Developing China: The Remarkable Impact of Foreign Direct Investment

Michael J. Enright

• Publisher: Routledge
• Year: 2016
• Print ISBN: 9781138228153
• eBook ISBN: 9781315393322
• Topic: Business
• Subtopic: Business General
• Index: Business

One of the most important features of China's economic emergence has been the role of foreign investment and foreign companies. The importance goes well beyond the USD 1.6 trillion in foreign direct investment that China has received since it started opening its economy. Using the tools of economic impact analysis, the author estimates that around one-third of China's GDP in recent years has been generated by the investments, operations, and supply chains of foreign invested companies. In addition, foreign companies have developed industries, created suppliers and distributors, introduced modern technologies, improved business practices, modernized management training, improved sustainability performance, and helped shape China's legal and regulatory systems. These impacts have helped China become the world's second largest economy, its leading exporter, and one of its leading destinations for inward investment.

The book provides a powerful analysis of China's policies toward foreign investment that can inform policy makers around the world, while giving foreign companies tools to demonstrate their contributions to host countries and showing the tremendous power of foreign investment to help transform economies.

1

China and inward foreign investment

Introduction

China has been one of the world’s great economic success stories since the onset of its program of economic reform and opening that started in the late 1970s. Foreign investment and foreign invested enterprises (FIEs) have been a major part of this story. While there have been numerous books, papers, and articles written on foreign companies and foreign investment in China, they tend to fall into two groups. The first group consists of scholarly works that use statistical techniques to address fairly narrow questions. However, this work can only address a limited set of questions, results are often inconclusive and difficult to interpret, and most of this work is inaccessible to all but other scholars. The second group consists largely of works that recount the trials and tribulations of foreign companies as they have tried to develop their China business. However interesting these may be, the cases tend to be idiosyncratic and hard to generalize, and only provide a partial view of foreign investment and foreign companies in China. Neither group provides a comprehensive picture of the environment for foreign investment in China or of the impact that foreign investment has had on China’s economy.

Obtaining such a comprehensive picture is becoming more and more important. As China continues to develop and its indigenous companies grow stronger, it is becoming fashionable in some quarters to minimize the past and present contributions of foreign investment and foreign invested enterprises in this development. At the same time, as foreign companies appear to be coming under increasing pressure in China due to market, regulatory, and competitive shifts, it is becoming more important for foreign companies to be able to ‘make their case’ in terms of the contributions that they have made and are making to China’s development. Many other countries in the developing world are looking to China, and how it deals with foreign investment and foreign companies, as a guide for their own policies and practices. Thus a failure to understand China’s approach to foreign investment and foreign companies, and the true impact that this investment and these companies have had on China’s development has implications that go well beyond China.

The project

The project upon which this volume is based had its origins in discussions between Merle Hinrich, Kathryn Dioth, and Stephen Olson of the Hinrich Foundation and Professor Michael Enright of Enright, Scott & Associates consultancy. The mission of the Hinrich Foundation is to promote sustainable global trade by fostering research on international trade and investment policy, supporting trade related education and training, and cultivating export-led job creation. The Foundation has spent years working on a wide range of issues associated with international trade and investment. Enright, Scott & Associates (ESA) is a leading Asia-based economic and strategy consulting firm with a long history of advising governments, multilateral agencies, and major corporations on economic development, trade and investment, and international business strategy, with particular expertise in Asia in general and China in particular. ESA has a long history of advising governments on investment promotion programs, and a long history of advising multinational companies on their approaches to host countries and host governments.

The discussions soon focused on the apparent disconnect between the advantages of international trade and investment claimed by economists, multilateral agencies, and multinational companies, and the restrictive approach to trade and investment seen in many parts of the world. One reason for this disconnect appears to be the lack of a complete picture of the impact that foreign investment and foreign companies can have on host economies. A decision was taken to mount a project that would attempt to take a more comprehensive approach to the impact of foreign investment and foreign companies on a single country before moving on to others. China was the obvious choice given its importance to the global economy, the finite time frame of its economic reform program, and the fact that China is increasingly taken as a touchstone by other developing countries.

