Chinese Economic Development in the Context of Foreign Direct Investment - Research Paper Example

 1. Introduction In the context of Foreign Direct Investment, China has achieved the most successful position in the last two decades. Starting from a mere US$3.5 billion in 1990, the fully utilized FDI inflow in China increased to US$53.5 billion in 2003 and US$92.4 billion in 2008(see Table 1 in the Appendix). (Ministry of Commerce of the People's Republic of China, n.d.) In the ranking of FDI stock, as reported in the Global Business Policy Council of 2005, China became the topper among all developing countries and the second best among the APEC countries, only behind the US. The FDI of China is mainly comprised of Greenfield investment. Foreign investment has turned out to be a crucial source of China’s investment in fixed assets (Global Business Policy Council 2005). Dang (2008) observes that foreign capital in China has played a largely positive role in China’s economic development during the reform. According to them, FDI can be more beneficial in many other economic aspects rather that merely solving the capital shortage problem of this developing country. FDI may provide better access to technologies for the local economy. Moreover, FDI might be responsible for indirect productivity benefits via spillovers. For instance, multinational firms may amplify the extent of competition in markets of the host-country. This will compel the existing inefficient firms to invest more in physical or human capital. The multinationals are also providing training of the workforce and management that may make them become available to the manufacturing sectors. Another likely strait for spillovers is the guidance given to local suppliers of intermediate commodities to satisfy the higher values of production and managerial standard. On the other hand, there are issues regarding the fact that FDI may bring harmful effect to the Chinese economy. Some claim that such foreign investment can exert negative impacts on the development of Chinese economy by replacing the domestic savings. Some others argue that FDI tends to exacerbate developing countries. Balance of payment deficits occurs as a result of increasing debt repayment obligations. (Dang, 2008, p.2) As reported by Graham and Wada (2001) the FDI in China was mainly comes from the other developing Asian countries in the period 1992-96. But after 1996, a major part of the FDI comes from the developing portions of the world, viz. Europe, North America and Japan. The FDI inflow from the developed nations has a different characteristic than that from the developing Asian nations. (Graham, and Wada, 2001, p.2) The FDI from the developed world focus on the export-processing activities, while that from the developing ones focus on the domestic market activities. As China is comparatively more advantageous in the export-processing activities, a number of foreign-invested enterprises has grown up in China and became more focused than other domestic enterprises. (Dang, 2008, pp.8-9) The present study is attempted to shed lights on the present scenario of FDI in China, its effects on the economy, its position in comparison to other developing countries and the determinants that are responsible for such FDI inflows. Is the country attracting more foreign capital compared to the other emerging or developing economies, despite the recent decline in the inflow of FDI to the Chinese economy? The following section covers the recent trends of the FDI in China. Section 3 gives an idea about the FDI impacts on the Chinese economy. Section 4 reflects lights on the comparative position of the country in respect to other developing countries. Section 5 briefly analyses the determinants of FDI inflows in China. Section 6 concludes. 2. FDI Inflow in China Poncet (2007) discusses that China saw economic reforms in 1984 during the Deng Xiaoping rule and has set up Special Economic Zones (SEZ) in different parts of the country. Since then, the Chinese economy became open to the global world and started to attract an increasingly large amount of foreign capital. The FDI in China comes mainly in three forms. These are foreign loans, direct foreign investment and other foreign investments. Between 1979 and 2000, the actual utilized foreign capital in China stood beyond US $500 billion, out of which above two third of foreign capital contribute towards direct investment (Poncet, 2007, p.3). Table 1 shows the FDI inflow in China from 1984 to 2008 (Ministry of Commerce of the People's Republic of China, n.d.). Table 1 (appendix) indicates that the inflow of FDI has severely enlarged since 1992. Before that the growth of FDI inflow was relatively very slow. Fung, Iizaka and Tong (2002) observe that during 1980 to 1983, the FDI inflow contributed to just 12% of the total foreign capital utilization of the country. Since mid-1980s, lots of policy measures have been