The author of the article is chairman and president of Export-Import Bank of China.

China’s investment climate hasn’t deteriorated and promoting indigenous innovation is justified.

Recently, some government officials, companies and the media in the US and Europe expressed concerns over the procurement and indigenous innovation policies of China, and thereby alleged that China’s investment climate had deteriorated. Indigenous innovation became another hot topic, next only to the RMB exchange rate in China’s economic relations with foreign countries.

Has China’s investment climate indeed deteriorated?

As early as in February 2006, the Chinese government published its indigenous innovation policy in the National Medium- and Long-term Program Outlines for Science and Technology Development(2006-2020). Government procurement is not a new concept in China. Why haven’t concerns from major developed countries surfaced until recently? Facts and statistics have proved that China set up no barriers to foreign companies.

In the definition of indigenous innovation products, all products manufactured by foreign companies in China are labeled as “Made in China.” In 2009, 55% of the government’s procurement contracts for mechanical and electronic products were given to foreign companies. In the same year, despite the fact that global foreign direct investment (FDI) plunged by 40%, the FDI to China dropped only by 2.6% thanks to China’s lowered foreign investment threshold and more open policies. However, criticism from the West never faded away. There must be some more profound reasons behind these complaints.

1.Has China;s investment climate really deteriorated?

The accusations from foreign media, companies and government officials were based on surveys on China’s business climate and confidence conducted by the American Chamber of Commerce in China (Amcham-China) and the European Chamber of Commerce (EUCCC), the 2010 White Paper or Policy Recommendations drawn from the above surveys, and Doing Business 2010 by the International Finance Corporation (IFC), a member of the World Bank Group. What did they say about China”s investment climate?

The surveys conducted by Amcham-China and EUCCC revealed that: first, this “once-in-a-century” financial crisis caused a large-scale economic contraction in America, Europe and Japan, whereas 70% to 80% of American and European companies in China still managed to make a profit. Over two-thirds of the surveyed reported profits equivalent to or higher than the global average.

Second, most companies were not only optimistic, but also planned to increase their investment in China.

Third, 70% of foreign companies aimed to supply the Chinese market, while only 12% targeted the US market. These survey results are of essential significance to the Sino-US trade and re-balancing the international financial market in the post-crisis era.

Fourth, the biggest challenge or risk facing American and European companies in China is not tightened policies and regulations. Compared with insufficient IPR protection, China’s economic slowdown, thirst for qualified management talents, difficulties in law enforcement and the rising labor costs are more serious problems.

Surveys on China’s Business Climate in 2010, By Amcham-China and EUCCC

Data source: Amcham-China 2010 Business Climate Survey and Innovation Policy Survey Analysis, and EUCCC Business Confidence Survey 2010.
1 Companies with production base in China (58%) and those supplying the Chinese market with imports (14%).
2 Including companies with break-even performance (18%).
3 Including companies considering China as their first investment destination (21%) and the rest 47% taking China as one of the top three investment destinations.
4 Companies taking sales increase in China as their primary strategy to expand profit.

Those surveys didn’t directly raise the question of whether the country’s investment and business climate had worsened. However, it should be noted that such a question was directly asked in a survey conducted and published by the American Chamber of Commerce in Shanghai (which has more members than the American Chamber of Commerce in Beijing), although hardly any Western media reported it.

According to this survey, 78% of the respondents thought China’s business climate had improved (45%) or remained unchanged (33%). The percentages were much higher than the 22% who held that China’s business climate had deteriorated. Ninety percent of the surveyed companies reported a stable or improved performance in China.

Among the respondents “Adjusting Business Schemes in China,” over 80% planned to expand investment, R&D, production and procurement in China. The survey concluded that China’s investment climate showed no signs of deterioration.

Japanese companies and media didn’t join the chorus of complaints about China’s investment climate, for the simple reason that the recovery of the Japanese economy to a large extent relies on the Chinese market.

Survey on International Operations of Japanese Firms(FY2009) published by the Japan External Trade Organization (JETRO) in March clearly indicated that a majority of Japanese companies (66%) planned to expand investment and explore new business opportunities in China in the coming three years. This percentage was higher than the 50% shown in the 2008 survey and much higher than the percentage of American companies responding to similar questions.

