Analysing factors effecting Foreign Direct Investment in China - Essay Example

Running head: Analysing factors effecting Foreign Direct Investment in China Analysing factors effecting Foreign Direct Investment in China s Name] [Institution’s Name] In case of the introduction of an innovation in a market the domestic markets benefit from the diffusion of new technology. In the other case when the labour move from domestic firms to foreign firm technology diffusion takes place. The benefits in shape of capital financing it generate put forth the idea that FDI plays an important role in the modernisation of economy and increasing the growth. These benefits from the whole process make the governments of countries to provide special incentives for FDI. The growth of the global economy has given rise to the importance of notion of FDI. In the past few years China has emerged as the largest FDI receiver. Objective: The objective of this paper is to The paper in the first place analyses the three phases of in flow of FDI in the Chinese Economy. The next part of the paper explains the factors, which contributes in attracting the FDI towards the Chinese economy. The countries, which contribute to the Chinese FDI, are also discussed. In the end, we present the different challenges faced by FDI in China. In the last section of the paper few recommendations are given in order to improve the FDI situation in China. With other empirical evidences a case study is also used, which will analyse the linkage between trade and FDI. Introduction: The people’s Republic of China (PRC or China, for short) has had a long tradition of isolation. In 1979, Deng Xiaoping opened his country to the world. Although his bloody 1989 put-down of protestors in Tiananmen Square was a definite setback for progress, China is rapidly trying to close the gap between itself and economically advance nations and to establish itself as an economic power in the Pacific Rim. Southeast China in particular has become a hotbed of business activity. Presently, China is actively encouraging trade with the West, and it is a major trading partner of the United States. Despite this progress, many U.S. and European multinationals find that doing business in the PRC can be a long, gruelling process that often results in failure. One primary reason is that Western-based MNCs do not understand the role and impact of Chinese culture. Since the last few decades there has been a multifold increase in the FDI in China. The Chinese economy has now gaining the power of effecting the decisions of the economic bodies of the world. History of FDI growth in China: The country launched its open door policy 26 years ago. Since the policy introduction the FDI flows in the country received a quick response. In 2004 China was at no.2nd position in the world of FDI with $64 billion. The Chinese FDI trends can be examined in two phases. First phase: 1979-82 Second phase: 1984-91 Third phase: 1992-99 In the first phase the government establish for special zones with incentive policies. Although there was a high inflow into those regions, the total FDI flow reached US $ 1.8 billion. In the second phase the provinces were opened and recorded US $ 10.3 billion. In 1989 however the trend dropped. In the third phase Deny Xiaoping opened China for overall economic reform. The phase was very fruitful for China. The government introduced new policies and market oriented economic reform. In result of these reforms the FDI’s started flowing into the Chinese economy at rocket speed. In November 1999 US-China had an agreement regarding the WTO, according to which many new reforms were made (Sandra, 2001) those included The sectors relating to the distribution services will be opened for repair and maintenance and China will phase in trading rights and distribution services over three years. The Government for the investment opened the telecommunication industry of China. The professionals were also allowed access to the service markets of China. The services included according, consulting, Information Technology and Engineering. (Lardy, 2000). FDI in China rose to a peak level of US $ 45463 million in 1998. In the first six months of 2002, actual foreign direct investment (FDI) in China rocketed to 24.58 billion U.S. dollars, setting a record growth rate of 18.69 percent year-on-year. (Beijing Time, 2002) On June 22, 2005, CNOOC, a Chinese company made a $18.5 billion bid to purchase Unocal Corporation, a U.S. energy company. News of the bid raised concern among several Members, many of who contend that the deal would threaten U.S. national security. On June 30, 2005, the House passed H.Res. 344 (Pombo) by a vote of 398 to 15, expressing the sense of the House of Representatives that a Chinese state-owned energy company exercising control of critical United States energy infrastructure and energy production capacity could take action that would threaten to impair the national security of the United States. On the same day, the House passed an amendment (H.Amdt. 431) to an appropriations bill (H.R. 3058) that would prohibit the use of funds from being made available to recommend approval of the sale of Unocal Corporation to CNOOC. On May 20, 2005, the Chinese government reported that first quarter real GDP grew by 9.4% in 2005 over the same period in 2004. On April 15, 2005, the Chinese government reported that its foreign exchange reserves had risen to $659.1 billion by the end of May 2005. (Morrison, 2005) Some researchers state the fact that the data reported for FDI in China is different from the reality. The Chinese FDI data is overstated. About ¼ of flight capital later returns (“round-trips”) as FDI when opportunities emerge. (Gunter, 2004) From the early 1990s most of the researchers from International bodies have calculated