Transcript Foreign Investment Chapter 17

Presented by Gabor Czeyda-Pommersheim (I24021)
due to 3rd of December 2009
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Foreign Investment
FDI in the Chinese Economy
“Zones”: the gradual liberalization of the
Investment Regime
4. The Investment Regime Today
5. Sources of Investment in China
6. The China Circle
7. FDI in Context
1.
2.
3.
7.1. Sectoral Composition of FDI: The WTO Impact
7.2. Modes of Capital Inflow
8.
Conclusion
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FDI (外國直接投資) is a
measure of foreign
ownership of productive
assets, such as factories,
mines and land.
 FDI is a measure of growing
economic liberalization.


FDI investor- individual,
incorporated, unincorporated
entity, public or private
company, enterprise,
government body

Biggest FDI receivers- US, UK,
Hong Kong, France, Germany
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China is major FDI receiver. Investment began to pour in 1992.
Annual inflows over US$40 billion since 1996. FDI inflows US$63
billion both in 2004 and 2005.
 China has accounted for one-third of total developing country
inflows in recent years, the created global manufacturing
networks will play critical role in world economy.

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Three distinctive characteristics of investment in China:
▪ FDI predominant form in which China accessed global capital
▪ Unusually large proportion of Chinese FDI inflows in
manufacturing industry (opposed to services or resource
extraction)
▪ FDI inflows predominantly from EA economies (Hong Kong,
Taiwan)
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The dominant role played by cross border restructuring of
export-oriented production networks developed in other EA
economies.
 New patterns are expected to emerge.
 Predominance of FDI shows that China hasn’t made much
use of other foreign investment. China has potential to tap
world savings. China’s entry to WTO (December 11, 2001)
began the process of liberalizing access to many service
sectors.
 Since 2002 beginning of capital inflows outside of FDI. These
are surprising because they have come before the formal
liberalization of the Chinese capital account.

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
China decided to accept FDI in 1978 and broke with the
socialist orthodoxy in establishing SEZs in 1979 and 1980.

Through the 1980s policy and institutional changes were
cautious, incremental and geographically localized.

Incoming FDI grew steadily and brought important changes
in the regional economies of Guangdong and Fujian.
Nationwide the impact was limited until early 1990s.

Investors from Hong Kong and Taiwan became quantitatively
most important. Other developed country investors followed.
Fundamental transformation of the Chinese economy.
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Deng Xiaoping ‘s Southern
Tour (南巡) in the spring of
1992
 For more than one decade
China gradually built
credibility with foreign
investors, gaining experience
and building institutional
infrastructure
 Muting the impact of
Tiananmen through FDI
friendly policies.
 New sectors were opened
(real estate). Manufacturers
could sell their output on the
Chinese market.

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
FDI share of Chinese GDP
 During 1980s didn’t exceed
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1% of GDP
In 1991 exceed 1%
In 1994 briefly exceeded 6%
then it settled back to 5%
Averaging 4% between 1996
and 2002
Slipped below 3% in 2005
China relatively open to
incoming FDI, contrast
with development
forerunners (Japan, Taiwan,
Korea)
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
China’s reliance on FDI similar to developing Southeast Asian
economies of Malaysia, Thailand, Philippines, Indonesia (inflows
around 4-6% of GDP)
 China fits into the “Southeast Asian” pattern in which economies are
quite open to FDI
 Particularly in export-oriented manufacturing with different degrees
of protection in trade policy
 Similar levels of development and policy orientation have led many to
perceive China and SEA countries are being in competition for a
limited total amount of FDI since 1998

Some regions in China more opened to FDI
 Inflows into Guangdong and Fujian from 1993-2003 the average
annual incoming FDI/GDP ratio was 13% for Guangdong and 11% for
Fujian
 Other regions: inflows to Shanghai 9% to Jiangsu and Beijing 7% of
the GDP.
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
FDI impact is multifaceted
 FDI contributes to overall investment and structural change
 Total amount of FDI is large: in 2004 the cumulative inflows of actually
realized investment surpassed US$500 billion
 China’s domestic saving rate is high so less dependent on FDI for
saving than many other developing countries. In China Gross
Domestic Capital Formation surpasses 40% of the GDP. Incoming FDI
in 1999-2001 accounted for 11% of total capital formation. Less than
the average for UN developing countries (15%).
 China’s GDP growth has been more rapid than the growth of FDI
inflows, share of FDI in GDP is drifting downward

