China's actual utilized foreign investment amounted to $383 billion during the 10th Five-Year Plan period (2001-05). This capital influx from outside the country has been one of the major financial sources sustaining the country's development. However, calls for an upgraded foreign investment structure that is technology intensive have been on the rise in recent years.

Hence, late last year, the National Development and Reform Commission (NDRC), China's top economic planning agency, came out with a blueprint outlining the broad policy intention concerning foreign direct investment (FDI) in the next five years, starting from 2006. The new program requires a more efficient utilization of FDI, shifting to a "quality, instead of quantity" approach. Specifically, the Chinese Government will encourage more imports of advanced technology, management expertise and high-caliber professionals. Meanwhile, it is willing to channel more foreign capital to ecological development, environmental protection, and energy and resource conservation projects, hoping foreign investors will help upgrade China's industrial structure and improve its technical levels.

21st Century Business Herald, a leading Chinese business newspaper, invited Zhang Yansheng, Director of the Institute for International Economic Research under the NDRC, and Zhao Jinping, Deputy Director of the Foreign Economic Department under the Development Research Center of the State Council, to take an in-depth look into China's future policy changes toward foreign investment. Some excerpts from their observations follow:

21st Century: China's foreign exchange reserves hit a record high of $1 trillion by the end of last year. Does this mean that foreign investment will not be that vitally important for the country's future development? What do you think about the major changes in the newly released Five-year Plan concerning foreign investment?

Zhang Yansheng: As a developing country, China's current foreign exchange reserves perhaps seem too big, indicating the urgency for a timely reflection of the old mode of investment introduction. Actually, many countries are absorbing overseas investment by releasing bonds instead of corporate equity/ownership transfers. However, China has taken a different path in this aspect. This is not only because of the fact that China had long suffered from a lack of capital and foreign currency. In an effort to introduce outside competitors to further promote the transformation of the market economy, we prefer strategic alliances with foreign investors. Meanwhile, we attempt to import advanced technology, modern management expertise and professionals and to localize such components to make them more adaptable to China's reality. After the scientific outlook on development, which emphasizes coordinated development of man and nature, was put forward in 2003, the government has attached more importance to the significance of training professionals, protecting the environment and conserving resources whenever jointly invested projects are launched.

The biggest change in this new plan would be the shift of focus to allow more overseas strategic investors to enter securities and fund markets. We need more FDI, which can simplify the procedure of manufacturing technology transfers and industrial resource imports to the Chinese market, boosting China's employment, industrial upgrading and technology development. The investment in securities and funds, however, is very significant, as it demands a mature stock market and sound financial and regulatory systems. The prosperity of China's FDI in those areas represents a new development stage of a more open, competitive market economy, though it means more challenges for the risk management capability of China's financial watchdogs.

China is obliged to make some changes to the previous mode of investment introduction. First, it should gradually shift the focus of preferential policies to industrial sectors from overseas entities and place investors from in and abroad at an equal starting line. Second, we should learn to distinguish and select qualified foreign investors. Finally, we will let market mechanism make a full play in attracting foreign investment. It is unfair that foreign-funded companies in China are enjoying a tax rate of corporate income lower than that for their local counterparts. A mature market economy should be dedicated to creating equal opportunities to all investors.

Zhao Jinping: The foreign exchange reserves and FDI are playing different roles in market economy and cannot replace each other. Foreign investors will not only bring us the funds for development, but also other value-added components that help to improve China's productivity levels, promote market competition and develop a healthy market system. The utilization of FDI is totally different from the reserve of foreign exchange kept to maintain the balance of payments and financial stability.

The centerpiece of this transformation is to enhance the efficiency of FDI utilization with three aspects factored in. Above all, our focus will shift to the transfer of advanced technology, management experience and high-caliber professionals specializing in certain sectors. We will also give priority to some environment-friendly, energy-saving foreign-funded projects, as well as spur on more foreign investment in the modern manufacturing and service sectors.

Are there any contradictions between the strengthening of foreign investment and the improvement of the local R&D system?

Zhao: We will stick to the opening-up policy to encourage more personnel exchanges and technology transfers. To enhance the local R&D system must give full play to the roles of market and enterprises. There are three major channels for companies to acquire new skills-foreign-invested hi-tech R&D centers, technology spillover effects of multinational companies, and innovations of local enterprises.

