Chinese Foreign Direct Investment

A Subnational Perspective on Location

Tao Qu, Milford B. Green

• Publisher: Taylor & Francis
• Year: 2018
• Print ISBN: 9781138617988
• eBook ISBN: 9780429866692
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

First published in 1997, this volume emerged in the wake of China's Open Door policy. Qu and Green focus on the spatial aspects of foreign direct investment within China. They aim to locate FDI within a subnational context, with particular reference to the Chinese experience between 1979 and 1993. Issues explored include the philosophy, objectives and process of inducing FDI, the choice of cities and the country of origin effect. Issues explored include the philosophy, objectives and process of inducing FDI, the choice of cities and the country of origin effect.

1    Introduction

Introduction

This book is about the location of foreign direct investment (FDI) within a subnational context, with reference to the Chinese experience during 1979 to 1993. This chapter explains the subject, the nature, and the scope of this study.

China’s ‘open door’ policy has caught enormous attention in the past ten years or so. It has been because China’s opening has provided many opportunities and has had a noticeable impact on the world. The real implications of this new process in China’s history will be in the years and decades to come. Indeed, China’s opening to the West shows a dramatic change in the undercurrent running through China’s thousands of years of history.

One aspect resulting from China’s opening to the world is the inflow of foreign direct investment from developed countries, newly industrialized countries (NICs), and some developing countries. Out of a host of academically and practically challenging areas of studies related to foreign direct investment; this book sets out to deal with only one aspect: the spatial dimension of foreign direct investment.

This subject is easily justified within several contexts. As a destination for international direct capital flow, China’s importance is second only to the United States, the world’s largest economy. Also, China has been a planned economy. The presence of foreign direct investment that is mainly from the NICs and the West in China creates a unique area of study within the domain of international production. That is, international production within a major socialist economy. Most issues related to foreign direct investment in China would stand as separate fields of study on their own simply because of their uniqueness and practical importance. That, of course, includes the locational issue.

The research conducted by this study is also justified by its contribution to the theoretical understanding of the location of foreign direct investment within the subnational context. Such a comprehensive conceptual and theoretical framework has been lacking.

This research is also justified with the importance of foreign direct investment in China’s economic development. Within the manufacturing industry, the gross output value of these enterprises invested in by foreigners accounted for close to 5 per cent of the national total in 1991. This was 8 per cent for the Coastal Open Cities, and 45 per cent for the four Special Economic Zones.

The definition of foreign direct investment and the scope of data coverage

Foreign direct investment and international portfolio investment are the dichotomous components in international capital flow. Portfolio investment is purely financial investment through the modality of the market. It does not entail control over the assets involved. Foreign direct investment, on the contrary, is international capital movement with the investing companies retaining the control over the use of the resources involved. It usually consists of a package of assets (Dunning, 1993, p. 5; Rugman, Lecraw, and Booth, 1985, p. 9).

The operational definition, though, varies from one country to another due to different assessments of effective control. The US Department of Commerce defines foreign direct investment as ‘the movement of long term capital to finance business activity abroad, whereby investors control at least 10 per cent of the enterprise’ (Ponioachek, 1986, p. 21). In Canada and other countries, this rate is usually higher than ten per cent (Rugman, Lecraw, and Booth, 1985, p. 9).

The operational definition of foreign direct investment used in this work, due to data constraints, covered a greater scope of enterprises. The Chinese government considers foreign investment in all the following four types of ventures as foreign direct investment:

1  wholly foreign owned ventures (WFVs),

2  equity joint ventures (EJVs),

3  cooperative joint ventures (CJVs), and

4  joint exploration ventures (JEVs).

In the earlier years of China’s open door policy, this list also included processing and assembly arrangements plus compensation trade that now is included in the ‘other FDI’ category in government statistics.

JEVs are usually formed between the Chinese government and foreign oil companies to investigate offshore oil resources in China’s sea territory. Both the total number and total amount of capital are negligible in the national total. As a result, foreign direct investment usually includes investment by the first three types of joint ventures that are collectively referred to as foreign invested ventures (FIVs) in this book.

