Professional Documents
Culture Documents
175
1. Introduction
The growth of Foreign Direct Investment (FDI) in China has been dramatic since
the beginning of the economic reforms in 1978. China is now the second largest recipient of foreign capital in the world (behind the United States). The expansion of
FDI in China has been accompanied by a rapid economic growth and an increasing
openness to the rest of the world.
It is important to ask why China has become one of the largest beneficiaries of
FDI in the world, what are the most important determinants of FDI to China, and
what are the effects of FDI on the Chinese economy?
We attempt in this paper to answer to these questions with an analysis of the
determinants and the effects of FDI in China, and through the implementation of
an empirical study based on the existing literature. Section 2 provides an overview of the development of FDI in China since 1979. Section 3 investigates the
determinants of the dramatic increase in FDI inflows into China. Section 4 studies
the effects of FDI on the Chinese economy and more particularly on economic
growth. Section 5 provides some concluding remarks.
176
`
STEPHANE
DEES
177
178
`
STEPHANE
DEES
1997). This leads to overvalued FDI inflows into China (one estimate suggests
that up to 20% of recent inflows were domestic capital that was round-tripped).
With 8.72% of the total accumulated inflows, Taiwan is the second most important
source of foreign capital in China. The Taiwanese began to invest massively in
China from the 1990s onwards. Before 1990, the government of Taiwan forbade
all direct investment in mainland China and Taiwanese enterprises had to invest via
Hong Kong or Macao if they wished indirect access to China (Shi, 1996). Japanese
direct investment in China has grown sharply since 1993. In 1995, Japan became
the second most important investor in China in terms of investment inflows (see
Table II).
The United States are an important investor with 8% of the FDI stock in 1994
(the third largest source). Even if Western European countries are the main source
in international direct investment in the world, their share in China is relatively
small; only the UKs share in FDI stock is above 1%.
The open-door-policy encouraged the dramatic development of FDI in China.
The growth of FDI was a key-element of the Chinese success, not only because
it had positive impacts on the economy, but also because it implied a change
in the way of thinking in the political sphere. China cannot continue to develop
without increasing openness to the rest of the world. FDI is probably the best way
to encourage the pursuit of the open door-policy and to sustain the economic
performance observed since 1978 in the future. However, the large scale expansion
of FDI that China has experienced in recent years seems to be limited in its duration. The high FDI inflows in China in 199395 were exceptional and have fallen
back to a more sustainable level in the long run (World Bank, 1997). Many reasons
explain this necessary reduction on FDI inflows. They include the elimination of
tax concessions for foreign investors in 1996 and the slowdown in the upsurge in
transfers of labour-intensive assembly operations from East Asian neighbours.
OVERVIEW
According to Zang (1995), the sharp rise of FDI since 1987 has been due to the
improving of the environment and to the impressive growth of the Chinese economy. However, prior to then, investors were reluctant to invest in China because
of the features peculiar to a Centrally Planned Economy that implied too high risks
as compared to profits. Huang and Shirai (1994) show that the pattern usually
observed for FDI in developing countries is appropriate for China. After a sluggish inflow and a period of fluctuation, FDI has grown rapidly. Once the degree of
