moments," ABC [Australia] News, September 2, 2020, https://www.abc.net.au/news/2020-09-03/china-australia-deteriorating-trade-diplomatic-relationship/12618738 accessed August 18, 2024.
[21] J. Stewart Black and Allen J. Morrison, "The Strategic Challenges of Decoupling," Harvard Business Review, May-June 2021, https://hbsp.harvard.edu/product/S21032-PDF-ENG accessed August 18, 2024.
[22] McKinsey Global Institute, China and the world: Inside the dynamics of a changing relationship, July 1, 2019, https://www.mckinsey.com/featured-insights/china/china-and-the-world-inside-the-dynamics-of-a-changing-relationship accessed August 18, 2024.
[23] Brendan Murray, "Why Biden Is Doubling Down on Trump’s China Tariffs," Bloomberg News, May 23, 2024, https://news.bloomberglaw.com/antitrust/why-biden-is-doubling-down-on-trumps-china-tariffs-quicktake, accessed August 18, 2024.
[24] Ken Moritsugu, "European companies are less upbeat about China’s vast market as its economy slows," AP, May 10, 2024, https://apnews.com/article/china-foreign-business-european-chamber-d0f2df56553e4aa41af65171bb84f8b8, accessed August 18, 2024.
[25] Elaine Kurtenbach, "Tensions between Beijing and Washington are the biggest worry for US companies in China," AP, April 23, 2024, https://apnews.com/article/china-foreign-business-biden-7ca061b49b1c1d3d42cbf7e5dfb760c8, accessed August 18, 2024.

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