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China Needs to Focus on ‘Soft Power’, to Keep Foreign Investment

There has been increasing fears about rising protectionism in China, due to Beijing’s push for innovation that have encouraged the rise of domestic players, arguably at the expense of foreign ones.

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Several multinational firms have weighed in on the issue: General Electric's CEO Jeffrey Immelt last month said GE was facing the toughest climate for doing business in China in 25 years, and that the firm was being squeezed out of lucrative government contracts. The heads of German firms BASF and Siemens have also flagged similar concerns.

Are they right? Is China closing the door to foreign firms? The answer lies in reality and perception.

The reality is, the country is not becoming more protectionist — just that some sectors that have never been open to foreigners, have remained that way. Energy and financial services industries, for example, which have been viewed by Beijing as critical to national security, will continue to be challenging for foreign firms to operate.

On the other hand, markets like the auto sector remain mostly open, as the government is in favor of joint ventures with key foreign players like Toyota and Ford , to ensure technology transfer and help the China catch up with other nations.

While the Chinese government is taking steps to open its doors, it is also careful not to allow foreign firms to benefit at the expense of its domestic markets. They point to how the South Korean authorities have come under criticism after private equity firm Lone Star made a fortune from its investments in the country.

The truth is, since China entered the World Trade Organization in 2001, the country has been far more open to foreign investment than ever before. The most welcoming sectors don’t have competing domestic interests or are ones which the government wants foreign investment; like software.

As such, companies in consumer product and IT sectors like Apple , Starbucks and Microsoft have been given relative free reign to operate; while firms like Citigroup , Google and Pfizer , which are in more protected industries, have always had challenges.

So if China is not actually getting closed off, why is it getting so much flak? First of all, the perception of China a decade ago, was that the economy did not matter much in terms of its overall global revenue share. But today, with China becoming a serious player in the global economy, and savvier companies like Corning and Intel making serious money there, there is a fear that if you don't win China, you will lose the world.

Secondly, unlike a decade ago, there are now well-capitalized and very aggressive Chinese firms like Huawei or Baidu intent on becoming global players. They are no longer competing on price or merely trying to be cheap but good. They are vying to compete on innovation and branding.

Executives of major German and American industrial companies have told my firm that their biggest fears come from Chinese emerging companies that not only have large lines of credit at state-owned banks like ICBC and Bank of China but are also competing headon in technology.

Unfortunately, perception is often more important than reality. Chinese officials may point out that foreign direct investment rose 20 percent in 2010 and is on track to see similar growth this year. They may argue that nearly 50 million local workers are employed by foreign firms and that serious profits are now being made by companies like Coca-Cola and YUM . But none of that matters.

As Americans question their way of life and worry about the lives of their children, it is easy for U.S. politicians like Senator Charles Schumer, who are looking for scapegoats for America’s economic mess rather than addressing the country’s very real internal structural and cultural problems, to point a finger at China.

And as unfavorable as it is for China, the country needs to do a better job at soft power if it wants to stave off rising anti-China sentiment, and keep support from foreign business. While the country is not in danger in losing continued investment, things could change as its labor and costs of business soar. Already, there is talk of Indonesia and Brazil becoming the next hot manufacturing destinations.

Although China still has one of the more open economies in Asia, the perception by the west is far from the case. The government needs to combat that by re-engaging the foreign business community and re-gaining more of its support.

Shaun Rein is the founder and managing director of the China Market Research Group (www.cmrconsulting.com.cn) a strategic market intelligence firm, and is based in Shanghai. Follow him on Twitter at @shaunrein. He does not own stock in any of the companies mentioned.

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