Foreign Direct Investment in China - Essay Example

By Foreign Direct Investment in China and  The most significant factors affecting Foreign Direct Investment in China Introduction Economic globalization is among the key features of today’s economic development with Foreign Direct Investment and International Trade being the core of globalization. FDI and International Trade represent the capital and flow of goods across the world respectively. FDI is defined as the capital, knowledge and management invested in a country to offer services and capabilities to both the native market and the world market while providing significant development to the country’s economy. FDI is vital as it brings the provision of goods and services globally and the foreign development influx displays the investor confidence in the business. China has been a major FDI attraction since it experimented in 1980 and opened up to foreign investment is a few coastal cities and specialized industry parks and economic zones. Since the initial admittance of the first foreign enterprise into China in the early 1980s, the accumulated FDI inflows have reached and outstanding $ 1160.11Billion as of December 2011 . In the early 1992 when Deng was touring in the southern region of china, the quantity of FDI inflows made China become the world’s largest recipient of FDI among the developing nations and the second largest worldwide with the United States taking the lead although China was the leading recipient of FDI worldwide in the year 2002. This move has increased China’s overall economic reforms thus making China more integrated into the world economy which continues to promote the confidence of more foreign investors to attract even more FDI inflows towards China. As the reforms and changes of China’s economic structure have been induced by the large amounts of FDI inflows the evidence is exhibited by the significant changes of comparative advantage in it trade which is continuously increasing in terms of technology intensive, labour intensive and capital intensive productions. As a result, the factor bequest of China has even much stronger complementariness with the world meaning that even more factors influencing FDI in china are increasingly immerging and growing stronger over time (Sheng-xian and Hua 2012). Objectives This research will largely concentrate on answering the following key questions: a) What are the most significant factors affecting Foreign Direct Investment (FDI) inflows in China? b) What is the magnitude and the relative importance of these factors in affecting FDI inflows in China? c) What are the challenges facing FDI inflows in China? d) Literature review China’s rise into its current position was mainly driven by the foreign direct investors who flocked into the country when it adopted the openness policy to allow FDI inflows into the country and has continued to grow due to its efforts in promoting FDI inflows (Sheng-xian and Hua 2012). This paper covers the most significant factors influencing FDI inflows into China while answering the questions why China? How the factors influence FDI and the relevance the factors have in China based on the works by Li Xinzhong (2007), OECD (2000 - 2002), Yunshi and Jing (2005), UNCTAD. (2010), Zhang (2008) and The World Bank reports (1998 - 2014). The most significant factors that promote and attract high FDI inflows into China are: the size and rapid growth of the Chinese economy and its prospects, the availability of natural and human resource endowments and their advantage in terms of cost and productivity of labour, the advancements in financial, physical, and technological infrastructure in the country (Zhang 2008), adoption of the openness policy allowing international trade to invest and have limited access to international markets, the development of China’s regulatory framework and the economic strategy coherence , Political and economic stability and the promotion of both investment protection and promotion policies (Sheng-xian and Hua 2012). Factors affecting China’s FDI. According to Zhao-Ming’s theory FDI is classifies into two: market-oriented FDI and export-oriented FDI. Market oriented FDI is regarded as the most vital factor in the attraction of FDI in regard to the host country’s size and growth while the export oriented FDI largely concentrates on cost competitiveness of the host country versus the rest of the world. China exhibits all the viable features and is thought to poses each of these characteristics. The main and most significant factors affecting china’s FDI are: i) Openness to international trade China has been identified as a major FDI inflow attraction since it implemented the export promotion development policy which has seen significant and promising success since its implementation in the Asian newly industrialized economies. When adjoined with the economic reforms, export promotion strategy, and the open door policies that China has implemented they create a large gateway for any willing investor to approach through (Sheng-xian and Hua 2012). China has also made efforts to encourage trade by finalizing several mutual trade measures and implemented unilateral actions. Generally, a substantial reduction of tariff barriers were implemented in the 1990s: according to OECD (2000), the standard un-weighted tariff rate on imports was reduced from 42.9% in 1992 to 17.6% in 1997 (Sheng-xian and Hua 2012). China has also adopted a chain of privileged strategies to promote international trade. For example, China has applied duty exemptions for all intermediate goods that are used in the production of export products; a move that has greatly boosted FDI in china (Sheng-xian and Hua 2012). However, there are still several barriers that limit free trade such as non-tariff measures and administrative enforcements. Although the import substitution policy was implemented to encourage FDI in China by promoting import of new technologies, it may be a barrier to the country’s growth since it might promote competition which is created by the increase in imports. Till today, china prohibits wholly foreign-owned companies to