uncertainty has declined, investors have been more attracted by the location of their
production in China, even if a lack of regional or industry-specific information is
an important remaining uncertainty. The role of the authorities is highly important
179
Year 198489
US$
Share
Millions
(%)
Year 199094
US$
Share
Millions
(%)
NIEs
Hong Kong
Macao
Taiwan
Singapore
South Korea
70653
57646
1459
8269
2060
1219
74.50
60.78
1.54
8.72
2.17
1.29
8962
8724
79
0
159
0
61.73
60.10
0.54
0.00
1.09
0.00
61692
48922
1381
8269
1901
1219
76.80
60.90
1.72
10.29
2.37
1.52
USA
7567
7.98
1723
11.90
5844
7.28
Japan
7049
7.43
1894
13.00
5156
6.42
West Europe
UK
Germany
France
Italy
Netherlands
Switzerland
Norway
Belgium
Denmark
Austria
Sweden
Finland
Spain
Others
3985
1268
792
549
503
287
173
69
98
67
46
54
31
36
12
4.20
1.34
0.84
0.58
0.53
0.30
0.18
0.07
0.10
0.07
0.05
0.06
0.03
0.04
0.01
963
272
158
139
144
41
17
52
28
38
24
13
28
7
2
6.63
1.87
1.09
0.96
0.99
0.28
0.12
0.36
0.19
0.26
0.16
0.09
0.19
0.05
0.02
3022
997
634
410
359
246
156
17
70
28
23
42
3
40
3
3.76
1.24
0.79
0.51
0.45
0.31
0.19
0.02
0.09
0.03
0.03
0.05
0.00
0.05
0.00
Other DCs
Australia
Canada
New Zealand
1033
520
475
38
1.09
0.55
0.50
0.04
199
147
45
7
1.37
1.01
0.31
0.05
833
373
430
31
1.04
0.46
0.54
0.04
ASIAN
Thailand
Philippines
Malaysia
Indonesia
1462
630
302
323
297
1.54
0.66
0.32
0.34
0.22
73
53
15
3
2
0.51
0.36
0.11
0.02
0.02
1389
578
286
320
205
1.73
0.72
0.36
0.40
0.25
180
`
STEPHANE
DEES
Table I. Continued.
Other Asia
303
0.32
0.04
298
0.37
East Europe
145
0.15
27
0.19
118
0.15
Latin America
267
0.28
11
0.08
255
0.32
Africa
168
0.18
0.02
165
0.20
Others
2209
2.33
658
4.53
1551
1.93
Total
94840
100.00
14519
100
80323
100.00
Table II. FDI inflows: the major source countries (Actually used. US$ billion)
83
84
85
86
87
88
89
90
91
92
93
94
95
HK Macao
Taiwan
USA
Japan
Korea
UK
France
Italy
0.47
0.83
0.19
0.01
0.04
0.01
0.75
0.26
0.23
0.10
0.02
0.02
0.96
0.36
0.31
0.07
0.03
0.02
1.33
0.33
0.26
0.04
0.04
0.03
1.81
0.27
0.27
0.01
0.02
0.02
2.43
0.24
0.60
0.05
0.03
0.04
2.34
0.29
0.41
0.03
0.01
0.03
2.12
0.46
0.52
0.02
0.02
0.01
2.66
0.47
0.33
0.61
0.04
0.01
0.04
7.91
1.05
0.52
0.75
0.67
0.04
0.05
0.03
18.03
3.14
2.07
1.36
0.38
0.22
0.14
0.10
20.33
3.39
2.49
2.09
0.73
0.69
0.19
0.21
20.62
3.16
3.08
3.21
1.05
0.92
0.29
0.27
Total
0.92 1.42 1.96 2.24 2.65 3.74 3.77 3.75 4.67 11.29 27.77 33.94 37.81
181
swings in economic policies and too many controls over FDI also discouraged US
investments.
It is worth noting that Chinese inward FDI is not a global phenomenon and that
there could be differences between the determinants of FDI in China accross source
countries. For instance, the motives of investors from developing countries (and
especially from East Asia) are quite specific. For Yue (1993), investments made
by the NIEs in China aim to capitalise on lower production costs, gain access to
natural resources, circumvent protectionist measures of developed countries, and
exploit firm-specific advantages such as lower managerial costs, better marketing
channels, more appropriate technology and better understanding of host countries
than investors from developed countries. Yue underlines also the role of geographical proximity, ethnic and cultural affinity in information flows between the NIEs
and China. Shi (1996) show that, initially, foreign investors (especially those from
Hong Kong and Taiwan) were attracted by cheap labour. FDI was used to produce
labour intensive goods in order to re-export them toward their traditional markets.
However, since the early 1990s, foreign investors have attached more importance
to the quality of workers in order to produce higher technological products. In
this case, labour quality could be another determinant of FDI. To sum up, the
motivations of the East Asian NIEs refer more to the factor cost advantage and
the growing demand of the Chinese market.
