Financial Markets and Foreign Direct Investment in Greater China

Hung-Gay Fung, Yahong Zhang

• Publisher: Routledge
• Year: 2016
• Print ISBN:
  9780765608048
• eBook ISBN:
  9781315499192
• Topic: Business
• Subtopic: Business General
• Index: Business

Based on rigorous state-of-the-art research techniques, this book deals with critical issues regarding China's financial markets and foreign direct investment -- key components of China's economic transformation.

FINANCIAL MARKETS

AND

FOREIGN DIRECT INVESTMENT

IN

GREATER CHINA

1

Introduction

Hung-Gay Fung and Kevin H. Zhang

For the last two decades, China has witnessed dramatic changes in financial reforms and inflows of foreign direct investment (FDI). In light of the recent East Asian financial crises and China’s entry into the World Trade Organization (WTO), a study on policy and practice of China’s financial market and FDI is warranted. The quality of the papers and the expertise of the authors should make the book a timely contribution to an understanding of the processes and prospects of China’s financial reform and foreign investments.

Chinese financial market reforms have removed many economic activities from state control and have helped build a basis for a civil society. Recent economic developments, inside and outside China, have made Chinese policymakers especially cautious about the potential for financial crises to destabilize the national economy. It remains the top priority for Chinese policymakers to reform the financial system so that a risk-control mechanism, compatible with the evolving Chinese economy, may be established. International lending institutions, such as the World Bank, are also greatly concerned that the financial reform in China is successfully carried out.

Financial market reforms enable Chinese state-owned enterprises (SOEs) and private firms to raise capital in domestic financial markets and offshore markets. The new sources of funding are important for China’s continued efforts to expand and grow. At the same time, the financial market reforms raise new issues and concerns for China as it becomes a more market-oriented economy. This edited volume will highlight some of these financial issues, which include reforms in stock and bond markets, banking and nonbank financial institutions, and the importance of corporate governance.

Since the economic reforms were initiated in the late 1970s, China has emerged as the most dynamic FDI-host country, and the role of FDI in the Chinese economy has burgeoned in ways that no one anticipated. FDI flows into China in 1997 totaled US$45 billion, which constitutes over 30 percent of total FDI in all developing countries. By 1999, the total FDI into China reached as much as US$311 billion. Inward FDI flows in 1995 constituted 26 percent of gross fixed capital formation. The foreign-invested firms employed 18 million Chinese by the end of 1996, constituting 18 percent of the total nonagricultural labor force. In 1997, 19 percent of total gross industrial output was produced by the foreign affiliates, and foreign-invested firms produced almost half of China’s total exports. Thus, FDI plays an important role in China’s economy.

This book is based on, and extended from, a recent international symposium on Challenges and Opportunities in the 21st Century for the Greater Chinese Economy, convened by the Center for International Studies and the College of Business Administration of the University of Missouri–St. Louis in March 2000. It is hoped that this book will provide readers with a better understanding of the processes and prospects of China’s reforms in financial markets and inward FDI, one of the most urgent tasks in the current stage of the economic reform in China. Successful establishment of a modern financial market and full utilization of FDI will provide an extremely important assurance that China’s economic reform will continue; it will also be instrumental in solving the dilemma of the state-owned enterprises through efficient allocation of domestic and foreign capital. To say that the ultimate success of the conversion of China’s centrally planned economy to a market-oriented economy turns on this single dimension—the financial market reform and use of FDI—is an understatement.

Three goals of the book are as follows. First, it provides a forum for academic research on China’s reforms in financial markets and the pattern of inward FDI. The rigorous theoretical modeling, statistical testing, and in-depth case studies in the book will not only lead to better understanding of China’s financial reform, but also provoke heated academic discussion on the most fundamental aspect of the economic transition in China.

Second, it provides policy guidance to China’s financial market reforms and regime for shaping multinational firms’ activities, as well as investment guidance to foreign investors. Policy-circle readers may utilize the book to enhance policy formulation, and investors may improve their opportunities based on the analysis in the book.

Third, the book could be used as a textbook in graduate or training programs at major universities in courses focusing on International Finance, International Business, International Economics, International Political Economy, and area studies on China or Pacific Asia.

The main body of the book consists of fifteen chapters on various aspects of China’s financial markets and FDI inflows, which fall into four parts: (1) Financial Markets: Institutions, Regulation, and Policy; (2) Recent Developments in Stock Markets; (3) Foreign Direct Investment; and (4) Business Environment and Policy Issues.

In the first part—Financial Markets: Institutions, Regulation, and Policy, there are four chapters. Specifically, Chapter 2, Financial Liberalization: Implications for Corporate Governance, explains the process of the financial liberalization in China by focusing on the development of the financial markets and the banking reforms. The discussion of the critical aspects of financial liberalization then leads to policy implications on corporate governance.

Chapter 3, on the stability of the RMB in the post–Asian crisis period, argues that the Chinese government is able to and will defend the Chinese currency (RMB) in the near future, but not for the long run. The cost for China to defend the RMB is not formidably high for the time being. However, as China implements an expansionary macroeconomic policy, causing changes in the macroeconomic environment, it will be economically unacceptable to peg the RMB to the U.S. dollar.

The next two chapters, Banking Reform in China and the Development of Nonbank Financial Institutions, examine different stages of banking and nonbank institution reforms under the gradual approach toward the market economic system. The problems and accomplishments in banking reforms are analyzed and the main characteristics of Chinese banking systems before and after 1978 are also compared. After providing a summary of the development of nonbank financial institutions in China, Chapter 5 urges that careful consideration and resources must be given to the guidance, regulation, and supervision of nonbank financial institutions in China, because they are important segments of the financial system but have been overlooked for a long time.

