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Foreign direct investment in China and how China benefits

This research is on the foreign direct investment (FDI) in China. It explains how China attracts FDI and benefits from them.

2. Objectives:

To investigate factors which made China attracted for foreign direct investment

To find out China has benefited from the large inflow of foreign direct investment or not

3. Research Question:

Why China is attracted for FDI, is it unique or can be replaced?

How do China benefit from foreign direct investment?

4. Introduction:

In 1978, reformists within the Communist Party of China (CPC) led by Deng Xiaoping had developed Socialism with Chinese characteristics and Chinese economic reform, and partially opened China to the global market. China became a market economy which capable of generating strong economic growth and increasing the well-being of Chinese citizens from planned economy. Deng Xiaoping’s reform and opening up policy is quite brilliant, this can be shown by the activities and development of China for the past 30 years (Chen, 2008).

China has managed  to  increase eightfold  its GDP per capita, with annual GDP growth averaging more than 9.5 percent  over  30  years,  and  GDP  per  capita  growth  of  8.1  percent. China witnessed significant changes in comprehensive national strength, people's living standards and international influence thanks to the reform and opening-up policy (XinHua, 2008).

Foreign direct investment (FDI) is defined as an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate). FDI implies that the investor exerts a significant degree of influence on the management of the enterprise resident in the other economy. Such investment involves both the initial transaction between the two entities and all subsequent transactions between them and among foreign affiliates, both incorporate and unincorporated. FDI may be undertaken by individuals as well as business entities (United Nations Conference, 2007). An important part of the economic reform process in China has been the promotion of FDI inflow. After more than 30 years of economic reform, China has become one of the most important destinations for cross-border direct investment.

5. Literature Review:

5.1 Foreign direct investment (FDI) Analaysis in China

The past few years has seen a great growth of foreign direct investment (FDI) that has exceeded both world output and world trade. China is definitely the largest recipient, and in 2004 exceeded the USA as host destination (Ali, 2005). It has consequently attracted an increasing attention from multinational businesses. Since China adopted the reform and opening-up policy in the late 1970s, foreign investment has played an increasingly important role in its economic growth.

As a result of the active government promotion through various policy measures, FDI in China has grown rapidly since the 1978, especially in the 1990s. From early 1980s to late 1990s, limited FDI inflow to China has increased from about US$ 1.5 billion a year to more than US$ 40 billion a year in 1999. During the same period, China is actual use of FDI grows from about US$ 0.5 billion to more than US$ 40 billion a year. China has been the world largest FDI recipient among developing countries since early 1990s. In recent years, FDI to China accounts for 1/4 to 1/3 of total FDI inflow to developing countries. Foreign investment has become an important source for Chinaís investment in fixed assets. Its share in total annual investment in fixed assets grew from 3.8% in 1981 to its peak level of 12% in 1996. After the Asian financial crisis in 1997, FDI inflow fell and its contribution to fixed assets investment has also decreased to about 9% and 7% in 1998 and 1999 (Fung, 2002). Foreign direct investment to China increased 7.7 percent year on year in the first quarter of 2010, up to US$23.44 billion, according to figures released by the Ministry of Commerce. China has moved to support foreign investment with the new regulations encouraging high-tech, service, energy-efficient and environmentally friendly projects (China Brifing, 2010).

Global rankings of the largest FDI recipients confirm the emergence of developing and transition economies: three developing and transition economies ranked among the six largest foreign investment recipients in the world in 2009, and China was the second most popular destination (as the chart below). China achieves the fastest growth rate of Gross National Product in the world and is likely to remain attractive for international investors in the next century.

Source: UNCTAD, based on annex table 1 and the FDI/TNC database, 2010 (http://www.unctad.org/fdistatistics)

5.2 China Attracts Foreign Direct Investment

Whether the MNCs are targeting local markets or using host country as an export base, the propensity of firms to produce in a specific location greatly depends on the characteristics that affect relative expected profits of the location over alternative locations. The location decision depends on the factors affecting the revenues and costs of the investment project (Estrin & Meyer, 2008).