taken up to improve the investment climate of the country. As a result the FDI inflow has been improved steadily and accounted for almost one-third of the gross inflow of foreign capital. This trend of steady inflow remained there till 1992. The inflow of FDI saw an increasingly upward trend during the period 1992-1998. In this period, China became the most vital destination for the FDI. This primely happened after the famous “Tour to the South” (Fung, Iizaka and Tong, 2002, p.5) by Deng Xiaoping. China turned out to be the second largest FDI receiver country in the world (only behind USA) and the largest nation to be at the receiving end among all the developing countries. (Fung, Iizaka and Tong, 2002, pp.5-6) The annual FDI has grown from US$4 billion in 1991 to about US$45 billion in 1998. During the years 1999 and 2000, FDI inflow decreased from its maximum height, yet amounted to above US$ 40 billion annually. However, in 1998, this upward trend has become disrupted. But after 2000, this trend resumed again. (Ministry of Commerce of the People's Republic of China, n.d.) Fung, Iizaka and Tong (2002) observe that the standard volume of FDI ventures started to get raised from1992 onwards. From the year 1992 to 1995, the average level of contract FDI ventures more than doubled, from US$ 1.2 million to US$ 2.5 million. After 1995, the average size of a FDI business projects lies between US$ 2.4 and 3 million. These recent figures reflect China’s attention on investments, which are capital intensive, high-tech and infrastructure oriented. They also illustrate the working pattern of large Western multinational enterprises (MNEs) in China, essentially in infrastructure investment and other main industrial businesses. Potentials for big markets, positive government policies and low cost of labor were lucrative for several big multinational houses in industries like telecommunications, automobile and petrochemical. (Fung, Iizaka and Tong, 2002, p.6) The Southeast Asian countries were already an important source of China’s FDI inflow. After 1992, a new and fresh FDI inflow emerged from the other parts of the world. These FDI inflows mainly come out from Western Europe and North America. Hong Kong is still in the most important position for FDI inflow in China. However, the proportion of Hong Kong’s investment out of the gross FDI inflow from Hong Kong has fallen from 68% in 1992 to approximately 48% in 2000. Similar trend is true for ventures from Taiwan, and also to the nations of Singapore and Malaysia. Again, ventures from western industrial nations, mainly those from North America and Western Europe, have augmented progressively all through the 1990s. In 1992, the United States is the fourth largest investor in China, accounting for about 4.6% of total FDI inflow (Fung, Iizaka and Tong, 2002, p.7). In 2000, the United States turned out to be the second largest foreign country in China to invest foreign capital, contributing 10.8% of the total FDI inflow. Similarly, the share of investment from United Kingdom, Germany, France, the Netherlands, and Canada together grew from 2.3% in 1992 to more than 10% in 2000. Industrial countries, on average, lead to above 30% of all FDI inflow in China in 2000, greater than twice the figure for 1992 (Fung, Iizaka and Tong, 2002, p.7). As reported by Hughes, Lin and Turner (2007), in December 2001, China finally entered into official membership of the World Trade Organization (WTO) after around two decades’ years of talks and negotiation (Hughes, Lin and Turner, 2007, p.1). With the accession, China promised to abide the WTO’s basic principles of non-discrimination, pro-trade, pro-competition and so on. In return, China will have the privileges enjoyed by WTO members. For example, China will also be able to enjoy the privileges provided to WTO members. These will have significant implications for future FDI inflow in China (Hughes, Lin and Turner, 2007, pp.2-3). 3. Impact of FDI on Chinese Economy Fung, Iizaka and Tong, (2002) report that FDI is a significant component in the reform and economic growth of China. After 1990s, FDI and foreign invested enterprises became the rudiments in China’s economic growth at the national level and regional level. The investment by the foreign enterprises remains most important part of the GDP growth during 1992-2006. But the distribution of the foreign investment at different parts of the country is not same. For coastal regions, foreign investment accounts for 14% of total investment and the average GDP growth from 1992 to 2006 is 12%. Three Southern coastal provinces make up the highest GDP growth during that period. They accounted for about 20% foreign investment and 14% GDP growth. But for the inward regions, the foreign investment is as low as 4% and GDP growth is only 10%. In particular, the western inland provinces get foreign investment as low as 3% and only 9% GDP growth. (Fung, Iizaka