FDI brings
 Management experience, marketing channels and technology
 FDI predominant source of technology transfer
 Central role played by FIEs in China’s export expansion (2/3 of
increment)
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The establishment of the SEZs
(經濟特區) in 1979 as visible
signal of commitment to
economic opening
Today much foreign investment
is still located in zones of various
kinds, and the rules are different
inside the zones.
Permitted incremental progress
within a rigid system.
Commitment to external
liberalization, enhanced the
credibility of the reform process.
Shenzhen SEZ as the symbol of
Chinese liberalization. Other
SEZs in Zhuhai, Shantou,
Xiamen
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
The initial SEZs were similar to EPZs (that spread in Asia since 1970s)
 Regions where foreign investment was encouraged by lower tax rates
 Fewer and simplified administrative and customs procedures
 Duty free components and supplies

The SEZs were part of the early development of the export processing
regime. Test beds for domestic economic reforms.

Wholly owned foreign subsidiaries were permitted in the SEZs long
before they were allowed elsewhere.

Important contribution, exemplified pattern of Chinese policy making
during the first era of reform (dual track, incremental reforms)

The start was slow, disappointing and infrastructure construction was
expensive.
 SEZs were attacked for facilitating smuggling and corruption
 FDI quickly began to leak out into surrounding countryside
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The EP agreements being signed with small firms throughout the
Pearl River Delta sometimes involved foreign businesses providing
equipment and technology being repaid with finished product (a
type of FDI)
 Second wave of liberalization began in 1984

 Visit to Shenzhen SEZ by Deng Xiaoping, he proclaimed Shenzhen as a
successful experiment
 14 new “Open Cities” –including Shanghai- were designated along the
coast, they set up Economic and Technological Development Zones
(ETDZs)
 ETDZs to bargain aggressively with potential foreign investors to facilitate
investment inflow
 Shanghai quickly improved the application of 3M corporation to set up a
wholly owned subsidiary (there was no provision in law for foreign
ownership)
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Dramatic proliferation of “zones” began
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Hainan island in entirety was designated as SEZ
Existing SEZs at Zhuhai, Shantou and Xiamen expanded rapidly
Pearl River Delta in Guangdong, Yangtze river delta around Shanghai
Total population 160 million
Third wave of opening of the Chinese economy at beginning of 1990s
 Creation of Pudong (East Shanghai) Special Zone
 18 new ETDZs were approved in 1992-1993, new type of zone, high
technology development zone
 Urban real estate was opened up to foreign investment

By 2003 over 100 recognized investment zones
 Six SEZs
 54 national level ETDZs
 53 nationally recognized high tech industrial zones
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Launching of the Western Development Program (for interior provinces)
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China provides generally favorable regime for investors today
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Taxes are moderate
Investment protection agreements are in place with most countries
Apparatus for arbitration is available
Most legal provisions are adequate in principle
The currency is convertible in the current account, few problems with
repatriation of the profit
The most striking features of the Chinese investment regime:
 Relatively decentralized nature, high degree of discretion retained by
government officials. Every investment contract has to be approved by
some governmental level.
 Hundreds of local investment boards. Provinces and zones usually have
authority to approve projects valued up to US$30 million.
 County governments are able to approve smaller projects (below US$10
million).
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The decentralized regime often favors the foreign investor.
 Foreign investors can play localities off against each other in search of favorable
package.
 Localities have incentives to attract foreign investors through lower taxes.
 Eager municipalities may provide concessionary terms on land rental and utility
rates.
 Local governments collude with investors to classify large projects as multiple
small projects in order to evade government monitoring.

Foreign investors have strong incentives to survey options in different
localities and exploit the particularities of the investment system.
 The statutory enterprise income tax rate in China is 33% (30% national plus 3%
local)
 Productive enterprises in SEZs and ETDZs are taxed at 15%, coastal cities and
provincially established zones set the rate at 24%
 Enterprises that export more than 70% of their output, designated as “high
technology” (they can enjoy further reductions, below 10%)
 Within zones a tax holiday is granted for the first two years, and tax rates are half
the long term rate for years three to five
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While multiple provisions may benefit the foreign investor, they also
create difficulties.
 Not always clear who has the ultimate power to approve a given set of tax rates or
land use agreements.
 Regions compete therefore foreign investors may have to navigate surprisingly
uncooperative and complex relationships between different regional or sectoral
authorities.
 The quality of local government offices varies enormously (from professionalism
to high levels of corruption, lack of training and transparency)

