CHINA has long been an investment haven for foreign companies, beating other emerging markets. But there are signs afoot that overseas investors may be having second thoughts about the world's biggest consumer market. Foreign direct investment in China, though still increasing, is on a declining trend. Last year, it grew 9.7 percent to US$116 billion, down from 17.4 percent growth in 2010, according to the Ministry of Commerce.

The number of new foreign businesses in China edged up only 1.1 percent to 27,712. Has China lost its luster?

Even foreign companies long established in China are retrenching. French diary giant Danone announced in December that its China operation would stop yoghurt production at a plant in Shanghai. Danone called it part of a business restructuring.

Pepsi China closed its bottled beverage business in China last year, and US consumer electronics retailer Bestbuy shuttered its China outlets.

Losing advantages

The painful truth for many foreign companies is they are not as competitive as they once were against domestic rivals. A survey of 328 senior executives by the Economist magazine last year said multinational companies are losing their traditional competitive advantages, such as superior technology and high-profile brands, to Chinese companies.

Back to the example of Danone. It failed to compete with Chinese counterparts like Mengniu, Bright Diary and Yili. Danone's market share in China dropped from 11.4 percent in 2008 to only 1 percent in 2009.

While Chinese companies may have lagged foreign competitors for decades, they are catching up fast. Chinese companies often have a better understanding of what Chinese consumers want, and they can produce quality products at only a fraction of the price of foreign brands. A survey by the American Chamber of Commerce in China on February 15 said US companies in China had a less profitable year in 2011. And more US companies said they see little improvement in China's regulatory environment than last year's survey.

Foreign firms in China like to blame the government for putting bureaucratic hurdles in their way. Bureaucracy certainly still exists in China, but that's also true elsewhere in the world.

If anything, the Chinese government does improve its policies concerning foreign investment. I will give an example.

In 2006, China introduced policies to encourage domestic innovation in clean energy and information technology. At the time, foreign companies criticized the policies, saying they would deny them access to the domestic market.

In a China Business Climate survey last year, conducted by the American Chamber of Commerce in China to its member companies, 62 percent said they were worried about losing business to Chinese state-owned enterprises as a result of domestic policies aimed at encouraging innovation.

Showing a goodwill to foreign companies, the Ministry of Finance rescinded three of the policies that linked government procurement to domestic innovation last July. Foreign companies came to China because of the good prospects they found in the market. Now it's time for them to review their business strategies against the backdrop of a changing domestic market.

While the local market is no longer what it was, we should also acknowledge that US and European companies are slowing down their investment significantly in face of global economic slowdown.

Affected by the debt crisis, European companies are short of money and they need to repatriate funds back from China. Closing China operation will be a sensible choice for cash-tight European companies.

In the US, recovery is on its way. US unemployment rate fell to the lowest in three years at 8.3 percent and GDP growth rose from 1.8 percent in the third quarter to 2.8 percent in the fourth quarter last year. But US economy still has a long way to go for a full recovery. US President Obama is recently pressing for tax cut extension to boost the economy.

Slowing domestic economy, coupled with weak global demand, has hampered China's trade. China's exports in January dropped 0.5 percent from a year earlier to US$149.9 billion. This is the biggest decline for China's trade since the 2008 financial crisis.

Even though foreign investment has been waning, and economic growth has been slowing, it could be argued that China remains the most promising emerging market in the world.

The yuan has the most development potential among the currencies of emerging nations, especially as the offshore yuan market is opened wider.

A Bloomberg survey earlier this month suggested that China is still a good place to do business, even though the International Monetary Fund forecasts growth will slow in the next five years.

The survey was based on factors such as investment climate, economic growth potential and ease of doing business.

India, which is often seen as China's biggest rival among emerging markets, ranked last in the Bloomberg survey, which found high inflation, high ratio of debt to GDP, and a difficult business environment there as deterrents.

Rising costs

There's no doubt that operating costs in China are rising. In the latest survey by the American Chamber of Commerce in China, 91 percent of American companies said rising cost in China is a major hindrance to their business.

Pay for factory workers jumped by 69 percent between 2005 and 2010, according to an article last May in the Economist entitled "Moving back to America."

A factory worker in China earns about 1,800 yuan (US$285) on average a month. When I visited factories in Cambodia in December, I was told a worker there earns only US$100 a month.

After decades of rapid development, things in China have become much more expensive than 10 years ago. Eating lunch out in Shanghai can cost US$10, about the same level as in US or the UK.

High costs in China have led some American companies to consider returning home to open new plants, the Economist said.

China, of course, is aware that it can't be the world's factory forever. The more it catches up with advanced economies, the more it loses its competitive edge.

No doubt that is why China is trying to shift its economic policies toward promoting domestic consumption and away from over-dependence on exports. I believe it is the only way out for China.