The Determinants of Inward Foreign Direct Investment in China Essay Example
The Determinants of Inward Foreign Direct Investment in China Essay Example

The Determinants of Inward Foreign Direct Investment in China Essay Example

Available Only on StudyHippo
  • Pages: 13 (3362 words)
  • Published: November 12, 2017
  • Type: Essay
View Entire Sample
Text preview

The reason for the emergence of trans-national corporations (TNCs) can be traced back to the continuous process of globalization that began after World War II. Gillies' 2005 report shows that there has been a considerable rise in multinational direct investment, which expanded from 4.4% of worldwide production in 1960 to 23% in 2003.

UNCTAD (2007) notes that foreign direct investment (FDI) has steadily increased since 2004 and is a crucial aspect of international business. FDI plays a significant role in China's economic growth, with Sun, Tong et al and UNCTAD (2007) reporting an increase from zero in 1979 to over 35 billion US dollars in 1998. The year 2006 witnessed a notable surge in FDI, reaching a sum of 69 billion US dollars, making China the top country for FDI in East Asia. Trietak's recent statistics indicate an even faster rise over the past decade; however, there are

...

concerns about whether current FDI figures cast doubt on China's success story. To explain the determinants of FDI inflow, various theories have been established including Dunning's eclectic framework for studying FDI determinants (Dunnings, 1993,2000).

In his analysis, he categorized various factors into three broad groups: 'ownership advantages, location advantages, and internalization advantages.' He argued that FDI only occurs when all these factors are met simultaneously. Navaretti and Venables (2005) then delved deeper into location-specific factors such as trade costs, market size, and taxes. Their research pointed out that these factors combined heavily influenced the decision to undertake FDI. Tseng and Zebregs (2003) looked at how preferential policies affect FDI and found that such policies had a significant impact on FDI levels. Empirical studies by Sun, Tong et al(2002

View entire sample
Join StudyHippo to see entire essay

and Zheng(2001) also highlighted the relevance of market size and openness to trade.

This article will analyze the determinants of FDI inflows in China, with a focus on location factors within Dunnings’ framework. The paper will explore market size, cost, and policies as they relate to FDI. Subcategories of each main category will also be examined. Some analysts suggest that China's large host market can reduce supply costs and encourage horizontal FDI due to economic scales (Tseng and Zebreg, 2003). However, it is not just China's population that makes it attractive but also increasing aggregate purchasing power. Over the past two decades, China has seen high-speed development with an average increase speed of two digits, surpassing countries worldwide.

Between 1997 and 2002, the Gross Domestic Product (GDP) of China increased from RMB7,446.3 billion Yuan to RMB10.2398 trillion Yuan, making it the world's sixth largest economy (GheeLim, 2003). The graph below (ibid) illustrates this steady growth. Additionally, during this economic expansion period, the total volume of exports and imports reached US$620.

In 2002, the foreign investment deposit amount in China exceeded US$430 billion and accounted for approximately one third of the year's GDP. Additionally, roughly US$50 billion in foreign investment is absorbed annually, which covers about 4% of the GDP. These conditions demonstrate that China provides a favorable market environment and a promising opportunity for foreign investment, as confirmed by empirical studies conducted by Sun, Tong et al (2002) and Zheng(2001). However, the driving force behind the increase in FDI in China cannot be attributed solely to market size. Other significant factors such as cost-effective labor and attractive policies should also be considered. In selecting a location for

FDI, transportation costs are a crucial factor that must be taken into account alongside other location-specific advantages. This section will examine three aspects of transportation.

According to various studies by Wheele and Mody (1992), Loree and Guisinger (1995), and Richaud et al., having improved transportation infrastructure, including road, railway, and airport, is believed to attract foreign direct investment (FDI) and increase productivity.

