Foreign Direct Investment Falling: Trend Could Last Long

China’s

Gordon Chang

Shen Danyang, Ministry spokesman, rejected the notion that Beijing’s anti-monopoly investigations of foreign companies had anything to do with the declining investment. “Groundless speculation is completely unnecessary,” he said. “Such thing will never happen that foreign investors are to be scared away by only a few anti-trust investigations.”

Especially since the middle of last year, Chinese authorities have been scrutinizing multinationals for violations of the Anti-Monopoly Law, which become effective in 2008. Last year, milk companies, in particular, were probed, but other sectors were also investigated.

More recent targets include Microsoft, Qualcomm, Mercedes-Benz, BMW, Audi, Fiat, and General Motors. This month, the National Development and Reform Commission imposed record fines on 12 Japanese car-parts manufacturers. Many have said, as is evident, that Beijing has been unfairly targeting foreign business with the new law.

The anti-monopoly campaign looked anti-foreign from the beginning. In July 2013, the NDRC brought together representatives from about 30 foreign companies—including GE, IBM, and Intel as well as Microsoft and Qualcomm—and tried to force them to write confessions. Chinese officials then, incredibly, showed the multinationals the “self-criticisms” of other companies to pressure them to submit.

NDRC officials, during the two-day meeting, also browbeat and threatened the foreign firms and warned them not to defend themselves. “The message was: if you put up a fight, I could double or triple your fines,” said one participant at the session to Reuters, reporting the remarks of Xu Xinyu, division chief in the NDRC’s antitrust bureau.

Discriminatory prosecution also appears to be a problem in Beijing’s other probes. The pharmaceutical business is one of the most corruption-ridden sectors in China, yet extremely few domestic firms have been prosecuted. Instead, officials have gone after, among others, Novartis, Sandoz, and AstraZeneca. Beijing has also been conducting a high-profile inquiry into the business practices of GlaxoSmithKline. The campaign took an especially unwelcome turn as the state prosecuted two of the principals of a private investigation firm the British-based concern had hired, thereby criminalizing data collection across China.

Although Shen, the Ministry of Commerce spokesman, is right to warn against speculation, it’s clear that selective prosecutions, whether pursuant to the Anti-Monopoly Law or otherwise, erode business confidence in China. The offensive against foreign companies has become so notorious that it has become a part of the global discourse. After all, Time asked at the end of last month, “Is no famous foreign brand safe in China?”

So what is causing FDI to level off and now fall? “With China speeding up economic restructuring, it’s normal for us to have some fluctuations in FDI figures,” said Shen, “but such fluctuations are not evidence for changing trends.”

He looks wrong on two counts and perhaps on a third. First, China at the moment is not reforming, at least on balance. There have been announcements of reforms but little in the way of actual implementation, and some implemented changes, like the widening of the trading band for the renminbi, have been so minor as to be inconsequential in actual effect. More important, there have been two significant steps backward, the reliance on state stimulus to create growth and, of course, the discriminatory attack on foreign business.

Second, even the announcement of reforms has triggered optimism among foreign business, so the prospect of “economic restructuring” would be good for investment, not bad as Shen implies. For instance, foreigners would pour money into China’s services sector if they thought it would be opened further. Need proof? For the first seven months of this year, FDI into service businesses increased 11.4% to $39.7 billion, bucking the overall direction.

Is Shen right to suggest the recent dip in FDI growth was merely a fluctuation? Since China joined the World Trade Organization at the end of 2001, FDI has grown steadily, hitting a record $117.6 billion in 2013.

Yet, in addition to the anti-foreigner sentiment so evident in Beijing these days, there are reasons to believe the long-term upward trend may have already ended. First, the Chinese economy is stumbling, perhaps badly. Independent data points to low single-digit growth, making China less desirable. And the country appears to be heading to a debt crisis of some sort. Properly calculated, the country’s total indebtedness looks like it is about three times gross domestic product. A debt reckoning—a “crisis” in common parlance—will surely scare off foreign investment, as it has in other countries.

Second, other destinations are gaining popularity. For instance, India now has a business-friendly government. Even the possibility of Narendra Modi’s election convinced foreigners to make a big bet on the subcontinent, and that was before he received a sweeping mandate to restart growth. And then there is what could end up as the most attractive region in the world, Africa, home to six of the planet’s ten fastest-growing economies. In all probability, we will see investment flows redirect from China to other locations.

Third, Chinese leaders will probably pursue their door-closing policies for some time, especially because state enterprises, which have gained political clout in recent years, will push them in that direction as these firms seek to consolidate their market position. And as they do that, they are undercutting foreign business and making China less desirable.

“Xi’s ‘China Dream’ has become ‘China First,’ writes Richard Harris of Port Shelter Investment Management in the South China Morning Post. “But for now the strategy is to keep tilting the playing field in your favor until someone notices.” Judging from the FDI numbers this year, someone is noticing.

Gordon G. Chang is a U.S.-based writer. Follow him on Twitter @GordonGChang and at Forbes.com.