The resulting project has had several major components: a review of the academic literature on foreign investment and foreign companies in China, an investigation of the evolution of China’s legal and regulatory regime governing foreign investment, a compilation of the relevant facts and figures concerning inward investment, the use of economic impact analysis techniques to estimate the impact of foreign investment and foreign invested enterprises on China’s GDP and employment, a compilation of a range of catalytic impacts and spillover effects of foreign companies, a series of case studies of the impacts of foreign investment and foreign companies on particular municipalities in China, a series of case studies of the impacts of individual foreign companies on China’s economy, and our own econometric analysis of some of the topics researched by academics. The goal was to go well beyond the existing literature, to combine several approaches to the analysis, to introduce some new tools and techniques while not being restricted by any particular tool, and as a result to present a fine-grained and multifaceted picture of China’s approach toward foreign investment and the impact of that investment on the nation’s development. The present volume presents the highlights of our analysis and results.

Preview

There are many conclusions that have come out of the project that we will describe in this volume.

We preview several of these here.

• Most foreign observers and even foreign managers operating in China do not really understand the approach that China has taken to foreign investment and foreign companies. Openness to foreign investment and foreign companies has not been an end in and of itself, but rather a means, and in particular a means to ensure that China and Chinese companies catch up with the rest of the world as much as to increase economic growth or improve consumer welfare. Moreover, this approach has been heavily influenced by the Chinese experience with foreign powers and foreign companies from the 1840s through the 1940s.
• The history of China’s approach to foreign investment over the last 35 years is a story of carefully controlled opening, always with the intention of ensuring that foreign capital, know-how, technology, and management expertise would be applied for the benefit of the Chinese economy, while preventing foreign companies from gaining too much influence. The step-by-step process was due in part to maintain control of the process, and in part because China had to develop the legal and regulatory institutions to govern a non-state economy from virtually zero.
• It took China some time to recognize that movement towards ‘international standards and norms’ was not something that foreign companies and governments necessarily wanted to impose on China, but rather had evolved internationally as solutions to the challenge of maintaining sovereignty and control while providing investors with the certainty and protections necessary to risk making investments.
• While foreign direct investment into China has grown to levels in excess of USD 100 billion per year, and cumulative FDI into China has reached nearly USD 1.6 trillion, inward FDI flows account for only a few percent of gross capital formation and fixed asset investment in China today. However, when one applies economic impact analysis tools to the foreign investments and the operations of foreign invested enterprises, the impact of these companies and the ripple effects through their supply chains in recent years has been on the order of 33 percent of China’s GDP and 27 percent of China’s employment (the figures for 2013 and the five-year average from 2009 to 2013). This does not include any impacts on downstream distribution or other catalytic and spillover effects on technology, management, business practices, and other areas.
• Foreign invested enterprises have been instrumental to China’s emergence as the world’s largest trading nation. Although their share has declined in recent years, foreign invested enterprises still account for nearly half of all of China’s trade. Foreign companies have also facilitated China’s trade by leveraging productive resources in China into world markets and by providing the physical and financial infrastructure associated with trade.
• Foreign invested enterprises have also been crucial to the development of many of China’s leading industries, including industries with substantial spillovers into the local economy, export-oriented industries, and industries that provide needed inputs for the rest of China’s economy. Sino-foreign joint ventures modernized the Chinese auto industry and allowed China to become not only the world’s largest producer of automobiles, but a significant exporter of autos and auto parts. Without foreign invested enterprises, China would not have much of a computer industry, and would not have developed nearly as extensive modern activities in chemicals, clothing, accounting, consulting, and numerous other industries.
• In addition to the impacts listed above are a whole range of catalytic impacts and spillover effects of foreign investment in China that are difficult or impossible to quantify. These include the modernization of Chinese industries (some of which were decades behind at the beginning of the reform program), the creation of suppliers and distributors in China, bringing improved technologies and R&D to China, fostering spin-offs, improving business practices and standards (including accounting, engineering, and quality control standards), improving the financial system in China, modernizing management training and education, bringing regional and global management to China, promoting legal and institutional reform, improving environmental and sustainability practices in China, contributing through corporate social responsibility (CSR) initiatives, and providing advice on economic and business-related policies. The impact of foreign companies in these areas is hard to overestimate.
• The results indicate that while one can argue that China would have benefitted more if it had opened its economy earlier or more completely, the introduction of foreign investment and foreign enterprises into China has been an enormous success with large impacts across the national economy.
