China’s reign as the manufacturing hotspot for foreign companies appears to be coming to an end. Greenfield and mergers and acquisitions (M&A) foreign direct investment (FDI) into China is plunging, and investors are growing more concerned about China’s future as other Asian countries become more appealing.
Key findings:
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- Greenfield FDI levels halved since 2019.
- M&A deals down too.
- Companies look to diversify away from China.
- Costs, supply chain disruption and geopolitics are key concerns.
- Other Asian countries such as India, Malaysia and Vietnam stand to prosper.
China is seeing much lower levels of greenfield FDI
China’s number of inbound greenfield foreign investments is plummeting. We expect its total of inbound projects in 2022 to be only slightly higher than the levels achieved in 2020 at the height of the global Covid-19 lockdowns. Investment levels in 2022 are only half the level China received in 2019.
China’s downturn is across all sectors
Foreign investment into China is down across all sectors. Some of the largest declines are in its largest FDI sectors (by number of projects). Inbound tourism FDI is down by 78%, while food and financial services FDI are down by 66% and 63%, respectively. However, the trend is generally grim across all sectors. This points to wider macro issues than simple industry-specific concerns.
In terms of business operations, investors tend to create manufacturing and sales functions in China. These two business functions account for almost 50% of China’s inbound FDI projects. In both cases, FDI levels in 2022 are half of those in 2019.
Chinese cross-border M&A levels are falling too
China’s FDI downturn is not only restricted to greenfield operations. M&A has been a popular method used by Chinese companies to establish operations in Europe and North America. However, tightening regulations, particularly from European and North American governments, are reducing Chinese cross-border outbound M&A activity. These governments are concerned about Chinese investments in security-sensitive sectors such as telecoms, aerospace and defence. Chinese M&A of non-Chinese companies fell by more than one-fifth in 2022, while the foreign acquisition of Chinese companies is also exhibiting a downward trend. The Chinese government has reciprocated and made foreign deals more difficult, while the slowdown in the Chinese economy and the country's zero-Covid policy have also shrunk M&A interest.
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By GlobalDataConversely, the number of Chinese domestic M&A deals rose by more than 50% in 2020, with opportunistic companies looking to get cheaper deals. In both 2021 and 2022, domestic M&A levels declined. However, the number of domestic deals remains 26% above the levels seen in 2019.
Why are companies turning away from China?
There are several reasons why companies are switching operations from China.
1. Increased labour costs in China
Firstly, China’s cost-effectiveness is dwindling. Labour costs in China have risen at a much higher rate compared with regional competitors such as Malaysia and Vietnam.
Average annual salary costs in China are around $16,798 (115,167 yuan). This is almost double the average salary in Malaysia ($8,627) and close to five times more expensive compared with Vietnam ($3,427). Therefore, investor interest is pushed towards other markets.
2. Slowdown in China’s economy
China’s double-digit economic growth was once the envy of almost every country in the world. However, it is experiencing its first significant slowdown in more than 30 years. Between 2010 and 2021, China’s economy was growing at a faster rate than most of its Asian neighbours. Only India was comparable. However, in 2022, China’s real GDP growth slowed to 3.2%, according to the International Monetary Fund (IMF). This is less than half the rate of Vietnam, India and the Philippines, and lower than Malaysia and Indonesia. The IMF’s current five-year forecasts also expect China to grow at a slower rate than its nearby competitors.
China’s housing boom was a key proponent of its high economic growth. However, its real estate sector has more recently become overheated. Rising energy prices, higher costs of living, growing private debt and changing demographics are among the key concerns for the sector. The real estate sector is rumoured to account for anywhere between 15–30% of the country’s GDP; therefore, it has a considerable impact on China’s economic growth.
Also, China’s labour productivity (output per worker) is low, and growth is weakening. According to the International Labor Organization, China’s labour productivity in 2022 was $21,715 – lower than 72 other countries. Its growth in labour productivity has slowed. Between 2012 and 2020, China’s labour productivity growth averaged around 7% a year. In 2021 and 2022, the rate slowed to 3.6% and 3.4%, respectively. Being unable to grow labour productivity is hampering economic performance.
3. Trade tension and supply chain disruption
China’s growing role in the global economy has caused concern for the US – the world’s largest economy. Also, the US is keen to reduce its overreliance on China. China’s widening trade surplus (over the US) – which stood at $397bn in 2022, growing annually by 1.9% – is worrisome for US businesses.
The Covid-19 pandemic illustrated supply chain issues in getting raw materials and component goods to the US, among other countries, originating from China. This is causing a trend in reshoring and nearshoring to ensure goods can continue to be produced without delays.
