German Foreign Direct Investment in China - Coursework Example

German FDI in China College Table of Contents 0 Introduction………………………………………………………………………...………….3 2.0 Definition of FDI………………………………………………………………………….…..3 3.0 Research on FDI………………………………………………………………………………4 4.0 Germany……………………………………………………………………………………….5 5.0 China………………………………………………………………………………………….5 6.0 Bilateral Relationship between China and Germany…………………………………………6 7.0 DATA AND METHODOLOGY……………………………………………………………..8 7.1 Data……………………………………………………………………………………….8 8.0 Methodology…………………….………………………………………………………..9 8.1 Descriptive statistics…………………………………………………………………..9 8.2 Ordinary Least Squares (OLS)…………...………………………………………….10 8.3 Propensity Source Matching (PSM)…………………………………………………10 9.0 Performance of German based companies with FDI in China………………………………11 10.0 Conclusion………………………………………………………………………………….13 11.0 Reference List…………………………………...………………………………………….14 German FDI into China 1.0 Introduction China has for a long time been a closed economy. It started the process of opening up at the end of the 1970’s and this opening up has seen it become a major destination of Foreign Direct Investment since the 1990’s (Wei, & Liu, 2001). This policy of integrating with the international community and opening up its markets has led to astronomical economic growth in its domestic economy and its real GDP was expanding at an unprecedented 8.5% on average between 1995 and 2004 (Devlin, Estevadeordal, & Rodríguez-Clare, 2006). But the capita GDP has remained relatively low due to its huge population of about a billion people. China at some point has even become the most the mist attractive country for FDI apart from Luxembourg in Europe. By the turn of 1993, Hong Kong was the biggest investor in mainland China. 2.0 Definition of FDI According to the OECD definition, this refers to a form of cross-border investment that is conducted by a resident entity in one particular economic jurisdiction with the aim of having a lasting interest in an establishment that is a resident in another economic jurisdiction. Exerting of influence over a direct investment enterprise is the main motivation behind carrying out an FDI. These Direct investments establishments are mostly quasi corporations but they can also be of various other recognized legal forms (Organisation for Economic Co-Operation and Development, 2002). An enterprise is referred to as a subsidiary if over half of it is owned by the direct investor. If the direct investor has between 10% to 50% ownership of the establishment. There exist two main types of FDI: Mergers and Acquisitions (M&A) Greenfield Investments These two have completely different impacts in their host countries. The main difference is that Greenfield investments mainly deal with new asset acquisitions and building in the host country while Mergers and Acquisitions mainly deal with acquiring of already existing assets and companies fully or gaining a controlling stake in them (Edmonds, 2002). 3.0 Research on FDI An enterprise that seeks to market and sell its products in a foreign country is bound to face various challenges: Problems in communication are the most frequent in case of differences in national languages and cultures between the two countries e.g. China and Germany. The new country will most definitely have completely different legislation when compared to the company’s home country. The issue of fluctuation in currency exchange rates. Political environment and landscape e.g. the new county may have excess state interference in the economy which makes nationalization of corporations a risk. These risks increase the uncertainties and costs of establishing the company in foreign soil. The company may opt to stay put and only export its goods to the target country but this will hinder its market penetration in the new market since they are not on the ground to correctly assess the market and its preferences which most probably are completely different from the home country’s (Organisation De Coopération Et De Développement Économiques, & Oecd-China Conference On Foreign Direct Investment In Chinas Regional Development, 2002). 4.0 Germany Germany has the largest economy in Europe and has also improved in the list of the globe’s top investor nations. It was ranked 6th in the global list of investor nations in 2012 with an investment portfolio of close to €52bn. In continental Europe, only the United Kingdom invested more at about €55bn. Both of these factors will be of utmost importance in this analysis. 