Foreign investment is showing new patterns, which requires new policies 　　 　　With the robust growth of the Chinese economy and the further opening up of the Chinese market, the government is continuing to develop regulations and policies on foreign investment. Since the beginning of last year, the preferential sectors and sources of foreign direct investment (FDI) have exhibited new characteristics.
　　After years of rapid increases, foreign investment reached a record high of $60 billion in 2004. Growth began to slow down in 2005, however, due to international competition in attracting foreign capital. Actual foreign investment in 2005 and the first six months of 2006 has declined 0.5 percent year on year.
　　For the time being, China"s actual foreign investment has stabilized at a relatively high level of $60 billion. According to statistics released by the Ministry of Commerce in June, the foreign capital utilized in 2005 amounted to $72.4 billion if foreign investment in financial services was included. Meanwhile, the average investment per project has continued to climb, rising 22.2 percent in 2005. The major reason is that local governments across China have shifted their focus in attracting FDI from quantity to quality. The government has given incentives to encourage investment in the hi-tech industry, modernized the services industry and modernized agriculture in order to attract multinational companies to move their R&D centers and assembly lines for high-value-added processing to China.
　　Cities such as Beijing and Shanghai and Guangdong Province, where foreign investment is concentrated, have formulated outlines for attracting foreign investment in the 11th Five-year Plan period (2006-10). The Shanghai Municipal Government has decided its efforts should be aimed at promoting economic growth by attracting more large corporations to base their headquarters in Shanghai and developing a modern services industry and advanced manufacturing sectors. Beijing and Guangdong Province have also started to attach importance to the quality of investment.
　　In the last two years, actual investment by the United States in China has declined, reaching $3 billion in 2005, 22 percent lower than in the previous year. This is largely attributable to the Homeland Investment Act of 2004, which led to a dramatic 45 percent drop in overall U.S. foreign investment in the first half of 2005. China has felt the strain of that change in policy.
　　Since April 2005, actual U.S. foreign investment in China has shown year-on-year declines of over 20 percent each month, while in some months the drop has approached 30 percent. Meanwhile, after a three-year upsurge, investment from Japan tumbled for the first six months of 2006, falling 31 percent from the previous year. Yet investment from the European Union (EU) has maintained robust growth. Following a year-on-year increase of 22.5 percent in 2005, the first half of 2006 has witnessed a surge of 19.8 percent.
　　
　　Booming financial sector
　　
　　Since China’s accession to the World Trade Organization in 2001, the Chinese Government has fulfilled its commitments of opening the services sector by issuing over 40 new rules and regulations involving dozens of areas, including finance, logistics, distribution, tourism and construction. The thresholds for entering these sectors have been considerably lowered. In 2005, the actual investment utilized in the distribution sector, the production and supply of electricity, gas and water, and transportation registered annual growth rates of 17.5 percent, 80 percent and 37.5 percent, respectively. The financial services industry has seen the most spectacular performance. As the reform of the country’s financial sector and share-holding system proceeds, a total of 17 banks have attracted foreign investment of $14 billion. The pioneering reformers, the Bank of Construction and Bank of China, have attracted several foreign strategic investors, which altogether pooled $10 billion into these two banks.
　　Meanwhile, the actual foreign investment in the services industry as a whole has experienced an annual decline. In 2005, actual foreign investment in the sector dropped by 4.5 percent from the previous year to $11.7 billion, accounting for 19 percent of the total foreign investment, which was nearly 1 percentage point lower than in the previous year. The proportion of investment in the services industry has steadily declined.
　　Foreign investment in the services sector is mainly concentrated in the real estate and traditional commercial sectors. Due to policy barriers, foreign investment in novel services industries, such as the IT industry, modern logistics industry, tourism, securities and insurance industry, consultancy, education and medical sectors is minimal.
　　For a long time, around 95 percent of foreign investment in China went into the construction of new production facilities. Yet in the last two years, mergers and acquisitions have become a vibrant form of foreign investment in China. According to statistics from the UN Conference on Trade and Development, foreign investment through mergers and acquisitions showed skyrocketing growth in 2005, accounting for nearly 20 percent of the total foreign investment, up nearly 9 percentage points from the previous year. Besides the enlarged scale, this round of foreign mergers and acquisitions has shown new characteristics.
　　First, in the manufacturing sector, foreign capital has switched from consumer products such as beer, cosmetics and camera film to strategic and basic sectors of equipment production and raw materials. In the steel industry, India-based Mittal Steel completed the acquisition of a 36.67 percent stake in the steel tube and wire division of Hunan-based Valin Group and EU-based Arcelor purchased a 38.4 percent stake in Laiwu Steel. In heavy equipment manufacturing, U.S.-based Caterpillar holds a 40 percent stake in Shandong SEM Machinery, one of China’s leading wheel loader manufacturers. Global private equity firm Carlyle Group has concluded an agreement to purchase an 85 percent shareholding in Xugong Group Construction Machinery, the country’s largest construction machinery manufacturer and distributor, while Germany-based Bosch Group holds a majority stake in Wuxi Weifu Group. In the cement industry, MS Asia Investment, an entity controlled by Morgan Stanley Private Equity Asia, acquired a 14.3 percent share in China’s largest cement maker, Anhui Conch Cement Co. Ltd. In March, Huaxin Cement announced a plan to issue shares to Holchin BV, a unit of Switzerland’s Holcim, making Holchin its largest shareholder. Holchin already owned 26.1 percent of Huaxin before the transaction.
