Calling their bluff

Criticism of China seems to be in fashion. The American Chamber of Commerce reports that a growing number of its members say they no longer feel welcome in China. Jürgen Hambrecht, chairman of German industrial giant BASF (BFA.LSE, BAS.FWB), used a meeting with Premier Wen Jiabao to complain that foreign firms are being forced to hand over technology to Chinese rivals in exchange for market access. Peter L?scher, his counterpart at Siemens (SI.NYSE, SIE.FWB), used the same meeting to criticize restrictions on investment in certain sectors.

Jeffrey Immelt, CEO of General Electric (GE; GE.NYSE), also referring to Beijing’s technology transfers requirements, bemoaned that he is unsure whether China wants "any of us to win, or any of us to be successful."

All of these groups have been strong supporters of China in the past, so the change in attitude is somewhat alarming. But what is the source of this negative feeling? And does it suggest that foreign investors, tiring of China, will turn their attentions elsewhere?

Much of the current unease arises from the fact that over the past several years Beijing has become more willing to intervene in the economy. This is manifested in aggressive moves to increase the scope and power of central economic planners and state-owned enterprises (SOEs) at the expense of local authorities and private enterprises, respectively. The government justifies this policy of centralization and intervention by citing the success of China in weathering the storm of the world economic crisis.

None of these moves are favorable to the operations of the foreign multinationals (MNCs), and the recent criticisms reflect their response to this general trend.

Back to reality

To put it more simply, foreign MNCs are being forced to confront the "real China." The China that many of them first encountered, before the WTO-mandated opening of the doors to foreign direct investment, was a sanitized version of commerce. Foreign investment in the country was limited to a handful of special economic zones where local officials welcomed overseas companies as a source of employment, funding and technical information. These investors operated under special regulatory regime, carefully isolated from what was going on outside.

Moreover, during that period central control over foreign investment projects was weak. Investors were often able to ignore national law as irrelevant to their activities in China.

The cozy arrangement began to slip away in 2006. In return for wider market access, Beijing now demands that foreign investors operate by its rules. The days of operating outside the Chinese legal and regulatory system are over – the dream that China had become "more capitalist than the capitalists" and was a paradise free of intrusive government regulation has been exposed as hollow.

What foreign MNCs now encounter is the same business and investment environment faced by all private firms operating in China, characterized by: a centrally planned economy; general hostility to private enterprise; SOEs benefiting at the expense of private business; extensive government intervention and regulation; complex regulations that constantly change direction in unpredictable ways; and political objectives taking precedence over economic objectives.

These conditions are difficult to accept for those weaned on Western-based free markets, and so there is much to complain about. But the complaints fall on deaf ears.

The master plan

None of this occurs by accident in China – it is all part of a carefully devised government policy. The Chinese believe that the economic growth and stability that attracted foreign investors to the country in the first place is a direct result of the centrally planned and highly regulated system. They find it illogical that foreigners would criticize the very policies that have created an investor-friendly environment.

Therefore, when confronted by these expressions of discontent, officials have made it very clear that they do not intend to make any changes. Their position is that foreign investors must come to China on China’s terms. If these terms are unacceptable, the foreigners can stay home or go home.

GE’s Immelt and others have threatened to do exactly this: begin investing in other locations. Beijing sees this threat as a bluff. The government understands the challenges facing many foreign investors; but it also believes foreign companies need China far more than China needs them, and so the country’s attractiveness as an investment target far outweighs its disadvantages.

While China maintains significant barriers to foreign investment, it is nevertheless by far the most open investment environment in Asia and among the most stable. In addition, it offers physical advantages no other country can match. The large numbers of workers, well developed factory and retail construction market, reliable and cheap energy supply and modern transportation infrastructure allow for production and retail projects in China on a scale far larger than any alternative in the world.

The country is also home to a rapidly growing yet relatively underserviced consumer market for the increasing number of foreign firms that want to sell their goods domestically.

There is simply no other economy in the world that offers an equivalent package of benefits. China’s leaders are confident the country will remain a primary investment target and foreign threats to move their operations elsewhere are simply a bluff. And so, with no small degree of nonchalance, they have called it.