5.0 China China was the second largest recipient of FDI in 2012 which stood at about $121bn. This seems set to increase by 2015 since in a survey done amongst multinational corporations on their preferred investment destinations from 2013 through to 2015; a large number which stood at 46% pinpointed China (Organisation for Economic Co-Operation and Development, 2002). The country’s twelfth five-year plan aims at increasing social welfare and educational coverage as well as increasing domestic consumption. There are also plans that aim to reduce disparities in incomes amongst its population. (KPMG 2011) This can be seen as an ideal destination for multinationals that seek to expand the market for their goods and services. This plan has also pinpointed the country’s priority industries into which investments will be encouraged: Energy sector specifically solar, wind power and nuclear. Environmental protection and energy conservation alike. Investment in biotechnology which comprises of medical services and drugs FDI in high – end semi-conductors and rare earth minerals Information technology infrastructure including network convergence and security. Aerospace technology and telecom equipment Next generation auto mobiles that use clean energy in order to assist the country meet its pollution targets. This means that German FDI in these sectors will encounter favorable policies from the Chinese government. This is the best possible period for high – end manufacturers to venture into the Chinese market. This will however come at a cost to low – end manufacturers. It will also lead to heightened competition between Chinese and foreign corporations who are steadily gaining on the latter in terms of brand recognition, sales and marketing capabilities as well as brand quality (Tusiad 2012). This will mean that foreign companies coming into this market will have to come with much more advanced technology so as to succeed in industries such as airplane engine construction and aerospace as well. In industries such as real estate and banking, German industries have to reinvent themselves to be successful in this market. German industries that seek to venture into this market have to realize that wages in China are rising at an average of 12%. This means that the previously major incentive of low labor costs in China may soon be wiped out by this increase in wages making companies to reconsider moving into neighboring states like Vietnam and Cambodia. (Jacob, 2012) 6.0 Bilateral Relationship between China and Germany Looking at German FDI in China between 2001 and 2011, it can be seen that it has increased by a factor of 24. This growth was steady up to 2004 when it experienced a minor drop in volume but again sharply expanded reaching almost €2.5bn by 2006. The FDI was then affected by the global crisis in 2008 when it declined to €1.8bn. But after these minor setbacks, it rapidly grew almost doubling between 2009 and 2010 and once again between 2010 and 2011 when it clocked €19.6bn. On average, the FDI expanded annually by 37.4% over the course of this decade (Devlin, Estevadeordal, & Rodríguez-Clare, 2006). This shows that the German FDI to China has not significantly been affected by the Euro zone Crisis and the occasional deceleration of the Chinese rate of growth. This can be attributed to the fact that Germany and China have both displayed incredible resilience during the various crises that have plagued the Globe. Germany recorded an average drop of 8% in its FDI but in looking at China as an individual country, the FDI was much more modest at only 2%. However when compared with all of Germany’s FDI destination, China accounts for only 0.84% of this since most of Germany’s FDI is destined for the Euro zone and North America which can be attributed to their superior production techniques, qualified human resource which sharply contrasts with China whose major attraction has been low labor costs when compared to other key markets. Since the global economic crisis, German companies have reviewed their investment strategies from short term to long term hence expanding their scope in the Asian Giant (Organisation for Economic Co-Operation and Development, 2002). Looking at the German Chamber of Commerce in China (GCCC), this trend is set to continue and even grow. The GCCC revealed that more than half of the top 10,000 German Companies are poised to set up investments in China and for those already in Chins, set to expand their initial investment portfolios. This shows that German Companies are increasingly viewing Germany as a significant Manufacturing, Supply and Production base. This is also helped by The Chinese Market’s association of the term ‘Made in Germany’ WITH prestige and high quality products. This will mean that the Chinese consumers will be more than willing to pay the higher price to acquire a German product which may be more expensive than similar Chinese products in the market. The automotive industry takes up about 20% of German FDI in China (Organisation for Economic Co-Operation and Development, 2002). These cars are associated with luxury and durability and the demand in China is expected to steadily expand in the coming years. 