Pioneering Economic Reform in China's Special Economic Zones

The Promotion of Foreign Investment and Technology Transfer in Shenzhen

Weiping Wu

• Publisher: Routledge
• Year: 2018
• Print ISBN: 9781138330108
• eBook ISBN: 9780429826511
• Edition: 1
• Topic: Economics
• Subtopic: Economic Conditions
• Index: Economics

First published in 1999, this volume assessed the economic situation of Shenzhen in Guangdong Province, China, including its trade connections with Hong Kong and foreign investments in the area. Designated as one of four Special Economic Zones (SEZ) as part of China's domestic economic reform in 1979, Weiping Wu examines Shenzhen's economic situation in the context of Hong Kong's transition just two years prior to publication in 1997. Wu explores the developments in Shenzhen in local policy, labor costs, export performance, domestic linkages and complementarity with Hong Kong as a result of Hong Kong's closer connection with the Shenzhen trade area. Shenzhen's suitability can then be assessed in its role as an SEZ to experiment with and digest western technology and management techniques for inland China and as a buffer between China and the wider world.

1 Conceptual and Policy Context

The creation of the SEZ policy and the subsequent establishment of four zones in Guangdong and Fujian Provinces were a direct response to the changes in China's economic policies around 1979. After breaking up with the former Soviet Union in the late 1950s and being closed economically and politically for over two decades, China for the first time opened its door to the outside world. This drastic reorientation, coinciding with local enthusiasm from Guangdong Province, paved the way for the development of the SEZ policy aimed at using special zones to promote foreign investment, technology transfer, and exports. China's SEZ policy borrowed heavily from the experience of Export Processing Zones (EPZs) in Asia, but embraced a wider array of economic activities such as services, agriculture, real estate and tourism. In order to attract foreign investment, China needed to create a legal framework compatible to international norms and to reduce official red tape often associated with a planned economy. This chapter gives an account of the conceptual and policy context for the SEZs and reviews the pertinent research in order to devise a framework for evaluating SEZs' performance in promoting foreign investment and technology transfer. It also outlines the political changes leading to the creation of the SEZs, the legal and administrative framework established to promote foreign investment, and a chronology of investment guidelines developed for the SEZs.

Assessing Shenzhen's Performance

There is a fairly rich body of literature in English on China's SEZs. Scholars have examined the various aspects of SEZs' economic performance: infrastructure building, industrial development, promotion of foreign investment and technology transfer, foreign trade, and financing systems (see Chai, 1986; Chen, 1988; Chu. 1987; Kleinberg, 1990; Oborne, 1986; Sit, 1988; Wong, 1985). In general, their evaluations of the actual economic accomplishments of the SEZs reveal a rather unsatisfactory performance in the early period, but a much improved one towards the late 1980s. Among these studies, two volumes are particularly comprehensive in scope, although different in approach. Kleinberg (1990) offers an analysis of the performance of the zones, in particular that of Shenzhen. He argues that by market standards, Shenzhen has been a success. Created out of a backward rural community within a decade, it is now China's most modern city and has become a model of efficiency. However, this local success story, when measured by its intended contribution to national development, is a failure. It has failed to introduce high technology and has drained capital investment as well as hard currency from the rest of China. Kleinberg puts forward three major underlying causes of this failure: the inadequacy of the investment environment, the inefficient management structure of Chinese enterprises, and the unwillingness of foreign investors to transfer high technology.

Crane (1990) tries to link the experience of China's SEZs to a more general discussion of political economy. He asserts that political instability and erratic performance are not simply questions of individual administrative failings or poor economic planning. The causes are deeply embedded in the nature of the Chinese state and society. Two aspects of China's "politicized bureaucracy"—the SEZ bureaucracy and the State bureaucracy—are the sources of "bad" policies and poor economic performance. But Crane does not adequately account for the international forces affecting China's zone policy. For instance, the general trend of a declining share of developing countries in the worldwide stock of international investment may very well undermine SEZs' goal of attracting foreign investment and promoting technology transfer.

Many authors agree that the SEZs have been fairly successful in attracting a large quantity of foreign investment (Chen, 1993; Falkenheim, 1986; Hsueh and Woo, 1988). There are some reservations, however, about such an optimistic conclusion (Crane, 1990; Kleinberg, 1990; Phillips and Yeh, 1989; Sklair, 1985). First, the zones have attracted most of foreign investment from Hong Kong. Second, the nature of the activities attracted has been criticized. For example, it was envisaged that the SEZs would develop thriving, innovative enterprises and attract high-tech projects from which the rest of China could learn and develop skills. But many of the initial projects involved tourism, recreation, retail, and luxury housing development. Even as the situation gradually changed in the second half of the 1980s, most industrial joint ventures were still of a low-tech nature. Third, several authors have pointed out the large discrepancy between the magnitude of foreign investment contracts and the actual amount of foreign investment in the zones.

