China and Monetary Policy - Coursework Example

In the late 1980s, foreign manufacturing investment accounted for more than 70 percent of the total FDI flowing into China; investment continued to increase rapidly, reaching more than 80 percent around 1990 (NBS, 1991). With increasing experience in the Chinese market and accumulated knowledge about China’s industrial structure, foreign firms extended their business scope into physical infrastructure facilities, including construction, energy, transportation, and capital-intensive and technology-intensive machinery and equipment. Such investments involved more technological inputs, higher start-up costs, and larger financial commitments and, therefore, foreign firms faced greater risks. With China’s accession to the WTO, other sectors, especially services, have become popular to foreign investors.

In China, FDI is highly agglomerated. It favors cities where targeted industries are fairly developed (Belderbos and Carree, 2002). Marshall (1898) proposes that the pool of specialized skilled labor, trade of intermediate inputs, and spillovers were driving forces of industrial agglomeration. Porter (2000) argues that industrial clusters increase the productivity of constituent firms, upgrade the capacity of cluster participants for innovation and productivity growth, and stimulate new business formation. Because of the lack of local knowledge, foreign investors encountered the so-called “disadvantage of an alien status” in China. Industrial clusters have helped foreign investors to attenuate these disadvantages (He, 2002, pp.1030). Therefore, foreign investors like to select geographically agglomerated industries with strong localized business linkages. Traditional FDI theories (Hymer, 1976; Kojima, 1978; Dunning, 1980) suggest that the industrial distribution of foreign investment depends on comparative advantages in host economies and the ownership-specific advantages that multinational corporations (MNCs) hold. Dunning (2000) argues that factors influencing MNC industrial choices have gone beyond the natural endowments in the era of globalization, and that benefits from industrial agglomeration are playing an increasingly important role.

Therefore, the industrial distribution of FDI in host economies might be influenced by industry-specific external economies, which arise from the geographical proximity of related firms and localized business linkages. There is some published literature concerning industrial patterns of FDI in host economies. Caves (1974), for instance, considers foreign firms’ shares in Canadian and UK manufacturing industries in the 1960s and emphasizes the importance of intangible capital, advantages accruing from the operation of multiplant enterprises, and the strength of entrepreneurial resources. Ratnayake (1993) concludes that foreign ownership of industry tends to be higher in skill-intensive and technology-intensive industries and those in industries enjoying high-level protection in Australia.