7.0 DATA AND METHODOLOGY 7.1 Data The data for this analysis was obtained from Orbis which is reliable database that assembles important information on global multinationals. There are more than 2.5million German Companies in this database. The advantage Orbis is that it permits differentiating of Foreign Direct Investment by the % of ownership. This made it easier to differentiate between associates and subsidiaries. Going by the database, the number of German Companies that have at least a subsidiary in China stand at 400. Orbis makes it even more convenient since it can generate a random sample if need be. I decided to retrieve these performance indicators over the past decade: Turnover Net Income Employee Numbers Profits per employee Profit margin R&D expenses in relation to turnover Total assets and added value 8.0 Methodology Different methodologies have been have been used to analyze this data. In order to give a brief over view, while in order to achieve investigating correlation econometric tools have been used. 8.1 Descriptive statistics An extensive analysis has to be carried out so as to get the present level of German FDI in China. In order to gain insight and compare the levels of performance indicators and the recent trends of FDI in China, the mean value development over the years ranging from 2003 to 2011 has to be looked at. I made use of histograms and boxplots so as to better understand sources of the observed differences. A box plot is a much easier means for showing statistical uncertainty than a histogram .The box plot is made up of a box that comprises of half of the data collected as well as indicates the interquartile range (IQR) of the data. It uses a line to show the median of the data while the 3rd quartile is the data’s upper limit and the 1st quartile indicates the lower limit. Points are used to depict values that fall lower or higher than these limits. I also employed t-tests to derive the statistical significance of the difference (Devlin, Estevadeordal, & Rodríguez-Clare, 2006). 8.2 Ordinary Least Squares (OLS) These regressions were done to determine whether the differences existed due to FDI in China or other unrelated factors like the size of the company can explain the presence of these differences. The best case scenario would have been to compare a German Company that has no FDI in China to the same company that does have FDI in China amongst its overseas investments (Devlin, Estevadeordal, & Rodríguez-Clare, 2006). This would have been the ideal method of determining the accurate effect of FDI in China. However, this is not feasible for very obvious reasons. To get an almost accurate result, one can also compare different corporations’ performances over a given period of time. Regressions were done for seven performance variables due to the fact that there a lot of R&D expenses values missing. One model was a reference model that contained the dummy FDI in China variable and FDI dummy variables for elsewhere as the explanatory variables. These models also included the number of years in business and the patents held by the company. There is however a recurring problem of missing values whilst trying to analyze correlation (Devlin, Estevadeordal, & Rodríguez-Clare, 2006). This is also compounded by the fact that most information on various companies is absent over several number of years. This will inevitably cause reductions in observations that can be applied in OLS. This made it impossible to utilize the results of the econometric methods and descriptive analysis in some areas. 8.3 Propensity Source Matching (PSM) One cannot adequately know whether the performance variables did better for companies due to learning by FDI or self-selection. One has to apply Propensity Score Matching (PSM) to get a more definitive answer. Almost 33% of companies present now in China only began setting up shop in the period spanning from 2003 up to 2011(Tusiad 2012). An example can be that if 40 companies started FDI in China in 2004, we have to locate a similar company for the rest of this period. Matching of this nature is normally utilized so as to avoid the problem of selection bias. Comparing the mean performance outcomes variables of companies that are elsewhere and those with FDI in China cannot be the most effective way to analyze correlation due to the huge differences between the two groups. This is because this difference is not adequately factored in. But looking at Matching, it makes comparisons between China Companies and similar elsewhere companies (Devlin, Estevadeordal, & Rodríguez-Clare, 2006). Hence by doing this, existing differences in characteristics can be credited to the effect of FDI in China. 