Japanese companies with plans to downsize or withdraw from the Chinese market accounted for only 0.5% of the surveyed, the lowest since 2004. Therefore, Japanese companies are more optimistic about China’s investment and business climate than their American and European counterparts.

The annual Doing Business by IFC did lower China’s world rank from 86th in 2009 to 89th in 2010. This can be mainly attributed to the adoption of a different calculation method, which did not reflect the real picture of the investment climate in China.

First of all, the IFC annual report was not based on business surveys. Instead, some quantitative indicators related to starting and closing a business, getting credit, registering property, paying taxes, trading across borders, enforcing contracts, dealing with construction permits (for example, procedures, time and cost to obtain construction permits), and employing workers were used as the criteria to judge whether existing laws and regulations, as well as systems, were in favor of investment. Yet quite a number of such indicators were not comparable among countries with different legal and social systems.

In addition, the IFC ranking system largely relied on legal provisions and ignored their real cost and effect after application. For instance, as for enforcing contract, an essential indicator in a market economy, China was ranked 18th in both 2008 and 2009. Both the period and the cost of contract enforcement in China were much lower than the average of the Organization for Economic Cooperation and Development (OECD) or developed countries. However, China was ranked at the bottom (108th) in terms of time to obtain construction permits. Although its speed and scale of construction were among the highest in the world, the relatively strict procedures have pushed China down to the lower end of the list.

The IFC rating system was far from scientific and objective, and the important indicators of enforcing contract and trading across borders were not given a fair weight, and thus affected China’s ranking in terms of business climate. In 2010, China’s ranking lagged far behind developed countries, and even lower than Belarus (58th) and Mongolia (60th). This was clearly not the true picture.

Second, the change in the annual Doing Business ranking merely reflected the revision of certain laws and regulations. In the 2010 report, China’s ranking in many aspects remained stable and even improved. Albania moved up from 89th in 2009 to 82nd in 2010 because of its regulatory reforms in starting and closing a business and trading cross borders. China was ranked lower because only its considerable improvements in cross-border trade were acknowledged. (IFC, 2010).

These analyses showed that China’s investment climate had become more attractive rather than deteriorated after the financial crisis. Most American, European and Japanese companies are optimistic and planning to increase investment mainly because of China’s huge market potentials and higher returns on investment. Examining the surveys made by various foreign chambers of commerce in China, the problems related to law enforcement, management talents and intellectual property rights (IPR) protection are all old stories rather than major evidence of the so-called deterioration of investment climate.

2.Why are the US and EU concerned over China’s industrial policy of indigenous innovation?

Sixty-two percent of American companies surveyed admitted China’s new policy on indigenous innovation had no negative impact on their presence in China, and 10% even thought they had benefited from the policy.

When asked if their future growth would be affected by China’s indigenous innovation policy, positive responses exceeded 40%. This showed that American companies’ concerns over the negative impact of China’s indigenous innovation policy were not really based on solid facts. They were worried that they could lose their edge in central and local government and State-Owned Enterprises (SOE) procurement market under China’s industrial policy of indigenous innovation.

However, given the fact that foreign companies were big winners of Chinese government procurements in 2009, there is no need to worry about China’s indigenous innovation policy.

For years China has been disclosing and executing its policies on indigenous innovation. Why is it only now that it’s become an important topic in economic relations between China and the developed world? The answer can be found in the surveys conducted by Amcham-China and EUCCC.

The reason is that Chinese companies are becoming increasingly competitive (a view held by 67% of American and 58% of European companies), threatening or starting to break down their monopoly. We should be soberly aware that those who are complaining and criticizing are the ones who once dominated China’s fully open market of durable consumer goods, equipment and materials of production, from which they had gained huge profits. Even today, some of these companies remain market leaders.

Therefore, the competition pressure from Chinese companies is just one side of the story. What is more important is that this round of financial crisis has greatly reduced the domestic and global competitive edge of these foreign companies, making them more dependent on the Chinese market, including the government procurement market, which grew in spite of the crisis. This is the very reason that these foreign companies have become so hypersensitive.

High-tech and information technology (IT) companies are the ones that voiced the strongest opposition against China’s indigenous innovation policy, especially those from the computer, telecommunication, software and green product sectors.