Problems with the enforcement of the IPR (Intellectual Property Rights).
Local governments in many cases have no incentive to enforce national
regulations, and may have incentives to violate them.
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Navigating the complex institutional environment can be costly for
foreign investors.
The contractual forms have evolved toward modes that permit the
foreign investor a higher level of control.
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In the early 1980s FDI was dominated by contractual joint ventures (JVs)
and joint development projects.
 Contractual JV (契約式合資企業) flexible agreement of association that don’t nec
essarily create an enduring legal entity.
 Useful in situations in which investment is combined with some kind of service
agreement (such as hotels)
 Profit can be divided among contracting parties in any form that is mutually
acceptable.

Joint development projects, form of contractual joint venture tailored to
oil exploitation.
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After the mid-1980s China began to encourage the use of equity joint
ventures (EJVs), which became the dominant mode of investment.
 Foreign partners were concerned with earning profit or establishing market share.
 Chinese managers were often concerned with maintaining employment, building
a larger firm, and accessing foreign technology.

Finally move toward operate independently, form of wholly foreign
owned subsidiaries (in 2004 2/3 of total realized FDI inflows).
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Four large stable source groups
By far largest ones: Hong Kong,
Taiwan, Macau
Hong Kong accounted for 42% of
cumulative total in 1985-2005
Since 1998 investment from
various tax havens (避稅港)
increased
In 2005 US$12.3 billion in incoming
FDI from British Virgin Islands,
Bermuda, Cayman Islands
In 2004-2005 US$35 billion
annually
1985 to 2005 period 60% of total
FDI (from Hong Kong, Taiwan,
Macau and all tax havens)
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
The developed country triad: US & Canada, Japan, EU accounted
for 25% of cumulative FDI in China in 1985-2005
 Unusual feature, worldwide developed countries accounted for 92% of
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FDI in 1998-2002
The relative weight of each leg of the developed economy triad regions is
comparable around 8% investment each (1985-2005)
The US was the third important investor, but since 2002 on downtrend
Japan’s investment is only 1/8 of Hong Kong, Taiwan and Korea’s together.
Japanese investment grew to US$6.5 billion in 2005
EU in recent years larger investor than US, US$5 billion in 2005
Korea and Singapore most important among Asian investors
 Korean investment started late, but grew rapidly, in 2004 it was third
largest investor. Both Korea and Japan investing heavily in northern
provinces (Shandong, Liaoning and Jilin).
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
Hong Kong is largest investor with special role
 July 1, 1997 the former British colony of Hong Kong became Special Administrative
Region (SAR) of China (香港特別行政區)
 HK has dramatically different economic and administrative system from China
 Much higher level of economic development that the rest of the Mainland, SAR
government has decision making authority, independent member of international
organizations (WTO)

Hong Kong center of manufacturing, finance and trade. Growing out to
Mainland territories. Better information on policy changes than other
investors.
 After three waves of liberalization (1979, 1987, 1992) HK share of FDI reached 68%
 January 1, 2004 Closer Economic Partnership between PRC and HK SAR (HK
subsidiaries of MNCs will enjoy earlier access to some of sectors being opened up
in China as part of WTO accession)
 Many subsidiaries of corporations in HK (1000 foreign company regional
headquarters, 256 from US, 198 from Japan, 106 from China)
 “Round tripping”- Parent companies in China channel investment from
subsidiaries back into China, headquarter of large firms owned by Beijing
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中國圈: Close economic
association between PRC, Hong
Kong and Taiwan
Basis of emergence is the
successful development of
Taiwan, HK labor-intensive
manufactured exports (light
industries)
Transferring of labor intensive
export production to Mainland
China (transaction costs were
low, common language,
customs)
HK and Taiwan specialized in
high value services and
technology-intensive production
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
Restructuring moved quickly for traditional labor-intensive
manufacturing (garments and footwear) completed by early 1990s.
 Taiwan firms moved their footwear production to China, in US imported shoes
from China displaced imported shoes from Taiwan.