　　Second, merger and acquisition activity has flourished in the services industry, especially in the financial sector, which has become the most important form of FDI in this sector. Along with the sale of a 16.85 percent share in the Bank of China to overseas strategic investors, including Singapore’s Temasek, Royal Bank of Scotland, UBS and Asian Development Bank, Bank of America and Temasek hold a 14.39 percent stake in China Construction Bank. The Bank of Communications, Industrial and Commercial Bank of China, Shenzhen Development Bank, China Bohai Bank and six city commercial banks in Shanghai, Beijing, Nanjing, Hangzhou, Jinan and Nanchong have sold over 10 percent of their shares to foreign strategic investors. In the insurance sector, Ping An Insurance and China Pacific Insurance have sold over 20 percent of their shares to HSBC Group and Carlyle Group, respectively.
　　
　　Merger targets
　　
　　Third, the targets of foreign mergers and acquisitions are increasingly the leading players in their fields. For example, Anhui Conch Cement and Huaxin Cement are the top two cement manufacturers in China in terms of market share. Wuxi Weifu Group is China’s market leader in automobile fuel injection systems. Foreign investors have massively purchased assets in the banking and insurance sectors and as a result financial institutions in some regions have been dominated by foreign capital. The merger and acquisition cases, which involve buying the industry leaders and quickly occupying a market share, will have a more profound influence on the domestic market.
　　Fourth, new overseas investors are more inclined to invest by purchasing existing companies. In the steel industry, unlike South Korean steel giant Posco’s investment in brand new production facilities at an earlier stage, the two largest global steel companies, Mittal and Arcelor, both entered the Chinese market by purchasing domestic companies. The advantage is that the production cycle can be greatly shortened based on updating production capacity and equipment with the input of capital, technology and management. This model has been copied by global financial groups, which differs from the previous practice of setting up branches, and features ownership or control of Chinese banks, insurance and securities companies.
　　Fifth, foreign mergers and acquisitions have become more closely related to the securities market by adopting new financial tools. In the past, foreign capital mainly bought non-listed companies, through acquiring shares or assets. In contrast, recent mergers and acquisitions for a substantial amount of money have involved the stock market. Foreign capital has either participated in governance reform at the pre-initial-public-offering (IPO) stage or bought a stake from listed companies. Meanwhile, foreign capital had adopted other tools, such as convertible debt offerings and tender offers.
　　The background of the acceleration of mergers and acquisitions in China is the new global wave of international mergers and acquisitions. Large multinational companies regard their moves in China as part of a strategic industrial restructuring. The services and heavy chemical industries are the two major battlefields for international mergers and acquisitions. In terms of China, the services sector is the key area for China’s post-WTO opening-up, where the entry barriers have become minimal. China boasts cost and market advantages in the chemicals sector, which has promising prospects and a low level of concentration. As the policies on mergers and acquisitions have become more transparent and predictable, economic growth has maintained a high speed and long-term political stability has been insured, foreign investment in Chinese companies will have a great boost.
　　
　　Side effects
　　
　　With the spiraling of foreign mergers and acquisitions, government officials, scholars and business leaders in China have had heated discussions on their possible adverse impacts.
　　First, investment in the form of a merger or acquisition cannot evidently increase jobs or tax revenue, which is contrary to China’s original intention of attracting foreign investment.
　　Second, the ensuing foreign penetration into companies involving national economic security has posed practical threats in certain sectors. The manifestations include the lowering of national control over strategic and sensitive sectors. Most countries attach importance to maintaining control over strategic sectors such as energy, aviation, telecommunications, urban infrastructure construction, port administration and raw materials by safeguarding a dominant share of domestic companies. Some local governments are obsessed with the total number of foreign investors, which, added to the imperfection of industrial policies, leads to full-scale mergers and acquisitions by foreign companies even in strategic or sensitive sectors, which has made inroads into the state’s domination of these industries. Moreover, certain foreign companies might monopolize their industries due to the constant purchase of market leaders in the country or in a region. This might end up harming the interests of domestic consumers. The large multinational companies should be the main targets in battling such a monopoly.
　　What’s more, excessive mergers and acquisitions might destroy China’s efforts to cultivate the capacity for innovation and nurture famous brands. Foreign investment may involve purchasing companies with well-established brands or growth potential out of the ulterior motive of eliminating competitors. After the acquisition, the new owner of the company intentionally discourages the brand nurturing and innovative capacity of the company, which will undermine China’s efforts to nurture internationally competitive companies with their proprietary intellectual property rights and well-known brands.