The majority or the authors attribute such a mixed performance in attracting foreign investment to economic factors. They point out that the SEZs and China in general have two special advantages in attracting overseas investment: the size of the potential Chinese market and the continuity of the clan system that connects overseas Chinese. These two factors help to explain why, in some cases, foreign investors have overcome their reluctance to commit capital to invest in the SEZs (see Sklair, 1985). Several authors single out the Hong Kong connection, specifically, to explain SEZs' performance. The relocation of Hong Kong's labor-intensive industries across the border has been a major factor for the zones' rapid development. This connection is further strengthened by long-established trading links, geographical proximity and cultural similarity (Chan and Kwok, 1991; Smart and Smart, 1991; Sklair, 1985). Access to China's cheap labor, land, and raw materials is another draw, since the SEZs have enjoyed a privileged status in recruiting labor and sourcing materials.

The discussion of such factors in relation to China's SEZs draws upon the "neoclassical" theory of foreign investment. The variety of possible factors determining foreign investment inflows to developing countries includes both macro and micro ones, and their effects differ from country to country. The major macroeconomic determinants are believed to be natural resource endowments, level of economic development as indicated by per capita gross national product (GNP), rate of economic growth, domestic market potential (aggregate GNP and purchasing power), and labor costs and skills (see Dunning, 1988; Grub and Lin, 1991; Schneider and Frey, 1985; Westendorf, 1989). Micro factors normally include siting, infrastructure, industrial capabilities, administrative procedures, and incentive packages (Amirahmadi and Wu, 1994; Sit, 1988).

The calculus of foreign investment decision-making differs by industry with respect to selecting a host country. For instance, the natural endowments of a host country and also their accessibility are major considerations for primary industries. Such industries can be characterized as weight-losing and resource-oriented (Root, 1990). Domestic market potential, on the other hand, is most important for weight-gaining or market-oriented industries, such as automobile, construction, food stuffs, and beverage manufacturing. In addition to the size of the host country's population, the growth of per capita GNP and income contributes to domestic market potential (Schneider and Frey, 1985). For those industries producing luxuries in a developing country, the maintenance of a certain market segment, namely the high-income proportion of the population, is crucial. For industries undertaking rationalization and restructuring, minimizing the comprehensive transaction costs, particularly labor costs, is the main goal in overseas investment. In that case, the existence of a pool of disciplined, low-skilled or semi-skilled labor (depending on the level of product standardization) can be an important attraction for investors.

Some authors point to a series of obstacles in SEZs' investment environment, and their consensus is that these zones are not yet ready to absorb the kind of industrial investment Chinese leaders have hoped to attract (Chu, 1987; Crane, 1990; Pepper, 1988; Phillips and Yeh, 1989; Stoltenberg, 1984; Yuan, 1993). The resulting foreign investment is largely low-tech and technology transfer has not been very successful (Chan and Kwok, 1991; Chen, 1993; Chu, 1987; Crane, 1990; Yuan, 1993). The low technological orientation of foreign investment is first and foremost the result of the fact that the majority of investors are small and mid-sized Hong Kong firms that only want to take advantage of the cheap labor. Moreover, hidden costs are created by an unskilled labor force unaccustomed to industrial production. Further dampening the interests of foreign investors is their inability to convert local profits in Chinese currency into foreign currency, because of the rigid foreign exchange system. The SEZs, it also is alleged, lack an export orientation, and their products are uncompetitive in export markets (Chan and Kwok, 1991; Crane, 1990; Pepper, 1988; Phillips and Yeh, 1989).

A number of authors, on the other hand, focus on politics, exploring the factors that have brought about inconsistent policies for China's SEZs from the beginning (Chan and others, 1986; Crane, 1990; Pepper, 1988). The experimental nature of the SEZs leads to policy inconsistency, and changing administrative rules and political controversies in turn affect the zones' performance. The scenario is presented as a "two-line struggle," with zone supporters drawn from the ranks of the reformist leaders managing changes in post-Mao China versus SEZ detractors found among the conservatives. These authors conclude that political factionalism has rendered the SEZ policy less effective, despite the strong political and financial commitment from the central government.

As an illustration of how political struggles have driven economic policies, the question of why the Chinese embarked on a set of ambitious market reforms around 1979 cannot be answered simply by pointing to the poor performance of China's previous economic system or to the post-Cultural-Revolution crisis. The proximate cause can be found in the succession contest between Deng Xiaoping and Hua Guofeng, the successor hand-picked by Mao. From its very origins, the Chinese economic reform has borne the mark of political competition among ambitious politicians (see Shirk, 1993). In consequence, the political basis of the SEZ policy has been unstable at times. Certainly, the SEZs have constantly drawn ideological and economic criticism. Without accounting for economic factors, however, such political analysis has limited utility in explaining SEZs' economic performance.

