What China’s fading appeal to foreign investors means for its economy

A printing and packaging factory in Qingzhou, in eastern China's Shandong province. China’s manufacturing industry is struggling to attract new investors. AFP

For years, the sheer size of China’s economy made it an irresistible magnet for foreign investors, with many – including sovereign wealth funds from the Gulf – contemplating larger allocations to the country.

China’s economy, generating more than $10 trillion annually, has consistently outpaced the growth rates of western counterparts, including the US. However, recent trends reveal a shift in sentiment among foreign investors, particularly those operating within China.

Once seen as a top region for investment, China’s allure is fading, with concerns about internal support for domestic companies and declining profitability for foreign ones.

As a result, foreign investment is increasingly gravitating towards select services sectors, leaving China’s manufacturing industry, once the engine of its economic miracle, struggling to attract new entrants.

A recent European Chamber of Commerce poll paints a bleak picture of foreign business confidence in China. The 2024 Business Confidence Survey found the percentage of companies ranking China as a top investment destination has hit record lows – 15 per cent for current investments and only 12 per cent for the future.

Many companies are now redirecting investments originally planned for China to other markets perceived as more stable and transparent. Those foreign subsidiaries in China that want to expand find it harder to convince their headquarters to allow them to do so, the survey found.

However, the latest IMD World Competitiveness Ranking paints a different picture. It found that while Singapore is the most competitive economy, China is closing the gap, having leapt seven places in the table thanks to its strong post-pandemic recovery.

China now ranks 14th, up from 21st last year. Among countries with populations of 20 million or more, China is now the fourth most competitive economy.

However, when it comes to its attractiveness to foreign investors, the country fell seven places to 11th. Clearly, a large economy isn’t enough to sway investors.

Data on foreign direct investment (FDI) into China isn’t promising either.

The UN data shows total FDI into China fell $25 billion in 2023 to $163 billion. From 2019 to 2023, the UN estimates total net inflows amounted to $681 billion. That may sound impressive but it pales in comparison to the total value of foreign corporate investments in China. That figure rose to $1.89 trillion over the same time period.

This increase could mean one of two things: either the value of the installed base of investments went up a lot, or most of the foreign expansion in China was funded by foreign companies that were already there. Either way, the figures will cast doubt on China’s ability to widen its appeal to new foreign entrants.

Realised FDI (the value of investments that actually occurred) in its manufacturing sector peaked in 2022 at some $57 billion. For the previous decade, the annual totals of realised manufacturing FDI, according to Chinese official figures, never exceeded $50 billion.

Moreover, the number of newly established foreign goods producers in China fell to its lowest level in 2022 at 4,608 firms – half the level seen in 2012 and a fifth of that witnessed in 2005.

If more first-time investors were being attracted to China as a production base – possibly as an export platform – then surely the number of new foreign firms should be rising, not falling.

China’s reputation as the “workshop of the world” makes the decline in manufacturing FDI particularly striking.

Instead, most foreign investment is now flowing to the service sector. Remarkably, every year since 2010, the total value of realised FDI in Chinese services has exceeded that of the country’s factories.

While 26.3 per cent of all realised FDI into China in 2022 was in the manufacturing sector, 12.6 per cent was in IT, another 16 per cent in research and development services, and 17.5 per cent in leasing and business services. In 2022, $131 billion was invested in foreign services, leading to the creation of more than 33,000 new service sector companies with foreign owners.

These outcomes are not in synch with Beijing’s aim to promote manufacturing over services, focusing on high-tech and strategic industries to boost economic growth and self-sufficiency. Despite the government’s emphasis on boosting manufacturing, foreign investors continue to focus more on the service sector. One reason for this mismatch is that foreign industrial firms operating in China have seen their profits grow slower than their Chinese peers, according to official data.

From 2014 to 2017, the profits of foreign industrial firms rose in line with Chinese peers. Then up to the pandemic in 2020, foreign firm profitability plateaued while Chinese industrial firms increased their earnings – creating a performance gap.

Although foreign companies saw a jump in profitability in 2021, Chinese firms experienced similar gains. After that, profits for foreign industrial firms declined more sharply than those of their Chinese counterparts, widening the performance gap. Despite some recovery in foreign firm profitability in the first half of this year, the gap remains significant.

Such findings will fuel claims that, since the mid-2010s, Chinese policies have increasingly favoured domestic firms over foreign rivals. It’s natural to expect Chinese firms to gradually catch up with their foreign competitors, as they improve their capabilities.

However, the consistent progress of Chinese firms year after year doesn’t fully explain the significant and sudden decline in the profit performance of foreign industrial firms operating in China, especially since 2017 and after 2021.

So long as suspicions linger that the Chinese government is tilting the commercial playing field in favour of local industrial firms, then this will dampen the allure of investing in the Chinese manufacturing sector. For the time being, what remains alluring to investors are certain high-profile Chinese service sectors, including the geopolitically sensitive IT sector.

While China’s economy remains a global powerhouse, its fading appeal to foreign investors, particularly in manufacturing, reflects deeper concerns about market predictability and fairness. As foreign investors weigh their options, China may need to reassess its strategies to maintain its position as a leading destination for global investment.

Simon J. Evenett is the professor of Geopolitics and Strategy at IMD Business School and co-chairman of the World Economic Forum Trade & Investment Council