exercise trade in majority of the key areas in china showing that it has not fully accepted multilateral investment which is vital in the promotion of FDI. A possible solution is underway since china joined the World Trade Organization (WTO) and it has started to liberalize it, if fully implemented the established foreign investment firms would aid China in expanding the scope of its investment and hence increase its market scope (Zhang 2008). ii) Natural, Sectoral and geographical distribution of FDI in China Sectoral Distribution Currently, the key share of FDI is derived for the manufacturing field and it takes up approximately 47% of the cumulative contracted FDI by the year 2011. The next large share is the real estate with almost 37.2%. The distribution industry portion, including wholesale, retailing and transport industries, is 12.5% while construction has a 3.3% share and the agricultural, forestry and fishing industries take up 10.3%. Since China’s entry into the WTO, significant advancements have been made in service trades. For example telecommunication, transport and finances resulting to a higher share in the key FDI. China has a vast land mass covering 9.597 million km² therefore it has many natural resources such as land, iron and other minerals that are economically available therefore having an advantage in the attraction of FDI inflows. iii) Human resource endowments – cost and productivity of labour One of the major factors that promote and attract China’s FDI inflows is the competitive production factors advantage it possesses. China is known worldwide as the working nation due to its large labour force and natural resources. Due to this fact and the level of development and growth of a China, it acts as a significant determinant of the total FDI inflows due to it being related to a higher education level, local infrastructure and domestic entrepreneurship. China having the worlds largest population (1.36 Billion people) is rich in labour resources and with the low average salaries remaining almost constant production in china is of low cost thus it attracts more FDI inflows. The labourers in China are of considerably high quality are mostly technical personnel due to China’s enforcement of a nine-year compulsory education. China is also a major producer of oil and is among the top producers worldwide although it also imports fuel based on the high consumption rate it has it is also one of the world’s largest producers of coal approximately 32.4% of the world’s total production leading to a high electric power supply throughout China (Voss, Buckley and Cross 2008). Fig 1. China’s Population Jan 2004 – Jan 2014 These factors are highly cost advantageous and they attract a vast majority of FDI inflows however, as the world economy is globalized investors are considering more important aspects such as advancement in technology over availability of cheap labour. iv) Size and growth of the Chinese economy and prospects The main aim of Market-oriented FDI is to develop firms that will supply goods and services to the host country’s local market. Market-oriented FDI may therefore be assumed to majorly exploit new markets. The universal allegation of market oriented FDI is that if a host country has a faster economic growth, a larger market size and a higher degree of economic development then it will inevitably offer more and enhanced opportunities for these firms to utilize their possession advantage and will hence attract even more FDI inflows (market-oriented). The host country’s market size is of equal importance for export-oriented FDI because bigger economies can output bigger economies of scale and spill-over effects. China with a population of 1.36 billion has an enormous potential for consumption of goods and services. Over the year China’s economic reconstruction has seen a tremendous outburst and is constantly increasing as the purchasing power of the consumers grows and become more brisk. China’s per capita GDP growth rate is still low but the increase in FDI inflows and the economic growth has increased the market oriented FDI inflows in fields such as automobiles, household electrical appliances and basic chemicals. Fig 2. China’s GDP Growth Rate The annual economic growth rate in China has significantly slowed down since 2012 and the recent years the economic growth rate still remains at around 7.3%. If we consider vital factors then we can conclude that as the overall level of economic development rises, the potential for technological innovation grows and the effect of restructuring is observed, it is then possible for China maintain a growth rate of 7-8% in the next 10 years meaning that China will continue to be a quick growing huge market for both FDI inflows and domestic investors. Fig 3. China’s GDP Annual growth rate Q3 2012 - Q3 2014 Fig 4. China’s GDP per Capital PPP However, there exists a drawback factor in that as the production capabilities continue to grow rapidly and the growth per capital income remains slow, China will experience a severe periodical saturation where the demand for goods and services will be exceeded by the production of the goods and services. v) Investment protection According OECD (2000), since china adopted the openness policy in late 1979 there have insignificantly low reports of expropriation of foreign direct investment this is due to the Joint Venture Law that was amended in China to forbid any form of nationalization, with the exception of special circumstances. The Contract law which was implemented in 1999 was also developed to protect FDI and it has had a major impact in terms of how foreign and local (Chinese) companies meet their contracts and obligations in the Chinese market (Yunshi and Jing 2005). The contract law’s main purpose is to protect all the legal rights of any party while allowing each party to determine its own remedies to resolve disputes and any breach of contract and to also attract foreign investment. Although this law was a major success in terms of procedure and transparency, it has significant shortcomings in regard to real enforcement. vi) Development of the regulatory