and Tong, 2002, p.11) Graham and Wada (2001) shows, a positive correlation is observed between investment by foreign enterprises and GDP growth at both national level and provincial level. This observation might posit that FDI inflow benefits economic growth by inducing higher GDP growth. It is, however, possible that increasing FDI is an answer to increasing economic prospects due to higher growth. Empirically, it is not easy to determine the causal relationship between inflow of FDI in an economy and economic growth. Only it can be commented that increasing FDI inflow has been an important part of China’s growth (Graham and Wada 2001, pp.10-11). According to Baskaran and MuchieIn, (2008) one direct consequence of the economic reforms undertaken in China is the growth of China’s trade with the rest of the world. External trade has turned out to be a very significant constituent of Chinese economy. During the last 30 years, China’s total trade rose from US$ 38 billion in 1980 to above US$ 474 billion in 2008. (Baskaran and MuchieIn, 2008, p.11) Fung, Iizaka and Tong, (2002) in 1980, China’s export and import contribute to around 0.9% and 1% of total world trade in 1980. The significance of China as one of the largest trading countries has been improving steadily. Standing in 2000, the figures were 3.9% (export) and 3.5% (import) of world trade. China has been the seventh largest exporter of the world in 2000 (an enhancement from position 26 in 1980). At the same time, trade also becomes more and more crucial n terms of a percentage of China’s GDP. In 1980, the export and import ratios to GDP were 6.0% and 6.6% respectively. In 2008, they rose to 21.4% (export to GDP ratio) and 20.8% (import to GDP ratio). (Fung, Iizaka and Tong, 2002, p.12) 4. Comparison with Other Developing Countries As per OECD’s report of 2003, the FDI inflow in China during the past two and a half decades is phenomenal compared to other developing nations. Questions arise that how and why China accomplishes the position over and above all the developing countries. China’s export growth has increased about two times rapidly than the export growth in rest of the world. As given earlier, China is the largest beneficiary of foreign investment out of all the emerging nations. The second largest nation was Brazil, which had about US$95 less investment than China during 1995-2003. The third largest trading spot is Hong Kong (China), which acts largely as a gateway to Mainland China. India, the mostly populated country after China, attracts ten times less than China during this period. (OECD, 2003, p.38) Though the AT Kearney confidence index ranks India ($5 billion) at the second position after China ($60billion) in FDI attractiveness, the difference between the two seems significant and the investor confidence for India are much as comparable to China. (Global Business Policy Council, 2005, p.5) On the other hand, as put forward by OECD (2003) Indonesia has experienced a sizeable disinvestment in 1998-2000 and recorded FDI inflows less than US$7.6 billion. (OECD 2003, p.38) China has allured more FDI compared to majority of the OECD member countries. For example, in 2005 the FDI in China was US$169 billion just below the US mark, but remained above all other OECD countries. However, the above data do not consider that China’s population is much above than the population in the OECD countries. If per capita FDI is measured, China would be well below from many OECD countries, except Turkey. But the comparison would be more favorable to China if the economic and geographical conditions were taken into account. (OECD 2003, p.38) In terms of the per capita FDI flows, China is also below of many developing countries. The per capita FDI in China is much below than the major FDI recipient South American countries, namely, Argentina, Brazil and Chile; and also remains much below of its South Asian competitors, viz. Singapore and Malaysia. It is still far ahead than India, Myanmar, Vietnam and Philippines. If the financial and ecological distinctiveness are taken into account, the performance of China is much ahead than the other developing nations (OECD 2003, p.40). Most of the literatures make a comparison of the major FDI inflow in China with the FDI inflow in India, as India is the nearest transition economy to China. In a study by Sinha (2007), he argues that India is growing with its service sector comprising BPO and Outsourcing. The flourishing of this sector cannot contribute to the larger rural sector of the country. On the other hand, the foreign capital is invested in the manufacturing sector of China, helping the country to help its poor general workforce, be it rural or urban. 