19 Jun Second Tier Insight: Foreign Direct Investment
Soon Maxxelli will publish it’s 2019 CICI (China International City Index) report that is generated in order to quantify the level of internationalization of second-tier cities in China. We annually offer a holistic, thorough analysis of selected tier two cities based on extensive research in order to ascertain a valuable city-by-city ranking of internationalization. Additionally, the report offers key information regarding specific indicators concerning these up-and-coming cities. Foreign Direct Investment is undoubtedly one of the most important factors regarding internationalization and economic development of cities and countries around the world.
A BRIEF INTRODUCTION TO FDI IN CHINA
In 1978, during the third session of the 11th Central Committee of the Party, China opened its walls to the outside world to focus on economic construction. Thanks to its policy reform for foreign investment it has been continuously, rapidly and healthily attracting foreign enterprises’ attention and building up the nation’s economy. Foreign direct investment (FDI) is particularly interesting for this purpose. There are different forms of FDI including Sino-Foreign joint ventures, joint exploitations, exclusively foreign-owned enterprises, foreign-funded shareholding companies and joint development. After a quick overview of recent trends, potential gains and setbacks, it will be followed by a graph explaining FDI development in top tier two cities.
China is renowned for its prominent manufacturing sector due to low-cost productions. Its output has risen 339% in the past decade. Based on the announcement of the Ministry of Commerce (MOC). FDI into the Chinese mainland expanded 4.8% year on year to reach 84.18 billion yuan (about 12.41 billion U.S. dollars) in January 2019. Additionally, FDI for the services sector more than doubled that for the manufacturing sector in 2018, reaching 56.2 billion yuan. According to the 2018 World Investment Report by UNCTAD, China is the most attractive FDI destination worldwide among developing countries and second in the world behind the US. Increasingly though, second tier cities that seem to be more attractive, as top tier cities such as Shanghai and Beijing’s markets are closely saturated, and labour and production costs are rising. Actually, the Wall Street Journal claims these fast-developing cities should be in fact called ‘first-class opportunities’. However, like most good things, both advantages and disadvantages can be encountered, and FDI in China is no exception to this rule.
REASONS WHY YOU SHOULD SET UP IN SECOND TIER CITIES
Despite first tier cities sounding more exciting and international, these markets have already been exploited and squeezed to the bone. For the past 20 years, cities like Shanghai or Shenzhen have been attracting a large majority of mainland FDI. These cities are the centre of China’s booming economic activity and are more so than the rest of China, combined. However, the rate of growth within second tier cities is fast and is attracting a lot of foreign investment and there are many reasons for that.
Firstly, the Chinese middle class is growing extensively and their consumer behavior with it. This new wealthy class is ready to spend their money on foreign products to show off in front of friends and they have money to put into international services and real estate, for example. Secondly, in comparison to first tier cities, second ones have lower labour and production costs. Thirdly, as this is an opportunity not to miss out on, it is attracting a high amount of competitiveness bringing once again the cost of production even lower. Additionally, the government has been handing out investment packages to push forward the economic development of these regions. Therefore, it is all the more interesting in terms of investment.
These metropolises are the perfect balance between first and lower tier cities: international, elaborate and cut-rate. Surveys conducted by Santander indicate that Chinese workers are eager to flock to these fast-growing locations, which gives companies, both international and local, access to new levels of talents. A survey conducted earlier this year indicated that second tier cities offer stronger job prospects than the main four cities due to increased urbanization and growing manufacturing orders which translates into a greater offer in employment. Naturally, with the influx of new industries and workers, second tier cities are thriving places of commerce, with large developing consumer and industrial markets. What is more, the government has been investing with confidence in infrastructure development through the development in high- speed rail and road systems and with air companies like Cathay Pacific and their sister company Dragon Air looking into reaching more destinations within the country.
