Xi Jinping Chokes Off Crucial Engine of China’s Economy

Desperate for capital and with their economies struggling, China’s cities are wooing Western businesses with previously unavailable goodies. Beijing has labeled 2023 the “Year of Investing in China” and local officials have embarked on promotional tours overseas to drum up interest from investors.

That effort is running headlong into President Xi Jinping’s national-security agenda, with its focus on fending off perceived foreign threats. That has made any Chinese investment a potential minefield for foreign firms.

A Xi-led campaign this year has hit Western management consultants, auditors and other firms with a wave of raids, investigations and detentions. Meanwhile, an expanded anti-espionage law has added to foreign executives’ worry that conducting routine business activities in China, such as market research, could be construed as spying.

The perception that doing business in China has become much riskier is choking the flow of capital into an economy already struggling with weak private investment and consumption, as well as soaring youth unemployment.

Foreign direct investment in China fell to $20 billion in the first quarter of this year, compared with $100 billion in last year’s first quarter, according to an analysis of government figures by analyst Mark Witzke at research firm Rhodium Group.

Goldman Sachs economists predict outflows from China this year will cancel out investment going into the country, a stunning change for a country that over the past four decades has consistently seen more money coming in than going out.

China’s growth, which in recent decades has been fueled by the country’s opening to the West, depends on foreign investment and expertise to boost innovation and productivity.

For Chinese leaders, keeping pressure on foreign firms while simultaneously trying to get them to invest is becoming an evermore precarious balancing act, which threatens to deprive the country of the capital, technologies, ideas and management skills that have helped power China’s rise.

Distressed cities

The tug of war is leaving financially distressed cities and townships across China in the lurch. Mired in debt and struggling to create jobs after three years of Covid-19 restrictions, many are in dire need of capital.

Local governments spent more last year than the year before, according to official statistics, triggered mainly by an 18% jump in health expenses used to cover Covid testing and related costs. Meanwhile, their income dropped, mainly because of a 23% year-over-year plunge in revenue from land sales to developers, a funding source on which local authorities long relied. Localities have borrowed more than they could afford, with debts owed directly by local governments amounting to 120% of their revenue.

Many officials say their traditional strategies for attracting foreign investment have foundered.

A trade official in Chengdu, the capital of southwestern Sichuan province, recently embarked on an investment-promotion trip to Europe. He 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 said.

A senior official in a county of southern Guangdong province, which earlier this year set a goal of attracting nearly $300 billion in investment in the next five years, told a visiting American trade group recently that the county would reward any U.S. corporate “decision maker” investing there 10% of the value of the promised deal, according to people briefed on the matter.

The trade group turned down the county official’s offer, which in the U.S. would constitute an illegal bribe, the people said. The Guangdong government didn’t respond to requests for comment.

Business pause

Recent surveys by business groups in China have shown American, German and other European companies pausing expansion or reducing investment in China. Crane, a large U.S. maker of vending machines and other industrial products that has been manufacturing in China since the 1990s, has sharply scaled back its investments in the country partly because of increased policy uncertainty, according to people close to the firm. Crane, based in Stamford, Conn., didn’t respond to questions.

Sean Stein, chairman of the American Chamber of Commerce in Shanghai and a former U.S. Consul General in the city, said the recent pressure on U.S. consulting firms risks “cutting off the eyes and ears of foreign businesses.”

Treasury Secretary Janet Yellen objected to China’s treatment of U.S. companies when she met with senior officials in Beijing last week. Commerce Secretary Gina Raimondo is also expected to raise the issue for her coming trip to China.

In the seaport city of Ningbo in Zhejiang province, local officials held an “Investing in Zhejiang” forum, where they touted a checklist of initiatives they could offer foreign investors, from building better roads and pipes to offering tax incentives and subsidies for purchases of high-end equipment.

“The message is that we’re really open for business,” said Cameron Johnson, a partner at TidalWave Solutions, a U.S. consultant and one of the half-dozen Westerners who attended the event in May.

At the same time, uncertainty over policies from Beijing has created paralysis in global corporate boardrooms, he said. “What’s the government’s real focus?” said Johnson, an American who has spent more than two decades in China. “Can there be more clarity or guidance on policy so foreign businesses can develop a road map to comply?”

Mixed messages

Pixelworks, a Portland, Ore., designer and producer of chips used in videos and other electronic display devices, has been welcomed with open arms by local officials in Shanghai, where its China operation is based. They are especially supportive of efforts by Pixelworks’ CEO Todd DeBonis to get the company’s Chinese subsidiary listed on Shanghai’s STAR board, the country’s equivalent to the Nasdaq.

“We’re going all-in in China,” DeBonis said, adding that most of Pixelworks’ research and development talent is based in China, and that is where the firm derives most of its revenue.

Despite the local support, Pixelworks is facing pressure from China’s central government to reconfigure its Chinese subsidiary to make sure it is independent from the company’s American operations. That is the kind of requirement increasingly imposed on foreign companies as part of Beijing’s national-security agenda, business consultants and lawyers advising multinational companies say. 

For Pixelworks, that means the company has had to essentially split itself in two, with its China operation separated from its U.S. parent firm, to get Chinese regulators to approve its initial-public-offering application.

Over the past 2½ years, Pixelworks has undergone a painstaking process aimed at making its Chinese subsidiary independent from the U.S. parent. As part of that effort, Pixelworks has transferred the intellectual property specific to its China operation from the U.S. parent to the China entity—a move intended to ensure the security of those patents and trademarks against any potential U.S. sanctions that could make them off limits to China’s markets.

To comply with Chinese security concerns, Pixelworks recently moved 15 employees who worked on projects for the U.S. parent to a separate floor of its office tower. Those employees, all Chinese nationals, have their own office networks that are completely separate from Pixelworks’ China operations, and confine their work to U.S. projects.

In late June, several officials from China’s Commerce Ministry in Beijing visited Pixelworks’ offices to “better understand” its businesses and the company’s progress in separating its China operation, said DeBonis, who at the time was attending a U.S.-China forum and fly-fishing in Montana and was informed of the visit by his China staffers.

DeBonis said Pixelworks’ China operation aims to submit its IPO application to Chinese regulators later this year. To be approved, it will need to convince Beijing it has bulletproofed its intellectual property against any potential U.S. sanctions.

“They won’t approve your application unless you mitigate the risks to Chinese shareholders,” DeBonis said.

Write to Lingling Wei at [email protected]