Research Articles Base: Foreign Direct Investment In China

THE ROLE OF FDI IN THE ECONOMIC GROWTH OF CHINA 1979-2004

THE ROLE OF FDI IN THE ECONOMIC GROWTH OF CHINA 1979-2004

IMPACT OF FDI ON THE ECONOMY OF A COUNTRY

IMPACT OF FDI ON THE ECONOMY OF A COUNTRY   How does outward foreign direct investment (FDI) affect domestic economic activity? This question has been the subject of extensive public policy debate in the industrialized world. Opponents of outward FDI argue that outward investment substitutes foreign for domestic production when firms shift parts of the production abroad. Accordingly, outward investment inevitably reduces domestic investment, employment, productivity, and thereby economic growth. Proponents of outward investment, in contrast, point out that outward FDI enables firms to enter new markets, to import intermediate goods from foreign affiliates at lower costs, and to access foreign technology. From this point of view, the entire domestic economy benefits from outward FDI due to the increased competitiveness of the investing companies and associated productivity spillovers to local firms.             Unfortunately, empirical studies do not provide a clear picture of whether and how domestic economic activity is influenced by outward FDI. Stevens and Lipsey (1992), for example, analyze the domestic investment behavior of seven US multinational companies. Their results suggest that that outward investment and domestic investment are substitutes. Desai et al. (2005), on the other hand, using time-series data for the US firms, find a positive relationship between domestic and foreign investment. This finding, in turn, is consistent with a study by Lipsey (1994), who reports a positive correlation between foreign production and domestic employment levels by the US firms. In contrast, the results by Blomström et al. (1997) suggest that in the US multinational firms, higher foreign production is associated with lower employment at home, whereas Swedish parent companies employ more labor at home when they produce more abroad. Finally, Braconier et al. (2001) examine the related question of whether domestic productivity is affected by outward FDI. Using firm- and industry-level panel data for Sweden, they find no evidence of FDI-induced productivity gains. This, however, is in contrast to the results by Barba Navaretti and Castellani (2004), who find that in Italian firms, outward investment increases domestic output and productivity growth. Admittedly, a common feature of all these studies is that they are based on firm- or industry-level data for manufacturing. Since, however, services have emerged as the leading industry for outward FDI, the large majority of outward investment is excluded from the analysis a priori. Furthermore, data restricted to individual investing firms or industries are by definition not able to capture the effects of outward investment on the economy as whole. However, resolving the policy debate about the effects of outward FDI on domestic economic activity requires clarifying the overall effects of outward FDI – in particular, the effects of aggregate outward FDI on economic growth. China has become the top foreign direct investment (FDI) destination among all developing countries and remained host to the world’s largest share of FDI receipts since its accession to the WTO in 2001. Together with the extremely impressive record of FDI influx since China’s economic reform in 1979, Chinahas also experienced remarkable economic growth and development by achieving a high growth rate of almost 10% per annum, on average, and over 10% during the period after Deng’s speech in 1992 reaffirming China’s continuous economic opening. Given such a notable economic growth performance, the quest of China’s sustainable growth continues to stimulate much discussion and vigorous debates among academics during recent years. However, in studying China’s growth, special attention has to be paid to the two major globalized delta economies (GDEs), Pearl River Delta (PRD) and Yangtze River Delta (YRD), located respectively in the south- and east-coastal China (Tuan and Ng, 2009). China’s economic reform and opening policy launched in 1979 successively made PRD and YRD the two most dynamic regions in China.2 These two GDEs represented the two most dominating, fastest growing regions and continued to out-perform all other regions in China in terms of GDP performance and FDI absorption.3 The PRD and YRD, which together account for only 1.4% of China’s total land area and 7.7% of the total population,4 have contributed (on average) 12.3% and 27.4%, respectively to China’s national GDP in recent years; they absorbed 26.2% and 36.1%, respectively, of the total national inward FDI during the post-reform period. In addition, the GDP growth rates of PRD and YRD reached an average of 13.8% and 11.9%, respectively, during the period from 1979 to 2005, a much higher pace than the national average growth rate of 9.7% during the same period (Tuan and Ng, 2009).   References   Barba Navaratti, G., Castellani, D. (2004), “Does investing abroad affect performance at home? Comparing Italian multinational and national enterprises”, London, CEPR Working Paper No. 4284, Blomström, M., Fors, G., Lipsey, R.E. (1997), “Foreign direct investment and employment: home country experience in the United States and Sweden”, Economic Journal, Vol. 107 No.445, pp.1787-97. Braconier, H., Ekholm, K., Knarvik, K.H.M. (2001), “Does FDI work as a channel for R&D spillovers? Evidence based on Swedish data”, Review of World Economics, Vol. 137 No.4, pp.644-65. Desai, M.A., Foley, F., Hines, J.R. Jr (2005), “Foreign direct investment and domestic capital stock”, American Economic Review Papers and Proceedings, Vol. 95 No.2, pp.33-8. Stevens, G.V.G., Lipsey, R.E. (1992), “Interactions between domestic and foreign investment”, Journal of International Money and Finance, Vol. 11 No.1, pp.40-62. Tuan, C. and Ng, L. (2009). “China’s post-economic reform growth: the role of FDI and productivity progress”. Journal of Asian Economics. 20(3), 280 – 293.   Credit:ivythesis.typepad.com

