Germany FDI in China - Analysis of Motives and Prospects within the Oli Framework - Case Study Example

Analysis of Motives and Prospects Within the Oli Framework: A Case Study of Germany FDI in China Table of Contents 3 Introduction 4 Main determinants of FDI in China 7 Growth of the Chinese economy and prospects 7 Low-cost “assembly line” 8 Location advantage 9 New opportunities arising from WTO membership 10 Obstacles 11 Lack of sufficient information and Planning Certainty 11 High input prices 12 Fierce competition 12 Conclusion 13 Bibliography 14 Abstract This thesis expounds on the various motives and prospects that influence Germany to invest in various industries in China. Germany is one of China’s most important trade partners and ranks sixth internationally. By 2003, various Germany companies had invested up to € 8.2 billion making it the top investor from Europe and the seventh international investor in China. Approximately two thirds of German investments are manufacturing firms especially from the automotive, chemical, electrical, and manufacturing sectors. Many economies may wonder why China attracts Germany to invest in most of its resources. Various studies have shown that China boosts of its market potential, having low cost assembly line, and they have new opportunities that arise from World Trade Organization, WTO. However, there are some impediments that hinder foreign investment in China: lack of sufficient information and planning of its legal frameworks, high costs of inputs, and the high number of fierce competitors. This paper contributes to the topic by preparing a detailed analysis of the various drivers that influence Germany’s investment decisions in China. Moreover, the paper presents important determinants in investing in China, and also the contributing factors that might slow down foreign investment. It presents Germany’s prospects in investing in China, and what Germany has to do to promote sustainable investment in Chinese markets. The conclusion provides an overall discussion of findings with regard to Germany’s business in China. Introduction Deardorff (2007) and Hultman and McGee (2005) show that China has received large amounts of FDI since the late 1980s. China shares in both the total world FDI inflows and the total FDI inflows in developing countries. Dunning, Guisinger, and Frankel (2008) confirm that China since 1992; China has been the largest host country among various developing countries, and it has become the second largest, after United States of America, FDI recipient. China’s ability to attract enormous FDI into its economy has cause concern in other top developing countries, and they fear that the huge FDI inflows to China represent a world’s diversion of FDI away from them (Jeon 2009). Balasubramanyam and Greenaway (2007) and Dunning, Guisinger, and Frankel (2008) emphasize that trade relations between China and Germany are increasing steadily. Research by Deardorff (2007) confirms that Germany is the top foreign investor investing in China. Currently, there are over 1500 German Companies represented in China. Two thirds of most German investment is manufacturing, automotive, mechanical engineering, and chemical products. Recent years saw Japan be the most attractive host country for investment, however; the year 2002 saw China surpass Japan as the most important trade partner with Germany (Balasubramanyam and Greenaway 2007). In 2002, the trade volume between Germany and Japan stood at EUR 27Billion, and China’s trade volume with German was at EUR 28 Billion. China widened this gap in 2003 and since then to date, China has the largest trade volume in Asia (Qian, Tong, and Qiao 2012). The accession of China to the WTO in 2002 marked the beginning of the process to remove the earlier existing trade barriers and to access the Chinese market (Scaperlanda and Maue 2008). Initially the trade barriers hindered several players from accessing the Chinese market. The opening of this market saw the 1.3 billion people market lure domestic and foreign traders to invest and take advantage of the existing market. Schneider and Fey (2007) and Li, Liu, and Parker 2009) confirm that China has not only boost its trade relations with various foreign countries, but it has seen increased direct foreign investment by Germany. As a growing market, China is attracting the large number of both domestic and foreign investment that has increased its flow of goods and investment that supports its progressive growth. According to Schneider and Frey (2007), Balasubramanyam and Greenaway (2007) and Hultman and McGee (2005) Germany had increased its investment from EUR 800 million in 1995 to EUR 8 billion in 2003. Jeon (2009) affirms that most of Germany’s direct FDI goes to the US and EU accounting for 1.2% of FDI to China. Germany is the top European investor overtaking the UK. Years before 2002 saw FDI from Germany to China to be small, but currently, the amount of FDI has tremendously increased and Japan is no longer the determiner in FDI in Asia. Root and Ahmed (2008) reveal that China has stripped all emerging Asian markets with regards to German’s investment interest. Only Hong Kong and Singapore are the major financial entrepots and financial hubs for German investment. German has neglected China’s neighbors. Hultman andMcGee (2005) show that approximately 3% of German FDI trickles to South Korea, Singapore, India, Malaysia, Thailand, Hong Kong, Philippines, and Taiwan. When China’s share was included, the FDI rose to 4% in 1993. This showed that, by 1993, China FDI alone was 1% compared to almost 2% of nine different countries in Asia. The findings by Jon Dunning were very influential in the FDI framework. Ownership, Location, and Internalization, OLI, must be present for FDI to take place (Dunning, Guisinger, and Frankel 2008). The theory is used when analyzing FDI motives. Due to various critiques, the theory has changed into the three paradigms: ownership advantages, location advantages, and internalization advantages. Dunning affirms