framework Regulatory framework China has in the past introduce measures to offer a more clear legal framework and business atmosphere by streamlining its legal system to accommodate and attract more FDI and it has amended several laws such as the Contract Law and the Equity Joint-venture Law (Yunshi and Jing 2005). China has also relaxed some restraints and has even liberalized them further that has and will continue to keep a great emphasis on the FDI inflows in the fields and regions that are supported. China has also made numerous and significant attempts to reduce and restructure the state-owned sector to encourage advancements in the managerial and internal efficiency. Although China has made significant changes to its legal system to attract more FDI inflows, more work needs to be needed to improve the legal system further for the market economy since the existing legal and legislative procedures have not been shifted fully to accommodate the needs of the market economy (Yunshi and Jing 2005). vii) Financial, Physical and technological infrastructure The availability of infrastructure can be presumed to affect the decision on whether to invest in a place or not: The more infrastructures are adjusted in regard to the size of the area then the more foreign direct investment inflows. Telecommunication services level is another vital in that the higher the levels of telecommunications services the more it will promote FDI inflows since the investors will consider the cost of communication, the speed and time information is gathered and dispersed thus assisting in the business activities. Research conducted by Li Xinzhong, supported by other empirical studies, validates the assumptions by stating that in China the provinces that have more developed infrastructure and telecommunication services attract higher FDI inflows. The same deduction can be applied to technological infrastructure since in recent years China has been consistently upgrading the speed of its industrial structure an action that was pushed by the increased market competition. For example, the advancements in technology (high-tech) have been significantly speeded up a move whose solemn goal is to attract more FDI into the country. viii) Political and economic Stability Political and economic stability represent the probability and the opportunities that foreign investors can manipulate and benefit in terms of a more reliable prediction. Political and economic stability of any country is vital since it dictates the influx of the country’s FDI. Foreign investors are attracted by a politically stabilized economy since they are assured that their assets are safe because there are not rioting, constant unrest, social turmoil and rebellion in the market and the production areas. On the other hand, economic stability is vital as cases of hyperinflation are greatly reduced and thus the chances that the country’s currency can be rendered virtually obsolete are completely eradicated. China has had its considerable share of Violence, criminal activities, kidnappings and counterfeit currency and products that have severely discouraged FDI inflows into the country, however, China has effectively adjusted its justice and legal systems to counter and eliminate rogue and corrupt law enforcements and to counter any other vice that would discourage foreign investors in an attempt to attract more FDI inflows. Methodology Many studied have been conducted by both domestic and foreign scholars on FDI management and factors affecting FDI inflows in China. This research is entirely literature based and will compare and analyse the literature written by major authors in this field. Many researchers and authors have developed theories to aid in the management of FDI in China, for example, Stephen Hymer offers the Theory of Monopoly (Theory of Industrial Organization) and Zhao-Ming Sun has developed many relevant variables to intensively analyses the factors which affect foreign Direct investment in China using the Co-integration Method that he considers to be the main factors. China’s main provinces and regions where FDI inflows were mostly experienced were the selected settings for the research based on the works of Li Xinzhong (2007), The World Bank reports (1998 - 2014) and Yunshi and Jing (2005). Conclusion In conclusion, China’s policies that were aimed at promoting FDI inflows have had tremendous success as internationalized manufacturing sectors are constantly being built and there is a possibility that the factors listed and other minor factors will encourage even more FDI inflows into china leading to the development of a more improved productivity based economy. Based on the factors, china could benefit largely by undertaking measures that attract high-return investments and even better productivity of products capabilities (Voss, Buckley and Cross 2008). Since China joining the WTO, it has experienced even more FDI inflows and it will continue to benefit as more FDI are attracted by the trade liberalization and the stronger competitive advantage it will have in both the domestic and foreign markets (Voss, Buckley and Cross 2008). However, there still remains a threat that foreign funded firms protected by the high non-tariff and tariff barriers will continue facing outstanding competition from imported products such as in the one being experienced in the automobile industry. China consequently has greatly benefited from FDI in terms of: increased employment for her people, increased education and skills of the local people, increased average wages, raise in productivity and increased technology transfer, increased domestic competition leading to provision of high quality goods for a reduced cost, increased overall industrial performance and on an international level China’s increase in FDI has contributed to: increase in regional discrepancies, increased comparative competitiveness and a lag of the domestic firms. Bibliography Sheng-xian. W,. Hua. Fang,. 2012. Empirical Analysis of Factors Affecting Chinas FDI. Vol. 3, No. 3, pp. 583-590, 2012 Ling-yuan Ma,. 2008. 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