Chinas FDI and Extent of Transition to a Market Economy - Essay Example

China’s FDI and Extent of Transition to a Market Economy 20 December Outline China as a Challenging Market for FDI 2 Introduction 2 Why China is a Challenging Market for FDI 3 Counter-argument 4 Conclusion 8 Extent of China’s Transition from a planned to Full Market Economy 8 Introduction 8 Extent of China’s transition 9 Counter-argument 11 Conclusion 14 References 14 China’s FDI and Extent of Transition to a Market Economy China as a Challenging Market for FDI Introduction Several business entities think of China as a haven for foreign direct investment (FDI) because of the amount of goods that leave the country and the capital inflows. However, contrary to these assumptions, those who actually do business there have found several difficulties that challenge this popular notion. It is imperative to study those factors in order to equip potential investors with the knowledgeable needed to survive the market, and to assist government stakeholders in making business climate more favourable for international business. China has quite impressive figures on investment, but three particular factors prove that this is still a challenging market; complex consumption patterns, poor regulatory climate and competition from locals. These areas will be the main areas of concern in the essay because they have been cited by several foreign investors in the country. Why China is a Challenging Market for FDI Prior to dissecting the attractiveness of China as an FDI destination, it is imperative to first define the term. Graham and Spaulding (2005) describe foreign direct investment as the process by which a business entity from one country makes an investment in another country through physical assets or management interest in a foreign company. FDI may manifest through joint ventures, company sets ups, licensing agreements, or other forms of internationalisation processes. Globally, a number of changes have been witnessed in the area of FDI such as reductions in the cost of communications thus increasing management of these investments. Tariff liberalisation has also become something worth focusing on, while restrictions on foreign investments have been dramatically reduced. Privatisation of industries and de-regulation has acted as a catalyst for the role of foreign direct investment in the global economy. Multinationals still account for the greatest number of FDI ventures globally even though technology is facilitating entrance of less traditional firms (Graham and Spaulding, 2005). In order to determine whether China is a challenging FDI market, it also critical to determine the qualities that make an area attractive for these sorts of ventures. First, a place ought to have a transparent and thorough regulatory framework; its administrative system should be devoid of red-tape that may hinder approval of the foreign direct venture as required. Economic policies in the targeted region need to be coherent and should allow for long-term planning, while infrastructure, including telecommunication, transportation and financial ones should be made available. The presence of other FDI stock also acts as a positive indicator because; it provides the required human capital, local administration and complementary industries needed to conduct business. Even availability of thriving local industries can be a strong indicator as it allows for subcontracting and provision of supplies from complementary businesses (Taueb and Ogutcu, 2002). If the above qualities are not prevalent in China, then it can be deduced that it is a challenging market for FDI. Counter-argument Some opponents to the above statement claim that China is an FDI haven, as indicated by the following statistics: Source: Hanemann, T., 2013. Foreign investment in China: A tale of two statistics. [online] Available at: http://rhg.com/notes/foreign-investment-in-china-a-tale-of-two-statistics [Accessed 19 December 2014] Percentage Increase Quantity of FDI inflows in China 2009 -2.1% $9.3 billion 2010 17.4% $105.7 billion 2011 11.3% $117.7 billion 2012 -3.7% $113.3 billion (Davies, 2013) Generally, there has been an upward trend in FDI inflows in China from 1983 onward; minor decreases have been reported thus indicating that the country must be doing something right. Furthermore, many of the qualities mentioned in the above paragraph seem to exist in China, including; strong infrastructure and the presence of other FDI. The existence of cheap labour and huge technology developments have been cited as some of the reasons why China is an FDI target; however, these qualities still do not overrule some of the difficulties faced by foreign investors in the country. Statistics support the notion that China is still a difficult place for foreign direct investment; this can be seen from the share of foreign banks in China by 2012, which only account for 1.82% of the players in the industry (Tradoc, 2014). A recent survey conducted in the EU revealed that at least 45% of the FDI participants in China felt that they missed opportunities in the country owing to regulatory barriers and market access issues (Tradoc, 2014). Issues with China Three particular areas warrant special attention when looking at the FDI