Tuesday, 24 February 2015

Ken Davies' article on China's new investment rules (Nikkei Asian Review)

February 20, 2015 7:00 pm JST
Ken Davies

China's new investment rules: A step forward, but more is needed

The Chinese authorities are at long last starting to simplify the law on foreign investment in line with recommendations from trading partners and international organizations like the World Bank, the United Nations and the Organization for Economic Cooperation and Development. While this is a step forward, it does not yet provide a completely open and nondiscriminatory environment for foreign investors.
     The Ministry of Commerce, in charge of framing and implementing policies on both inward and outward investments, published a draft Foreign Investment Law on Jan. 19. This followed over a year of public consultation and there was a short window of opportunity -- until Feb. 17 -- for comments to be submitted before the law is finalized.
     This process continues the trend of increasing transparency in the formulation of economic laws that started with the 2007 Labor Contract Law.
Much needed simplicity
The new law is designed to replace the unnecessarily complex series of laws that apply to different categories of enterprises: the Law on Sino-Foreign Equity Joint Ventures, the Law on Sino-Foreign Contractual Joint Ventures and the Law on Wholly Foreign-Owned Enterprises. Discriminating between these types of enterprises makes even less sense than treating foreign investors differently to domestic investors.
     In the three OECD reports on China's policies towards foreign investment published in 2003, 2006 and 2008, I recommended that China replaced all three laws and its Catalogs for Guiding Foreign-Invested Industries with one simple, closed list. There was muted response from Beijing at the time, but it now looks like the suggestion was taken seriously.
     At present, all industries are split into four confusing catalogs based on whether foreign investment is permitted, encouraged, restricted or prohibited.
     The largest catalog is that of permitted industries. This is too long a list and changes frequently to accommodate new technologies and products, so it is the one catalog that is not published.
     The prohibited catalog contains items that other countries routinely put in their closed lists and also industries that are anyway illegal in China. But it also includes industries where a foreign ban makes no sense, such as the processing of green tea.
     There is a restricted catalog in which the authorities place, inter alia, services sectors which had to be opened after China joined the World Trade Organization in 2001, and an encouraged catalog of sectors to which the government wishes to attract investment. As with investment in poorer regions, this is largely done through nondiscriminatory incentives available equally to domestic firms, in line with good international practice.
     In the new law, the catalogs will be replaced by a negative list which includes both industries where foreign investment is banned outright and those which have thresholds of restricted investments above which Ministry of Commerce approval will be required.
     The negative list appears to give the Ministry of Commerce more control over approvals than it has under the catalog regime, which is really a hodgepodge of restrictions dictated by various ministries and other bodies. Indonesia did something similar in 2010, and its experience has shown that such a negative list is easier to liberalize.
     Under the new law, China would therefore grant foreign companies the same treatment as local ones apart from the sectors on the negative list, something which a few years ago was being loudly rejected by the Ministry of Commerce and which would take China into a new era of international investment diplomacy.
Why is China doing this? And why now?
The three earlier laws were drawn up hastily in the 1980s and 1990s to ensure that foreign investment would not threaten the existing economic system.
     By the turn of the century, China had become the largest developing-country recipient of foreign investment and these laws had become redundant since the economy had become a lot more open.
     Lawmakers had also gained a wealth of experience, having scoured the world for precedents in building a basic legal framework for businesses and the economy.
     Since 2000, while China has continued to attract large quantities of foreign investment, it has developed rapidly to become one of the largest sources of investment to the rest of the world.
     This has totally changed the outlook of the country's leadership. Whereas China for decades saw foreign investment as something to be welcomed but carefully restricted and controlled, it now sees foreign investment through the eyes of an investor. After all, it has now encountered the same problems that foreign investors have experienced in China. A clear sign of this change of attitude is China's readiness to pursue a bilateral investment treaty with the U.S.
     The replacement of the catalogs by a "negative list" was initially proposed for the Shanghai Pilot Free Trade Zone. But in over a year since the zone was established, this has not really succeeded in attracting large quantities of liberalized foreign investment. In any case, it makes more sense to make the change at the national level rather than play around with a quite unnecessary pilot scheme.
     To the extent that the new law will reduce formalities for foreign investors in China, it is a welcome development. But much more needs to be done. The negative list will become a target for China's trading partners, who will continue to insist that it is reduced to an essential minimum and that the authorities publish an explanation of the reason for each prohibition. It is also uncertain just how far the newly defined "foreign investors" (previously "foreign-invested enterprises") will receive national treatment. Nor is it clear whether national security and monopoly reviews of foreign investments, which have been used in recent years to protect domestic enterprises from competition, will become fairer and more transparent.
     Most of all, there is still much to be done to guarantee the rule of law and the unbiased functioning of the courts.
Ken Davies is president of Growing Capacity, a consultancy promoting investment for development. He was previously the chief Asia economist at the Economist Intelligence Unit in Hong Kong and head of global relations in the investment division of the OECD in Paris.

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