International Investment in China - Essay Example

Introduction This paper provides an insightful study into the recent trend of enhanced direct investment by the multinational corporations into the emerging markets of the world particularly the Asian markets. Among all the rising Asian economies, the Chinese market has been a centre of special attraction for the multinational corporations. The companies in United Kingdom are also increasingly taking decisions to invest considerable funds in the Chinese market so as to avail the prevailing business opportunities. There tend to be several opportunities for multinational corporations in the Chinese market with regard to low cost production and boosting economy etc. However, associated with these opportunities are also risks confronting the businesses in the context of international investment. This essay primarily encompasses the direct investment concerns in the international business spectrum and also presents the case of Shell plc as an example of UK's direct investment in China. Investment Of UK Companies In Emerging Market- China There has recently been an increasing trend on the part of the multinational corporations from the developed world to enter into trade and investment with emerging economies of the world. There happen to be several factors responsible to induce the foreign companies to invest in less developed or emerging markets. Samli and Kaynak (1984) refer to the concept of emerging markets as similar to less developed countries characterised primarily with agriculture based economy, high population growth levels, lower income levels, low literacy level, lack of substructure, and lack of capital etc. China is also one of the emerging economies of the Asian world, which is speedily climbing the ladders of economic progress and prosperity through a remarkable growth in various industrial and economic sectors. The recent rapid economic boom in China and open market policy has projected the country's image in the world as an attractive market for international investment (Sun and Chai, 1998). Hence, several companies from the developed world are making direct and indirect investment in Chinese market so as take full advantage of the prevailing opportunities for foreign companies. This is very well reflected in the increasing foreign direct investment in the Chinese market from all over the world that is further enhancing the economic growth of the country. Chinese government and financial environment purposefully support and encourage multinational companies to enter the market so that it can affirm the consistent progress of the Chinese economy (Zhao, 2003). In the same vein, several UK companies having identified and analysed the opportunities in the Chinese market are making direct and indirect investment in the country that brings foreign reserves to the country as well as happens to be profitable for the these corporations. Huaning and Colin (2004) refer to the United Kingdom as the pre-eminent investor in China during the recent years among all the European Union countries. Case: Shell's Investment In China Shell happens to one of the major investor in Chinese market. In the year 2002, it entered the oil market of China with an investment of 255m (FT.com News, 2002). The company further expanded its business activities in the country and recently the company confided to a project concerning coal exploitation in a joint venture with a Chinese partner with a prospective investment of about 2.7b, probably the largest ever investment received by the country (FT.com, News, 2006). In this way, Shell plc invested in the Chinese market by way of direct investment. The increasing interest of Shell plc in the Chinese market is reflective of the investment attractiveness of the country with regard to its inexpensive labour, growing economy and surging demand. Determinants And Merits Of Investment By UK Companies In China Changhong and Weili (2002) propound that there happen to be two significant forms through which the multinational corporations invest in a developing country viz. direct and indirect. Under direct investment, these companies purchase shares and securities whereas in the indirect investment, the foreign firms are allowed to perform their business operations in the country and compete with domestic firms. China, being an underdeveloped country, confronts the problems of growing population, poor infrastructure, and lack of resources conducive for rapid technological advancement, yet it happens to be an attractive investment option for the international companies. Within the context of international investment in a country, it is imperative to study the major determinants that influence the multinational corporations to make huge investments in an emerging market like China. Businesses exist for profit and enhancement of shareholder value; hence in all the activities they undertake, this focus remains to be of significant importance. This suggests that in the increasing trend among multinational corporations to invest in the less developed countries of the world, lies the immense opportunities for enhanced profits and reduced costs. The studies conducted by several authors (for eg. Findlay (1978); Glass and Saggi (1998); Konings (2001) etc) suggest that there happens to be profound investigation and analysis on the part of multinational corporations in the decision-making concerning the prospects of international investment. Zhao (2003) refer to the differences between the host country and the source country's political uncertainties, cultural environments, and economic growth levels as important determinants of the investment decisions taken by multinational corporations. The relative backwardness and contagion model put forward by Findlay (1978) suggests that the gap between the economic growth in two countries determine to a great extent the opportunities available in a market for multinational corporations to exploit. He says