Why has China attracted such huge amounts of foreign direct investment (FDI) over the last 30 years?

Is the trend likely to continue?

Essay, 2012

7 Pages


Why has China attracted such huge amounts of foreign direct investment (FDI) over the last 30 years? Is the trend likely to continue?

Foreign direct investment (FDI) occurs when a firm establishes, acquires, or increases production facilities in a foreign country, fundamentally it’s a movement of capital. (Leslie Hamilton 2009) Critically FDI is a key business indicator as it demonstrates that Multi-National Companies (MNC’s) have set out strategies to exercise their control in foreign countries and overseas markets. Over the last thirty years China’s FDI inflows have grown at a staggering rate, for example in 1980 FDI in China was $57m annually and in 2008 it was $108,312m. (UN n.d.) In order to understand the reasons why this pattern has occurred both the micro and macro environment need to be considered. Amongst the academic business world the reason why China has attracted large amounts of FDI has been reviewed comprehensively. Between 1997 and 2002 eight major studies were carried out, they all agreed that although levels of FDI have increased the rate of growth has never been constant. (Y. Wei, Foreign direct investment in china : a survey 2003) Therefore it is evident that a number of factors need to explored, this is what the first part of essay discuses. The second part of the question is inevitably based upon opinion and prediction. In order to judge if the trend of FDI is to continue, it has to be constructed upon the past trends but also the external environment. For example The Economist has built a case for why India’s annual GDP growth will outpace China. (Economist, India's surprsing economic miracle 2010) Fundamentally this kind of speculation amongst the business world is likely to raise questions on the location of where MNC’s will do business and where FDI will follow. This will be further explored in the second part of the essay.

In 1978 China began a series of economic reforms under the rule of Deng Xiaoping. His objective was to introduce a new market structure, which would allow China to take advantage of Western technology and most importantly investment. This would be the start of China’s open door policy. This enabled trade with countries other than the USSR, at the time its sole trade partner. This was the start of FDI being invested in China and would become a key indicator into how successful the relationship of trade was between communist China and the rest of the world. In relation to the characteristics of FDI in China and how it progressed it generally has followed the same pattern. This being an increase in the flows of FDI into China for example from the year 1979 annual inflows of FDI to China has increased every year consecutively apart from 1999 and 2009. (UN n.d.) However the early years of the open door policy is described by Wei as ‘experimental’ highlighting that although China was liberalizing, the FDI was focused in four economic zones spilt between two provinces rather than on a national scale. (Y. Wei, Foreign direct investment in china : a survey 2003) Rapid growth in FDI took place between 1984 – 91 after a series of laws and regulations were implemented to improve the business environment creating investor confidence. It is important to recognize the source of FDI to China over the last 30 years as it is fundamental to the question of why China attracted particular countries investment. Table 1 displays the share of major source countries of realised FDI in China between 1986 & 2000. (Y. Wei, Foreign direct investment in china : a survey 2003)

Abbildung in dieser Leseprobe nicht enthalten

Source – http://www.chinafdi.org.cn/english (accessed 3/11/2010)

Table 1

The general pattern is that over time China has become more attractive to Western economies and that investor confidence has rapidly grown in order to create a steady level of growth up to the year 2000. This has continued up until 2008 with recorded inflows of $108,312, placing China 3rd in the world for FDI investment (Economist, Pocket World in Figures - 2011 Edition 2010). Furthermore the share of FDI from ethnic Chinese countries has decreased which fundamentally raises the question, what has caused for transition of investment to take place?

There are a number of reasons why FDI is used by companies, whether it is to exploit natural resources or lower production costs there remains one underlying fact FDI is used to improve competitiveness. In relation to China a number of reasons exist why FDI levels have risen. Amongst the academic world there seems to be no definitive answer, however strong cases exist. These consist of micro and macro principles such political liberalization, Chinese demographics, development factors and the role of exchange rates.

Exchange rates and values of currency have continued to be part of the debate into the success of the Chinese economic boom. The levels of controversy around this subject have reached the stage that individuals have been quoted that a currency war is taking place. On the 28th September 2010, Guido Mantega, the Brazilian Finance Minister said “We're in the midst of an international currency war," (Bevins 2010). But whatever controversy exists, the role of Chinese currency (the yen) has played a fundamental part in the attracting FDI to China. There is evidence that the Chinese government have used polices in order to devalue the yen and pegging it back against the US dollar. This has resulted in China’s global competitiveness becoming extremely strong; a figure which supports this is that 40% of US imports are produced by US companies, which operate in China. (Leslie Hamilton 2009) This has occurred because by pegging back the Yen China is able to offer extremely low production costs compared to developed countries. This will ultimately reduce production costs especially in labour intensive industries. Furthermore MNE’s have also been attracted by the devaluation of assets such as factory space; in particular automotive companies such as Volkswagen and General Motors. This in turn brings a host of advantages to China. De Gregorio (1992) conducted a test on the efficiency of FDI compared to domestic investment, concluding that it is three times more efficient. (Photis M. Panayides 2002) Furthermore by attracting foreign firms such as Intel and Microsoft it provides China with a “fast track” way of implementing advanced technologies and managerial practices. Yuqing Xing from the International University of Japan has used the example of Japan’s FDI in China, in order to show that the real exchange rate between the Yen and Yuan is one of the most important factors influencing FDI investment from Japan. From Xing’s empirical investigation he published Figure 1 which displays the correlation between Japanese FDI in China and the exchange rate. By taking into account inflationary terms the graph indicates that as real appreciation of the Yen occurred, the levels of FDI would increase in turn and vice versa. This fundamentally led Xing to reach the conclusion that the exchange rate may be a major factor in determining FDI inflows in China. (Xing, Why is China so attractive for FDI? The role of exchange rates 2005) Furthermore creditability must be added to the fact that Japan sources a large share of Chinese FDI as Table 1 shows between 1986 & 2000 Japans FDI outflows to China averaged at 9.4%.