According to Morisset (2000), Asiedu (2002), and Sekkat et al. (2004), there is supporting evidence that transport infrastructure has a positive effect on foreign direct investment (FDI). Seetanah (2008) suggests three reasons why improved transport infrastructure has a beneficial impact. Firstly, there are lower start-up costs when public infrastructure is provided as the transportation of materials becomes less expensive. Secondly, it is possible to enhance the usefulness of privately owned and operated cars and trucks with better road designs, and thirdly...

According to research from The University of Technology, improving quantity and quality of transportation systems can reduce supply costs through more efficient use of existing resources. This is evident in the positive correlation between FDI and transport infrastructure in 30 Sahara Africa countries from 1984 to 2002. In China, the coast provinces, particularly the Shanghai region, attracted over 40% of FDI projects, but the government's 'Go West' policy has spurred development of transport infrastructure in interior provinces, leading to increased interest from FDI, according to Drewry Shipping Consultants Ltd.

Secondly, to avoid high transportation costs, multinational companies may choose to engage in Foreign Direct Investment (FDI) for the purpose of exporting. For instance, many American enterprises previously opted for FDI in Mexico to utilize the competitively priced resources available there to manufacture goods and

then export them to the Chinese market. However, in recent years, these companies have shifted their FDI focus to China to avoid high export transportation costs (Hansan, 2001). Thirdly, several multinational corporations have pursued export-oriented FDI in China.

There is controversy surrounding whether high transportation costs deter some multinational companies from manufacturing in China and exporting their goods to other markets. However, the advantages of integration may surpass such expenses. This tactic can be especially advantageous for businesses that sell products back to their home countries, where they possess greater market familiarity. Furthermore, foreign investment in resource-rich nations continues due to the allure of natural resources, despite their decreased significance since World War II.

China has plentiful resources, especially in energy minerals such as coal and oil, as noted by the OECD (2000). The country also possesses valuable assets like land and minerals. This abundance of resources has attracted multinational corporations (TNCs) to China's extractive industries in recent times. Due to a thriving oil market, TNCs have invested in significant coal mining and processing projects across the country.

UNTCAD (2007) reported that Royal Dutch Shell planned to invest $5 billion in a coal-to-liquids facility located in Ningxia province, which was announced in July 2006. Nevertheless, foreign companies may choose to invest in other developing countries with available resources due to China's high energy consumption resulting from an energy shortage. Additionally, the factor cost of essential infrastructure for resource exploration increases, leading ultimately to decreased interest in foreign direct investment.

Labour plays a crucial role in the decision making of companies towards foreign direct investment (FDI). When the host country possesses a comparative advantage in labour, companies are more inclined

towards FDI. A large scale of low-cost unskilled labour or high-quality labour with efficient productivity are preferred. But the advantage of cheap labour is deemed volatile and movable; UNCTAD supports this view (1998:110). As the economy of the host country progresses, the wage rate is expected to increase.

China's extensive workforce offers a competitive edge, but it could result in divergent outcomes for transnational corporations (TNCs). Industries that require manual labor may transfer to other less developed nations with comparable benefits. In contrast, companies seeking efficiency might be enticed by China's enhanced human resources.

Despite the fact that Chinese workers' mean salary is on the rise, its labor-intensive sectors continue to attract attention due to their comparatively lower wage rates. This is evidenced by China having the largest amount of foreign affiliate employees, with around 24 million occupying 3% of overall employment in 2004 (UNCTAD, 2004).

According to the National Bureau of Statistics (NBS), there was a consistent average wage increase of around 14% between 2001 and 2006. Xinhua News Agency reported in 2004 that urban workers had an average salary of 24,932 yuan ($3,561.3 USD) in 2007. Despite this significant wage increase, FDI data suggests a rising trend during these years, implying that TNCs seeking resources may be less attracted due to higher labor costs. However, UNCTAD observed in 2007 that TNCs are shifting towards more capital-intensive production where labor costs matter less.