9.0 Performance of German based companies with FDI in China The average turnover stood at around €6.67bn in 2002 but slightly contracted in 2006 to stand at €6.23bn. A further decline was experienced during the global economic crisis and hit a turnover of €5.46bn 2009. However, their turnover has been growing steadily since then hitting a value of €6.72bn by the year 2011 (Tusiad 2012). Almost 90% of these companies record a yearly turnover of more than €5Om. Looking at net income, this has been expanding from slightly over €100m in 2003 to €448m which was the income in 2007 just before the global financial crisis. After the decline during the crisis, it managed to rise to €425m by 2011. Another trend to be seen is that almost 24% of German Companies in China were recording losses however this figure has dropped to about 7% by 2012. The number of employees has been steadily rising since 2008, after the global financial crisis. But one may state that there may be a selection effect because the number of companies observed in 2003 stood at 152 in number who employed almost 31,700 employees. The number of companies increased to stand at 290 in the year 2007 who employed close to 20,150 employees. It can also be observed that in 2003, 93.96% of the German companies employed 100 or more people while this number stood at only 85.46% by the turn of 2006. This concludes that there was no absolute picture in their employment tendencies (Kaufmann, 2005). In 2003, the profits per employee figure stood at an average of 32,900 in a sample of 141 German Companies. This rose to an average of 38,950 by 2004 in a sample population of 147 companies. This figure although drastically dropped by 2005 when with a sample population of 169, the mean profit stood at about 26,800 (Devlin, Estevadeordal, & Rodríguez-Clare, 2006). This fluctuation was evident during the majority of this period. About 20% of the German companies recorded losses in the year 2003. This figure dropped to about 7% in the pre-crisis year of 2007 but shot up in 2009 when it hit an all-time high of 29% due to the global economic crisis (Jiang, 2003). The profit margins in 2011 stood at about 9% for German Companies but the outlook was bleak in 2009 whereby the margins were on average hovering around the three and a half percentage mark. By far the best year so far for German Companies in China was in 2006 when they enjoyed margins of up to ten and a half percent. R&D expenses in terms of turnover have been declining since 2003 when they averaged at 5% to about 4% in 2007. The year 2009 however was not a good year for German Companies when their R&D expenses peaked at almost 5% (Blackford, 2008). We have to note however that R& D expenses are usually expressed as a percentage of turnover which was at its lowest during this year. These expenses are normally fixed at the beginning of a period determined with the company’s experienced over the previous period. That is why when turnover took a nose dive in 2009, the percentage rose sharply in relation to the reduced turnover. 10.0 Conclusion We can conclude that investing in China leads to much higher returns than conducting an FDI in any other country currently. If we analyze sector activity and size in OLS regressions, we can conclude that German Companies that have FDI in China perform better compared to exporters to China and those with FDI in other countries apart for China. However, these changes are highly dependent on sample sizes and variables. 11.0 Reference List WEI, Y., & LIU, X. (2001). Foreign direct investment in China: determinants and impact. Cheltenham, UK, Edward Elgar Pub. ORGANISATION DE COOPÉRATION ET DE DÉVELOPPEMENT ÉCONOMIQUES, & OECD-CHINA CONFERENCE ON FOREIGN DIRECT INVESTMENT IN CHINAS REGIONAL DEVELOPMENT. (2002). Foreign direct investment in China challenges and prospects for regional development. Paris, OECD. http://new.sourceocde.org/9264194436. EDMONDS, R. L. (2002). China and Europe since 1978: a european perspective. Cambridge, Cambridge Univ. Press. BLACKFORD, M. G. (2008). Rise of Modern Business Great Britain, the United States, Germany, Japan, and China. Chapel Hill, The University of North Carolina Press. http://www.msvu.ca:2048/login?url=http://www.msvu.eblib.com/patron/FullRecord.aspx?p=906736 KAUFMANN, L. (2005). China champions: how German companies can successfully integrate China into their global strategies. Frankfurt a.M., Europ. Management Publ. JIANG, X. (2003). FDI in China contributions to growth, restructuring, and competitiveness. New York, Nova Science. (2006). Germany: [special Feature: Fostering Product Market Competition]. Paris, Organisation for economic co-operation and development. ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT. (2002). Foreign direct investment in China challenges and prospects for regional development. Paris, OECD. DEVLIN, R., ESTEVADEORDAL, A., & RODRÍGUEZ-CLARE, A. (2006). The emergence of China: opportunities and challenges for Latin America and the Caribbean. Read More