The joint ventures financially and technically supported by multinationals are also helpful to elevate China's innovative capacity. Owing to their competitive edge in science and technology, rich capital and plenty of brand management experience, these joint ventures will bring in intensive competitive pressure, leaving only the fittest to survive. The survivors have to face the challenges of the market competition by enhancing their core competence and innovative capability. Anyway, whatever the results are, in an open market environment, competition will help stimulate innovation in general.

Zhang: Some people may argue because of their misunderstanding about the relationship between hi-tech transfer and R&D by local enterprises. Not all companies operating in China can be seen as local entities, and the inventions of foreign-funded affiliates cannot be factored in. In a global village, every link on the business chain can be realized by international cooperation, but it is illegal to share unauthorized intellectual properties. Other people are inclined toward another extreme, believing that innovation should be completely proprietary, refusing any help from the foreign partnership. Actually, China should learn how to protect its intellectual property rights, while at the same time, develop a partnership for advanced technology and research methods that will help its intangible assets and value-added techniques. Of course, we have seen some conflicts between the two. Foreign companies are afraid of China's growing innovative capacity, thus they are reluctant to transfer high technology to China. Therefore, Chinese enterprises should be more aware of the importance of self-innovation.

The R&D centers set up by foreign companies will contribute to China's innovation system. Despite more wholly foreign-owned companies aiming at preventing technology spillover, we will give more preferential treatment to the multinationals with R&D centers in China.

How will the Chinese Government adjust its Catalogue for the Guidance of Foreign Investment Industries to optimize the industrial structure in further opening to the international market, while still protecting the environment and curbing investment in sectors trapped in overcapacity and low efficiency?

Zhao: We hope foreign investors to aim high in China by investing more in the hi-tech industry, modern manufacturing and service sectors, which would motivate China's industrial restructuring. China will also further promote energy-saving and environment-friendly projects and drop those resource-consuming and polluting industries.

Frequent adjustments of the guidance policies are not beneficial to the optimization of industrial structure in the long term. As China opens up and financial reform deepens, it is very likely to make a unified industrial policy that treats all investors equally, irrespective of where they are from. The only exception would be some strategic industries critical to national security. After the transition period given by WTO, China will see more market-oriented bids and competition, and the government is poised to oversee investment activities in a more regulatory market. For instance, the newly adopted antitrust law is applicable to all the entities doing business on the Chinese mainland.

Zhang: The major intention of this adjustment would be industrial structure optimization through investments in various sectors that we encourage, allow, limit or prohibit. The next step is to set up scientific and practical procedures to facilitate the realization of the new policies, enabling energy-saving and environment-friendly products, and those in short supply, to reach China quickly. Administration by law and improvement of the legal system are key in the process.

As a matter of fact, China's traditional manufacturing industry is suffering from overcapacity. Later, foreign investment is expected to enter these fields mainly through mergers and acquisitions. In the development of the service sector, bottlenecks exist in financial service, logistics and R&D capacity. In the following years, we are expecting a rapid increase of overseas capital in those areas and the emerging manufacturing industry.

There would be a certainty of structural adjustment of foreign capital for several reasons. First, the possible appreciation of renminbi, stricter social security regulations and the revaluation of energy and land resources are expected. Second, multinationals are facing growing pressure in the Chinese market, pushing them to introduce more advanced technology to strengthen comparative advantages. Third, in recognition of the importance of IPR protection, the Chinese Government is sparing no efforts to create a more conducive market environment for foreign investors. Additionally, a more efficient business promotion system will help the investors find suitable opportunities much faster.

The NDRC's plan allows foreign investment a bigger role in the restructuring of China's state-owned enterprises to liquidate remnant assets. Does this plan in any way conflict with the regulations issued by the Ministry of Commerce, which set guidelines for international mergers and acquisitions (M&A) in China? How will China ensure its economic security through antitrust legislation and other censorship and surveillance procedures?

Zhang: Since the 1990s, a trend of M&A has dominated the global market. However, China is short of rules to regulate such business transactions, such as procedures for risk appraisal and standards to identify strategic industries and sensitive products.

The monopoly is against the free market spirit and might hurt public interest. Most industries in China are taking baby steps and are fragile in the face of competition from global conglomerates. We have to strengthen our defense system against monopoly-seeking investment. Meanwhile, we will restrain market surveillance to a certain extent, and ensure it won't discourage foreign investors.

Zhao: The M&A regulations set for foreign investment, either issued by the NDRC or the Ministry of Commerce, are aimed at preventing hostile mergers that will pose threats to industrial security. Every market economy has similar rules.

The antitrust law is essential for fair market competition. After all, the multinationals can more easily form industrial monopolies because of their strong competence and tremendous capital.