climate in China; regulatory climate, consumer qualities and local competition. Competition from local players is still one of the reasons why foreign investors do not do well in this Asian country. Currently, domestic companies are entering into areas previously perceived as a reserve for foreign players; these include; brand recognition, product quality and marketing and sales. Foreign companies from the US now state that competition from Chinese firms accounts for a considerable reduction in their operations. A case study of this phenomenon is the Chinese electricity sector, which is characterised by several power-generating firms; most of these generators are government-owned, and continued growth is leading to inefficient investment. This has suffocated the foreign players. Most of these players have called for a reduction in their growth strategies and management of their assets (Xuegong et. al., 2012). Another case study illustrating intense local competition is Wal-Mart China; the company only has 400 stores despite being in China for almost 2 decades. Riley (2014) reports that the organisation plans on closing a number of its stores down, due to a poor execution of its strategy. Souza (2013) states that; Wal-Mart inc., known for its everyday low prices, met its match in China. Street vendors, local stores and larger domestic chains all had various knock-offs; they had mastered the supply chains and were better at delivering low prices than Wal-Mart. Government policies have been a big problem to foreign investors as many of them claim that they discriminative. The following table summarises some of the major sources of despondency over the regulatory environment in China: Regulatory obstacles in China Percentage Local implementation of only Chinese standards 35% No harmonisation with global standards 39% Poor coordination of different forms of regulations 40% Poor implementation of broad laws and regulations 42% (Davies, 2013) The greatest concern among the European Union foreign investors, responsible for the above statistics, is the issue of poor enforcement of broad laws. Many foreign investors feel that Chinese laws are too ambiguous to enforce compliance. In fact, legal disputes between them and locals are difficult to settle as the Chinese tend to rely on personal rather than formal contracts, which are enforceable in court. The poor legal environment/system has thus perpetuated corruption and eventually put off some foreign investors, which has led a certain number of investors to suspend their plans (Tseng and Zebregs, 2002). The area of intellectual property rights is particularly wanting in the country as trademarks and copyrights are inefficiently protected in the country. Statistics indicate that as of 2010, China has a regulatory restrictiveness score of 0.5, which is neither closed (earns a score of 1) nor fully open (earns a score of 0). Improvements have been in the FDI policy framework in China, but 0.5 is still a long way to go from the ideal (Davies, 2013). Discriminatory practices in procurement have also been reported by foreign investors. They feel that the government favours locals over them. A case study illustrating the full ramifications of having an inadequate regulatory system is the electricity sector and its investment patterns. Xuegong et. al. (2012) found that the entire sector is totally fragmented and uncoordinated, which means that private sector players find it difficult to comply with the legal requirements. Electricity is characterised by rent-seeking regulators who do not adhere to particular rules or hide under opaque systems. The Chinese consumer market is a complex one that often causes global players to struggle in the environment, especially in the retail sector. As earlier stated, income is unevenly distributed; therefore, care must be taken when selecting the right geographic location for specific ventures as low per capital income makes some buyers price-sensitive. Alternatively, consumers in the middle income bracket are also quite sensitive to quality, and will not buy something unless they are absolutely satisfied by it (Trefis, 2014). Many of them do not have social safety nets like the Americans, so they tend to exhibit greater frugality in picking items than typical western consumers (Souza, 2013). Wal-Mart has struggled to understand Chinese consumers over the past years, and has thus not done well (Gereffi and Ong, 2007). Many of the buyers do not appreciate the so-called “fresh produce” in supermarkets as they can get items fresh from farms. Furthermore, many Chinese buyers rarely buy in bulk and the middle class is concentrated in cities, which already have local suppliers; these peculiar traits make it quite challenging for foreign investors to do business in China (Riley, 2014). The following figures demonstrate some statistics on why conventional assumptions about FDI should be challenged; the narratives chosen to explain them depend on an idnividual’s agenda: Source: Hanemann, T., 2013. Foreign investment in China: A tale of two statistics. [online] Available at: http://rhg.com/notes/foreign-investment-in-china-a-tale-of-two-statistics [Accessed 19 December 2014] Conclusion As mentioned in the introduction, three areas were chosen for analysis