It is argued that imposing trade barriers discourages potential investors, as it involves a considerable start-up cost for foreign investors (Henley, Kirkpatrick et al, 1999). Despite some mixed effects discovered by various studies, both theoretical and empirical evidence support this perspective (Sun, Tong et al,

2002). Prior to the openness reforms initiated in 1979, China was considered a closed economy. Following a gradual progression over the past three decades with the establishment of several laws and regulations, China has emerged as the top destination for foreign direct investment amongst developing nations (Fung, Iliza et al, Sun, Tong et al, Henley, Kirkpatrick et al). This growth is illustrated by the dramatic increase of FDI inflows shown in the figure below. These findings demonstrate the significant impact of policies implemented by Chinese authorities on FDI promotion.

In their study, Sun, Tong, and Yu (2002) investigated the development of Foreign Direct Investment (FDI) in China as outlined by DEES (1998). The research revealed three phases leading up to China's admission into the World Trade Organization (WTO) in 2001. The initial phase began with the creation of Special Economic Zones (SEZ) and Joint Venture laws in 1979 that facilitated the influx of foreign investment into mainland China. The second stage commenced in 1986 when legal rights were given to wholly owned foreign enterprises, encouraging FDI inflows while deepening "opening-door reforms." Finally, the third stage was marked by Deng Xiaoping's "south China tour" and sustained double-digit growth in FDI.

According to the study conducted by Tsing and Zebregs (2002), there is a positive correlation between Chinese government policies and FDI inflow growth rates, as shown in the Figure. Econometric methods were used by Zhang (2001), Sun, Tong et al (2002), and Cheng, Kwan (1999) to investigate the relationship between FDI inflows and trade openness levels. Zhang's (2001) regression analysis using Ordinary Least Squared method with a dummy variable for trade openness supported the hypothesis that trade

openness has a significant positive impact on FDI inflows. However, this methodology was criticized for not capturing varying levels of trade openness over recent decades. Alternatively, Sun, Tong, and Yu (2002) used imports over Gross Domestic Product (GDP) to measure country openness in their more complex model.

In line with Zhang's (2001) earlier research, the current study also shows a noteworthy positive association. However, Sun, Tong, and Yu (2002) point out that the model's efficiency may be hampered by multicollinearity, and there are doubts about the validity of the openness measurement. In conclusion, empirical evidence and econometric investigations both indicate a strong likelihood that trade openness is a determining factor of FDI inflows in China.

Further research is needed, particularly for the post-China-WTO period, to better assess the impact of openness on FDI inflows despite the reduced clarity of results resulting from the simplification of models. Fiscal incentives are believed to be crucial in attracting FDI in China, with two primary perspectives on the matter endorsed by advocates.

According to Bora (2002) and Blomstrom and Kokko (2003), fiscal incentives can increase FDI under specific conditions. However, opponents such as Halvorsen (1995), Wilson (1996), Osman (2000), Wells et al. (2001), and Cleeve (2005) argue that the costs of using incentives to attract FDI outweigh the benefits and that they may not be the best method. This section focuses on the effects of fiscal incentives on FDI in China, which lowered its national profit tax in Special Economic Zones (SEZs) during government-led opening up reforms. In comparison to the 33% rate outside of SEZs, one SEZ had a rate of just 15% (Cheng and Kwan, 2000).

China's incentive policy has

created an attractive environment for foreign capital inflow since the late 1980s. The country offers a low-lax policy for foreign investment enterprises and preferential tax policies in industries and regions where investment is encouraged by the state. Currently, foreign investment enterprises and individuals can benefit from favorable taxes such as business income tax, personal income tax, turnover tax, and tariff. For instance, foreign investment enterprises are exempt from paying business income taxes during the first two years after the beneficial year followed by half taxation over the next three years. In addition, those endorsed by the state in middle-and-western regions may have their taxes reduced or exempted for five years with an extension of three more years to only half income tax collection after expiration (Bora, 2002).

In the late 1980s and early 1990s, China implemented policies to attract foreign direct investment (FDI), resulting in an increase in foreign capital. However, the impact of tax incentives on FDI is uncertain. Hines (1999) conducted a survey of empirical studies and found that local FDI selection has low sensitivity to tax treatment levels, with an elasticity of FDI to taxation being -0.6 (inelastic). Recent time-series econometric analysis and surveys of international investors have revealed that tax incentives do not play a significant role in choosing investment locations. Both analyses and surveys have concluded that tax incentives are insufficient instruments for counterbalancing negative factors within a country's investment climate (Morisset, 2001).