Besides China’s procurement policy, the development of its own technological standards and accreditation systems are also on the top of their dislike list. They fully understand that any successful Chinese standard would inevitably become global due to China’s huge market scale. American and European firms consider advanced science and technology their core competitiveness.

Therefore, it is not at all surprising that foreign companies and their government officials voice their opposition to competition from Chinese companies and China’s indigenous innovation policy when they feel that their monopoly in this fastest growing market is under threat, and the Chinese government and companies are significantly empowered by increasing input in the R&D sector as a number of frontiers achievements are successfully commercialized (for instance, high speed railways).

3. The truth behind the debate on investment climate and indigenous innovation

China’s argument with the US and EU on investment climate and indigenous innovation clearly reflects the following aspects: 1. Developed countries’ dependence on and contest for the Chinese market amid global demand changes in the post-financial crisis era; 2. Monopoly and anti-monopoly battle in the field of science and technology as China is at a crucial juncture to move upstream in the industrial and value-added chains from a mere major manufacturer and exporter; 3. Defense of development rights and competition for a leading role in development between the developing and the developed world.

The global market in the post-financial crisis era

Currently, demand from non-government sectors in the US and Japan is sluggish.

With their inventory adjustment coming to an end and the impact of extraordinary fiscal stimulus fading, their economy will undoubtedly be weak in the first half of this year. In the meantime, the EU is forced to adopt fiscal adjustments earlier than planned, and its unemployment rate exceeds that of the US and Japan. All of these factors have placed exports as their only hope for economic recovery. Asia, especially China, is where new global demand comes from.

According to the International Monetary Fund (IMF)’s latest prediction, from 2010 to 2015, 78% of global economic growth will come from developing countries, China alone accounting for 37%. By comparison, the US is predicted to contribute only 9.7%, which is much lower than before the financial crisis. This trend has determined that developed countries would rely heavily on and go all out to fight for the markets of developing countries, especially China.

Sino-US economic disputes reflect people’s mindset as well as reality.

Tremendous changes have taken place in the two countries’ import volume in recent years. From 2000 to 2009, US’ share of global import volume dropped by 6%, while China’s increased by 5%. The import volume gap between the two countries is narrowing and China’s impact on the world economy is rising as US’ drops. Meanwhile, US exports to China are taking up a growing percentage of its total volume. In 2009, US exports to China increased despite its decreasing exports to other parts of the world. Therefore, China is playing an increasingly important role in stimulating US exports and creating its export-related employment opportunities.

Indigenous innovation and intellectual property rights

Indigenous innovation is the natural choice of a country when it develops its economy on its comparative advantages.

After years of export-oriented processing and becoming one of the world’s largest manufacturers, China now is faced with the mission to upgrade its industries. However, Western companies are more than reluctant to sell their core and cutting-edge technologies to China. In other words, nothing like an open market exists in the field of IPR.

Facing this reality, on the one hand, China needs to strengthen market competition to urge developed countries to introduce their most advanced technology and products to the Chinese market; on the other hand, China undoubtedly has to choose the path of indigenous innovation.

In an IPR market where fair competition is not fully guaranteed, the adoption of necessary market intervention measures to protect competition rights of the latecomers is a must. The US, Japan and the EU have all gone through this stage in their development. Since technological monopoly is destined to be temporary, the right thing for market leaders is to keep on innovating under pressure of competition.

Indigenous innovation and IPR protection are two aspects that reinforce each other. In business surveys, American and European firms all admit that China’s indigenous innovation policy is not exclusive, and may even benefit foreign companies. As a matter of fact, out of the 71 models of new energy vehicles enjoying government subsidies, foreign brands take up the majority.

China has been strengthening its IPR protection measures to safeguard its own interests and to stimulate innovation initiatives of its companies. China’s IPR protection policies apply to all industries, including those currently dominated by foreign companies and brands. It is therefore illogical and unfaithful to say that China’s indigenous innovation policies have weakened its IPR protection.

China’s indigenous innovation will fuel global economic growth.

It is incorrect to say that China’s indigenous innovation policies may shorten the profit cycle of patented products of developed countries, such as aviation, telecommunications and automobiles, and would discourage the momentum of global technological innovation. Patent protection does not always encourage innovation.

Research shows that prolonged patent protection of certain scientific discoveries, such as human genome sequencing, undermined further development and the application of existing discoveries. Under the precondition of IPR protection, China’s increased investment in indigenous innovation is bound to boost research and development globally. The cost and feature of Chinese products and technologies cater to the needs of emerging markets.

