China’s Aggression Is Killing Foreign Investment

Image: (Aug. 18, 2007) SHANGHAI, China - A boarding team, from the U.S. Coast Guard 378-foot High Endurance Cutter Boutwell, demonstrates along with the Chinese Coast Guard their specific boarding techniques and procedures on Saturday here. The crew from the Boutwell is representing the U.S. Coast Guard here and other foreign ports to help increase international maritime security and safety in the Northern Pacific Ocean and its borders as part of the North Pacific Coast Guard Forum. (Coast Guard photo by Pe

Beijing's pushy policies scare capital away.

Every time China’s military forces advance with a territorial claim in the East or South China Seas or in India’s Arunachal Pradesh or across the Taiwan Strait, foreign direct investment into China retreats. As Senator Everett Dirksen once said, “a billion here, a billion there,” and pretty soon it’s real money.

If a strong economy is key to survival of the Chinese Communist Party, Beijing’s brain trust has made a huge strategic blunder in abandoning its “peaceful rise” in favor of a rapid military buildup and pursuit of territorial claims throughout Asia. Naked aggression by the People’s Liberation Army, coupled with Beijing’s hard, bullying line on a host of disputes, is not just driving most of the rest of Asia into America’s arms. The specter of a new Imperial China is also raising very real questions in corporate boardrooms around the world as to the wisdom of long-term capital investment in China.

Make no mistake about the importance of foreign direct investment (FDI) in China’s economic development and transformation. In the wake of Deng Xiaoping’s 1978 economic “second revolution,” first a trickle and then a flood of FDI transformed China into the world’s largest factory floor and drove double-digit GDP growth for more than three decades.

Today, however, China’s flood of FDI may have reached its high-water mark. In 2015, India overtook it as the world’s top FDI destination, while FDI into China has plateaued since 2011.

Even more ominous for China’s growth and job-creation prospects, the mix of FDI has significantly shifted from in-flows to build factories to that for financial services; and it’s no secret as to what is going on here: Once-naïve business executives are now slowly but surely beginning to reevaluate the mounting risks of locating factories or parts of their supply chain in China—or even opening new markets on the mainland.

In fact, once the rose-colored glasses are lifted, this is a simple risk calculation. On the one hand, China continues to dangle the prospects of cheap labor, lax regulations, illegal export subsidies, and one of the world’s largest masses of humanity spending like drunken sailors in an orgy of consumption.

On the other hand, Beijing’s autocrats are imposing increasingly onerous conditions of market entry. These include the requirement of a local “joint venture” partner, the forced transfer of one’s technology, and stringent currency controls. In addition, wages that used to be cheap are rising, already severely polluted water is in increasingly short supply, and air quality continues to deteriorate further from abysmal levels. Dickensian England never looked this grim or gray.

There is also this stark risk factor: Any company that does business with China risks having all forms of its intellectual property stolen. Sadly, this risk starts from the moment a business executive takes a laptop or a cell phone through Chinese customs and has one’s data stripped clean—most S&P 500 companies don’t even allow their executives to bring their laptops or phones to China. And of course, once one factory gets built to foreign specifications, it is a simple matter to replicate that factory under a Chinese flag.

The newest and biggest looming risk, however, is purely geopolitical. To understand the nature of such geopolitical risk, look no further than the debacle of revanchist Russia’s taking of the Crimea and large chunks of Eastern Ukraine at gunpoint. In the wake of Russia’s gambit, its trade with the West has been sharply curtailed, tough economic sanctions remain in force, the Russian economy is in recession, and, most importantly from a geopolitical-risk perspective, any foreign company with a major Russian exposure—from Poland and Italy to Germany—has taken a very heavy hit.

For anyone who thinks this geopolitical risk scenario can’t repeat itself with an equally revanchist China, think again. Indeed, the canary in the coal mine for a much larger economic catastrophe may be found in the aftermath of the violent 2012 anti-Japanese riots across more than a hundred cities in China.

The 2012 riots (as well as less raucous protests in 2010) were over China’s historical claim to five small islets that comprise less than two square miles of territory—Japan’s Senkaku Islands in the East China Sea. While Japan has held this territory for more than one hundred years, Beijing’s revanchists claim the islets as the “Diaoyus,” and at least the rabid nationalist element of China appears willing to go to war over them.