IMPACT OF FDI ON THE ECONOMY OF A COUNTRY

IMPACT OF FDI ON THE ECONOMY OF A COUNTRY How does outward foreign direct investment (FDI) affect domestic economic activity? This qu...

Foreign Direct Investment (FDI) : case of China

One of the mostly discussed issues about Foreign Direct Investment (FDI) is its impact on the export performance of the host country. According to numerous studies the impact of FDI on export performance of host countries varies according to the type and source of FDI. FDI is believed to lead to diversification of the host country’s export sector both directly and indirectly. It may not enter the traditional export sector, which is defined as the sector consisting of those industries whose share in world exports is high in the host country, but may enter the non-traditional export sector, which is defined as the sector consisting of those industries whose share of world exports is low. Indirectly, FDI can lead to diversification of exports through spillover effects, which occur if the presence of FDI in an industry raises the export intensity of the domestic firms in that industry. These spillover effects are expected to be stronger in the non-traditional export sector, because the presence of FDI in this sector may lower the fixed cost of introducing its products in the international market. The domestic firms may also learn from the export behavior of the foreign firms and become aware of foreign markets. Therefore, an increase in the export intensity of the domestic firms in this sector may lead to further diversification of the host country’s exports (Banga 2006).   Knowledge Spill-over increases Export Productivity             Exports raise productivity by giving rise to various benefits, such as more efficient use of resources, greater capacity utilization and gains of scale effects associated with large markets. It is believed that through international trade, knowledge transfer and technology diffusion are facilitated. For example, when local goods are exported, the foreign purchasing agents may suggest ways to improve the manufacturing process. Buyers want low-cost, better-quality products from main suppliers. To obtain this, they transmit implicit and occasionally proprietary knowledge from their other suppliers, which are often based in developed countries. Participating in export markets brings firms into contact with international best practice and learning and productivity growth. Exports may also raise productivity by spurring development of new technologies. Knowledge diffuses via export activities. According to Blomstrom and Kokko (1998) suggest that Multinational Enterprises (MNEs) often have knowledge of, and experience in, international marketing established international distribution networks and lobbying power in their home markets.   FDI aids in Technology Acquisition             The most important reason why countries try to attract FDI is perhaps the prospects of acquiring modern technology, interpreted broadly to include product, process, and distribution technology, as well as management and marketing skills. Technological developments introduced through interaction with technologically-forward MNEs can increase export productivity.   FDI increases Export Efficiency             FDI contributes to efficiency by breaking supply bottlenecks, introduces know-how by demonstrating new technologies and training workers who later take employment in local firms, breaks monopolies and stimulates competition, transfers of technologies to local suppliers, and forces local firms to increase their managerial efforts (Blomstrom and Kokko 1998 cited in Wei and Liu 2006).   FDI contributes to the development of the Manufacturing Sector             In today’s rapidly globalizing world, successful exporting not only depends of competitive products, but also marketing expertise and access to international markets. FDIs contributes to the manufacturing sector in a way that it provides greater access to local products in international markets. It can also be effective means of providing resources, such as skills, training, technology, capital goods and immediate inputs needed to exploit a country’s existing comparative advantages. The most prominent role played by FDI in the exports of developing countries is in the manufacturing sector. In the manufacturing sector, foreign affiliates tend to  be the leaders in export-oriented and marketing, and linking up to marketing and  distribution channels is crucial. The impact of foreign affiliates on the domestic companies’ export activities can be both direct and indirect. Direct effects occur  when exporting foreign affiliates establish backward linkages with local firms,  which then become indirect exporters. Indirect effects of the presence of export  oriented foreign affiliates occur when local firms manage to copy the operations  of foreign affiliates, employ staff by foreign affiliates, and benefit from  improvements in infrastructure and reductions in trade barriers undertaken in  response to the demands of foreign companies.   