China Expecting a Long-Term Slowdown of FDI Inflows

In recent years， the development of FDI in China has demonstrated two major characteristics: the pace is slowing down， even continuously showed negative growth; disguised foreign investments account for an excessively high proportion. Investors from countries and regions in Asia， especially Hong Kong and Macau and some dutyfree islands， have dominated the FDI in China for a long time. In the last two months， investing capital flowing out of these areas added up to US$15.379 billion， accounting for 88.67% of the total amount of FDI in this period. However， a large proportion of FDI from these areas are “disguised FDI”， which comes from domestic sales of commodities originally produced for exports. It actually has greatly reduced the international technology spillover effect of FDI and affected the overall quality of FDI entering China. As a matter of fact， China’s economic development and continuous growth of its total factor productivity， since the reform and opening up， are the result of productivity liberation to some extent. But mainly， they rely on the technology and management spillover brought by FDI.

The major cause for the ongoing negative growth of FDI in China， we think， is not the adjustment of China’s FDI policies. Instead， it is because that the marginal rate of return on investment income in China is gradually decreasing to the level of other countries and regions. To be specific， along with an aging population in China， some resource managements have a high degree of external dependence and under the high inflation pressure， wages and factor prices are also rising， especially the price of some energies monopolized by stateowned enterprises， which is now close to and even higher than the price on the international market. For example， the domestic oil price is now significantly higher than that in Europe and the United States. Obviously， these factors have greatly reduced the marginal rate of return on capitals in China， as well as the appeal of China to foreign investors.

After the global financial crisis， European countries and the United States suffer from an economic downturn and great loss of job opportunities. The relatively high unemployment has reduced the wage level in these countries. Besides， other factors， such as the relatively higher labor productivity in Europe and the United States and the high cost for logistics and cross-border trade， have all made it economically possible for European and US manufacturers in China to return to their homeland. In the second half of last year， there was an obvious reflux of foreign capital and decrease of FDI， mainly US investment. This year， EU investment reduction is more prominent. The latest statistics released by the Ministry of Commerce showed that， in the first two months， the actual input of US capital was $525 million， a year-onyear increase of 0.87%， but compared with the once input of $906 million， it has decreased by 33.32 %. The reflux of European and US capital， on the one hand， has led to a continuing weakening of offshore RMB exchange rate since last September， and on the other hand， slowed down the accumulation of China’s foreign exchange funds， even causing negative growth. This has also caused tight liquidity within the domestic formal financial institutions and finally pressured the central bank to cut the deposit reserve ratio to ease the liquidity of the financial system.

In addition， other reasons why China is attracting less FDI include that， in recent years， the state-owned capital becomes increasingly strong， reform of the key sectors lags behind， the turnover tax puts a heavy tax burden on foreign investors and the protection for intellectual property rights is not effective and sufficient. First， the expansion of state-owned enterprises has not only compresses the investment space of the domestic private enterprises， but also limits the investment of foreign capital. Second， due to the monopoly of state-owned enterprises in financial and energy area， the price of some factor resources is soaring， increasing the operation cost of FDI， reducing the return on investment and thereby， impeding investors’ willingness to invest in China. Third， the turnover-taxdominated tax system in China puts a much heavier burden on foreign investors than other countries and once the return on investment in China decreases， foreign investors have to carry an excessively heavy turnover tax burden. Therefore， they are more willing to shift their investment to their own countries， or to Vietnam and India. Fourth， although in recent years， China has strengthened the protection of intellectual property rights， some intellectual property infringement are still not effectively curbed， which also， to some extent， weakens the willingness of foreign investors to invest in China.

The weakening ability to absorb FDI of China also reflects the fact that， along with the aging trend of the whole world， all the countries are facing the common problems of dropping savings rate and widening savings gap. That means， the slowdown of FDI inflow in China will be a long-term trend， instead of a short-term effect. In the future， all the governments will take efforts to cut tax， release regulations and adopt other policies to attract foreign investment， so as to boost the development of the economy.

Nowadays， as China’s vast population is aging rapidly， the continuous decline of the savings rate in China is inevitable. Therefore， absorbing more foreign investment to boost domestic economy is beneficial to the longterm interests of China. To effectively attract foreign investment and make full of external savings， China should deepen its domestic reform， break the monopoly of state-owned enterprises in key sectors and guide the SOEs to withdraw from these competitive areas. In the meantime， it should clarify the boundaries between the government and the market， and ease government regulations， so as to reduce economic and social operation cost. Apparently， these pragmatic reformative measures will contribute to more foreign investment inflows and at the same time， stimulate the vitality of domestic capital and restrain the outflow of domestic capital that is caused by the lack of investment channels within the country.