to illustrate why China is still a challenging FDI market; competition from locals, regulatory climate and complex consumption/ market. Consumption or complex market challenges in the country revolve around the unique nature of the Chinese consumer, who is both price and quality sensitive. The second issue consists of local competitors, who have their own networks and can offer the qualities that customers want. Foreign investors often struggle to decipher these unique market qualities; the situation is further complicated by the regulatory environment in the nation (the third quality). The legal framework is rather ambiguous and laws are poorly implemented; regulations and regulatory agents are poorly coordinated, and discrimination in procurement is a challenge. If the government of China can tackle these problems by reprioritising development efforts and streamlining its regulatory framework, then China can become a less challenging FDI market. Extent of China’s Transition from a planned to Full Market Economy Introduction China’s economy is continually growing since it transitioned from a planned to a market economy, yet implementation of the model is not yet complete. China’s success has caused a series of scholars to speculate about the extent to which the country has transitioned, and whether its development model was appropriate. No doubt exists concerning the decentralisation, privatisation and economic policies that have led to these successes; all the characteristics are attributes of a market economy. However, a number of qualities are still missing from the Chinese economic environment to make it a full market. Therefore, it will be argued that China is still transitioning to a market economy, but it is nearer to the full market than the planned economy one; this means that the country is on the right track to completing this transition. The paper will specifically focus on three areas to prove the thesis that China has made significant transitions to a planned market economy: new economic enterprises, economic achievements like agricultural reform, and the rule of law. These areas were chosen because they are indicative of the extent to which a country is governed by market principles as they are the tools used to drive the economy. Extent of China’s transition Source: International Monetary Fund, 2000. Transition economies: An IMF perspective on progress and prospects. [online] Available at: https://www.imf.org/external/np/exr/ib/2000/110300.htm [Accessed 19 December 2014] Source: Rittenberg, L. and Tregarthen, T., 2013. Economies in transition: China and Russia. [online] Available at: http://catalog.flatworldknowledge.com/bookhub/21?e=rittenberg-ch20_s04 [Accessed 19 December 2014] The diagram above demonstrates that the economic transition in the country has largely been a successful one as seen through its high GDP growth rates. Some studies have been conducted on how other countries perform when transitioning to market economies as seen in the first graph: China seems to outperform most of them. China is indeed on the right track owing to a number of specific factors; first among them is agricultural reform; the country has been able to break its large firms into smaller ones. It has also introduced household responsibility systems in farms that are relatively small; these changes had a direct impact on the nature of food productivity in the sector. Alterations in agriculture enabled high savings levels, which transformed peasants into wealthy income earners. No longer were they doing substance agriculture, but most of them became trading partners with larger cities. In essence, this created a large market for locally-made goods (Intriligator, 1997). The growth in incomes within rural areas also encouraged a vast number of farmers to move from rural to urban areas. This means that industry growth could be facilitated through the high level of labour supply; other countries that have been transitioning into a market economy have often failed because they have ignored agriculture. It also has free economic zones in places like Guangdong province, Shenzhen and Fujian provinces (Intriligator, 1997). These zones attracted industries that target export markets and thus enabled China to start earning foreign exchange. Currently, the economic zones have led to high capital inflows; economists explain that these signify an integrated capital market. In a market economy, capital usually looks for the highest rate of return; the high flux of capital or foreign exchange into China indicates that the market is doing relatively well, and serves as a beacon of how to transition into a market economy (Park et. al., 2006). Finally, the nation has been quite successful in establishing new economic enterprises like township and village enterprises so that minimal resources are wasted on privatising the old economy enterprises. China worked on having new entrepreneurial units at village, province and town shop levels; its economy was not adversely tied to its state-owned enterprises. This means that the nation was highly flexible in going through the transition. Rather than dwelling on privatisation or alteration of certain ownership structures, the country was keener on making the units efficient. Minimal