wrong FDI. It is Mainland Chinese monies that flowed out to access better financial, regulatory and legal services and round-trip by returning to China as apparent FDI to access the fiscal incentives and improved investor protection offered in China to foreign investors. (Erskine, 2004) Outward FDI: “The figures on FDI outflows vary. According to China’s BOP statistics, the cumulative total during 1990 to 1997 was US$18.9 billion, consisting exclusively of equity capital. Since the 1980s, China has been fast acquiring assets abroad. Researchers7 estimate that Chinese FDI in Hong Kong totalled US$20-30 billion by the end of 1993 or 1994. In fact the net wealth of Chinese affiliates abroad can be measured in hundreds of billion dollars. Officially, the Chinese SOEs had as many as 5 666 affiliates abroad at the end of 1998 with a combined FDI of US$6.33 billion.” (Chandra) Both the in-ward and the out-ward FDIs are a strong influencing forces which effect the trade performance of a country. This can be further explained by conducting the following case study. The study reveals increased value to Economy of China due to FDI. Source countries: Among the developed countries Japan & United States are the most important investors in China. Hong Kong is also an important investor and newly industrialised (NIEs. From 1990’s some of the countries like Philippines Malaysia & Indonesia have also increased their investment levels in China. Other countries are also showing interest in investing in China in future. In 2003, Sino-Japan trade reached a record high $132 billion. Examining the fast expansion of the bilateral trade suggests that direct investment from Japan performed a critical role in strengthening the economic integration between the two economies. Japanese affiliated manufacturers in China contributed to the soaring bilateral trade in dual ways: exporting their products as final products and intermediate inputs to Japan, and importing intermediates inputs from Japan for their production in China. In 2002, Japanese affiliated manufacturers exported 1,057 billion yen products to Japanese market (METI, 2003). The effect on China’s exports and its national economy is tremendous. (Xing, 2004) FDI from China: Not much material is provided regarding the subject. Although Hong Kong can be viewed as the destination for out ward flow of FDI from China. Factors attracting FDI in China: The first set of factors which was involved in bringing the FDI to China was the improvement in technology, cheap labour, cost effective production of the goods, cheap and efficient supply chain. The Chinese Government also has the cutting edge of Channelling the FDI in the right direction. They are attracting most of the MNEs towards China because at present the Chinese economy can provide them with all the suitable factors desired. Due to its increase in population China has become a growing and profitable market for most of the MNEs & products (Dean A. Yoost, 2004). The second set of factors, relating to SOEs, will change significantly and alter the market environment that foreign firms will face in China. Many if not the majority, of China’s best SOEs in industries accessible to foreign investors have set up joint ventures with foreign companies. In the foreseeable future, as the number of SOEs in the national economy continues to shrink, China will facilitate the entry of private domestic firms. MNCs will tend to build up their own affiliates rather than look for Chinese domestic partners. At the same time, they will face more competition from private Chinese firms as their numbers increase. All of these will become attractive features of the Chinese market. Foreign invested enterprises (FIEs) have provided an alternative to private entrepreneurship because private Chinese firms have been largely discriminated against. In the past 20 years, the highly efficient FIEs have contributed a great deal to the Chinese economy. In 2002, even though FDI accounted for only one 10th of the gross fixed capital formation, FIEs contributed one third of the industrial output, one quarter of the value added, more than half of the exports, and nearly three quarters of the foreign exchange balances held in Chinese banks by corporations. (Zhang, 2005) Sectoral and geographical distribution of FDI in China Sectoral Distribution: “So far, the major proportion of FDI is drawn for the manufacturing field, which takes up almost 60 per cent of the total contracted FDI by 1998. Next follows real estate with the share of 24.4 percent. The portion of the distribution industry including transport, wholesale and retailing is 6.0 percent. Construction comes next with 3.1 percent. The primary industry such as agriculture, forestry and fishing takes 1.8 per cent. In the future, service trade, such as finances, telecommunications and wholesale and resale commerce, will take up a larger share as a result of Chinese accession to WTO and further liberalisation. Further investment liberalisation should also take place in traditional industries. Especially, the expansion of FDI in agriculture will depend on the degree of opening up to the market circulation of agricultural products and the industrialised process of production operations. FIEs also generated nearly one fifth of the total tax revenues and 23.5 million job opportunities, employing about one 10th of urban workers. These numbers suggest FDI has contributed nearly one quarter to one third of China’s GDP growth.”