‘Reform and Opening Up’ Reloaded

On Friday, March 15, 2019, China’s National People’s Congress (NPC) adopted the Foreign Investment Law of the People’s Republic of China by a margin of 2929-8 vote, with eight abstentions and three delegates not voting. The Foreign Investment Law (FIL) is the most significant external economic liberalization-related measure since the recent inauguration of a new round of ‘reform and opening up’, and one of the most consequential economic liberalization measures since the entry of China into the World Trade Organization (WTO) almost two decades ago. Upon taking effect on January 1, 2020, the FIL will replace the current patchwork of laws (Equity Joint Venture Law; Wholly Foreign-Owned Enterprises Law; Contractual Joint Ventures Law) that govern China’s foreign inward investment regime and date back to its initial ‘reform and opening up’ period.

The Foreign Investment Law (FIL) bears useful similarities with the landmark Sino-Foreign Equity Joint Venture Law (EJV) that was promulgated at the second session of the 5^th National People’s Congress in July 1979. Now, as then, the FIL is the first major piece of reform legislation to express the country’s commitment to ‘reform and opening-up’. Now, as then, a key purpose of the law is to expand international economic cooperation and technology flows while standardizing and promoting China’s foreign investment regime. Now, as then, this expression of ‘reforming and opening up’ has been condensed into a compactly-worded 42-article law. The EJV law was in fact a sparse 15-articles long. Now, as then, the FIL’s ambitious scope but brevity in detail has touched-off criticism from the foreign investment community. Like the EJV law, it will require more detailed implementing regulations to provide clarity and comfort to investors. Unlike the EJV implementing regulations though (which took four years to be ironed out), the FIL’s implementing regulations are expected to be in place by the end of this year.

A key driver for the passage of China’s new Foreign Investment Law (FIL) is foreign businesses complaints of the de facto technology transfer obligations that have crept into the practice of China’s foreign investment-related joint venture rules. To be clear, these rules do not condition market access on technology transfer; such a conditioning would violate China’s WTO accession protocol. That said, there have been instances when foreign businesses have felt the need to involuntarily share their trade secrets as a condition to enter and operate in the Chinese market. These involuntary technology leakage practices take a variety of forms. They range from foreign ownership limitations that require the foreign investor to bring in and share know-how with a local partner, the use of administrative approvals and licensing processes to pressure the transfer of technology, arbitrary and duplicative processes that unduly burden and subject the foreign investor to potentially abusive regulatory practices, to the use of regulations that necessitate the disclosure of sensitive technical proprietary information at the time of product certification and review.

The Foreign Investment Law goes a significant distance, in principle, towards assuaging these long-standing concerns. Article 22 categorically orders government officials to desist from de facto coercion of transfer of technology via administrative means. Article 23 insists that proprietary trade secrets be handled confidentially and without conflict of interest on the part of regulators. Malpractice on any of these counts is liable for criminal prosecution (Article 39). Article 35 envisages the setting-up of a foreign investment information reporting system and requires that government departments not unnecessarily duplicate their investment information-related requests from foreign investors. Further, Article 24 instructs lower levels of government to comply with central laws and regulations and desist from imposing discretionary entry or exit barriers. Arbitrary and duplicative processes that unduly burden foreign investors and open them to potentially abusive administrative practices are to cease. Overarchingly, Article 4 categorically spells out that a system of pre-establishment national treatment and an across-the-board negative list is being implemented. With that list having been whittled down aggressively over the past two years – meaning fewer and fewer foreign investors are forced to enter the Chinese market via the Joint Venture route, foreign investors now stand to enjoy a level playing field with their domestic counterparts across broad swathes of industry and services during the investment access stage.

The Foreign Investment Law is not without its sharp edges though. Article 35 leaves the definition of ‘national security’ open-ended and vague. Decisions made in this regard by the (to-be-established) foreign investment safety review system are to be treated as final like a presidential finding within the U.S.’ CFIUS system, there is no recourse to appeal. Furthermore, Article 40 empowers the Chinese government to take “corresponding [retaliatory] measures” against a country or region if it imposes discriminatory, prohibitive or restrictive measures against Chinese entities in the field of investment. On the whole though, the Foreign Investment Law is a well-written one. In time, it will likely come to be seen as that milestone law which launched a dynamic new era of ‘reform and opening-up.

As welcome as the Foreign Investment Law is in China’s long march to advanced market economy standing, there is more work to be done. Policy attention must now shift to the negative externalities that have begun to radiate internationally from the practice of the state’s industrial policies. A number of principles should be firmly inscribed in China’s trade, investment and intellectual property rights (IPR) policies and practices, in this regard, going forward.

First, China’s polices must abide by the ‘most favored nation’ and ‘national treatment’ principles. Aside from the area of government procurement, there should be no nationality-based conditionalities or restrictions on purchase, sale or use. Domestic regulatory oversight, not local product use, must become the norm across-the-board. Second, China’s industrial policy interventions must metamorphose from a subsidies-based model to a fiscal incentives-based and indicative planning model. This will require the reformulation of the role of the state as a producer as well as subsidizer at every level of government. Criteria and classification measures that clarify the state’s commercially neutral stance in the course of SOE operations should be spelt out. To the extent that subsidies are tapered down but continue to be disbursed, they should be narrowly tailored.  Third, China’s innovation policies must be technology-neutral and concentrate on usage rights, not proprietorial ownership per se. To incubate a local, high-technology manufacturing eco-system, China should experiment with an enabling tax credit regime. And insofar as knowledge-creation is concerned, the government’s matrix of support measures should evolve towards government sponsorship of basic research and licensing of government-sponsored IPR. Finally, China should construe measures governing ‘national security’ reviews, including for retaliatory purposes, narrowly and as best as possible limit it to ‘essential’ security interests. Economic security preferences should not be fused with ‘national security’ considerations.

These reform principles will help alleviate tensions with its American and European trading partners. Over the longer term, it will also fuel China’s escape out of the ‘middle income trap’ and facilitate its transition from an excess investment-led and debt-fueled growth model to one that is more consumption-oriented, productivity-led and high-quality growth-based. Foreign-invested and export-oriented enterprises in its coastal regions were at the foundation of China’s remarkable late-20^th century economic renaissance. Should a new round of ‘reform and opening up’ under Xi Jinping lead to a similarly far-sighted liberalization of China’s investment and industrial policy regime – much like Deng Xiaoping had engineered of its trade regime three decades ago, China could well become the advanced manufacturing center, and leader, of the world by mid-century. The Foreign Investment Law is both a milestone and harbinger of things to come in this regard.