Some empirical evidence is available from econometric work. Using a panel
data set? Wei (1995) runs regressions for the flow and the stock of FDI. He finds
a positive and significant effect of the Chinese GNP: a 1 percent increase in the
size of a host country is associated with a 0.53 (0.74) percentage point increase
in the flow (stock) of FDI. He finds also a positive correlation between the inflow
of FDI and the stock of human capital in the host country (proxied by literacy).
Finally, the effect of distance between the investing country and China is negative
confirming the hypothesis that FDI is highly regionalised. Wei only studies the
Chinese inward-FDI coming from developed countries. Therefore, his work does
not take into account the growing share of the East Asian countries like Taiwan or
Korea and also Hong Kong, the largest investor in China.
In their study, Liu et al. (1997) analyse, through an error-component model, the
economic, political and cultural determinants of FDI in China. The panel data set
covers a time period of 19831994 and 22 countries/regions as well as mainland
China as the host. Hong Kong and the East Asia NIEs are taken into account as
investor countries. The results show that bilateral trade, cultural differences and
relative changes in market size, wage rates, and exchange rates are important explanatory variables for FDI in China. Country risk is not a significant determinant,
whilst geographic distance is significant but wrongly signed.
The previous econometric studies on the determinants of Chinese inward FDI
suggest that the use of panel data is appropriate to analyse such a topic. This
? The basic data set is outward FDI from the five largest countries (Japan, UK, USA, France and
182
`
STEPHANE
DEES
econometric technique is highly useful in this case because it takes into account
the diversity and the specificity of different investors.
3.2.
EMPIRICAL EVIDENCE
183
184
`
STEPHANE
DEES
185
0.366 (11.46)
0.656 (5.13)
0.260 (1.97)
0.539 (2.28)
0.174 (5.74)
0.314 (3.62)
0.265 (2.12)
0.864738
0.846343
1.882750
0.373574
1.792
0.710
1.473
The change in patent registration by the foreign firms has a positive effect suggesting that innovation in the home country is a determinant to invest abroad. This
corresponds to the effect expected and generally found in such works. The trade
relationships between the home countries and China have a positive influence on
FDI inflows. The decision to invest in China is linked with the share of the home
country export in the Chinese activity. Finally, the Tiananmen Square incident has
been a negative and significant impact on FDI in China. This event confirms the
importance of the political situation in the decision of the host country. In the case
of China, this event interrupted the growth of FDI only in the short-term, not calling
into question the long-term increasing trend.
4. Effects of Foreign Direct Investment on the Chinese Economy
4.1.
OVERVIEW
FDI has played an active role in the Chinese economic development. In terms of
contribution of FDI to GDP growth, the proportion of FFE output in total industrial
output rose from 2% in 1978 to almost 17% in 1995 (Table IV). There are several
186
`
STEPHANE
DEES
Total industrial
output
(bn yuan)
FFE output
(bn yuan)
1987
1988
1989
1990
1991
1992
1993
1994
1995
1,381.30
1,822.40
2,201.70
2,392.40
2,824.80
3,706.60
5,269.20
7,690.95
9,189.50
27.62
49.20
74.86
105.27
161.01
263.69
535.21
1,042.13
1,523.1
2.0
2.7
3.4
4.4
5.7
7.1
10.1
13.5
16.6
positive impacts of FDI on the Chinese economy. First, since the early 1990s,
FDI has implied the import of advanced technology and equipment, narrowing
the technology gap between China and the rest of the world. Furthermore, via
technology transfer, FDI has improved the Chinese factor productivity (Liang and
Zhu, 1996, shows econometrically that about 32% of economic growth was contributed by total factor productivity from 1978 to 1994). The import of technology
is indispensable to improve the Chinese industrial efficiency and to put China on
equal footing with its Asian neighbours. Introducing modern technology to China
is also a good way for FFEs to penetrate the Chinese internal market (Chen and
Wong, 1995). Second, FDI has introduced new management serving as reference
for domestic enterprises. Third, the impact in state revenue and employment has
been substantial (FFEs employ more than 6 million people and taxes on foreign
businesses in 1992 were 10.7 billion yuan). Finally, the role of FDI in the balance
of payments has been quite important, increasing export of manufactured products
(Zang, 1995). The expansion of international trade and FDI have both played a
crucial role in the Chinese reforms. It has led to a rationalisation of the internal
price structure and prompted some fundamental changes in laws concerning the
ownership of enterprises (Hussain, 1996).