　　All these call for urgent legislative efforts to regulate foreign-capital-driven mergers and acquisitions.
　　
　　Low penetration in services sector
　　
　　Traditionally, foreign investment in China has been concentrated in the manufacturing sector, which accounts for 70 percent of total foreign investment. In contrast, investment in the services sector only stands at 20 percent. According to the World Investment Report 2004 of the UN Conference on Trade and Development, the worldwide average of foreign investment in the services sector was 60.14 percent in 2002. The proportion of foreign investment in the services sector is an important gauge of the general level of foreign investment in a country. In this regard, the percentage of foreign investment in the services sector in China compared with the total foreign investment is not only much lower than that of developed countries but also lower than most developing countries. What’s worse, while the global trend is for an increasing share of foreign investment to go to services sector, the same ratio has steadily declined in China.
　　In the services sector, the industry grabbing the biggest share of foreign investment is real estate, absorbing almost half of the investment in the services sector. In 2005, the absolute amount of foreign investment in real estate projects was $5.42 billion, accounting for 43.8 percent of the national total. The strong growth momentum has been maintained in 2006. By the end of June, new registrations of foreign-invested real estate companies had grown by 25.4 percent over the same period of the previous year, involving 27.9 percent more capital than the previous year. This spurred the government to formulate policies limiting foreign investment in the real estate sector in July.
　　The low penetration of foreign investment in the services sector is closely related to the limited input in financial services, telecommunications and retailing-related services. Most of these industries are monopolies and feature a low level of opening up.
　　The United States, Japan and the EU, the three largest economies in the world, are also the biggest investors globally. But they are not the top investors in China, which now overwhelmingly relies on investment from Asia. Forty-two percent of investment in China comes from Hong Kong. According to statistics from the UN Conference on Trade and Development, the total investment from industrial countries amounted to $637.36 billion, accounting for 87.3 percent of the global FDI. By the end of June 2006, the United States, Japan and EU contributed meagre 8.03 percent, 8.55 percent and 7.75 percent, respectively, to China’s actual use of foreign capital. The total amount is about one fourth of the foreign investment in China.
　　Among my suggestions on how China should attract foreign investment, the first is on transnational mergers and acquisitions. As the primary international investment form nowadays, foreign mergers and acquisitions are widely adopted by multinational companies when they see favorable conditions in the industrial development, market environment and legal environment in investment destination countries.
　　In recent years, certain industries in China have had excess production capacity, while foreign mergers and acquisitions do not create new production capacity. Therefore, in maintaining the relatively large scale of foreign investment, equipment and facilities can be updated, industrial concentration increased and China’s economic structure improved.
　　In line with the rule of transnational investment, the rapid development of foreign mergers and acquisitions in China can be seen as an important symbol of the maturation of the Chinese market economy. As one of the favorite destinations of global FDI, we should observe the new form of investment in China comprehensively and objectively. From a national perspective, the key is to properly deal with the relationship between foreign investment and economic security. From the perspective of industries, the healthy development of key sectors must be guaranteed while maintaining orderly competition within the sector. As for individual enterprises, they face the tasks of enhancing their core competitiveness, increasing their capacity for innovation and choosing strategic investors. A regulatory mechanism for foreign mergers and acquisitions must be set up.
　　The global trend in FDI is its rapid growth in the services industry. The major engines driving the inflow of FDI into the services sector include the booming services outsourcing industry, the elimination of barriers, privatization, increasing competition and the rapid development of the IT industry.
　　China, despite being the fourth largest economy in the world, cannot be a real economic power without a competitive services industry. China’s services industry falls far behind those of industrial countries in high-value-added sectors, such as finance, insurance, telecommunications, retailing and logistics. Therefore, China must further open up and boost the general level and competitiveness by attracting more foreign investment.
　　
　　Attracting investment
　　
　　Since the proportion of investment by industrialized countries in China is unusually low, the priority is to promote investment from these countries while stabilizing investment sources around Asia. Such a strategy will help to enlarge the scale of foreign investment and improve its quality.
　　First of all, although China has more and more exchanges with other countries, many enterprises in industrial countries, especially small and medium-sized companies, have little knowledge of China’s investment environment. Therefore, the next step is to expand promotional campaigns in the United States, EU and Japan, through brochures and advertising in newspapers, magazines and on TV, in order to let people know about the opportunities in China.
　　Second, investment promotion activities should be carried out not only at the government level, but also by providing platforms for exchanges with companies with investment potential.
　　Third, attention should be given to learning from the investment promotion practices of industrialized countries in setting up investment promotion branches in key countries to better serve companies by offering detailed information on business exchanges.
　　Last, it is important to emphasize advantageous industries and meet the tailored demands of investors. To be specific, encourage industrialized countries to move their manufacturing and services industries to China, encourage multinational companies to set up R&D centers and regional headquarters in China and provide incentives for foreign mergers and acquisitions.
　　
　　The author is an associate researcher of the Chinese Academy of International Trade and Economic Cooperation

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