• Case studies of Shenzhen, Tianjin, Shanghai, and Chongqing show how China’s approach to foreign investment, and to economic reform overall, evolved over time, and how China’s rapid development has changed the economic landscape. Shenzhen, just north of Hong Kong, was the initial experiment in economic opening. Its success as an exporter of light manufactured goods gave impetus to further the reform process. Shenzhen itself has become a leading high-technology hub and a modern service centre for South China. Tianjin, near Beijing in Northern China, became a focal point for large-scale manufacturing investments to serve the Chinese domestic market as well as exports, and is presently diversifying and upgrading its service economy. Shanghai was able to re-establish its position as China’s leading business city with the help of foreign investment and foreign enterprises, and has become a headquarters, financial, service, transportation, and manufacturing location of international importance. Chongqing, which was opened later than the other cities, shows how China’s program of western development has also featured the attraction of foreign investment to build up the city as well as its economy, and how foreign investment has helped turn what was once a relatively backward city into a modern metropolis linked to the global economy.
• Also of interest is the fact that most of the major initiatives that led to the development of these four cities, Shenzhen, Tianjin, Shanghai, and Chongqing, as leading economic cities in China have involved attracting foreign investment. Even today, the most important initiatives to further develop these cities also involve attracting more and different types of foreign investment. In all four cases, the path to the next level of development will involve further opening to foreign invested enterprises.
• Corporate case studies on foreign companies in China, including Hong Kong pioneers in China, Procter and Gamble, Maersk, and Samsung, show the wide range of influences of foreign investment on China’s development. Hong Kong companies were early investors in light manufacturing, ports, roads, utilities, hotels, property, and services, not just in China as a whole, but in virtually all of China’s major provinces and cities. In many instances, Hong Kong companies provided the examples and the basic business infrastructure that allowed other foreign companies to follow.
• P&G helped in creating entire product categories in China, developed local suppliers and distributors that now serve the country as a whole, brought modern advertising and marketing practices to a country that had little expertise in these areas previously, invested in public health and education initiatives, developed its Chinese staff so it is now a net exporter of management talent from China, and brought world-class environmental and CSR practices to China. Maersk invested in helping establish Chinese shipyards (now world leaders) as viable producers of ships for the international market, in connecting China to the rest of the world, thus helping China become the world’s leading trading nation, in improving port efficiency and environmental performance in China, and in tackling logistics difficulties that have held the Chinese economy back. Samsung became one of China’s largest foreign investors, created complete production chains, including advanced components in China, and set up several cutting-edge R&D centres in China. However, as costs increased in China and Samsung became more concerned about its position in China, it shifted some of its focus to Vietnam, where its investment rivals that which it has made in China.
• The academic literature on foreign investment in China focuses on the influence of foreign investment on China’s GDP and GDP growth, productivity, technological capacity, domestic investment, employment and wages, trade, environment, and a number of other parameters. Many of the results of this literature are expected, such as a positive influence of foreign investment on economic development, trade, wages, and environmental performance. The results also indicate that the impact of foreign investment depends on the industry, source country, and location within China of the investment. There are also some counterintuitive results that might be due in part to questions of variable use, statistical methods, and time period.
• One interesting feature of this academic literature, particularly the Chinese literature, is the focus on the impact of foreign investment on Chinese firms, rather than China’s economy as a whole, and the focus on issues that the Chinese Government has flagged as important, such as industrial and trade upgrading. The results of this literature, particularly the Chinese literature, provide grounds for some scepticism about the benefits of foreign investment. It is crucial for companies, analysts, and foreign governments to understand this because this literature influences China’s policy stance toward foreign investment.
• ESA’s own econometric work focused on several of the major issues addressed in the academic literature, only using expanded time frames, clearer variable definitions, and more modern statistical techniques than some of the existing literature. The bulk of the results support a positive impact of foreign investment on GDP growth, productivity, innovation, domestic investment, incomes, trade, and environmental performance (foreign firms perform better than domestic firms). The results include some reversals of negative results found in prior literature, particularly on domestic investments. The results also show regional differences and time period differences in the impact of foreign investment on China’s economy. Overall, our results show a more positive picture of the impact of FDI on China’s development than some of the existing literature.
• The story of foreign companies and their influence on China’s economy is by no means over. Slowing growth, rising costs, a difficult economic transition, and perceptions that China is becoming in some ways less welcoming to foreign companies are causing many companies to reassess their China positions. China is moving away from a regime that required ex ante approvals for foreign investment to one in which foreign companies will be subject to ex post regulation of behaviour. While this should be a positive for foreign investment, it all depends on how China uses its legal and regulatory tools, and the role that China’s leaders wish foreign investment to play.