that the higher the growth gap between two countries, the level of opportunities available for multinational corporations will be significant in the less developed country. This gap in economic growth determines the investment decision of multinational corporations in the emerging markets. Similarly, a company having its major operations in the United Kingdom when intends to make a significant investment in the Chinese market considers the aspect of opportunities available in the country conducive to the company's business operations. Sun (1999) refers to several factors contributing to the direct investment decision of a multinational corporation. The author propounds that the social and cultural gap between the host and source countries impact the entry mode decision considerably. In case of high degree of social and cultural differences in the environment enhancing the cost of information and business uncertainty, the author recommends entry through a joint venture and affiliation with a domestic firm. Joint venture is also feasible if the technological facilities are similar in both the countries, however in case of high degree of variation in technology, the MNC might not opt for a joint venture to enter a foreign market. Glass and Saggi (1998) illuminate the eminence of technological gap between the two countries as a determinant of foreign investment by multinational companies. The higher the gap between technological edge in two countries, the less technologically advanced country is less likely to have the network and substructure available to perform certain business activities. This does not only determine the investment decision of multinational corporations, but also identify the kind of technology transfer to the country. In the similar fashion, a company from UK makes its investment decision considering the state of infrastructure, network and technology in China relative to the company's business. For instance, if the Chinese market lacks the kind of technology necessary for its activities, then the company will need to transfer that particular technology to the country. Konings (2001) propound that multinationals deciding to invest in a less developed market, have several advantages over the domestic firms that reduce the marginal costs of these companies and thus these companies can conveniently exploit the fragility of domestic firms in the country by inducing the customers towards their products and driving them away from competitors. This refers to the availability of resources accompanied with advancement of technology in the market entry of a multinational corporation. A UK company bringing investment and technology to China utilises not only the opportunities favourable for business in the country, but also comes with undeniable strength to drive its competitors out of the market. Hence, grabbing a double-edged sword, the multinational corporations fully exploit the business opportunities in an under developed market. The question that follows is what opportunities actually exist in an emerging underdeveloped economy that induces these companies to make huge investments in its market. Plausibly, the first and foremost reason behind such activities happens to be the attractive labour force in the country at cheaper wages. Hence, multinational corporations benefit from availability of low wage labour in China. The Chinese workers work for 12 hours per day and are habitual of working overtime even beyond these working hours. Zhao (2003) puts forward the same point that China happens to be one of the most attractive choices for international investment, being a land of opportunities with increasing population and booming economic structure. Risks Underlying International Investment- United Kingdom And China Risks are inherent in all the business activities and when it comes to investing in a country that is less developed and confronts several economic problems evokes further concerns regarding the sensibility of the investment decision. However, in order to take advantage of the opportunities in emerging markets, companies also need to face certain risks relevant to doing business in such countries. The major risks underlying the international investment concerns the economic, political, social and cultural differences between the host and home countries. These factors are country-specific and influence the overseas operations of multinational corporations. For example, the legal and political environment where all the business activities are controlled and influenced by state can affect a company's free operations. In China, despite vigorous activities underlying trade liberalisation, much control is exerted by the state. Furthermore, the culture and social environment of China is entirely different from that of the United Kingdom. A UK multinational company, therefore, needs to consider the environmental risks prevailing in the country because these can affect the company's activities considerably. Zhao (2003) posits that financial factors such as foreign exchange rate and the cost of borrowing, along with other variables, also influence the investment decision of multinational corporations. The author asserts that the multinational companies from developed countries with stronger currency would always be willing to invest in a country with weaker exchange rate so as to mitigate costs and enhance their competitiveness internationally. The second significant variable, being the cost of borrowing in the source as well as the host country also determine the extent to which MNCs borrow from the source as well as host country. These two risks are most significant in a company's decision to invest in an emerging market. The flexibility of exchange rate poses significant threats, as the company's cash flow and market value also tend to fluctuate with the movements in exchange rate. Goldberg and Kolstad (1995) illuminate that the foreign companies tend to investigate into the impact of