Theory classifies FDI into two types: market-oriented and export-oriented FDI. Market oriented FDI means the most important factor to attract FDI is the size and growth of the host country. The export oriented FDI mostly looks for cost competitiveness. There are also some factors in common for both types of FDI. China is considered have all these characteristics (OECD, 2004).

5.2.1 Size and growth

Market oriented FDI targets to supply goods and services to local market, this kind of FDI may be tried to develop new market. Tariff barriers, the market size, prospects for market growth, and the degree of development countries are very important location factors for market-oriented FDI. The general implication is host countries with larger market size, faster economic growth and higher degree of economic development will provide more and better opportunities for these industries to exploit their ownership advantages and, therefore, will attract more market-oriented FDI. Even for export-oriented FDI, the market size of host countries is important because larger economies can provide larger economies of scale and spill-over effects (Mateev & Stoyanov, 2007).

China has a population of 1.3 billion, which is a large potential for consumption. Over the past 30 decades, China’s economic reconstruction has been expanding, with the purchasing power of the people are strong enough. Although the GDP of China is still very low, but the rapid economic growth and continuously increased purchasing power has made China attractive to FDI. Large market size and growth of China is a key point that influences FDI flows.

5.2.2 Cost and productivity of labour

The other factor to attract FDI in China is the advantage in competitive production factors which are labour force, land and natural resources. Domestic entrepreneurship, education level, and local infrastructure are the one of the most important determinations of FDI flows.

Foreign investor mostly aim to take advantage of lower cost labour but the production is intensive (Andresosso-O’callagham & Wei 2003). With the world’s largest population, China has plenty resources of labour. Moreover, their average salaries considered as low level. China has paid great attention on the education of its people such as nine-year universal compulsory education. Therefore, Chinese labourers are mostly educated and high level. Labour’s cost considered an important factor, though not the primary one.

China is also very rich in energy reserve. Chinese production of oil is the largest and also among the highest in the world (Saudi Arabia being the main producer) because that China imports it owing to high consumption. China is the largest producer of coal, roughly one third of the world's total production and its coal industry has been concerned by a serious oversupply problem. As with coal, China’s electric power supply is also experiencing an oversupply problem. Other major natural resources such as land, iron and other minerals are economically available.

5.2.3 Physical and technological infrastructure

Physical infrastructure has slightly affected the decision of FDI flows. For an example, the more highways, railways and waterways results the more FDI inflows. Another important variable is level of technological infrastructure. In recent years, China has been pushed by the market competition; the upgrading speed of China’s industrial structure has been accelerated. Especially, the development of high-tech has been greatly speeded up. The current level of the technology of China is attracting FDI.

5.2.4 World Trade Organisation (WTO)

In December 2001, China finally became a formal member of the World Trade Organization (WTO) after roughly 15 years of negotiation (BBC, 2001). With the accession China promised to take the WTO’s basic principles of non-discrimination, pro-trade, pro-competition and so on. In return, China will have the privileges enjoyed by WTO members. For example, China will also be able to enjoy the privileges provided to WTO members. These will have significant implications for future FDI inflow in China.

WTO agreement provides incentives for more export-oriented FDI. First of all, the world export market for China, as a WTO member, will be larger and more predictable. Quota and restrictive measures against China’s export will be either eliminated or reduced. In addition, China will be able to resolve trade disputes with other member states under WTO’s trade dispute settlement mechanism. As a result, FDI in industries where China has comparative advantage will grow.

More importantly, WTO membership will serve to encourage China to implement further economic reform as well as various legal and institutional restructuring to fulfill its WTO obligations. As a result, there will be important improvement in China is business environment for foreign as well as domestic companies.

In the industrial sector, the lowering of tariffs will encourage more U.S. exports and may reduce the incentive for some foreign firms to locate in China to avoid paying the high tariffs. However, Chinese accession to the WTO will also boost investor’s confidence in the Chinese economy and the Chinese market and thus will induce more direct investment in China (Fung, 2002).

6 Conclusion

China has made great step in its reforms to open up its market for foreign direct investment. Among developing countries, China is now the largest recipient of foreign capital. No doubt, huge market size is the most significant factor for FDI inflow in China. China’s large population, rapid growth rate and with the membership of World Trade Organization are their advantages.

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