FDI also has an effect on growth through the contribution to capital. Table
V presents the share of FDI in total investment in China. This share has continually grown since 1983. In 1994, FDI accounts for more than one sixth of
total investment. This underlines the increasing role of foreign investors in capital
accumulation.
187
Total
investment
FDI
Value Share
in percent
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
143.0
183.3
254.3
302.0
364.1
449.7
413.8
444.9
550.9
785.5
1245.7
1704.3
2001.9
1.8
3.3
5.7
7.7
9.8
13.9
14.2
17.9
24.8
62.3
160
292.6
315.7
1.2
1.8
2.2
2.5
2.7
3.1
3.4
4.0
4.5
7.9
12.8
17.9
15.8
Wei (1995) estimated the effects of FDI on the Chinese economy. His evidence
is based on a statistical analysis of a city-level data set covering the period 1988
90. He finds statistical evidence that FDI is positively associated with cross-city
differences in growth rates, after taking into account the growth of labour, physical
and human capital.
In his comment on Weis work, Woo (1995) thinks that the empirical procedures
used may greatly overstate the FDI contribution to growth ... one major reason why
FDI has an output effect beyond its expansion of the capital stock is that in general
FDI occurred in the cities that have liberalized and hence have raised their growth
potential the most. In short, FDI is correlated with total factor productivity (TFP)
growth because FDI is a good proxy for the degree of economic liberalization and
the greater the liberalization, the higher TFP growth.
4.2.
EMPIRICAL EVIDENCE
188
`
STEPHANE
DEES
explained by an object gap (lack of valuable objects, like factories, roads and raw
materials), but rather by an idea gap (no access to the ideas that are being used in
industrial nations to generate economic value). For a developing country, idea gaps
are easier to solve than object gaps. Hence, the diffusion of ideas by multinational
firms allows a rapid convergence of developing countries toward the developed
countries standards. In the Chinese case, the notion of a purely domestic response
to policy reform misses the enormous flows of direct foreign investment that China
has received since the latter half of the 1980s (Romer, 1993). In other words,
through the introduction of new ideas, FDI may raise technical progress and hence
longevity in economic growth. Previous studies on FDI effects on growth suggest
that inflow of new technology and working practices from multinational firms
create a significant potential for spillovers to domestic firms in the host country
(Blomstrm and Kokko, 1996).
To assess the role of FDI in the Chinese economic growth, we define a constant
elasticity of substitution (CES) production function as follows:?
Q = [s(K) + (1 s)(Let ) ]1/p
(2)
where Q, K and L denote output, capital stock and labour, t technical progress,
a scale parameter and s the contribution of capital to growth. The elasticity of
substitution ( ) is given by 1/1+. Technical progress is assumed to be labour
augmenting. To estimate and , we use the labour demand equation that can be
derived from the first-order condition that marginal product of labour must equal
the mark-up adjusted real wage:
Q/L = (1 s)Q(1+) (Le t )(1+) et = (w/p)
(3)
189
This framework will help us to investigate the role of FDI in technical change
through the effects of technological spillovers on growth. By technological spillovers, we mean, like Grossman and Helpman (1991), that (1) firms can acquire
information created by others without paying for that information in a market transaction, and (2) the creators (or current owners) of the information have no recourse,
under prevailing laws, if other firms utilize information so acquired. An abundant
literature attempts to endogenise the role of innovation in the growth process by
linking the productivity level of a country with the cumulative R&D expenses and
with the effective stock of knowledge. As pointed out by Coe and Helpman (1995),
in a world with international trade and FDI, a countrys productivity depends not
only on its own stock of knowledge but also on the stock of knowledge of its trade
partners and foreign investors. In a country like China where expenditure on R&D
is quite small compared to developed countries (0.5% of GDP in 1994? Chinese
Statistical Yearbook, 1995), the level of productivity is likely to be related to the
other economies innovations. Through trade and FDI, China can develop its own
productivity level via technological transfer.
