In addition to concerns about the U.S.-China technology standoff, doubts about China's willingness to open up more to the outside world are also hindering cash flows into to the country.
If decoupling with the West due the drop foreign investment continues, the effect could be felt beyond the Chinese economy to throughout the world.
Direct investment by foreign companies in China in the second quarter totaled $4.9 billion, an 87% decrease on the year, the largest drop since 1998 when comparable data first became available, according to figures released this month by the State Administration of Foreign Exchange of China.
The drying up of foreign cash is not new. FDI in China has dropped by more than 50% since the April-June quarter of last year. China's strict zero-COVID policy, which locked down commercial hub Shanghai for large parts of last year, increased foreign uncertainty and contributed to the loss of investment momentum.
Economic activity has normalized since the zero-COVID policy was dropped in January, but foreign direct investment has continued to decline. According to China's Commerce Ministry, foreign companies invested 2.7% less in terms of yuan, including reinvestment, in the first six months of 2023 than in the same period last year.
Escalating U.S.-China tensions are having a chilling effect on corporate investment plans. In fall 2022, the American Chamber of Commerce in the People's Republic of China (AmCham China) asked approximately 320 member companies about what business risks they faced in the Chinese market. U.S.-China tensions was the most common answer, mentioned by 66% of companies.
Meanwhile, Washington is promoting the idea of "friend-shoring," which would build supply chains with friendly countries. On Wednesday, the Biden administration announced tighter regulations on investment in China in such areas as semiconductors and artificial intelligence. New investments through joint ventures are included in this, which could further hamper investment.
Doubts about China's openness to the outside world have also dragged down investment. When AmCham China asked members if they had confidence that the country would continue to open up over the next three years, only 34% said yes, down from 61% two years ago.
"There is growing concern that the revised anti-espionage law will restrict trade and investment," Toru Nishihama, chief economist at Dai-ichi Life Research Institute said.
The law, which broadened the scope of what is considered spying, went into effect in July. There is widespread concern among foreign companies about employees becoming targets.
Even seven months after the zero-COVID policy ended, the Chinese economy lacks momentum. The real estate market, which had been driving growth, has entered a structural adjustment phase, and private capital formation, including housing, is unlikely to grow. Declining labor force participation will also put downward pressure on growth.
China aims to build a domestic supply chain network in semiconductors and other industries, but obtaining the necessary equipment and parts from overseas has been stymied. If the pace of technological innovation and productivity growth slows, the economic stagnation could last longer than expected.
Slowing growth in the world's second-largest economy is bound to be a heavy burden on the entire world.