According to Gorg, Molana, and Montagna (2007), reducing corporate tax by two percent results in a one percent increase in inward FDI. However, increasing the level of social expenditure may have a larger effect on attracting inward FDI

than cutting taxes. Public infrastructure is crucial for the development of any society. Eisner (1991) and Easterly and Rebelo (1993) discovered a consistent correlation between public investment in transportation and communication and economic growth. Kumar (2001) believes that infrastructure availability contributes to attracting FDI inflows, even when holding other factors constant.

While the transportation infrastructure is discussed under the ‘Transportation’ section, this one is solely dedicated to the telecommunication and information structures. Over the years, TNCs' FDI has shown a rise, particularly in high-tech fields like communications and electronics (as depicted in the figure below). There are varied reasons behind this trend, with one being the importance of communication systems such as telephone lines to ensure smooth communication between the host and home countries.

According to Loree and Guisinger (1995), the use of high-tech advancements like email is much quicker than traditional postal services, which leads to significant savings in time and money for businesses. China has also established over 50 high-tech economic zones, attracting nearly half of the nation's high-tech industries. This encourages agglomeration effects and entices more multinational enterprises (MNEs) to invest in the Chinese market. As a result, utilizing high-tech options reduces expenses and improves efficiency, leading to a near fourfold increase in foreign direct investment (FDI) during 2000-2006 within these areas.

According to the U.S. Census Bureau, foreign direct investment (FDI) in the United States has significantly increased from $3 billion to $102.5 billion due to improved infrastructure such as roads, highways, ports, communication networks, and electricity. These enhancements have led to greater productivity and appeal for FDI.

According to Wei et al. (2000), a location's attractiveness over others is increased by having strong

infrastructure. In China, various factors within a location's range have differing impacts on foreign direct investment flow. The country's significant market size, driven by its large population and increasing purchasing power, has made it an appealing destination for considerable FDI influx. Additionally, transportation and production expenses greatly affect TNCs' site selection decisions.

While transportation costs have varying effects on companies that seek markets and those dedicated to exporting, China's inward foreign direct investment (FDI) has historically been drawn in by the country's labor and resource cost benefits. However, such benefits have decreased in significance over time. Instead, FDI growth can be credited to several policies aimed at improving trade openness, providing economic incentives and better infrastructure. Though these measures' individual impact may differ, their cumulative effect is undoubtedly a driving force behind FDI inflows into China.

The task of evaluating the importance of FDI determinants in China is challenging due to several factors, including cultural and political stability, that have an impact on FDI inflow. Unfortunately, this document cannot fully cover these elements. Source: Bora, B.

The World Trade Organisation in Geneva produced a working paper titled "China's Attracting Foreign Investment Policy" in 2002. The Journal of International Economics published "What are the determinants of the location of foreign direct investment?" by Cheng and Kwan (1999) discussing China's experience with foreign direct investment location determinants. E. Cleeve (2005) from Manchester Metropolitan University in the UK conducted a study called "How Effective are Fiscal Incentives to Attract FDI to Sub-Saharan Africa?" DEES (1998) explored foreign direct investment in China, its determinants, and effects on economics and planning in their work titled "Foreign Direct Investment in China: Determinants and Effects".

(1993)

The Journal of Monetary Economics published a study on the relationship between fiscal policy and economic growth, which investigated empirical evidence and spanned across Volume 32, Issue 3. This research was conducted in correlation with Eisner's commentary on infrastructure and regional economic performance, as featured in the New England Economic Review during September to October of 1991.

Fung, Iizaka and Tong (2002) wrote about Foreign Direct Investment in China, discussing the policy, trends, and impact on the economy. J. H. Dunning (1993) wrote about Multinational Enterprises and their role in the Global Economy.

