Planning to invest in or open a business in China? Here are some of the challenges to expect when doing business in the Chinese market in 2023.
Doing Business in China
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How Easy Is It to Do Business in China?
Despite the challenges posed by COVID, for a long time China managed to maintain the strength of its economy and even bounce back stronger than before. In 2021, China was hailed as the top two foreign direct investment (FDI) destinations globally, with USD 334 billion in investments across various industries.
During the height of the pandemic, China shifted its economic gears from running high-speed growth to high-quality development. As such, the government laid out several plans to attract investors such as relaxing restrictions and introducing improvements to the business and regulatory environments. According to the latest rating of the World Bank, China is ranked 31 among 190 economies when it comes to ease of doing business.
The long-term positive outlook that the Chinese economy displays invites more investors to partake in the local market.
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Can Foreigners Do Business in China?
Yes, in short foreigners are able to participate in the market and do business in China through the following entities: Wholly Foreign-Owned Enterprise (WFOE), Joint Venture or Representative Office.
Wholly Foreign-owned Enterprise (WFOE)
- The WFOE in China is a Limited Liability Company through which a foreign investor’s capital is used to establish the business in the country.
- The biggest advantage of this setup is that foreign investors maintain complete ownership of the business. Investors do not have to partner with local entities and they can hire both foreign and local employees.
Joint venture (JV)
- This type of Limited Liability Company in China is formed through a partnership between a Chinese company or individual and a foreign investor.
- A JV is the most commonly used business structure for foreign investors who wish to access restricted industries in China.
Representative Office
- Registering a Representative Office (RO) is the easiest way for foreign investors to test the Chinese market for their business.
- A Representative Office grants foreign businesses presence in the local market, however not as a legal entity established in the country.
- Businesses registered under an RO cannot issue invoices, directly partake in profit-generating activities, or hire local Chinese employees.
Challenges of Doing Business in China
While China has relaxed its policies when it comes to foreign and local investments, there are still several challenges that investors can anticipate and prepare for if they decide to participate in the Chinese market:
1. Bureaucracy
Government officials play an active role in managing the national and local economies. This has been illustrated over the periods of the COVID lockdowns, where local governments had imposed strict measures on businesses, to restrict the virus from spreading.
Domestic businesses may also enjoy more privilege and protection compared to international firms. Market access is also limited, especially when it comes to imported goods and service providers.
2. HR Challenges
Regulations for hiring in China can be restrictive for foreign business owners. Also, obtaining references from previous employers for background checks can be challenging since it is not a common practice.
Foreign representative offices also cannot directly hire local employees. They need to go through special HR management agencies to comply with local hiring requirements. This process can create a disconnect between what the company needs compared to what the agency looks for in a candidate.
3. Intellectual Property Protection (Lack of Protection)
IP infringements has been a major concern for foreign businesses when doing business in China. Often this has been seen with counterfeited products like handbags, shirts, shoes, and other goods such as auto parts, pharmaceuticals, and high-tech equipment.
Foreign firms have often faced barriers with judicial protectionism, challenges in obtaining evidence, and a perceived bias which in turn makes foreign firms hesitant to participate in the market.
4. Increasing Labor Costs and Standard of Living
The cost of living in major cities in China has seen a drastic increase in the past few years, along with the rise in demand for a qualified and skilled workforce. This means that the cost of hiring skilled talent has also increased, forcing companies to raise the salaries of their valued employees.
5. Uncertainty in the Market
With the on-going COVID restrictions and the recent difficulties faced in China’s property market, there is a lot of uncertainty facing those who intend to invest in China in the short term.
The uncertainty exists on many fronts, including regulatory challenges, supply chain difficulties, travel restrictions, COVID measures and more. While most businesses agree that China is an important part of their long-term global strategy, there is currently a great deal of uncertainty in the short-term.
As such, many businesses are making adjustments to their Chinese based operation or are putting investments on hold, until a certain level of stability has been established.
6. Market Competition
Market competition in China is very tight and whether the market is highly fragmented or only has a few players, it is often hard to enter and gain momentum. Many foreign businesses with a strong overseas presence have entered and found the marketplace difficult to participate in. Some notable examples of this can be seen with companies such as Walmart and Amazon, who despite having achieved success in their home markets, were not able to be successful in the world’s largest consumer market.
Foreign investors have to compete with local businesses that are more favored by the government when it comes to access to resources.
The supply of skilled employees in China remains to be one of the major hurdles that investors have to face if they plan to establish a foothold in the country. The demand for workers outnumbers the supply, making the talent market highly competitive.
7. Attracting Foreign Talent
Foreign talent and personnel remain a priority for foreign businesses who have operations in China. Even though there is a large workforce based in China, the demand for expertise and cultural understanding of a particular company or brand still remains strong.