In the second part, Recent Developments in Stock Markets, there are three chapters dealing with the issue of Chinese stock markets. The opening of stock exchanges in Shanghai and Shenzhen in 1989 and 1991, respectively, symbolized a key step of financial reform in China. Chapter 6, The A- and B-Share Chinese Equity Market: Segmentation or Integration, takes a close look at the two types of shares traded: A shares available to domestic investors, and B shares to foreign investors. The evidence presented in the chapter suggests that A- and B-share markets are trending toward integration, based on the increasingly similar link of return volatility with the bid-ask spread and trading volume across the two markets, and decreasing differences in risk behavior of A and B shares.

In Chapter 7, on Ownership Restrictions and Stock Price Behavior in China, the stock price behavior of the Shanghai and Shenzhen Stock Exchanges is investigated under the two-tier trading systems of A and B shares. The A and B share prices tend to be driven by their own economic forces because of differences in the ownership distribution, liquidity, and financial characteristics of the firms.

Chapter 8 (Market Structure, Volatility, and Performance of H shares) compares the market structure and pricing of A and H shares issued by the same Chinese companies. H shares are highly liquid, extremely volatile, and traded at a large discount to corresponding A shares. Yet the share discount has increased dramatically over the years due to listed firms’ lack of financial transparency, poor management, improper usage of funds in noncore businesses, and deteriorating profitability.

In the third part, issues relating to foreign direct investment are discussed. The two most prominent characteristics of FDI inflows in China are the dominant position of Hong Kong and Taiwan in FDI sources, and the growing role of FDI in the Chinese economy. This part of the book focuses on the two issues to provide readers with a broad picture of foreign capital in China in the past two decades.

Chapters 9 (China’s Inward FDI Boom and the Greater Chinese Economy) and 10 (Taiwan’s Outward Investment in Mainland China) explore the link between China’s FDI boom and the greater Chinese economy, and factors that influence such capital flows. The large amount of investment from Hong Kong and Taiwan has been associated with the greater Chinese economy and Chinese connections. Like investments from Hong Kong, the Taiwanese investments were motivated primarily by cheap labor, incentive policies, market access, and cultural and linguistic affinities that provide Taiwanese investors with operation advantages over other investors.

In Chapter 11, on Changing Trends of FDI Patterns in China, the author discusses the impact of FDI in terms of sales, tax revenue, and assets on the Chinese economy, focusing on primary industry, secondary industry, and tertiary industry. The analysis sheds light on industrial structural change resulting from FDI and potential effects of FDI after China’s accession to the World Trade Organization.

Chapter 12 (Location Advantages, FDI, and Technology Advance: Evidence of China) explores the importance of location advantages, which are considered critical by MNCs when they decide where to invest. The chapter first develops a theoretical location advantage framework and then applies the multilevel analytical methodology to empirical analyses. The paper thoroughly examines the international factors, intranational factors, and their relationship. The results are considered robust and more compatible in studies on the relationship between location advantages and FDI.

The last part of the book is on business environment and policy issues. Chapter 13, on United States-China-Taiwan: A Precarious Triangle, focuses on the interesting issues related to economic relations, on political relations, and military relations among the United States, China, and Taiwan. Although business environmental issues are domestic, that basic difference in national treatment generates serious political difficulties in the United States in maintaining good trade relations with China. The United States should welcome the development of improved relations with China and further progress in the day-to-day interactions of its people. However, the United States should be prepared for more pragmatic relationships and less happy outcomes.

Chapter 14, International Business and Multinational Corporations in China, applies Porter’s theory of entry strategy to develop a congruency model that depicts the interrelationships among entry strategies and environmental determinants. The model suggests that design of entry strategies should be treated as an ongoing and dynamic process to allow for maximum flexibility and adaptability. The model has implications for multinational corporations to develop effective entry strategies for successful ventures in China.

The next two papers are written by government representatives of Hong Kong and Taiwan in the United States. In Chapter 15 (Taiwan’s Recent Economy and Business Environment), the author not only demonstrates that Taiwan has undergone remarkable economic growth for several decades, but also discusses Taiwan’s recent economic performance in terms of trade, foreign investment, and trade partners. The future challenges facing Taiwan in the context of the greater Chinese economy are discussed.

Chapter 16, on Opportunity and Challenge of Hong Kong in the New Millennium, is devoted to discussing the opportunities and challenges facing Hong Kong after its reversion to China in 1997. The focus is on Hong Kong’s business environment, its role after China’s accession to the World Trade Organization, and policy implications for its future development.

Part I

Financial Markets: Institutions, Regulation, and Policy

2

Chinese Financial Liberalization: Implications for Corporate Governance

Hung-Gay Fung and Wai Kin Leung

Chinese economic policies have been viewed as models for developing countries because of China’s remarkable economic growth rate since 1978. This success is attributable primarily to various sound economic plans. They include economic reforms such as different economic zones, provision of government incentive packages that promote exports, opening up the economy to foreign investors for joint ventures and investment, and the restructuring of numerous unprofitable state-owned enterprises (SOEs).

Bank credit and government-issued treasury bills and bonds are the traditional sources of financing to SOEs. Because government...

Table of contents

• Cover
• Title Page
• Copyright Page
• Table of Contents
• 1. Introduction
• Part I. Financial Markets: Institutions, Regulation, and Policy
• Part II. Recent Developments in Stock Markets
• Part III. Foreign Direct Investment
• Part IV. Business Environment and Policy Issues
• Editors and Contributors
• Index