To catch up with the wealthy east coast, China’s rising western cities should play nice with foreign enterprises

  • Paul Sives says Chongqing and Chengdu are joining the league of China’s top cities in terms of economic growth but there are still too many barriers to doing business in western cities, especially for foreign companies
PUBLISHED : Friday, 16 November, 2018, 2:04pm
UPDATED : Friday, 16 November, 2018, 6:01pm

For many years, China has sought to narrow the development gap between the wealthy east coast and the less-developed western regions. As part of a Go West strategy, the government has invested dizzying sums in hard infrastructure – roads, airports, railways and bridges – to better integrate the western regions into global production chains.

Now, these investments are beginning to pay off. In 2017, while coastal regions still led the way in terms of absolute income, two inland cities – Chongqing and Chengdu – outpaced nearly every other Chinese city in terms of economic growth.

Both southwestern cities are increasingly attractive to investors, too. Back when China first became the factory of the world, foreign businesses clustered in cities like Beijing, Shanghai and Guangzhou, taking advantage of low costs to manufacture and export goods to their home markets. Times have changed: coastal cities are reaching saturation point and can no longer offer the same low operational and labour costs as in the past; and, as Chinese consumers’ purchasing power grows, many foreign firms have pivoted away from the export-driven model to serve the domestic market.

Southwest China offers foreign investors a lower threshold for entry than coastal regions, due to less crowded markets and relatively low costs. Chengdu stands out in particular, due to the local government’s efforts to diversify economic growth and bring in outside investment.

However, there are still too many barriers to doing business in southwest China. Many might be initially drawn by the promise of subsidies and free office space but, in reality, the preferential policies may prove difficult to access, with little transparent information publicly available. Furthermore, while local governments can be extremely welcoming to large multinationals, especially Fortune 500 companies, the support is not guaranteed in the long term and is rarely extended to smaller firms.

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For many, enforcing contracts can be a huge headache, and not just with wayward local companies. There have been instances when district governments have not compensated companies for early terminations of contracts. Although such issues can often be resolved through negotiation with officials, the process can be lengthy and costly for businesses. Even when firms willingly try to relocate, the competition for tax revenue between districts means deregistering a business can take many months or even years.

Competing with local firms is also a major challenge, especially when state-owned enterprises receive preferential treatment on public procurement contracts but are less accountable for compliance issues. As a result, some local companies can offer products and services at lower costs due to savings made in evading tax and social security payments. Furthermore, there is a lack of financing options, as foreign companies are cut off from loans and overdrafts – funding channels that are essential for doing business back in their home markets.

There may be a high concentration of good universities in Chengdu and Chongqing, which means there is no shortage of junior-level staff, but it is difficult to persuade senior executives to leave first-tier cities and settle in southwest China. Many foreign firms find themselves having to pay above market price to convince management to relocate, and issues with the standard of living may be further deterrents. Overcrowded hospitals and a lack of early-education options mean that many senior managers are reluctant to bring their families, and while air pollution has been addressed by stricter emissions regulations in recent years, it is still bad enough for foreigners to think twice about moving there.

In the quest to compete against the coastal regions, government subsidies can only go so far. More important is the development of “soft infrastructure”, which includes governance, law enforcement, the financial system, education and health care.

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Above all, foreign companies are seeking a more predictable operating environment. To achieve this, local governments would do well to provide more transparent and relevant information online. Equally important is a reliable and independent judiciary that can uphold businesses’ property rights. The authorities need to take concrete steps to ensure all companies, whether foreign or domestic, are treated fairly and equally. Involving the business community in regular discussions with government officials would be a good start, as it would allow firms to directly put forward recommendations, leading to better legislation.

If the local governments succeed in establishing sound institutions and creating a competitive business environment, then they will be able to attract more capital and know-how, which is necessary to make up for diminishing returns on hard infrastructure and catalyse sustainable economic growth. When this happens, Chengdu and Chongqing will begin to rival coastal cities and deliver vibrant, developed economies.

Paul Sives is chairman of the European Chamber of Commerce in China’s Southwest China Chapter