With experience working in a culturally familiar setting, there is an increased sense of understanding a brand or company, which is why top foreign talents were frequently transferred to China over the past 2 decades. However, convincing employees to transfer to China has been difficult over the past few years, primarily due to the travel restrictions and city-wide lockdowns.
Despite the maintained COVID measures undeniably keeping international workers from staying in China, there are notable efforts to enhance the country’s appeal to global talent including more efficient visa systems and working permits.
8. Transparency on Regulations
For a large number of foreign businesses, unfavorable regulations and lack of transparency make it hard to comply. This deters foreign investors from establishing a business, or in some cases decoupling their Chinese entity from their foreign entity, due to the inconvenience and difficulty of complying with regulations. A prominent example of this is with China’s implementation of the Data Privacy Law which has led to some firms decoupling from their foreign entity.
9. Corporate Culture
Chinese business culture has quite a number of differences from its Western counterparts (read more about business culture in China). For example, corporate culture in China gives huge importance to hierarchy in comparison to Western firms.
Chinese managers expect obedience from subordinates, which means that asking questions or raising disapproval during meetings is treated differently, as opposed to a Western environment
10. Systemic Control on Foreign Exchange
Strict compliance with a ‘closed’ capital account policy means that companies face barriers in moving money freely into or out of the control. While progressive changes are being made to create a more liberal foreign exchange market, companies still deal with regulatory challenges regarding the administration of foreign exchange policies.
What are the Emerging Opportunities for Doing Business in China
Despite the aforementioned challenges, the Chinese government is continually attempting to make the market more accessible and enticing to foreign entities, as well as more competitive for local businesses.
Some of the opportunities that encourage investors to take part in the Chinese market are:
Free trade zones (FTZ)
FTZs or special economic zones (SEZs) were introduced by the government to encourage foreign direct investment in several industries available in certain regions.
The first one opened in Shanghai in 2013, followed by Guangdong in 2015.
The other FTZs in China are located in Anhui, Beijing, Chongqing, Fujian, Guangxi, Hainan, Hebei, Heilongjiang, Henan, Hubei, Hunan, Jiangsu, Liaoning, Shaanxi, Shandong, Sichuan, Tianjin, Yunnan, and Zhejiang.
Companies doing business in FTZs enjoy:
- Lower corporate taxes
- Faster VAT refund
- Fast customs clearance
- Import tax exemption within the designated zone
- Easy access to logistic service providers
FTZs give access to businesses to receive, handle, manufacture, reconfigure, or re-export goods without the intervention of local authorities.
But when moving the goods to consumers within the province wherein the FTZ is located, customs duties and other regulations will apply.
Revised Negative List
The Negative List consists of industries that are prohibited or restricted to private companies in China. Foreign investors planning to do business in any industry on the Negative List must go through a complex process to get additional administrative approvals. Industries not on the list are presumed to be open to investment.
Last March 2022, the National Development and Reform Commission and the Ministry of Commerce released a revised version of the Negative List. From the 123 industries included in the list, the government trimmed it down to 117 to invite more investors into the Chinese market.
Some of the biggest industries that foreign investors can have a majority stake in are automotive and television manufacturing. Investors can now also fully own enterprises in vehicle manufacturing, specifically special purpose, new energy, commercial, and passenger vehicles.
Market size and growth potential
While China’s economic growth has slowed down, it still outpaces other countries and remains to be one of the most viable countries to invest in.
Plus, the sheer market size of one of the world’s largest economies — with a population of 1.4 billion — is enough to surpass the GDP of the entire 27-country European Union.
According to the British Consultancy Centre for Economics and Business Research (CEBR), China is projected to continue growing between 4 to 6% per year until 2030. By that time, China will have surpassed the USA as the world’s largest economy.
Labor pool
China is known for its vast and affordable labor pool. However, labor costs are rising because of increasing worker productivity, an experienced and more educated workforce, and better infrastructure and working environment.
The breadth of China’s labor pool presents highly adaptable workers who can work in various fields. Aside from cost efficiency, foreigners can get the chance to tap into the Chinese worker pool that’s composed of highly educated talents.
The Chinese market remains to be one of the most attractive places for foreign investors and businessmen. However, it can be challenging to register a legal entity in the country due to the complex processes enforced by the local and national governments.
If you are considering expanding your enterprise to China, we can help you to enter the market. MSA has supported a diverse range of clients with navigating the Chinese regulatory environment and effectively setting up their business in China. We specialize in accounting, financial advisory and corporate set-up services and can help your business succeed in the Chinese market. Contact us right away to find out more about how we can help!