that a firm’s assets are their main center for competitiveness. The assets that the company has will be the determining factor before they decide to invest in any market. Ownership assets may include managerial skills, abundant financial resources, good reputation or branding. A company should exploit their strong ownership advantages before exploiting the FDI. This is the reason why a company with strong ownership skill will look for perfect foreign market to exploit its ownership skills internationally (Dunning, Guisinger, and Frankel 2008). Location advantages determine the country that will act as a host for investment. Location advantages may include availability of natural resources, transport cost, labor cost, investments policies and taxes, cultural closeness, market and its potential to grow. Finally, a firm intending to invest must internalize their host’s location to efficiently and effectively operate (Li, Liu, and Parker 2009). The main idea presented here is that a company intending to invest must be better off exploiting its own ownership advantages rather than selling or licensing to another party. The company will find out that internalizing cost is minimal when they sell or license it to another firm. Internalizing helps a firm has control over its operations at reduce risks associated with brand image, property rights and overpricing. The costs of internalizing will be less than if sold or licensed to an outside firm. Furthermore, by internalizing the firms will be able to exert more control over its operations and reduce the risks associated with property rights, brand image, and overpricing. Main determinants of FDI in China The OLI theory classifies FDI into two types: export-oriented and market-oriented FDI (Jeon 2009). In market-oriented FDI, the size and growth of the host country are the attracting factor. However, export-oriented mainly deals with cost competitiveness (Qian, Tong, and Qian 2012). There are factors that are common for both market types and they act as incentives to Germany investment in China. Growth of the Chinese economy and prospects China’s population is about 1.2 billion with a huge potential for consumption (Lim and Lundgren 2008). Many current and potential investors ascertain that China has the largest potential market in the world. Investors regard the Chinese market as an enormous market that has not yet been exploited (Vernon and Frankel 2009). China’s economic reconstruction has been increasingly expanding for the last decade. Wheeler and Mody (2011), Qian, Tong, and Qiao (2012) and Scaperlanda and Maue (2008) affirm that the purchasing power of people in China is strengthening and their markets are becoming brisk. China has approximately 76 million prosperous consumers who do not spend much of their income on housing and food. This figure is higher than Germany’s population. Although China has a low capita GDP, it is evident that its economy is still growing. Its increased purchasing power has made it attractive for investors such as in household electrical appliances, automobiles, chemicals, drinks, pharmaceutical, and electronics goods (Root and Ahmed 2008). The economic growth of China remains at around 7 percent, and considering its economic development, effect of restructuring, and its potential technological advancement, it is evident that China will keep the growth rate at 7-8 percent for the next years (Schneider and Frey 2007). In this case, then China will be the fast expanding market for its domestic and foreign investors. However, this continuous growth has led to the downside of China. Balasubramanyam and Greenaway (2007) and Scaperlanda and Maue (2008) say that the rapid rate of production and the slow rate of its per capita income and consumption have led to saturation in China. Many countries experience the phenomenon that supply exceeds demand, but China has experienced severe experiences in its activities and some sector. Low-cost “assembly line” Dunning, Guisinger, and Frankel (2008), Lim and Lundgren (2008) and Root and Ahmed (2008) affirm that China has an advantage in the low cost of production factors such as labor force, natural resources, and has a low cost of productivity. The degree or level of development in the host’s country is considered one of the vital determinants of FDI flow, and China has one of the greatest degrees of development. Li, Liu, and Parker (2009) and Vernon and Frankel (2009) affirm that degrees of development is positively related to the host’s entrepreneurship, local infrastructure, and education level. With the largest population, China has rich and increased labor of average salaries. Qian, Tong, and Qiao (2012) confirm that the cost aspect is the driving force in investment in China. Germany has recognized the benefits of using China as its low-cost manufacturing site especially when they produce goods that are marked to be exported. China has invested heavily in education that has produced high quality with technical experience that is best in manufacturing industries. Fierce global competition has forced Germany to exploit China resources, which are not only relatively cheap but of quality. Location advantage Lim and Lundgren (2008) and Balasubramanyam and Greenaway (2007) say that approximately ninety percent of investments flow to the Yangtze River Delta/ Greater Shanghai area, the Pearl River Delta, and the Industrialized North East. Germany’s automotive industry, Volkswagen invested in China in 1985 forming a joint partnership with China’s SAIC.SAIC is the largest and profitable automobile groups in China (Deardorff 2007). VW has managed to utilize its ownership advantage by selecting China as the best location for its operations. Moreover VW has strategically selected SAIC as its partner, not because it is one of the most profitable auto companies but also that SAIC is located in Shanghai, one of the most lucrative places in China (Li, Liu, and Parker 2009). Being one of the pioneers in auto industries in China, Germany choose the best local human resources