While WFVs and EJVs are up to international standards in their definition, investments made by CJVs are a debatable category of foreign direct investment. In a CJV, a Chinese firm and a foreign firm, work together on a specific project usually with the Chinese side contributing mainly in kind, normally land or buildings, and the foreign investors contribute technology and capital. Profits are distributed according to a formula specified in their contracts. Because of the vague definition (in fact, the law governing CJVs was not published until early in 1988), in practice many such ventures have been treated as EJVs. This venture type was important in earlier years primarily for investors from Hong Kong. Its role as a dominant mode of entry in terms of contract numbers ceased after 1985. Nevertheless, it was an important vehicle for both local authorities and foreign investors to learn to cooperate and explore future opportunities.

Major objectives of this study

This work is about the location of foreign direct investment within a subnational context and the Chinese experience. As an objective and as a necessity to precede the empirical analysis of the spatial dimension of foreign direct investment in China, a comprehensive conceptual and theoretical framework for the location of foreign direct investment with a subnational context is built. Such a framework should be comprehensive and dynamic, within which various locational issues of foreign direct investment can be addressed.

The second objective is to uncover the locational determinants of foreign direct investment in China, not only as an empirical case study but also as a special area of study within the domain of foreign direct investment because of its importance and uniqueness. The general location patterns are not expected to be stationary, but will change through time. These changes represent nothing short of a dynamic process between foreign investors on one hand and host cities on the other. Within this dynamic context, the changes of the model, that are the changes of factors and variables about the location of foreign direct investment as whole, are discussed.

If the second objective is to answer the question of what makes one host city/region more attractive than another, the third objective of this book is to answer what causes foreign investors to prefer some cities to others as possible locations for their investment. It is really a question about the presence of foreign direct investment, rather than the spatial distribution of foreign direct investment (in actual amount or number of contracts). To answer this question, a distinction is made between cities that have foreign direct investment of varying amounts (FDI recipient city) and cities that have no foreign direct investment presence (FDI void city).

When compared with investments made by national firms, foreign direct investment represents a distinct category. However, this does not mean foreign direct investment is a homogeneous category. In fact, it can be further differentiated by its country of origin, size, and competitive strategy. It is out of the reach of this study to examine all the aspects of this diversity. Rather, this research aims to uncover only the country of origin effect, i.e., the locational deviation of foreign direct investment because of its country of origin.

Structure of this book

This book proceeds in the following fashion. After the literature review on the main foreign direct investment theories, location theories and corporate geography, plus the empirical research on the location of foreign direct investment in Chapter Two, a conceptual and theoretical framework for the location of foreign direct investment at the subnational level is built in Chapter Three. This framework is a result of a process that involves critical selection of existing theories and studies and combining them into a hybrid framework. Chapter Four is a descriptive analysis of the overall process of foreign direct investment involvement in China since 1979 within the context of China’s policy changes toward a more liberal investment environment. It provides not only some critical background information and an overview of the process, but also some inputs that are used later. Vigorous statistical modelling and analyzes mark Chapters Five, Six, and Seven. They are based on the comprehensive conceptual framework and achieve the stated objectives. While the presence of foreign direct investment is the focus of Chapter Five, Chapter Six aims at the general location pattern, the spatial distribution of foreign direct investment, and its change over time. Chapter Seven dissects one of the three dimensions of the conceptual framework, the effect of country of origin on location patterns of foreign direct investment. Chapter Eight concludes this work by summarizing the main results and proposing areas of further research.

2 The location of FDI: a literature review

Introduction

This chapter delves into a wealth of literature on foreign direct investment, both theories, empirical studies, and corporate geography, to uncover the locational mechanisms of foreign direct investment. A comprehensive locational framework for the location of foreign direct investment seems lacking. In the process of the unraveling of the key components of the major foreign direct investment theories, it is shown that corporate geography can contribute to the building of a conceptual and theoretical framework to accommodate the location of foreign direct investment. All the major strands of foreign direct investment theories, e.g., the market imperfection approach, the internationalization approach, the product cycle theory, the eclectic paradigm, and the macroeconomic approaches, are discussed.

The lack of a complete locational theory for foreign direct investment has not prevented empirical investigation on location related issues of foreign direct investment, e.g., the overall spatial patterns and locational determinants (factors). Two groups of studies of varying spatial units contribute to our understanding of the locational aspects of foreign direct investment:

1 survey studies and empirical analysis of determinants of foreign direct investment among countries, and

2 studies of the location of foreign direct investment within one country or geographical region.

The differences between these two groups are mainly in their foci, with the first group focusing on distribution of foreign direct investment within an international context and the latter on a subnational spatial context.

