American and international firms are pondering whether they should enter or expand operations in China’s domestic market, which increasingly operates under state direction with lines blurred between Chinese companies and government authorities. On the one hand, the market of 1.4 billion potential consumers is difficult to ignore. Many large, Western-based companies derive significant portions of their global profits from doing business in China. But foreign companies have long complained about unequal treatment and market restrictions in the Chinese market compared with the access granted to Chinese state-owned enterprises (SOEs), which makes conducting business in China more difficult, and more expensive, than elsewhere. The stakes are rising as the Chinese Communist Party (CCP) is stepping up its control over different parts of the economy, particularly in response to the coronavirus pandemic, raising political and regulatory risks for investments in China, according to analysts. If you are running a business in developed markets, you know how to price in your costs. But in China, it is impossible to price in the regulatory risk Zhuang Bo, TS Lombard Challenges in toeing the party line, censorship, and strict controls on capital flows are among the uncertainties that foreign firms face when conducting operations and making investments in China. “If you are running a business in developed markets, you know how to price in your costs. But in China, it is impossible to price in the regulatory risk,” said Zhuang Bo, chief economist of China research at TS Lombard. “You don’t want to go against the party line and end up stuck in a difficult position and become subject to some Chinese regulation.” In recent years, Chinese President Xi Jinping has been strengthening the ideological conviction of following a path of socialism with Chinese characteristics , in which all forms of work in the country are directed by the CCP’s leadership and its vast state-planning apparatus. Reported plans that Ant Group will turn itself into a financial holding company overseen by China’s central bank, in response to new stringent capital regulations, underscore the possibility of regulators taking control of major, private businesses, Zhuang said. “If an American bank decided to liquidate its assets in China overnight, would it be able to repatriate all of its money back to the US immediately? Probably not,” Zhuang said. China tries to woo wary foreign firms with market access to offset US decoupling Paul Romer, a professor at New York University’s Stern School of Business, said foreign firms need to accept that their interactions with China are based on the notion of “Westphalian sovereignty”, and must follow the norms and rules of the state-directed Chinese system. The Treaty of Westphalia, signed in 1648 to end the Thirty Years’ War in western Europe, said every nation has sovereignty within its borders to make its own decisions about how to govern its affairs. “The system in China may be well-suited to lead things forward in coming decades,” Romer said. “[China’s] strong government-led system is capable of really important innovations.” Romer was chief economist for the World Bank from 2016-18 and was a co-recipient of the Nobel Prize for Economics in 2018 for his contributions to understanding how long-term economic growth relates to technological innovation. This week, a report written by a number of prominent tech industry officials, including former Google CEO Eric Schmidt , called for a rethink of the US-China tech relationship, with a likely bifurcation of the two countries’ tech industries because of “asymmetric” competition resulting from the Chinese government’s strong involvement in and influence over the market. Google shut down its Chinese operations in 2010 because of censorship restrictions on its search engine. “China plays by a different set of rules that allow it to benefit from corporate espionage, illiberal surveillance and a blurry line between its public and private sector,” the report said. The perks enjoyed by SOEs are major issues in the US-China trade dispute, while reducing them was one of the main motivations behind the just-signed investment treaty between the European Union and China. What is the China-EU CAI and how is an investment deal different from a trade deal? Chinese SOEs are pervasive in almost every sector but are especially prevalent in utilities, transport and steel manufacturing, the International Monetary Fund (IMF) said in a recent report. The latest data shows that total assets of Chinese SOEs stood at 194 per cent of GDP in 2018, higher than in the early 2000s, and several orders of magnitude larger than in any other country. Despite improvements in recent years, SOEs continue to underperform and have significantly lower revenue productivity than private firms in the same sector, the IMF said. As Beijing tightens restrictions on political freedom, it is selectively opening up the economy to entice foreign companies such as JPMorgan Chase and Tesla to stay put, while encouraging other American companies to join them. At the virtual World Economic Forum on Monday, President Xi called on countries to abandon ideological prejudice, and he restated China’s commitment to opening up to facilitate trade and investment. “China will promote institutional opening that covers rules and regulations, management and standards, fostering a business environment that is based on market principles, governed by law, and up to international standards,” Xi said. Reflecting the attractiveness of China’s domestic market after a rapid economic recovery from the pandemic, foreign direct investment into China rose to a record high in 2020, posting the fastest growth rate in five years, and thus strengthening China’s supply chains and the nation’s status as the “factory of the world” . The financial sector, including asset management, private wealth management and insurance sectors, is especially attractive as it remains largely untapped by foreign players. American financial institutions such as American Express , BlackRock , The Carlyle Group , Citigroup and Goldman Sachs have all moved more actively into China over the past year or so following China’s decision to scrap caps on the share of domestic financial operations that foreigners could hold, while awarding new business licences for financial ventures in the domestic market. Zeng Peiyan, who served as Chinese vice-premier from 2003-08 before becoming a top economic policy adviser in Beijing, said China can prosper only if globalisation continues. Likewise, through economic reforms and opening up, China has benefited the world. In the past 40 years, US-China bilateral trade has grown over 250 times and cross-border direct investments have reached nearly US$240 billion, Zeng said. If [firms] don’t want to go in and operate under the Chinese system, they shouldn’t … there are other firms who will Paul Romer, Nobel laureate Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, strongly defended the Chinese system on Monday, saying that China’s industrial policies have helped prevent excess competition, curbed polluting and indebted companies, and built a domestically based industrial chain. The resulting competitiveness of Chinese products does not come at the expense of labour protections, Guo argued. Tesla has seen a rapid rise in sales following its investments in China, with production this year expected to exceed 500,000 units – or nearly half of its worldwide output. Romer also contended that China’s state-led economic model creates a strong central government that stands ready to mobilise regions and cities to control the pandemic. This, he said, puts China in a better position than the US to prevent innovations that are harmful to the economy, even though they may be profitable to companies. The role of credit default swaps in the financial sector in the US is an example of how a harmful innovation helped precipitate the 2007-08 global financial crisis, he said. “If [firms] don’t want to go in and operate under the Chinese system, they shouldn’t, and the Chinese people shouldn’t care that they don’t come in, because there are other firms who will,” Romer said.