5. Determinants of FDI Inflow in China Market Size Now the question comes that what are the determinants that drag all the FDI inflows around the world towards China. According to Dang, (2008) with the largest population in the world and the fastest growing economy, China appears to have increasingly large demand and enlarging domestic market for consumption. Thus the large potential market of China attracts the FDIs from Europe and North American countries, as their products are mainly market oriented. These countries show interest to set up their production plants to produce and serve for the domestic market of China. The previous empirical studies show that market size is a positively significant determinant of foreign investment. Shapiro (1998) reflected upon the fact that foreign enterprises always watch the potentiality of new markets to make their investments there. Market size is considered as a prime motivation for FDI. With larger market size of a particular economy, increasing FDI would be attracted towards that region. Many Chinese researchers indicate in their research that both at the national and the regional level, empirical studies have found a strong positive correlation between GDP and FDI inflows in China. They also pointed out that market size is more important determinant of FDI from developed nations, such as Europe and USA, rather than for FDI from the emerging economies like Hong Kong and Taiwan, because the developing nations are more export oriented. Extant literature also contends that the market demand and market size exert positive impact on attracting FDI because they directly affect the expected revenue of the investment (Dang, 2008, pp.20-21). Cheap Labour In the last three decades, China is widely known as the “World Factory” or “labor-intensive manufacturing country” (Dang, 2008, p.21). China, having world’s largest population, has cheap labour for manufacturing sector that attracts the foreign enterprises for investment. In order to lower their manufacturing cost, foreign investors start investing in China. As the theory suggests, with a lower labor cost in any country, the country becomes more attractive for investors, because lower wage is a significant determinant of FDI. In the empirical studies on China also, researchers show that there is a positive relationship between lower wage and FDI in China. It means that lower the wage in China, greater will be the FDI inflow. However, during the recent economic transition period in many economies, China attracts foreign investment not exclusively through cheap labor. The multinational firms in China show their desire to get quality workers in China. Thus they offer to pay a wage premium to their workers. The higher wage may well reflect higher labor productively. Hence, it can be commented that the regions attracting higher FDIs also give their workers higher wages than any others. (Dang, 2008, pp.21-22) Infrastructure Another important determinant of FDI, as reported by Dang (2007) is infrastructure. In the last three decades the quality of infrastructure has improved to a large extent. The improvement in infrastructure includes transportation, communication, water supply, electricity and natural gas. The supplies of energies, raw materials and resources have also been improved a lot. The improvement of infrastructure provides a much comfortable production and operation situation for the foreign enterprises. The quality of energies has shown great improvement. However, most of the improvement in infrastructure construction can be observed in the coastal areas. The regions with more developed infrastructure are being more attracted by the foreign enterprises. Therefore most of the FDI inflows are seen in the coastal regions of China with their developed infrastructure. Studies show that infrastructure has undoubtedly a positive impact on FDI inflow. The regional disparity in the foreign investment is seen as most of the investments, because of the availability of better infrastructure, are in the coastal regions. Another reason for such disparity is that the coastal regions are characterized by the low information cost areas. Therefore the companies can enjoy preference towards China’s liberalization policies. (Dang, 2008, pp22-23) Policies and Political Environment The Chinese government took several policies that came favorable to the foreign enterprises towards their investment in China. The government makes income tax exemption, several tax reduction policies and makes the imports tariff-fee during 1980-1993. Since 1994, the government amended their tax system, making the same tax structure for domestic and foreign enterprises. But after some time, a new five-year tax refund program was initiated with the previous tariff-free treatment to attract more FDI and international trade. For high technology or export-oriented enterprises, the foreign investor may receive a full refund. The Chinese government also has improved the legal systems in such a way that it could be helpful for more foreign investments. Also the political stability in China makes the investment environment more favorable. (Dang, 