Similar restructuring of electronics industry began in 1990s.
 In recent notebook industry (2002-2003)
 In PC and components industry, production of keyboards and power supply units
came first followed by production of monitors and motherboards, and expanding
range of IT hardware products

In result the Mainland coastal provinces have been industrialized rapidly
while Taiwan and HK deindustrialized.
 HK and Taiwan lost one million manufacturing jobs while Guangdong and Fujian
gained about five million

Both HK and Taiwan experienced success in upgrading to higher skilled
activities while experiencing steadily rising incomes and low
unemployment.
 HK services, finance, transportation, telecommunications
 Taiwan moved to technologically more sophisticated products
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Chinese Company
Parent Company
Parent Home
Export value
(US$ billion)
1. Tech Front
Shanghai
Quanta
Taiwan
5.2
2. Hongfujin
Precision Industry
Hon Hai
Taiwan
4.2
3. ASUStek
computer Suzhou
ASUStek
Taiwan
3.2
4. Motorola China
Motorola
US
2.8
5. Great Wall
International
Great Wall/IBM
China/US
2.6
6. Dongguan
Export Processing
Dongguan
China
2.6
7. Dell China
Dell
US
1.7
8. Mingji Diantong
BenQ
Taiwan
1.7
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
FDI has enormous impact
 Transferring manufacturing capability, jobs and export markets
 EA economies with leading of the China Circle created competitive,
flexible and low cost manufacturing networks

Challenge for China
 To expand the benefits receiving from openness to foreign investment
 More sectors should be opened to foreign participation

Manufacturing (製造業) is much larger part of FDI than for the rest
of the world
 Accounted for 70% of inflows in both 2003-2004 for China, for services
only 27% in 2003
 Only for 38% of the stock for other developing countries in 2002, while for
services 55%
 Accounted for 62% of registered foreign capital

Chinese restrictions on foreign entry into most important service
sectors (服務業).
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Access to WTO means commitments to dramatically lower the
barriers, most dramatic in opening service sectors
 The share of investment of manufacturing has increased, Chinese
comparative advantage remained strong (while India is getting
strong in services)
 Three service sectors for large proportion of FDI (in 2001-2002 for
developing countries)

 Wholesale and retail trade (7.4%)
 Transport and telecommunications (8.0%)
 Finance (11.5%)

By contrast in China incoming FDI concentrated in real estate (房
地產)
 Especially Property development
 Accounted for 10% of total investment in 2003
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The sectors to open due to WTO
accession
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Wholesale and retail trade (2.1%)
Transport and telecom (1.6%)
Finance (0.4%)
Only 4% of total inflows in China
(for world developing country
inflows 27%) (P:420)
Wholesale trading rights granted
(2003-2005)
Transport and telecom opened
to foreign ownership (2005-2008)
Financial sectors open to foreign
participation with bank market
opening in 2007
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In the early 1980s borrowing from governments and international
organizations were form of capital inflow to China (role of banks)
 From 1993 FDI’s growing role

 One reason is China’s financial markets were closed to portfolio
investment
 Policy makers preferred because it has brought technology, commercial
expertise and capital
 China maintained strict controls on foreign borrowing in 1990s

China’s total foreign debt was US$194 billion (14% of GDP) while
it had US$403 billion foreign-exchange reserves (2003)
 US$77 billion short term, US$52 billion borrowed from governments or IOs.

China maintained restrictions on capital account convertibility.
 Exporter/importer can freely convert RMB, individuals/businesses can’t do
in large amount.
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
Despite nominal lack of convertibility on capital account, liquid
capital flows to and from China are quite large.
 Reflects that individuals and businesses in the absence of capital account
convertibility utilize many different channels to move money into and out
from China
 Standard way to look at balance of payments is to break it down into the
current account (payments for goods and services) and the capital
account (transfers or assets).
 When there is a surplus in the private transactions in the balance of
payments it must be equal to the accumulation by the Central Bank of
official foreign exchange reserves.
For China balance of trade positive above 2% of GDP since 1996, it
jumped in 2005.
 FDI inflows stable, 3-4% of GDP since 1996
 “All other component” huge and volatile

 From 1997-2000 net outflows of liquid capital over 6% of GDP
 Flows then turned around in 2003 surpassed 5% of GDP inflow
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Volatility of capital flows during Asian financial crisis of 1997-98
highlights China’s reliance on FDI

China was exposed to volatile flows of financial capital like other
EA economies, it enjoyed a more reliable inflow of FDI

The investors made a long term commitment, their assets were
not the type that could be quickly liquidated.

Less vulnerable to financial crisis because of “patient capital”

Challenge for China to move for greater openness (service sector),
at same time China will be production base with expanding
capabilities for global manufacturing networks.
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Thank You for listening!
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