direct investment into another country with respect to the exchange rate risks faced by the company. For instance, a multinational corporation would prefer investing direct into a country if it observes an increase in exchange rate volatility because direct investment mitigates the company's exposure to this risk. A company from United Kingdom that invests considerable funds in China confronts the risks of uncertain movements in exchange rate and hence would base its mode investment on the rate of fluctuation in exchange rate. However, the hedging methods are available for an international company to mitigate its exposure to the exchange rate volatility risks. Joseph and Hewins (1997) also suggest that hedging by means of forward contract can alleviate the impingement of foreign exchange rate movements on international investments by multinational corporations. Muller and Verschoor (2006) propound that a company's hedging activities greatly influences the degree to which it is exposed to exchange rate fluctuations. The companies that perform hedging activities are less open to the exchange rate fluctuations as compared to the companies that do not hedge. Hedging is also suitable for companies willing to reduce the volatility of their profitability. As exchange rate volatility causes great variations in the company's profitability and cash flow movements. This can have a great impact on the company's market value, but this effect can be negated with the help of hedging activities. Joseph and Hewins (1997) put forward that the multinational corporations perform hedging activities in order to mitigate the volatility of the company's cash flow and also to defend its market value from being affected by the fluctuations in foreign exchange rates. Zhao (2003) explains that the Chinese currency has a lower rate of exchange than the developed economies that encourages foreign countries to import from the country and also to directly invest more conveniently in the Chinese market. Hence, the stronger the currency of the MNC's country as relative to the Chinese currency, the greater will be the direct investment in China from that country. This point can also be taken as further attraction of investing in Chinese market. In an international environment where companies are likely to face the risks of increasing currency and exchange rate, a company investing in China can also benefit from the lower value of Chinese currency in the way of cost reduction. For example, if a UK company makes direct investment in China and conducts its business operations, the low cost of production in the country will further be lowered due to the Chinese currency's value against that of the UK. The cost of borrowing, as mentioned above, happens to be another risk underlying international investment. The cost of borrowing refers to the interest rates that are to be paid on the amount of borrowings. Zhao (2003) illuminate that even though the financial institutions such as capital market in China happens to be relatively fragile than many economies, yet the government allows capital borrowing at the rates acceptable by the foreign companies so as to enhance direct investment. The Interest rates are also lower in China as compared to many emerging economies in the world owing as a reaction to the deflationary pressures in the Chinese economy. Hence, the company from United Kingdom also gains from the low interest rates prevailing in the Chinese market and the consequent low cost of borrowing. Conclusion This essay provides a study on the merits and opportunities underlying a UK company's investment into the Chinese market along with the risks associated with the decision of international investment. There happen to be several opportunities underlying the investment in emerging or underdeveloped markets such as low cost of labour, massive population, high demand and less competitive abilities of domestic firms. However, in the context of international investment, a company is very likely to face social, political, cultural, environmental and financial risks in its investment decision. The Chinese market is quite favourable for the investment by a UK company because of rich economic and technological gap between the two countries that can easily be availed by the UK multinational companies. The paper also investigates into a real company from UK (i.e., shell) and its investment in China and finally reaches to the conclusion that it is very feasible fro a UK-based multinational company to make investment in the booming Chinese market. References Changhong, P. and Weili, Q. (2002), "Internationalisation of Securities Market After China's WTO Accession", China & World Economy, 4, pp. 24-27 Findlay, R. (1978) "Relative Backwardness, Direct Foreign Investment, and the Transfer of Technology: A Simple Dynamic Model", Quarterly Journal of Economics, 92, pp. 1-16 FT.com, Jul 24, 2002, Shell expands China interest in $400m deal, accessed 01.09.06 from http://search.ft.com/searchArticlequeryText=shell+UK+investment+in+china&javascriptEnabled=true&id=020724000711 FT.com, Jul 12, 2006, Shell Commits To Coal In China Oil Joint Venture, accessed 01.09.06 from http://search.ft.com/searchArticlequeryText=shell+UK+investment+in+china&javascriptEnabled=true&id=060712000909 Glass, A. and Saggi K. (1998) "International Technology Transfer and the Technology Gap", Journal of Development Economics, 55, pp. 369-398 Goldberg, L.S. and Charles D. K. (1995), "Foreign Direct Investment, Exchange Rate Variability And Demand Uncertainty", International Economic Review, 36, pp. 855-873 Huaning, L. and Colin, M. 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(1998), "Direct Foreign Investment And Inter-Regional Economic Disparity In China", International Journal of Social Economics, 25(2/3/4), pp. 424-447 Zhao, H. (2003), "Country Factor Differentials as Determinants of FDI Flow to China", Thunderbird International Business Review, 45(2), pp. 149-169 Read More