The book

The main goal for this volume is to provide a more comprehensive and nuanced view of China’s approach toward foreign investment and the impact of this investment on China’s economy than is generally available. In extracting results from the larger project, we have done so with three main audiences in mind.

One audience for this work is policy makers inside China and outside China who can use the descriptions, impacts, and tools reported to get a fuller picture of the impact of foreign investment on China’s development for use as input into their own policy making. Another audience is managers of foreign invested enterprises in China and elsewhere, as well as chambers of commerce and governments that represent foreign invested enterprises, who can use the results and tools reported here to ‘make their case’ when it comes to justifying their presence in host countries. Finally, another audience is analysts and researchers who perhaps can add to their own knowledge and analytical toolkit when it comes to assessing the impact of foreign investment and foreign invested enterprises in China and elsewhere.

The structure of the remaining parts of this volume is as follows. Chapter 2 traces China’s approach toward foreign investment since the onset of the reform program, with special attention focused on the legal and regulatory frameworks used to govern inward investment, as well as the basic statistics of foreign investment since China’s economic opening. Chapter 3 looks at the importance of inward investment to total investment in China and applies the tools of economic impact analysis to assess the impact of the investment, operations, and supply chains of foreign invested companies in China. The latter is the first analysis of this type across an entire national economy of which we are aware.

Chapter 4 highlights the wide range of catalytic impacts and spillover benefits of foreign investment in China that go beyond those estimated in the previous chapter and has helped to shape China’s development. Chapter 5 focuses on case studies of the impact of foreign investment on four major cities in China, Shenzhen, Tianjin, Shanghai, and Chongqing, that differ in terms of state of economic development, geography, timing of opening to foreign investment, development goals associated with foreign investment, and the mix of types of investment. Each shows how foreign investment has been crucial to municipal development. Chapter 6 consists of summaries of three corporate case studies of Hong Kong pioneers in China, Procter and Gamble, Maersk, and Samsung, that highlight the range of impacts that different types of foreign companies have had on China’s development and perhaps provide some cautions for the future. Chapter 7 provides a brief summary of existing academic literature as well as summary results from our own econometric work on impacts of foreign investment on China’s economy. Chapter 8 provides a summary of some of the lessons from the work as well as views on the future of foreign investment in China.

We hope the multifaceted approach represented in this volume will give a more complete and nuanced view of China’s approach to foreign investment and the impact of foreign investment on China’s development than has been available to date. We hope that officials, business pe...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of figures
• List of tables
• Foreword
• Acknowledgements
• 1 China and inward foreign investment
• 2 China’s approach toward foreign investment
• 3 The economic impact of foreign companies in China
• 4 Catalytic impacts and spillovers from FIEs
• 5 Foreign investment in Chinese cities
• 6 Corporate case studies
• 7 Econometric analysis of foreign investment in China
• 8 Perspectives on foreign investment in China
• Index