Amid the transformative currents of economic evolution, foreign investment has assumed a dynamic role in China's economic development over the past 40 years.

As China transitions from an economy marked by acute capital scarcity to one with improved technological prowess, the role of foreign investment has also undergone a transformative shift.

As the country positions itself for high-quality development, it is a strategic imperative for the country to foster a favorable environment for foreign investment in the new era.

Dynamic change

Foreign investment has distinct characteristics at different stages of a country's economic development. In the process of an economy transitioning from a low- and medium-income stage to a medium- to high-income stage, its capital tends to be relatively scarce, but it has other advantages, such as lower costs, to attract foreign investment. Therefore, during this phase, the scale and growth rate of incoming foreign investment are usually at quite high levels.

It has been the case in the early stages of China's reform and opening-up, where scarce capital led to rapid increases in inbound foreign investment and high economic growth, with its per capita gross domestic product now close to $13,000. India, with a per capita GDP of less than $3,000, is currently seeing a rapid influx of foreign investment, which aligns with the above-mentioned trend.

As its per capita GDP increases and labor costs rise, China is becoming relatively less attractive to foreign investors in labor-intensive industries. The structure of foreign investment has also undergone significant changes.

Although economic transformation has driven the relocation of foreign capital in some labor-intensive industries to other countries, in industries such as chemicals, automobiles, new energy, semiconductors, electronic communications and pharmaceuticals, foreign investors remain willing to stay in the Chinese market.

It is, therefore, crucial to recognize that at different stages of development, the access, structure, and business environment for foreign investors are constantly changing. Consequently, timely policy adjustments to better attract and utilize foreign investment, as well as improvement in foreign investment-related system arrangements, are needed to promote China's high-quality development by fully bringing out the role of high-quality inbound foreign investment.

Boosting confidence

Elevating foreign investor confidence in the ever-evolving economic landscape necessitates a multifaceted approach.

First, it is important to uphold a firm attitude toward high-standard opening-up. In the face of competition among the world's major powers and geopolitical influences, confidence from foreign capital is inevitably compromised. In this regard, China's unwavering commitment to opening-up is conducive to restoring confidence in foreign investment. Additionally, pursuing peaceful development and creating a favorable external environment also align with China's goal of high-quality development.

Second, efforts should be made to prevent and defuse risks from the real estate sector and local government debt. China's previous growth model was established after the tax-sharing reform in 1994 and the abolition of the welfare housing system in 1998.

The tax-sharing reform was a large-scale adjustment of the tax distribution system and tax structure between the central and local governments, rendering more fiscal resources for the central government; it is regarded as a milestone in the transition of China's fiscal system.

However, as the rising cycle of the real estate sector, which became a vital pillar supporting the country's high economic growth rate, is now past, it has become apparent that the real estate-supported growth model is unsustainable, and issues related to real estate and local government debt have gradually emerged in recent years, which can shake foreign investor confidence, especially during the transitional stage of economic growth.

Targeting China's long-term economic prospects, foreign investors usually attach great importance to the prospects of the real estate sector and whether local government debt can be gradually and smoothly resolved. Therefore, concrete measures in those areas, such as a more reasonable debt restructuring approach and a more effective institutional design for solving the real estate and local debt problems, will be conducive to alleviating concerns of foreign investors and boosting their confidence.

Third, China should stabilize economic growth through strengthened macroeconomic regulation. Stable and reasonable economic growth is crucial for restoring confidence, which requires intensified efforts in cross-cycle and countercyclical regulation while addressing structural issues. For example, coordination between fiscal and monetary policies should be enhanced to help maintain a relatively reasonable growth rate in the macroeconomy.

Fourth, it is indispensable for China to further optimize its business environment. China should attract and utilize foreign investment in a more effective way, by building a world-leading business environment that is market-oriented, law-based and internationalized, standardizing foreign investment policies and regulations, facilitating investment operations, and enhancing relevant financial and fiscal support.

Last but not least, China should expand domestic demand within the dual-circulation framework. Dual circulation refers to China's new economic development pattern in which its domestic market remains the mainstay, with domestic and international markets reinforcing each other. As China constitutes a vast domestic market, enlarging and strengthening domestic demand within the dual-circulation framework will be conducive to boosting foreign investors' understanding of, and confidence in, the Chinese economy, which will be conducive to encouraging foreign businesses to integrate into China's economic development.

What to improve

Expanding the scale of high-quality foreign investment calls for improvement in the following aspects. First, there should be a clear understanding of what is most needed during China's current development stage. Different development stages usually have different demands for economic development and corresponding foreign direct investment. After years of rapid development, China no longer faces acute scarcity of capital. Consequently, the focal point of attracting investment has shifted toward technological advancements and management expertise that foreign investors may bring through their investments.

With a rational understanding of China's development stage, policymakers should devise foreign investment policies that align with the country's current stage of development and implement structural guidance to, for example, provide more support for research and development in the manufacturing and services sectors that align with the country's high-quality development agenda.

Moreover, it is important to keep a balance between supporting foreign investment and encouraging the development of domestic enterprises. Although it is necessary for China to optimize its business environment for foreign investors and increase incentives and preferential policies toward foreign investors, such moves should be kept within appropriate limits; it is crucial to prevent super-national treatment from undermining fair competition.

Leveraging institutional advantages within the dual-circulation framework is also imperative to boost high-quality foreign investment. In China's central and eastern areas, generally, infrastructure is already adequate. However, there is still room for progress in effectively combining talent and capital, such as pushing for reforms in permanent residence registration and social security systems. Significant progress in such reforms will better leverage the institutional advantages within the dual-circulation framework and consolidate the strength of the vast domestic market.

China should maintain stable cooperative relationships with European countries and the United States, while it should continue to strengthen cooperation with countries involved in the Belt and Road Initiative, in areas such as energy, to promote collective achievement of diverse, autonomous, balanced, and sustainable development across nations.

By Zhao Wei, chief economist at Sinolink Securities.