FDI contributes to the development of Export and Economy             Expanding exports is a means to an end – economic development. To achieve this end, promotion of export oriented FDI should be an integral part of the overall developmental strategy. FDI can help a country in its efforts to raise exports in all kinds of industries by providing the missing elements, that they need to compete or by improving local based skills and capabilities.  In general, two possible relationships describe FDI and exports: (1) substitutes, and (2) complements. Substitutive relationship assumes that international trade is driven by differences in factor endowments and factor prices for homogenous products. These differences become smaller when international factors become mobile between countries. This school of thought also assumes reduction in import tariffs reduces exports and encourage foreign direct investment.  A complementary relationship indicates that FDI and exports move in the same direction. Under this relationship, trade happens when FDI creates or expands the opportunity for export growth. Production by foreign companies of one product may increase total demand for its entire product line, making FDI and exports complementary.   The Case of China             FDI promotes exports by facilitating China access to new and larger market. This involves foreign affiliates’ privileged to not only MNCs international production systems, but also MNCs intra-firm markets and access at arm’s length to MNCs’ customers in global, regional and home-country markets. Export oriented foreign affiliates provide training for the local workforce and upgrade technical and managerial skills that benefit the Chinese exports. This is especially true for export-oriented investments in advanced technological capabilities. China has already attracted significant MNC export activities at labor-intensive and low technology levels. The strategic challenge facing China is that its future competitiveness depends on the host government’s ability  to boost the human capital and technological infrastructure. In turn, MNCs feed benefits back  into local skill and technology systems, providing information, assistance and contracts. The positive role of FDI in China’s exports may be summarized in terms of direct and indirect effects. The direct effects refer to exports by foreign affiliates. The spillovers of FDI on export activities of local firms make up the indirect effect.   The contributions of foreign affiliates to China’s exports include the following four aspects: 1. Exports through processing and assembling – by processing components and assembling in which domestic forms import unfinished and intermediate goods, China became a dominant exporter of labor intensive products (toys, shoes, clothes, and sporting goods) and some technology intensive products (machinery and equipments, including electronic circuits, automatic data-processing machines, and mobile phones). 2. Exports through converting import-substituting industries – many developing countries including China restrict imports of manufacturing products but may allow FDI in these sectors. With well-designed policies, China started and increased exports of the import-substituting products by combining its cheap labor with advanced technology embodied in FDI. 3. Export of new labor-intensive final products – the success of some Chinese brand names of light consumer goods in entering world markets is partly due to FDI providing links to final buyers, especially in the US markets. 4. Exports of local raw materials processing – in the processing of locally produced raw materials, foreign affiliates may have better export potential than indigenous firms, because of their business contacts abroad, marketing skills, and superior technology, both in  product and processes, and greater general know-how. This is especially true in the 1980s, when the Chinese firms lacked these assets and FDI was the only means, at least for the time being, of increasing exports.       References   Banga, R. (2006). The Export-Diversifying Impact of Japanese and US Foreign Direct Investments in the Indian Manufacturing Sector. Journal of International Business Studies 37(4): 558+.   Blomstrom, M. and Kokko, A. (1998). Multinational Corporations and Spillovers. Journal of Economic Surveys. 12(2): 1-31.   Wei. Y. and Liu, X. (2006). Productivity Spillovers from R&D, Exports and FDI in China’s Manufacturing Sector. Journal of International Business Studies 37(4): 544+.           Credit:ivythesis.typepad.com

Foreign Direct Investment (FDI) : case of China

One of the mostly discussed issues about Foreign Direct Investment (FDI) is its impact on the export performance of the host c...