Additionally, governments have introduced measures (including subsidies) to encourage domestic companies to produce at home and ignore manufacturing bases in countries such as China. An example of such is the US Chips Act, which aims to encourage US companies to manufacturer semiconductors, a key sector, at home. It also hopes to lure other global chip manufacturers to establish a presence in the US.
Although the media rhetoric would make one assume that the US and China will all but cease to trade with each other soon, the reality is highly different. Current trade between the US and China is at record levels, and the US is the leading destination for Chinese exports. According to China’s General Administration of Customs, in 2022, the US accounted for 16.2% of Chinese exports (or $582bn). The US is also China’s fourth-largest import market – behind Taiwan, South Korea and Japan – accounting for 6.5% of total Chinese imports ($178bn).
Data from the US concurs. China is the US’s third-largest export partner behind Canada and Mexico. By US accounting methods, in 2022, the US exported $154bn-worth of goods to China, or 7.5% of its total exports. China was the US’s leading import market, with imports amounting to $537bn.
However, the growth in trade between the two countries is slowing compared with trade with other countries. US exports to China only grew by 1.6% in 2022. This compares with a 19.1% growth in US exports to all other countries. Similarly, US imports from China grew by 6.3% compared with a 16.5% annual growth from all other countries.
As it is almost impossible to have a blanket ban on trade, perhaps the slowdown in trade growth is a strong indication of rising tensions between the US and China. We could be soon approaching a peak in US-China trade levels.
4. Geopolitical instability
China is an authoritarian one-party state government, and it has come under scrutiny for environmental concerns and inequality. Additionally, tensions have arisen in some areas of China such as Xinjiang, with accusations of attacks against the Uyghur ethnic group and other Turkic Muslims in the region, while allegations of the removal of Tibetan culture have also been raised. Also, China’s military drills near Taiwan have increased anxieties.
Several European countries introduced tighter FDI regulations to prevent foreign companies (primarily Chinese companies) from acquiring domestic companies, and national concerns have progressed from a loss of technical knowledge and job creation to security fears.
In addition, the spotlight has been shone on China’s special relationship with Russia after the latter invaded Ukraine in February 2022. China is one of only 35 countries that abstained from the UN vote to condemn Russia’s invasion of Ukraine.
Also, the US recently shot down a suspected Chinese spy balloon as well as three other unidentified objects. The incidents caused US Secretary of State Andrew Blinken to cancel a visit to China.
Which companies are reducing dependency on China?
Thousands of companies appear to be considering rebasing their existing Chinese operations.
Sony has transferred production of cameras sold in Japan, the US and Europe from China to a factory in Thailand. In principle, its factories in China only make products for China, equating to only 10% of Sony’s total production, with the company saying it wants to avoid potential supply chain malfunctions.
Dell plans to stop using China-made chips by 2024. It also wants its suppliers to reduce China-made components in its products. The company suggests this is being done to explore supply chain diversification. Meanwhile, HP is gauging the feasibility of moving supplier production away from China.
Japan’s Daikin, a provider of air conditioning units, is also moving away from using Chinese parts in its air conditioners from 2024. The company grew frustrated over China’s zero-Covid policy, which prevented it receiving parts from China for its manufacturing process.
Similarly, Japanese capacitor manufacturer Murata is looking to open a new plant in Thailand in the final quarter of 2023. The company is keen to reduce its supply chain reliance on China and is looking towards Indo-Pacific markets for future growth.
Equally, South Korea-based Samsung and LG are both looking towards India as their high-growth market. Both companies are keen to reduce their reliance on China in manufacturing and sales operations.
Which countries are benefitting from China’s decline?
Our provisional data shows that Asia-Pacific will be the fastest region for inbound FDI in 2022. We expect FDI inflows to grow, annually, by around 30%. Although China still ranks as the fourth-largest inbound market in the region (behind India, Australia and Singapore) it is one of only a few countries to experience declining FDI levels.
Inward investment into the region is being driven by India, which will become the third-largest global investment destination for the first time in 2022. However, other Asian countries such as the Philippines, Malaysia, Vietnam, Taiwan and Indonesia are all experiencing large increases in foreign inflows.
China's FDI decline: what can the country do?
To prevent further loss of foreign companies China must address the key issues discussed in this article. It must attempt to repair relations with the US. This is not only impacting US company investments in China but also most of its allied nations (such as the UK and Japan).
Improving its business environment, including removing red tape, not adding to it, is a must, while listening to global concerns, not only domestic, are key. These include climate issues, Covid policies, supply chain disruptions and several other areas. Also, it must be more open with other countries to address key concerns around security.
If China wants to continue to be a global economic powerhouse it must address these issues sooner rather than later.