2008, p.23) Some Other Determinants Dang (2008) reports that There are some other determinants that make it comfortable to invest in China. There are “scale effects” (Dang, 2008, p.24) that can the increase in FDI. Scale effects say that more amount of investment in a region increases the confidence of other investors to invest in this region. For instance, in Guangdong, Fujian, Zhejiang and other regions of the east China, the construction of production plants makes other investors to invest in the allied sectors like schools, bank services and hospital. Also in these areas the transportation facilities get improved and more improved market areas becomes available. (Dang, 2008, p.24) Another major socio-cultural factor for the success of China’s FDI inflow is its cultural background. Studies show that because of this reason, Hong Kong, Tai Wan and Singapore, have accounted for more than half of the FDI flows to China. They all get included in the large Chinese Diaspora. These investors like to invest in Mainland China for its cultural background that they can share, rather than other favorable positions that are present in China. For investors who are not Chinese natives, they have to conquer culture obstructions, such as language, which may entail a cost. (Dang, 2008, p.24) 6. Conclusion From the work of Xiojuan, (2001), we may infer that in the recent years, China has made great leaps in its policies to liberalize its market for foreign direct investment. Among all the developing countries, China is at present positioned as the largest recipient of foreign investment. It has also remained well above most of the OECD nations. The overall trend in FDI inflow in China is positive since 1980s, with a big jump after 1992. But there is significant regional inequality in the distribution of FDI among different Chinese regions. Most of the FDIs are concentrated in the southeast and the coastal areas. In the recent times a slow process of diffusion has also been observed. (Xiojuan, 2001, p.3) The work of Dang (2008) shows that FDI is contributing in a positive manner towards the economic growth of the country. The improved FDI is also attracting the domestic investors too. About all the countries are investing in China in these days. In comparing to other developing countries like India, China is significantly ahead of them. Foreign enterprises perform an increasingly significant role in Chinese economic transition. It is also a large part of China’s trading activities with the rest of the world. There may be some different explanations with respect to the role of foreign direct investment in the growth of China’s GDP, only a few would reject the view that without FDI inflow such improvement in GDP cannot be observed. There are several determinants that attract the FDI in China. First, the huge domestic market of China attracted the foreign investors. Second, due to the availability of cheap and skilled labour force the foreign investors prefer to invest to lower their manufacturing costs. Third, there are lots of improvements made in infrastructure, which helps the investors to get better production environment. The infrastructure development also helps enterprises to enhance their technology levels. Fourth, the stable political environment is a significant element in alluring FDI in China. The political leadership imposed a vision or the path of growth and development of the country. Also the favorable legal structure helps in FDI inflow promotion. Lastly, the culturally rich Chinese Diaspora attracts many South Asian countries to make investment there. (Dang, 2008) According to some researchers like Baskaran and Muchie, (2008), FDI inflows in China have increased the capital formation and total factor productivity. It also helps in establishing several Foreign-funded enterprises (FFEs). This, in turn, increases GDP growth. FDI inflows in China also play an important role in increasing China’s export, which directly results in the huge trade surplus of China and US, EU and other countries. The FDI inflows in China created a large number of job opportunities through FIEs, but it also have broadened the income gap between eastern and western China. (Baskaran and Muchie, 2008) The FDI in China encounters some new confrontations and positive aspects. The key challenge is the appreciation of the Chinese Yuan within the global currency market. Another important challenge is increasing production cost of raw material and labor. However, the Chinese government encourages more investment in western China and takes measures to protect environment. It is expected that the policies of the government would show necessary insights and new opportunities for FDI in China. References 1. Dang, X. (2008). “Foreign Direct Investment in China”, Department of Economics, Kansas State University, Manhattan, Kansas. The report by Dang (2008) presents a general overview of the Chinese economy with respect to FDI inflow and the reasons for the same., the advantages enjoyed by the economy which attract the foreign investments are highlighted here. This report gives an elaborate analysis of the increase in foreign investments towards China. 