(OECD, 2004) Case Study: The impact of FDI on trade: evidence from Chinas bilateral trade The study uses the gravity model framework in order to investigate the impact of Foreign Direct Investment on the trade performance of China. The data used comprises of the trade & stock data of 75 countries and regions for the period of 1989 to 2000 i.e. for ten years. The outward FDI was predicted as a stronger influencing force on Chinese exports rather than the inward FDI, on the other hand inward FDI was found a stronger influencing force for Chinese imports rather than outward FDI The study found FDI motivation and region-specific characteristics as the influencing forces in different regions of the world the gravity model, which has been used to explain bilateral trade flows among many countries over long periods (Frankel et al. 1995; Hejazi and Trefler 1996; Fontagne L. and Pajot M. 2000). The major empirical conclusions of this paper are: (1) Much of the measured trade effect is through FDI rather than cost, as the theory of FDI would indicate, and that studies which concentrate on cost as the channel significantly understate the extent of such expansion. (2) On the whole bilateral country level, outward FDI has a larger predicted impact on Chinas exports than does inward FDI. On the other hand, inward FDI is found having a larger predicted impact on Chinas imports than does outward FDI. (3) There is much cross-regional variation and differences in the patterns of FDI-trade links. Regarding to the impact of inward FDI on Chinese trade, FDI is found to boost both export and import growth in Asia, Europe and Oceania. As far as outward FDI is concerned, a unanimous complement link between FDI and trade exists only for Asia, and Africa. (Yong, 2003) Barriers in the way of FDI in China: The Chinese government has applied a controlled competition culture which against the liberalisation provided by the WTO which lift most of the regulations from the trade & commerce (Yoost, 2005) Many assets in commercial and industrial sectors are state owned. This in turn gives rise to the problem of hidden state regulation imposition of the government on the foreign investors. This strengthens the view that China does not practise liberty in Business. Some of the sectors of economy are still protected by the government. Due to the situation the WTO commitments are not fulfilled which gives rise to local competition for foreign investors The work undertaken in this paper is an improved one because it takes into account all the aspects related to the FDI including a set of countries which contributes towards the FDI in China, the contribution made by this paper is in more fully evaluating an important policy question regarding the effect of FDI. Second, it takes into account national changes both in inward FDI and outward FDI over a considerable period of time. Future Recommendations: If the aim of attracting FDI to China is to introduce advanced technology, improve management and expand markets, it would appear to be working. More and more private Chinese-owned spin-offs of the FIEs are capable of competing with these FIEs in China as well as in the global markets. China needs to learn from post-World War II Germany and avoid the experiences of Botswana. The former encouraged foreign investments but was not dominated by them – instead, it succeeded in strengthening its own innovation capacities. By contrast, foreign companies have to a large extent dominated the economy of Botswana, with daunting social and political consequences, even though FDI has contributed to the economic growth of the country. To many foreign investors with market-seeking motivations, preferential treatment is not the determining factor in their investment decisions anyway. Thus it is not a sustainable strategy for attracting efficiency-seeking FDI. China must create an open and fair competitive environment for all firms, domestic and foreign alike, to cultivate the growth of national champions. As it strives to build up a rule-based market economy that respects policy transparency, protects intellectual property rights and upholds fair competition, China will increase its advantages in attracting FDI. But the new instruments will shape FDI structures, and round-tripping FDI is likely to decline and disappear eventually, reducing China’s FDI figures statistically. That in it may relieve other countries’ concerns, though the magnitude of this change may be hard to detect in the short term. (Zhang, 2005) References Beijing Time, (2002). News analysis: FDI in China Keeps Growing Saturday, July 20, 2002, retrieved 10/01/06 from http://english.people.com.cn/200207/20/eng20020720_100031.shtml Chandra, N.K., "FDI and Domestic Economy: Neo-liberalism in China",. EPW Special Articles (www.epw.org.in/34-45/sa3.htm) Eskine, A., (2004). 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China’s Economic Conditions, Foreign Affairs, Defence and trade, Congressional research service, The library of Congress, Retrieved 02/01/06 from www.fas.org/sgp/crs/row/IB98014.pdf OECD, (2000). Main determinants and impacts of foreign direct investment on China’s economy, Working paper on Investment, Number 2000/4, retrieved 12/01/06 from http://www.oecd.org/dataoecd/57/23/1922648.pdf Xing, Y., (2004). Japanese FDI in China: Trend, Structure, and the Role of Exchange Rates March 2004 retrieved 13/01/06 from http://www.iuj.ac.jp/faculty/xing/papers/FDI_JC_xing.pdf Yoost, D. A., (2004),”People’s Republic of China-Rewards, Risks and Recommendations”, Orange County Business Journal, Vol. 27,No 17, retrieved 02/01/06 from http://www.ocbj.com/ Yong L., (2003). The impact of FDI on trade: evidence from Chinas bilateral trade: Journal of the Academy of Business and Economics, Jan, retrieved 13/01/06 from http://www.findarticles.com/p/articles/mi_m0OGT/is_1_1/ai_113563595 Zhang, Y., (2005). China must adjust its FDI policies if it wants to retain its global lead in inflows, Foreign Direct Investment, Financial Times Business, April 12, 2005, retrieved from 13/01/06 from http://www.fdimagazine.com/news/fullstory.php/aid/1211/Tips_for_the_top.html Read More