Chengdu, the capital of the Sichuan Province, with over 15 million inhabitants is a city not to be overlooked. It is one of the world’s fastest-growing cities, as it is becoming a pivot for science and educative sectors, and in other sectors nonetheless. The city is driven by its ability to develop and attract human capital, its clusters of aerospace, aircraft design, and electronics industries, and support from the central government (including tax and investment incentives to foreign and domestic firms). Qingbaijiang, located just northeast of Chengdu is a portal to the rest world: its railway lines which have links all over Asia and Europe is an express and governmental-incentive way to export/import to and from Southwest/central China. Actually, Chengdu and the city of Chongqing are the only two in the top ten cities in China that are located outside of China’s economically propulsive east coast.
POTENTIAL SETBACKS OF FDI IN CHINA
Not just in second tier cities but also in all of China, several problems are encountered when setting up your business: Lack of transaction transparency, IP protection rights, corruption or protectionist measures, quality labour and management training and general Chinese ‘know-how’.
The issue when investing in China is, they will always favour their own. So if, per say, you decide to enter together with a local partner, and you come about a dispute with your Chinese partner/investor, the Chinese would most likely come out on top. It is therefore important to disclose all contracts in binding.
IP protection rights
Chinese are renowned to be worldwide copycats. Indeed, intellectual property protection is of upmost consequence if you decide to do business in China. The Chinese have different rules concerning IP rights and will not give it a second thought if your patent or license has not been protected within their borders and will reproduce it on the spot by the millions. Cover your assets.
Corruption & protectionism measures
Xi Jinping’s government has been cracking down on corruption and under the table transactions. So, this should not be so much to worry about in the second half of this decade.
Quality labour and management
Despite having high-quality universities around in first and second tier cities, it is often an issue to retain skilled labour in other places than international locations such as Shanghai or Beijing. Nowadays, Chengdu and Chongqing are more and more appealing to young Chinese graduates and fresh talent. Other cities try to attract overseas talent and improve the city’s international business environment. Shenyang grants visas to international graduates who want to start businesses.
Furthermore, it is necessary to find tailored management for your company in order to give out correct training and leadership. Expatriates are a good solution to this predicament yet, several challenges remain so as to attract and retain the talent they need.
These challenges would be first and foremost the air quality which can have serious health consequences in particular for children and other vulnerable groups such as the elderly, which in turns leads to healthcare costs and decreases in labour productivity.
Secondly, the numbers of international healthcare facilities are limited outside of first tier cities. For example, in Chengdu the quality of medical care is below international standards according to a survey conducted by the European Chamber. Indeed, without a certain key characteristic a city remains less attractive destination in which to work and reside.
Finally, Increasing the internet speed and access to foreign websites would be a plus as it is limited and sometimes censored which can have a negative impact on businesses and disturb personal leisure.
Prohibitions and restrictions
Since 1995, the Catalogue of Industries for investments has directed China’s FDI, although evolving through the years with the latest update from 2017. Library of Congress explains that previously such catalogues were divided into the three categories of encouraged, restricted, and prohibited industries for purposes of market access to foreign investment in China. The 2017 Catalog keeps the encouraged category and provides a “negative list” of the special administrative measures that contains the restricted and prohibited categories and also restrictions such as equity ratio and senior executive requirements for certain types of foreign investment industries. Investment restrictions that apply to both foreign and domestic investments and those not related to market access are not included on the negative list. This is a summary of the newest catalogue however the entire list can be found on MOFCOM’s website.
SECOND TIER CITIES IN FDI NUMBERS:
Based on factual information and thorough research, Maxxelli has come up with dynamic information regarding the internationalization of two first tier and 22 main second tier cities across China. In order to give you a more visual idea of the extent of this for each of these cities we have integrated our data into graphs. The first one explains the amount invested in 2016 and 2017 of FDI per city, and will give you a comparative view of the number of companies in each city, as well.
The second one shows a ranking of the Chinese government’s ‘Best performing cities in China in 2018’ divided into two categories: 1st and 2nd tier cities, and third-tier cities.