and best suppliers that have enabled them achieve high localization content and this has made them competitive in the world market (Root and Ahmed 2008). For example VW made a strategic choice when it chose to establish a partnership with SAIC. Shanghai has a dense population and it is one of the most prosperous cities in China. Shanghai serves the entire Yangtze River Delta and upstream region. According to Jeon (2009), Deardorff (2007), and Root and Ahmed (2008) due to the close political and economic ties Shanghai has with Central China, its goods have often received high reputation and there is no chance that the products will be rejected by the local market. Being an early entrance, Germany has managed to receive various trade incentives and Central China provides Germany with support at various levels (Hultman and McGee 2005). Currently the incentive policies that Germany receives with respect to its industries have greatly encouraged domestic growth and development of Germany’s FDI. New opportunities arising from WTO membership Qian, Tong, and Qiao (2012) and Li, Liu, and Parker (2009) affirm that the forces driving investment in China has changed since 2002. China joined WTO in 2002, and this was the beginning of its success. Before China joined WTO, its market was not fully accessible to investors (Deardorff 2007). Its membership in WTO has opened its market and it has invited foreign investment. The membership has enabled foreign companies to enjoy the vast resources that China offers, and China has increased its importation activities. Germany has increased its FDI in China because China provides a significant access to their market. WTO has proved to be the force driving Germany’s FDI in China (Shangjin 2009). The rapid economic growth in China despite the Asia crisis has promoted Germany’s investment. However, Germany experiences some obstacles in its FDI in China Obstacles Lack of sufficient information and Planning Certainty Wheeler and Mody (2011) and Li, Liu, and Parker (2009) argue that China has limited market transparency. China lacks sufficient data on its consumer frameworks and preferences for their suppliers. China has persistent legal uncertainties that are reflected in the absence of intellectual rights and the right to protect investors’ investments. Root and Ahmed (2008) affirm that China’s is quickly changing these frameworks and regulatory obstacles. This is making Germany fear investing wholly in China. Moreover, Germany is finding it difficult in defining individual market segments in China (Lim and Lundgren 2008). Potential investors are finding it difficult to collect the relevant information. Hultman and McGee (2005) assert that potential investors find it difficult communicating with their Chinese market because of cultural and linguistic barriers. Some parts of China are still underdeveloped and accessing these areas is difficult and frustrating. Potential investors’ major problem is insufficient qualified managers who are trustworthy and know Chinese language (Qian, Tong, and Qiao (2012). There are few engineers and technicians who at times demand high payments that investors cannot provide. The high fluctuation rates pose a big threat to many investors as many customers do not make their payment in time. High input prices Apart from the high costs of professional and legal services, investors are also facing high prices of inputs arising from electricity and raw materials (Scaperland and Maue 2008). This makes investors experience high costs of investments and this reduces their profit margins. Jeon (2009) and Qian, Tong, and Qian (2012) affirm that electricity demand increased by fifteen percent and its capacity increased by eight percent leading to approximately forty gigawatts shortage. Many investment companies are forced to operate on Sundays, at night and holidays in order to meet their market demand. According to Wheeler and Mody (2011), China is in the process of commissioning additional electricity capacity to meet its demand that will balance demand and the supply. This electricity crisis explains the rising world prices of various commodities such as aluminium, tin, and copper prices. Fierce competition Many foreign countries are striving to invest in China, and that means that countries must produce high quality goods and services than other investors (Dunning, Guisinger, and Frankel 2008). Many investors had been investing in China even before Germany entered the market, for example, US companies have been operating in China. Competition in the manufacturing sector is the most competitive sector, and this is where Germany has invested two thirds of its FDI (Balasubramanyam and Greenaway 2007). Germany technology operates in the premium segment because it enjoys great reputation with China, and US provides the most competition. This has forced Germany to invest more on manufacturing and spending more time and resources to maintain their investment position and provide quality products that meet their customers’ needs. Conclusion Germany and China are making tremendous progress in recovering from various economic downturns they experienced the past few years. Germany, the biggest European economy, and China should maintain their international trade relations because it would be beneficial to them both politically and economically. China with its increasing economic growth remains the target for most investors both from domestic and foreign companies. Both Germany and China will continue to benefit from their international relations. China’s development will depend on the technological know-how they get from foreign investors. It cannot be opposed that despite the mentioned obstacles China still offers Germany with the largest market for its products. Also, various foreign companies can cut down their production costs to increase their level of competitiveness. A new Sino-German agreement between the two countries will promote bilateral trade and international relations. 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