Hence, China’s indigenous innovation will inject vitality into global technological innovation and economic growth, and benefit developing countries. Competition is the engine of economic growth and technological improvement. Excessive IPR protection does not protect progress, but shields backwardness.

A leading role in development

The root cause behind the debate over China’s investment climate and indigenous innovation policies is not whether China has adopted sufficient IPR protection methods or whether its government and SOE procurement is fair. Instead, in the post-financial crisis era and under the circumstance that de-coupling exists during mid-term growth of developed and developing countries, the debate is which country and what kind of concept should take the leading role in global economic growth.

In the post-financial crisis era, China’s economic growth will rely more on technological innovation. Trade and investment among developing countries will play a bigger role in the world economy. With the increasing innovation capacity of emerging markets, such as China, developing countries will be more empowered to dominate world economic growth.

It is understandable that developed countries, facing grim economic prospects and massive structural unemployment, will try to stimulate growth by increasing exports. However, it is not a workable plan for developed countries to secure their monopoly by changing the market conditions of developing countries while still relying on the same market for profits. And it is less practical to maintain their dominance in economic growth by challenging and oppressing indigenous innovation in developing nations.

4. How to seize initiative in international competition

The above analysis shows that Sino-US and Sino-EU debate on investment climate and indigenous innovation policies is in fact a competition for dominance in global economic development.

As one trying to catch up, China’s efforts in indigenous innovation are justified. And for foreign companies, they have played an important role in promoting China’s technological imports, and have meanwhile gained considerable profits from the Chinese market. Facing the future, instead of making the issue political, the two sides should cooperate in an open and honest manner to encourage competition and collaboration on technological innovation, which will be mutually beneficial.

First, indigenous innovation is closely related to China’s development rights and interests, and is key to its economic growth mode transformation and scientific development.

China is justified in defending its rights and adopting further measures to support innovation. Owing to the high threshold set by previous industry monopoly, the commercialization of many high-tech products, such as jumbo jets, has to go through a market exploitation period, during which it goes down the cost curve or moves up the learning curve.

In a market where fair competition is not guaranteed, reasonable interventions, including policy financing, can help many emerging industries in China to overcome thresholds and initial cost barriers, and finally benefit from scaled production.

Second, China will strengthen its legislation and implementation of IPR protection laws.

China is as determined as Europe and the US concerning IPR protection and has been striving to do so. Domestic and foreign companies are treated equally under China’s IPR protection practices. Therefore, China’s progress in IPR protection will also facilitate companies from Europe and the US to seek profit opportunities in its investment market.

Meanwhile, developed countries should understand that everything, including IPR protection, should be conducted properly to certain limits. Excessive protection will protect monopoly and oppress competition, which is detrimental to scientific and technological development. Hence, IPR protection should always be in moderation.

Third, major developed countries should have an objective view on China’s technological improvements. A huge gap remains between China and the US and Europe in terms of economic strength, per capita income and level of science and technology. The dominance that developed countries have in the high- and new-technology field is still firmly rooted.

However, the rise of China has become an inevitable trend and cannot be stopped by opposition from old market leaders. Having always been an advocate of competition, European countries and the US should adjust their attitudes toward China, the new competitor, instead of completely blocking contests.

Fourth, China, the US and the EU can all benefit from a more open market.

Chinese companies face many barriers when entering the US market. In 2005, CNOOC bid for Unocal. In 2008, Huawei Tech intended to buy 3Com and bid for 2Wire and a division of Motorola in 2009. Anshan Iron & Steel Group Corp tried to invest in America’s iron and steel industry – now a sunset industry in the US – in 2009. Yet none of these attempts were successful even though in some cases China made the highest offer, such as in the case of Huawei’s bid for 2Wire.

Non-financial interference is a major reason. This has shown that for Chinese companies, the investment climate in developed countries is not so favorable.

Market access should be mutual. China has a huge and fast expanding market, which is essential to developed countries in the post-financial crisis era. To promote reciprocal cooperation, Western countries should also adopt a more open attitude, offer equal opportunities to investors from various countries, and provide a fairer investment climate.

The author is chairman and president of Export-Import Bank of China.

By Li Ruogu