Xi Jinping's National Security Agenda Creates Minefield Of Risks For Foreign Firms Eyeing Investment In China

Desperate to attract investment and boost their struggling economies, Chinese cities are offering new incentives to Western businesses.

Beijing has designated 2023 as the "Year of Investing in China" and local officials have been touring overseas to generate interest from potential investors.

However, this effort is conflicting with Chinese President Xi Jinping's national security agenda, which aims to protect against perceived foreign threats.

As a result, any investment in China has become a potential minefield for foreign companies. This year, under Xi's leadership, there has been a crackdown on Western management consultants, auditors, and other firms through raids, investigations, and detentions.

Additionally, an expanded anti-espionage law has raised concerns among foreign executives that routine business activities, like market research, could be misconstrued as spying.

The perception that doing business in China has become increasingly risky is hindering the flow of capital into an already struggling economy. Private investment and consumption are weak, and youth unemployment is on the rise.

Foreign direct investment in China dropped significantly in the first quarter of this year, falling from $100 billion in the same period last year to just $20 billion, according to an anlaysis of government figures by analyst Mark Witzke at research firm Rhodium Group.

The situation in China is further compounded by predictions from Goldman Sachs economists, who anticipate that outflows from the country will offset any investment coming in. This represents a significant shift for a country that has traditionally seen more money flowing in than out over the past four decades.

China's economic growth has long been fueled by its openness to the West, relying on foreign investment and expertise to drive innovation and productivity.

However, the current situation threatens to undermine this growth, as the country risks losing the capital, technologies, ideas, and management skills that have been instrumental in its rise.

Chinese leaders find themselves in a delicate balancing act, as they try to maintain pressure on foreign firms while simultaneously encouraging them to invest.

This precarious situation could potentially deprive China of the resources it needs to sustain its economic development and maintain its position on the global stage.

The ongoing tug of war is leaving financially distressed cities and townships in China in a difficult situation. These areas, burdened with debt and struggling to generate employment opportunities after three years of Covid-19 restrictions, are in desperate need of capital.

According to official statistics, local governments spent more last year compared to the previous year. This increase was primarily driven by an 18 per cent rise in health expenses to cover Covid testing and related costs.

At the same time, their income decreased, mainly due to a 23 per cent year-over-year decline in revenue from land sales to developers, which has been a long-standing source of funding for local authorities.

As a result, localities have accumulated debts that exceed their capacity to repay, with debts owed directly by local governments amounting to 120 per cent of their revenue.

According to a Wall Street Journal report, many officials admit that their traditional strategies for attracting foreign investment have failed to yield positive results.

A trade official from Chengdu, the capital of southwestern Sichuan province, recently went on an investment-promotion trip to Europe but returned empty-handed.

"In my 20 years of trying to get investments from Europe, this was the first time we didn’t get to sign even one memorandum of understanding,” the official was quoted as saying by The Wall Street Journal.

According to the WSJ report, a high-ranking official in a county in southern Guangdong province recently informed an American trade group that the county would offer a reward of 10 per cent of the value of any promised deal to any US corporate "decision maker" who chooses to invest there.

This county had previously set a target of attracting nearly $300 billion in investment over the next five years.

Recent surveys conducted by business groups in China have revealed that American, German, and other European companies are either pausing their expansion plans or reducing their investments in China.

Crane, a prominent US manufacturer of vending machines and industrial products that has been operating in China since the 1990s, has significantly scaled back its investments in the country due to growing policy uncertainty, according to sources cited in the WSJ report.

Sean Stein, the chairman of the American Chamber of Commerce in Shanghai and a former US Consul General in the city, expressed concerns that the recent pressure on US consulting firms could potentially "cut off the eyes and ears of foreign businesses."

During her recent visit to Beijing, US Treasury Secretary Janet Yellen expressed her objection to China's treatment of US companies. It is expected that US Commerce Secretary Gina Raimondo will also raise this issue during her upcoming trip to China.

A forum called "Investing in Zhejiang" was organized by local officials in the seaport city of Ningbo, located in Zhejiang province. At this event, they highlighted various initiatives that could be offered to foreign investors, including infrastructure improvements, tax incentives, and subsidies for the purchase of advanced equipment.

However, the lack of clarity and guidance on policies from Beijing has led to uncertainty and hesitancy among global corporations.

Pixelworks, a chip designer and producer based in Portland, Oregon, has received a warm welcome from local officials in Shanghai, where its China operation is located.

The officials are particularly supportive of CEO Todd DeBonis' efforts to list the company's Chinese subsidiary on Shanghai's STAR board, which is similar to the Nasdaq in the United States.

According to DeBonis, Pixelworks is fully committed to China, as most of their research and development talent is based there, and the majority of their revenue is derived from the Chinese market.

Despite the local support, Pixelworks is facing pressure from the Chinese government to restructure its Chinese subsidiary to ensure its independence from the company's American operations.

This requirement is becoming increasingly common for foreign companies as part of Beijing's national security agenda, according to business consultants and lawyers advising multinational corporations.

To gain approval for its initial public offering, Pixelworks has had to essentially divide itself into two entities, separating its China operation from its parent company in the United States, in order to meet the demands of Chinese regulators.

Pixelworks has spent the past two-and-half years working diligently to establish its Chinese subsidiary as an independent entity separate from its US parent company.

As part of this process, Pixelworks has transferred the intellectual property specific to its China operation from the US parent to the China entity.

This strategic move aims to safeguard the patents and trademarks against any potential US sanctions that could restrict China's access to these assets in its markets.

In order to address Chinese security concerns, Pixelworks recently relocated 15 employees who were working on projects for the US parent company to a separate floor within its office tower.

These employees, who are all Chinese nationals, now operate on their own office networks that are completely isolated from Pixelworks' China operations. Their work is focused solely on US projects.

In late June, officials from China's Commerce Ministry visited Pixelworks' offices to “better understand” its businesses and the company’s progress in separating its China operation, according to DeBonis.

DeBonis shared that Pixelworks' China operation plans to submit its IPO application to Chinese regulators later this year. However, in order to obtain approval, the company will need to convince Beijing that it has effectively protected its intellectual property against any potential US sanctions.

“They won’t approve your application unless you mitigate the risks to Chinese shareholders,” DeBonis was quoted as saying in the WSJ report.