In this chapter, theories on foreign direct investment are discussed first, followed by a brief review of corporate geography’s contributions. The empirical analysis on the location of foreign direct investment is reviewed at the end of this chapter.

Conventional theories of foreign direct investment and their locational implication

The market imperfections approach and industrial organization

The market imperfections approach (Hymer, 1976; Kindleberger, 1969; Caves, 1971, 1974b, 1974c; Calvet, 1981) starts with the basic assumption that without market imperfections foreign direct investment would never occur. Market imperfections can be caused by both goods and factor markets, scale economies, and government imposed regulations (especially tariff and trade barriers) that prevent the efficient allocation of resources and distribution of products. In a perfect market, the only vehicle needed to serve a foreign market is international trade.

It was also recognized that foreign direct investment is far different from portfolio investment. In the first place, foreign direct investment is more than just the transfer of capital, it is the transfer of a package of assets that includes technology, managerial skills, and access to international markets. Second, there is no change of ownership in the process. Multinational enterprises (MNEs) internalize the market by directly controlling the resources acquired with foreign direct investment. As such, portfolio capital theory that is based on the interest rate is insufficient to explain the movement of direct investment.

If an MNE intends to pursue foreign value-added activities, it is perceived to face some disadvantages in comparison with indigenous firms, e.g., the information cost concerning the operation of firms within a foreign social, institutional, and political system. To overcome the inherent disadvantages of owning international production, MNEs must possess some kind of ownership advantage. These perceived ownership advantages can be expressed as technology, cost effectiveness, established markets, and financial strength. Clearly, this assumption is along the line of reasoning in industrial organization theory where firm behavior is affected by market structure.

Many scholars have explored what kinds of firm characteristics and in what kinds of industries MNEs are prone to international production (Horst, 1972; Caves, 1974a; Hirsch, 1976; Lall, 1980). It was found that ownership specific advantages usually rest on intangible assets created by large firms with intensive research and development activity. This points to the high technology industries such as chemicals, pharmaceuticals, and instruments. Industries in mature oligopolies with higher seller concentration and higher barriers to entry also tend to play an important role in international production.

Although the market imperfections approach to foreign direct investment does not have a spatial dimension, it is important for our understanding of the characteristics of foreign direct investment. It aids us in understanding the locational mechanism of foreign direct investment, as any locational choice made by an MNE is one of the responses that it makes within a dynamic environment concerning its own ownership specific advantages and competitive strategies.

Product cycle theory

Vernon’s product cycle model is an integrated model for international trade and investment (1966, 1979). Three basic assumptions are made in Vernon’s product cycle hypothesis. First, the monopolistic advantages enable MNEs to take on the special costs and uncertainties of direct production abroad. Second, there are marked differences between the markets and factor conditions of home and host countries. Third, a new product or innovation possessed by an MNE is stimulated by the promises of its home market.

Once a product is created through innovation, it is destined to go through a process of several stages from a new product to a mature product to a standardized product. Along this sequence, the specific aspects of monopolistic advantages that an MNE possesses change. So do the market demand, market structure, and the scale of production. Most important, in response to these changes and the differences in the factor conditions between host and home markets, the modes for the MNE to exploit its firm specific advantages change from export from the home market to direct production in host countries. Though there have been tremendous changes in the landscape of international production, the product cycle hypothesis remains relevant in explaining international trade and investment (Vernon, 1979), especially when it comes to the foreign direct investment from developed to developing countries.

Product cycle theory distinguishes itself from other theories in two aspects: its dynamic nature and its explicit locational dimension. The driving force in this dynamic process is innovation and technological progress. Yet, depending on their positions in the product cycle, MNEs adopt different strategies. Later, this was explicitly explored within a framework of three kinds of oligopolies: innovation-based, mature, and senescent oligopolies (Vernon, 1974). For the innovation-oriented industries, the oligopolistic strength of MNEs is through the development and intro...

Table of contents

• Cover
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• Figures and tables
• Preface
• 1 Introduction
• 2 The location of FDI: a literature review
• 3 The location of FDI within a subnational context
• 4 The philosophy, objectives, and process of inducing foreign direct investment
• 5 Why these cities and not those?
• 6 Location of FDI at the prefecture city level: a statistical analysis
• 7 The country of origin effect
• 8 Conclusions
• Appendices
• References