(Xing, Why is China so attractive for FDI? The role of exchange rates 2005)Abbildung in dieser Leseprobe nicht enthalten

Abbildung in dieser Leseprobe nicht enthalten

Figure 1

The significance of exchanges is strong however China holds a number of internal qualities which have contributed in attracting FDI and these should not be overlooked. A study conducting by L.K Cheng and Y.K Kwan has identified that China’s large regional market and good infrastructure have a positive effect on FDI. However they also made the observation that “the location of FDI in China is characterized by enormous spatial as well as temporal diversity”. (Leonard K. Chang 1999) This conclusive statement can be supported by the evidence that the Chinese government planned on directing the FDI to special economic zones (SEZs) and areas geographically within the East of China. Examples of incentives put in place include tax reductions on profits in Open coastal areas. Furthermore it could be suggested that this area of China has been used to attract FDI due to the close proximity to Hong Kong, Taiwan and recently Macau. This is due to close relationship between the three locations which are referred as Special Administrative Region of the People’s Republic of China. This has provided the correct cultural awareness in order to attract high levels of FDI into the Chinese mainland. Furthermore this provided China with a method of taking advantage of Hong Kong’s high level of growth during the 1960’s/70s under financial secretary Sir John James Cowperthwaite. (Durkin 2010) Figures in relation to the share of FDI to China support this with Hong Kong being the number one source of FDI inflows into China between 1979 – 1999 at 50.32%. (Zhang 2005) Zhang provides both a supporting argument but also a firm justification that over the last 30 years the source of |inflows of FDI into China have largely come from Hong Kong and Taiwan. However the point of transition has to be highlighted. Zhang has suggested that as China’s domestic market has become more liberalized it has attracted a higher proportion of FDI from the EU, US and Japan (Triad). Furthermore Zhang supports the viewpoint of Chang and Kwan by pin pointing four factors which have significantly played a role in attracting such high levels of FDI from the three regions of Hong Kong, Taiwan and Macau. Firstly the strategy’s put in place by the Chinese government, secondly the labour market characteristics of China, thirdly the setup of Hong Kong and Taiwan as export-oriented investor. Lastly and which I believe to be the fundamental factor, the countries unique cultural similarities which has allowed inflows of FDI to flourish.

There is no doubt that what China has had in the last 30 years is a boom in the level of FDI inflows. It therefore raises the question can it continue? However because it requires predicting the future the difference in opinion is going to be quite vast. One way which this could be approached is to make comparisons of developed economies which have encountered high levels of growth and success in a relatively small part of history. The Economist published an article within a special edition of its magazine which questions the sustainability of China’s economic boom. By comparing China’s development with Japan’s in the 1980’s they have highlighted a number of similarities, therefore suggesting that the Chinese boom will become a bust just like Japan. In relation to FDI one similarity is significant; this is the huge levels of investment over a short period of time which in the long term could lead to devastating effects. (Ecomomist 2010) However the article also referred to China’s ability to overcome the latest global downturn compared to developed nations such as the US. Therefore demonstrating that China has a strong economy with potential for more investment. In contrast to the balanced opinion of the Economist, Shang – Jin Wei provides an optimistic view based upon the geographic and demographic characteristics of China thus creating massive potential for more FDI investment. (S. -J. Wei 2002) The figures which support this are quite staggering, with a population of 1, 3336.3million and land mass of 9,560,9002km 3rd in the world China is full of potential to attract more FDI. (Economist, Pocket World in Figures - 2011 Edition 2010) Wei’s main point which demonstrates his optimistic prediction relates to how the majority of FDI inflow is soured from the Special Administrative Regions of the People’s Republic of China. Therefore there is still massive potential to attract FDI from developed Western economies such as France and Germany. One criticism which could be drawn from this opinion is regarding a change in the macro environment for example if US was to take action in order to pressure China to alter the value it currency against the dollar. This would have an effect on the cost of exports from China and potentially divert FDI to other nations. Finally it is also important to take a long and short term stance on this issue. Firstly because in the short term it appears that China will continue to grow economically and become an extremely important global influence, therefore creating a prime location for investment. However in the long term quite drastic changes could take place especially if China remains heavily dependent on export trade, which could leave its economy exposed to a number of external influences ultimately reducing FDI levels.

In relation to reasons why China has attracted high levels of FDI over the last 30 years it remains evident that a number of reasons exist and continue to influence FDI today. Issues over the exchange rate will be debated, and China’s domestic potential is likely to be heavily targeted by foreign companies thus creating further FDI. Therefore there is no doubt that China is likely to attract further inflows of FDI at least in the short term. However in the long term as China becomes more developed, new reasons are likely to emerge resulting in the current influences becoming less so dominant. Therefore it would be hard to pinpoint a long term trend and divided opinion is likely to create a healthy debate into this question.


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Why has China attracted such huge amounts of foreign direct investment (FDI) over the last 30 years?
Is the trend likely to continue?
University of Kent  (Kent Business School)
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Luke Gipson (Author), 2012, Why has China attracted such huge amounts of foreign direct investment (FDI) over the last 30 years?, Munich, GRIN Verlag, https://www.grin.com/document/377100


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