Our empirical work will be built on the theoretical models of innovation-driven
growth in the line developed for instance by Grossman and Helpman (1991). We
assume that technical progress is a function of the stock of FDI, together with an
exogenous element proxied by a linear time trend. We add also an indicator of
openness, justifying its presence by the link existing between openness and capital
import. For Romer (1993), idea gaps can equally be solved by import of capital
(and more particularly by machinery import). Openness is proxied by the share of
import in GDP.
Hence, the TFP term (t) can be written as (5):
t = TIME T I ME + FDI ln(F DI )t 1 + M ln(M/GDP )t 1
(5)
This specification, as suggested by Barrell and Pain (1997) or Coe and Helpman
(1995), implies that technical progress will grow at a constant rate if direct investment and imports over GDP grow at a constant rate. We have assumed that the
effects of FDI and imports have impacts on technological change with a quarter
lag.
With Equation (5) we can re-write (4) as (6) which becomes the central equation
of our theoretical framework
ln(L/Q) = ln(w/p) + ( 1)(TIME T I ME + FDI ln(F DI )t 1
+M ln(M/GDP )t 1 )
(6)
where = ln{(1 s)/} + ( 1) ln( ).
? Major economies R&D expenditures (Figures as a percentage of GDP, 1995): Japan: 2.8; US:
2.4; France: 2.3; Germany: 2.3; UK: 2.1 (Statistical Abstract of the US for US and Japan; Eurostat
for European economies).
190
`
STEPHANE
DEES
( )/ = / 1 = 1
191
0.45 (2.89)
0.53 (3.96)
0.16 (1.90)
0.026 (3.68)
0.016 (2.36)a
0.206 (2.75)
0.60 (3.78)
0.09 (6.17)
R2 = 0.51637
se = 0.020216
RSS = 0.015122
Serial correlation: F(1,31) = 1.3186
Functional form: F(1,34) = 2.8715
Normality: 2 (2)= 0.50191
Heteroscedasticity: F(1,41) = 0.27586
Note: a The stock of EDT is significant only for the period
1990Q11994Q4. The coefficient of ln(FDI)1 has been
estimated by multiplying the data of FDI stock by a
dummy variable equal to 0 for 1984Q1 to 1989Q4 and
equal to 1 afterwards. b Equal to one for the four quarters
of 1994; equal to zero otherwise.
size, the low cost of its labour force, its real exchange rate, its openness to the rest
of the world and the source country degree of innovation. The Tienanmen square
incident seems to have had a negative impact on the inward FDI in China.
Concerning the consequences of FDI on the Chinese economy, a CES production function has been used to assess its effects on growth. Through the estimation
of a labour demand equation we have investigated the role of FDI in technology
transfers and its effect on technical change. We have endogenised technical change
by assuming that technical progress is a function of the inflows of FDI, together
with an exogenous element proxied by a linear time trend. We have also added an
indicator of openness, justifying its presence by the link existing between openness
and capital import. Our conclusions support the view that FDI affects Chinese
growth through the diffusion of ideas. FDI has had a significant positive effect
on Chinese long-term growth through its influence on technical change (this influence is significant only in the 1990s). This conclusion is also confirmed by the
192
`
STEPHANE
DEES
Acknowledgement
The author is grateful to Ray Barrell, Eric Girardin, Nigel Pain, Shujie Yao and
an anonymous referee for discussions and helpful comments. They are in no way
responsible for any errors in this paper. The work is part of a project financed by a
European Commission grant (contract number ERBFMBICT950260).
USED IN SECTION
Stock of FDI:
GDP:
Relative wages:
Real Exchange Rate:
Patents:
Exports:
2-
Production (Q):
Labour (L):
FDI:
M/GDP:
193
References
Barrell, R. and Pain, N. (1997). Foreign direct investment, technological change and economic
growth within europe, Economic Journal, forthcoming.
Barrell, R., Pain, N. and Hubert, F. (1996). Regionalism, innovation and the location of german
direct investment, NIESR Discussion Paper No. 91.
Blomstrm, M. and Kokko, A. (1996). Multinational corporations and spillovers, CEPR Discussion
Paper No. 1365.