The following sources provide information on China's transport infrastructure, logistics, foreign investment, and growth:

  • Wokingham, Berkshire: Addison Wesley
  • Drewry Shipping Consultants Ltd. (2003) China’s Transport Infrastructure and Logistics [online] ;http://www. pl. com/assets/applets/more_to_china_ex_summary. pdf ; [03 April, 2008]
  • GheeLim(2003) Determinants of, and the relation between, foreign investment and growth, a summary of recent literature International Monetary funds Gorg H.

The online source by Molana H. and Montagna C. (2007) discusses the effects of tax competition and social expenditure on Foreign Direct Investment. The source can be found on http://www.gep.org.

Below are references related to globalization, foreign direct investment, and international taxation:

  • UK Shared Lev Publications: GEP_taxMNEsBGrndFINAL.pdf; [02 April 2008]
  • Hansan (2001) The Globalization of Production [online] http://www.nber.org/cgi-bin/printit?uri=/reporter/spring01/hanson.html [03 April, 2008]
  • Henley, Kirkpatrick and Wilde (1999) Foreign Direct Investment in China: Recent Trend and Current Policy Issues Blackwell Published: Oxford
  • Hines, J. (1999) Lessons from Behavioural Responses to International Taxation National Tax Journal, Vol.

In a study conducted by Kumar in 2001, it was found that infrastructure availability is linked to both foreign direct investment inflows as well as export-orientation. The study explored

this connection across multiple countries and is documented in volume 52, pages 305-22. The authors of the study are Loree D.W. and S.

E. Guisinger's (1995) study titled "Policy and non-policy determinants of U.S. equity foreign direct investment" published in the Journal of International Business Studies, volume 26 issue 2, pages 281-299, examines the various factors influencing foreign direct investment in the United States. Similarly, J. Morisset (2001) discusses the use of tax incentives for attracting foreign investment.

The article "Main Determinants and Impacts of Foreign Direct Investment on China's Economy" can be found in the World Bank's FIAS Occasional Paper 15 and the OECD's Working Papers on International Investment (2000).

The following sources have been referenced:

  • 2000/4. Available at: ; www.oecd.org/dataoecd/57/23/1922648.pdf; [April 16, 2008]
  • Sun, Tong and Yu's (2002) study on determinants of foreign direct investment across China in Journal of International Money and Finance
  • Trietak's (2006) article "Is China’s lustre dimming? From a first glance at recent FDI statistics it might appear so, but upon closer inspection …" published in The inside Bureau Issue No.5-October 2006
  • Tseng and Zebregs' (2002) IMF Policy Discussion Paper on Foreign Direct Investment in China with lessons for other countries
  • The United Nations Conference on Trade and Development's (UNCTAD) report from 1998

The United Nations has issued multiple reports on international trade and investment. Among them is the 1998 publication of the World Investment Report. In 2002, UNCTAD released a report connecting transnational corporations (TNCs) to high export growth in developing countries. This report can be accessed at http://www.unctad.org/Templates/webflyer.asp?docid=2511=2079=1. Additionally, UNCTAD published another report in 2004.

The United Nations published the World Investment Report in 2004 and

2007, both in Geneva and under the supervision of UNCTAD.

The website of University of Technology, Mauritius presents an online resource entitled "Transport Infrastructure and FDI: Lessons From Sub Sahara Africa Economies" which can be found at http://www.afdb. The resource is undated.

Wei, S. (2000) examines the effects of corruption on international investors and provides insights while org/pls/portal/docs/PAGE/ADB_ADMIN_PG/DOCUMENTS/AEC/TRANSPORT%20INFRASTRUCTURE%20AND%20FDI%20LESSONS%20FROM%20SSA.PDF; [03 April, 2008] explores the lessons on transport infrastructure and FDI in SSA.

The citation "82 (1): 1-11" is enclosed within a paragraph tag.

Get an explanation on any task
Get unstuck with the help of our AI assistant in seconds
New