Internationalisation on standby

With news of China’s gross domestic product having expanded 4.9 per cent in the third quarter, it is easy to get caught up in the narrative that all is back to normal in the world’s second biggest economy, especially as the rest of the world battles a second wave of the virus. In Shanghai, where foreign companies contribute a quarter of GDP, a third of taxation, and a fifth of employment, the pandemic’s downturn has not so easily been reversed.

European companies have long played a critical role in developing China’s most international city, but the pandemic has threatened this situation. Prior to the pandemic, members in Shanghai were already reporting that businesses had become more difficult, indicating a shaky level of confidence in the market. Then for several months, expatriate employees were stuck outside China. This had a significant impact on company operations and profit and, despite lifting of some travel restrictions, could have long-lasting impacts on the willingness for international talent to make Shanghai their home and for businesses to increase investment in the city.

Despite the uncertainty that COVID-19 brings to all markets, there are factors that Shanghai can control to increase the confidence of European investors, for example the many regulatory barriers that have prevented foreign companies from full participation in the market. As President Xi has recently tapped Shenzhen as the city to test economic reforms, giving it the autonomy to carry out various pilot programs for market opening, Shanghai must do whatever it can to match this level of opening and maintain its status as a global investment hub.

According to the European Chamber’s  Business Confidence Survey 2020 (BCS 2020), 70 per cent of respondents believe that Shanghai is a more attractive place to set up R&D centres compared to other cities in China. As Shenzhen seeks to become an innovation powerhouse, Shanghai must not grow complacent, but rather recognise how to fix its shortcomings. For example, tax incentives for high and new technology enterprises remain out of reach for many foreign enterprises whose core intellectual property is registered overseas. Although IP protection in Shanghai has undoubtedly improved, fear of IP infringement is the leading reason why a quarter of respondents are unwilling to bring their latest technology to China. Extending tax benefits to HNTEs with overseas IP would bring new innovation without companies fearing IP theft.

President Xi highlighted the development of human capital within Shenzhen’s reforms, with much emphasis on making the labour market more flexible. Shanghai is uniquely reliant on an influx of foreign talent for its internationalisation, but suffers from China’s tax regime, in particular the impending removal of benefits exempt from individual income tax. The vast majority of members rank the costs for international schooling as excessive; employers generally cover this expense, but will be reluctant to take on the extra burden of 45 per cent tax come January 2022. High salary and package expectations are already the biggest hurdle for hiring foreign talent in Shanghai, and the exacerbated burden will very likely lead to less assignments of high-level employees.  On the path to internationalisation and domestic competitiveness, having less international talent will be a huge step backwards, especially as the Greater Bay Area is offering subsidies for ‘high-end and urgently-needed talent’ to offset the tax allowance changes.

While regulatory reform is necessary to increase foreign investment, it must be complemented by transparent and predictable legislation. For SMEs in particular, transparency and predictability are of the utmost importance. While multinational companies have the resources to deal with a complex and confusing regulations, SMEs do not and thus rely on clear, open policy to navigate the business environment. A July 2020 survey of European Chamber members revealed that SMEs were less than half as likely as larger companies to consider further investment over the next year. Unfortunately, Shanghai implementation regulations for the FIL, meant to represent a major shift in the business environment and institutionalise an investment regime to provide equal treatment for foreign companies, remains vague and unpredictable, without any accountability or punishment mechanism for officials who violate provisions. Article 27 states that under ‘special circumstances’ the government may expropriate foreign investment for the ‘public interest'. Yet the regulations lack a clear definition of ‘public interest’, which gives a lot of discretion to the implementing departments and thus raises fears within the European business community over whether or not they will be affected.

European companies are eager to bring more investment if barriers are removed. For example, 81% of BCS 2020 respondents in the legal sector would increase investment in China if granted more market access. For a sector that has long been almost completely closed to foreign investment, the potential for growth is immense, and the city’s legal ecosystem and overall business environment would be strengthened as a result. Ultimately, the growth of the foreign business community in Shanghai will depend on real reforms. High-level, yet ambiguous plans and policies simply cannot address the regulatory barriers that disadvantage foreign-invested enterprises.