Chen, C. (1996). Recent developments in foreign direct investment in China, Chinese Economy
Research Unit, Working Paper No. 96/3, University of Adelaide (Australia).
Chen, E. and Wong, T. (1995). Economic Synergy : A study of two-way foreign direct investment
flow between Hong Kong and mainland China, in The new wave of Foreign Direct Investment in
Asia, compiled by Nomura Research Institute and Institute of Southeast Asian Studies.
Coe, D.T. and Helpman, E. (1995). International R&D Spillovers, European Economic Review,
Vol. 39, pp. 859887.
Engel, R.F. and Granger, C.W.J. (1987). Cointegration and error correction: Representation,
estimation and testing, Econometrica, 55, 251276.
Froot, K.A. and Stein, J.C. (1991). Exchange rates and foreign direct investment: An imperfect
capital markets approach, Quarterly Journal of Economics, Vol. 106, No. 4, pp. 11911217.
Grossman, G.M. and Helpman, E. (1991). Innovation and Growth in the Global Economy, MIT
Press, Cambridge, MA.
Grub, Ph.G., Lin, J.H. and Xia, M. (1990). Foreign investment in China: A study and analysis of the
factors influencing the attitudes and motivations of U.S. firms, in Neghandi, A.R. and Schran, P.
(eds), China and India: Foreign Investment and Economic Relations, Research in International
Business and International Relations, Vol. 4. pp. 8399, JAJ Press Inc.
Grub, Ph. G. and Lin, J.H. (1990). Foreign Direct Investment in China, New York, Quorum Books.
Harding, H. (1987). Chinas Second Revolution: Reform after Mao, Brookings, Washington D.C.
Huang, D. and Shirai, S. (1994). Information externalities affecting the dynamic pattern of foreign
direct investment: The case of China, IMF Working Paper 94/44.
Hussain, A. (1996). Growth, stability and transition to a market economy in China, mimeo,
STICERD, London School of Economics.
Hsiao, Ch. (1986). Analysis of Panel Data, Econometric Society Monographs, Cambridge University
Press.
Kamath, S.J. (1990). Foreign direct investment in a centrally planned developing economy: The
Chinese case, Economic Development and Cultural Change, Vol. 39, N01, pp. 107130.
194
`
STEPHANE
DEES
Li, K-W. (1994). Financial Repression and Economic Reform in China, Westport: Praeger Publishers.
Liang, Y. and Zhu, B. (1996). Forecast of Chinas economic development for the next ten years,
Mimeo, State Informal on Center, China.
Liu, X., Song, H. Wei, Y. and Romilly, P. (1996). Country characteristics and foreign direct
investment in China: A panel data analysis, Weltwirschaftliches Archiv, 133(2), pp. 313329.
Markusen, J.R. (1995). The boundaries of multinational enterprises and the theory of international
trade, Journal of Economic Perspectives, Vol. 9 (2), pp. 169189.
Romer, P. (1993). Idea gaps and object gaps in economic development, Journal of Monetary
Economics, 32, 543573.
Shi, Y. (1996). LInvestissement direct dans la transformation Chinoise, Economie Internationale,
No. 67, pp. 3144.
Wei, S-J. (1995). Foreign direct investment in China: Sources and consequences, in Ito, T. and
Krueger, A.O. (eds), Financial Deregulation and Integration in East Asia, NBER-East Asia
Seminar on Economics, Vol. 5 University of Chicago Press.
Woo, W.T. (1995). Comment on Weis paper (1995): Foreign direct investment in China: Sources
and consequences, in Ito, T. and Krueger, A.O. (eds), Financial Deregulation and integration in
East Asia, NBER-East Asia Seminar on Economics, Vol. 5 University of Chicago Press.
World Bank (1997). China 2020: Development Challenges in the New Century, Washington, D.C.
Yue, C.S. (1993). Foreign direct investment in ASEAN economies, Asian Development Review,
2(1), pp. 60102.
Zang, X. (1995). Foreign direct investment in Chinas economic development, in The New Wave
of Foreign Direct Investment in Asia, compiled by Nomura Research Institute and Institute of
Southeast Asian Studies.