The scholarly literature reveals a mixed performance of the SEZs in attracting of foreign investment. Largely following the "neoclassical" theory, the general emphasis of the literature has been on low-cost labor, domestic market potential and incentives as major determinants of SEZs' performance. This book is an effort to fill in the gaps in the literature and to show why and how well the SEZs have performed in promoting foreign investment, technology transfer and exports. The major theme is that spatial placement and unique planning activities are more important in explaining the performance of the SEZs than is acknowledged in the literature. Spatial placement here refers to active state initiatives in site selection, with an additional political dimension beyond the concept of location in traditional economic theories.

The focus of this book is Shenzhen, the largest and most successful zone among the four (see Table 1.1). The assessment of Shenzhen's performance in the period of 1979 to 1994 is largely based on its primary objectives, namely the promotion of foreign investment, technology transfer, and exports. The contributing factors underlying its performance are investigated. Shenzhen's fulfillment of the secondary goals—integrating with particular external economies and experimenting with a market system—are examined as I emphasize the importance of spatial placement and unique planning activities. The book assesses five major propositions:

• The growth of foreign investment in Shenzhen is a positive function of proximity to major sources of investment, in physical, economic, cultural and political terms.
• The growth of foreign investment is positively related to a favorable local policy environment, operationalized in terms of policy autonomy and openness, liberal investment policies, and sizable government investment.
• The growth of foreign investment is only weakly responsive to labor cost differentials between Shenzhen and other potential sites, and to domestic market potential.
• he growth of foreign investment has not led to meaningful technology transfer, primarily because of the low-tech nature of investment, but also because of the lack of an effective regulatory framework and because of Shenzhen's low industrial capabilities.
• he growth of foreign investment in Shenzhen is not accompanied by substantial net exports and domestic linkages, largely because of the high import propensity of FIEs and the limited domestic supply capabilities.

Table 1.1 Selected Indicators for China's Four Special Economic Zones, 1994

Indicator	Shenzhen^a	Zhuhai	Shantou	Xiamen^b
Area (square kilometers)	2,021	1,583	2,064	1,516
Population (millions)	3.4	0.6	3.9	1.2
Employment (millions)	2.2	0.5	2.1	0.9
Fixed asset investment (current prices, US$ billion)^c	1.86	1.14	0.87	0.60
Gross domestic product (current prices, US$ billion)^c	6.71	1.96	2.33	2.24
Gross value of industrial output (current prices, US$ billion)^c	11.27	2.85	3.49	3.38
Contracted foreign investment (US$ billion)	2.99	1.27	1.33	1.87
Utilized foreign investment (US$ billion)	1.73	0.76	0.77	1.24
Exports (US$ billion)	18.31	1.49	2.20	3.39

Note: All data are for city proper.

a The original Shenzhen SEZ was 327.5 square kilometers, and this was expanded in 1993 to include Baoan County. The population figure for Shenzhen includes both registered permanent residents and temporary migrants.

b Foreign investment data for Xiamen only include foreign direct investment, not foreign loans and other foreign investment.

c These figures are converted from the Chinese currency (RMB), based on the 1994 exchange rate of RMB 8.45 yuan = US$1.

Source: Ministry of Foreign Economic Relations and Trade, Almanac, 1995; Business China, 27 November 1995, p.9; Shenzhen Statistical Bureau, Statistical Collection, 1991; and State Statistical Bureau, China Statistical Yearbook,1995, and China Urban Statistical Yearbook,1995.

The Political Economy of China's SEZ Policy

Domestic Political Changes and SEZs' Creation

The formation of the new open door policy around 1979 led to the creation of the SEZ policy. That particular domestic policy shift, however, was not accidental. In the mid-1970s there was an economic policy debate in the central government that presaged such a change. Deng Xiaoping had taken the lead in criticizing China's old economic policies, pointing to widespread and fundamental problems such as stagnant grain production, declining industri...

Table of contents

• Cover
• Half Title
• Dedication
• Title
• Copyright
• Contents
• List of Tables
• List of Figures
• Acknowledgments
• List of Abbreviations
• Glossary
• Introduction
• 1 Conceptual and Policy Context
• 2 Foreign Investment in Shenzhen: Proximity to and Complementarity with Hong Kong
• 3 Local Policy Environment and Labor Costs
• 4 Technological Content of Foreign Investment
• 5 Export Performance and Domestic Linkages
• 6 Conclusions and Policy Implications
• Notes
• Bibliography
• Index