2. Graham, E. M. and E. Wada (2001). “Foreign Direct Investment in China: Effects on Growth and Economic Performance”, in Peter Drysdale edited Achieving High Growth: Experience of Transitional Economies in East Asia. Oxford University Press. The article talks of the large inflow of FDI to Chinese economy and the contribution of the same towards its growth. It talks of the Hong Kong economy specifically. Despite controversies regarding the investments coming from Asia countries (excluding Japan) foreign investments still are a driving factor of China’s growth. 3. OECD (2003). OECD Investment Policy Reviews. China: Progress and Reform Challenges. OECD Publications Service, France. pp.40-41. The book highlights the promises provided by the land of China to the foreign investors and also talks of fiscal incentives which have helped in attracting foreign capital. The book also puts forward certain measures to be undertaken or policy initiatives in order to improve the situation further. 4. Sinha, S. S. (2008). “Comparative Analysis of FDI between China and India: Can Laggards Learn From Leaders?”. Dissertation.com, Boca Raton, Florida, USA. pp. 21 The book provides a comparative analysis of FDI inflow between China and India the author has shown where China has gain over India and the other developing nations as well. The factors which give China a higher score with respect to foreign direct investments have been highlighted here. 5. Xiaojuan, J. (2001). The New Regional Patterns of FDI inflow, OECD, available at: http://www.oecd.org/dataoecd/58/32/2369911.pdf (accessed on December 13, 2009) The article concentrates upon the regional distribution of FDI in China and the strategies and policies framed by the government in order to attract foreign investment. The new policy and the key components of that policy have been described here. The article also discusses the impact of FDI on the economy of China. 6. Global Business Policy Council (2005). FDI Confidence Index, AT Kearney, available at: http://www.atkearney.ro/pdf/fdici_2005.pdf (accessed on December 13, 2009) This article discusses the FDI index ranking of different nations and highlights China’s position in this context with respect to the other countries. 7. Baskaran, A. and M. Muchie (2008), The Impact of the National Innovation Systems on the Flow and Benefits of Foreign Direct Investment to National Economies, Global Academy, available at: http://www.globelicsacademy.net/2008/2008_lectures/GA2008%20Lecture%2020b.pdf (accessed on December 13, 2009) The article talks about the National Innovation System and how it influences the direction of FDI. It also helps in generating economic benefits from the FDI. It also talks about the pattern of investment and trend of multinationals. It also discusses whether FDI can ensure technology transfer and the other associated benefits. 8. Fung, K.C., and Iizaka, H. and S. Tong (2002) Foreign Direct Investment in China: Policy, Trend and Impact, available at: http://www.hiebs.hku.hk/working_paper_updates/pdf/wp1049.pdf (accessed on December 13, 2009) The article gives an account of the development of FDI inflow into China, its impact on the economy and the FDI policies in China. The Chinese accession of WTO and future development of FDI inflow in China has been described in this work. 10. Poncet, S. (2007) Inward and Outward FDI in China, April 28, available at: http://team.univ-paris1.fr/teamperso/sponcet/Perso/Book%20chapter%20Poncet%20April%2028%202007.pdf (accessed on December 13, 2009) The article talks about the essential features of FDI in China and outward policies. It highlights the factors affecting FDI. It brings forward the factors which determine the outward flow of FDI. This article describes the impact of FDI on China. This has been categorized into direct and indirect impact. 11. Ministry of Commerce of the People's Republic of China (n.d.). FDI inflows into China 1984-2009, Available at www.chinability.com/FDI.htm (accessed on December 13, 2009) This article gives an account and tabular presentation of year wise (1984-2008) FDI inflow and utilized FDI in China. APPENDIX Table 1 : FDI inflow in China from 1984 to 2008 (in US$ billion) Year Contracted FDI inflow Utilised FDI inflow 1984 2.7 1.3 1985 5.9 1.7 1986 2.8 1.9 1987 3.7 2.3 1988 5.3 3.2 1989 5.6 3.4 1990 6.6 3.5 1991 12 4.4 1992 58.1 11 1993 111.4 27.5 1994 82.7 33.8 1995 91.3 37.5 1996 73.3 41.7 1997 51 45.3 1998 52.1 45.5 1999 41.2 40.4 2000 64.2 42.1 2001 71.1 48.8 2002 84.8 55 2003 115.1 53.5 2004 153.5 60.6 2005 60.3 2006 63 2007 74.8 2008 92.4 Source : Ministry of Commerce of the People's Republic of China. Available at www.chinability.com/FDI.htm Read More