subsidies or resources were wasted on state-owned establishments as new entities were welcomed thus illustrating that privatisation is not the only method of transition (Lin, 2004). Counter-argument There are several issues which prove that China is not yet a market economy, but for purposes of brevity, only three will be discussed; the rule of law, the status of state owned corporations and new private enterprises. These factors are key indicators of the government-business relationship in the country; a government that allows sufficient room for entrepreneurial activities without much interference is one that is committed to flourishing its markets. Several countries in the West have been successful economically owing to this diminished interference, while socialist regimes that have failed tend to exhibit excess bureaucracy (Horbah, 2012). State-owned enterprises (SOEs) in China and their management are indicative that the country is yet to attain its goal of being a market economy. SOEs tend to create a fiscal burden on a government that has the ability to destroy the financial sector; in China, the government still has a close relationship with businesses owing to SOEs. Industrial output within the country still depends largely on SOEs (25% of the sector is from these areas) (Li and Xia, 2008). An even larger share can be seen in transportation, banking, and communication; in fact, ownership monopolies are evident in some sectors such as telecommunication and transportation or even the airline industry (Perkins, 2002). Large SOEs still control the economy of China, and they have thus imposed certain burdens on the government; if the government were to commit to withdrawal from these sectors, there would be a substantial level of freedom in the market. However, currently, the government states that there are certain pillar industries that it must continue to support and control (Qian and Wu, 2000). Private enterprises are still wanting in China and should be improved in order to maintain a market-friendly relationship between government and business. In the services sector, less than 50% of the enterprises are private thus showing that much is yet to be achieved. Small and medium enterprises (SMEs) have the capacity to transform a nation’s economic performance; in the US, newly formed small and medium firms were responsible for the impressive economic growth in the 1990s; they were able to overcome monopolies by larger organisations. In China, Township Village Enterprises were a step in the right direction as they accounted for a significant share of industrial output, yet they were state-owned. It was in the mid 1990s, that their competitive advantage gradually fizzled out. SMEs and other private enterprises are not performing well in China owing to a number of reasons. There is ideological discrimination as well as political discrimination against private ownership; Small enterprises face considerable hurdles in opening up and accessing finance in the country since they require huge capital and are limited in terms of how they will grow (Riskin, 2009). The rule of law is another matter that demonstrates China’ unachieved market economy goal; the nation still suffers from the lack of uniformity with regard to business laws. Many of them are still unpredictable and thus nurture corruption as well as rent-seeking; transaction costs are often exacerbated and economic efficiency is still a challenge. In China, it appears that the government is not constrained by the law as its agents have plenty of discretion to make decisions on property rights among others. Individuals can scarcely sue the government, but they do not have the ability to protect themselves from really high fees (Tisdell, 2009). Contract enforcement also falls under rule of law, and is an essential quality in a properly-functioning market economy. In China, the government is not a neutral party yet as it still administers economic activities, which are essentially qualities in a centrally planned economy; the country’s ministries still run some of the company monopolies thus showing that much is yet to be achieved. The above facts can be supported by GDP data on China and other countries that are considered as market economies; China has not superseded the United States as shown below. Source: Purdy, M., 2013. China’s economy in six charts. [online] Available at: https://hbr.org/2013/11/chinas-economy-in-six-charts/ [Accessed 24 December 2014] Conclusion Economic transitions made by China were gradual, but effective and have shown that moving into a market economy is possible if a government is firmly committed to the goal. China is well on its way to becoming a market economy owing to the way it has structured its agriculture sector, as well as its approach towards privatisation. New enterprises grew and the country was more than willing to forego ideological preferences for economic efficiency even at lower levels of government. The implementation of entrepreneurial activities at low levels means that few decisions have to be centrally made. On the other hand, China is yet to achieve its ultimate goal owing to challenges associated with the relationship between its government and business. 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