History
China’s experience with foreign direct investment has been a quite recent one. Although the Chinese traded with far away Europe as early as 114 BC, it were always the emissaries of the emperors who established contact and kept embassies in the countries along the famous “Silk Road” and the less well know “Porcelain Route”. The heyday of the Silk Road corresponds to that of the Byzantine Empire in its west end, Sassanid Empire Period to Il Khanate Period in the Nile-Oxus section and Three Kingdoms to Yuan Dynasty in the Sinitic zone in its east end. Trade between East and West also developed on the sea, between Alexandria in Egypt and Guangzhou in China, fostering the expansion of Roman trading posts in India .
During the Qing dynasty (1644-1912) China came under growing foreign pressure to
open up its borders to the Western seafaring powers. In 1535 Portuguese traders obtained the right to anchor ships in the harbor of Macao, a small island off the coast of mainland China. In 1557 the first walled settlement marked the earliest Direct Foreign Investment on Chinese soil. The island prospered under the new administration where the Portuguese acted as middlemen for traders on the route Guangzhou-Macau-Nagasaki, shipping silks from China to Japan and silver from Japan to China. Despite clashes with the Dutch, who were looking to establish trade colonies of their own, the Portuguese managed to hold on to their outpost (with a stint of independence in 1849) until the formal handover to China on December 20th 1999 .
Britain had its own reason for investing in the Middle Kingdom. In the early 19th century, British tea imports had taken such flight that a great trade imbalance between China and the British Empire existed. Although Britain exported commodities like silver, clocks and watches to China the market was too small to counter the local demand for tea. As a result, Britain started to export opium and soon established itself as the sole provider of the addictive drug. The Qing dynasty voiced their objections through the Chinese commissioner Lin Zexu to the British Queen Victoria but when the British Empire proved to be non responsive to Chinese complaints had to revert to military enforcement of its drug laws. During the resulting opium wars (from 1839 to 1842 and from 1856 to 1860) British victories forced the Chinese government to hand over Hong Kong which soon became the second foreign trade colony on Chinese territory.
After the Second World War, cheap labor and capital brought in by refugees from Mainland China transformed Hong Kong’s economy from a trade colony to a manufacturing and industrial hub. On July 1st 1997 sovereignty of Hong Kong was handed over to China which kept the former colonies capitalist system intact and created a Special Administrative Region (SAR) .
FDI in recent times
China’s experience with foreign direct investment has been a quite recent one. Although the Chinese traded with far away Europe as early as 114 BC, it were always the emissaries of the emperors who established contact and kept embassies in the countries along the famous “Silk Road” and the less well know “Porcelain Route”. The heyday of the Silk Road corresponds to that of the Byzantine Empire in its west end, Sassanid Empire Period to Il Khanate Period in the Nile-Oxus section and Three Kingdoms to Yuan Dynasty in the Sinitic zone in its east end. Trade between East and West also developed on the sea, between Alexandria in Egypt and Guangzhou in China, fostering the expansion of Roman trading posts in India .
During the Qing dynasty (1644-1912) China came under growing foreign pressure to
open up its borders to the Western seafaring powers. In 1535 Portuguese traders obtained the right to anchor ships in the harbor of Macao, a small island off the coast of mainland China. In 1557 the first walled settlement marked the earliest Direct Foreign Investment on Chinese soil. The island prospered under the new administration where the Portuguese acted as middlemen for traders on the route Guangzhou-Macau-Nagasaki, shipping silks from China to Japan and silver from Japan to China. Despite clashes with the Dutch, who were looking to establish trade colonies of their own, the Portuguese managed to hold on to their outpost (with a stint of independence in 1849) until the formal handover to China on December 20th 1999 .
Britain had its own reason for investing in the Middle Kingdom. In the early 19th century, British tea imports had taken such flight that a great trade imbalance between China and the British Empire existed. Although Britain exported commodities like silver, clocks and watches to China the market was too small to counter the local demand for tea. As a result, Britain started to export opium and soon established itself as the sole provider of the addictive drug. The Qing dynasty voiced their objections through the Chinese commissioner Lin Zexu to the British Queen Victoria but when the British Empire proved to be non responsive to Chinese complaints had to revert to military enforcement of its drug laws. During the resulting opium wars (from 1839 to 1842 and from 1856 to 1860) British victories forced the Chinese government to hand over Hong Kong which soon became the second foreign trade colony on Chinese territory.
After the Second World War, cheap labor and capital brought in by refugees from Mainland China transformed Hong Kong’s economy from a trade colony to a manufacturing and industrial hub. On July 1st 1997 sovereignty of Hong Kong was handed over to China which kept the former colonies capitalist system intact and created a Special Administrative Region (SAR) .
FDI in recent times
Foreign Direct Investment started when China’s Communist government decided to loosen the reigns of socialist dogma and allow China to become part of the world economic community. In 1980 the first Special Economic Zones were created in Shenzhen, Zhuhai and Shantou in Guangdong Province and Xiamen in Fujian Province as well as the entire province of Hainan. In addition, 15 free trade zones, 32 state-level economic and technological development zones, and 53 new- and high-tech industrial development zones have been established in large and medium-sized cities. The SEZ’s were driven by a “four principles” policy namely:
1. Construction primarily relies on attracting and utilizing foreign capital
2. Primary economic forms are sino-foreign joint ventures and partnerships as well as wholly foreign-owned enterprises
3. Products are primarily export-oriented
4. Economic activities are primarily driven by market forces
The results were astounding. In 1999, Shenzhen's new-and high-tech industry became one with best prospects, and the output value of new-and high-tech products reached 81.98 billion yuan, making up 40.5% of the city's total industrial output value. Nowadays, the city rivals Hong Kong in size and scope. Guang Dong Province has become a major hub for electronic and industrial manufacturing mainly geared towards exports. According to a report by DTZ, there are over a hundred Fortune 500 companies established in Shenzhen with a total of about 84,000 foreign expatriates. In terms of FDI, Shenzhen has maintained a high rate of growth in the last few years, with FDI in 2006 registering 10.6% higher than the year before.
China’s vast labor market, low wages, good infrastructure and relatively disciplined work ethics have led to the largest manufacturing engine in the world. Foreign Direct Investment is crucial to the building efforts of Chinese manufacturers as well as foreign companies establishing a presence in Mainland China. The development of local economies goes hand in hand with the establishment of Special Economic Zones and shows a strong relationship with FDI.
The role of FDI in the development of a country.
In colonial times, foreign investment was a matter of domination. When the Dutch established their trade colony in the East Indies, they didn’t come as partners but soon took the reins of government from the local rulers. In modern times, this has made countries like China and India weary of foreign investment. Wherever Western countries have economic interest, they want to establish political and legal authority as well. The efforts of the US to push for reforms in China’s legal and economic system are not inspired by bilateral equality but by US interests alone. Still the beneficial effects of FDI on China’s economy are so great that China’s government can’t disallow it without risking severe economic and political repercussions. However, the story of FDI in China is not quite as rosy as these summary sentences suggest. By all accounts, the policy environment for foreign direct investors in China is difficult, and much anecdotal evidence suggests that some of these investors are becoming discouraged by this environment while other potential investors have been deterred by it.
An explanation for the effect of FDI on a country’s development can be found in an analysis of the local economic situation. Countries like China, India, Brazil and Mexico have a vast population but a relatively low income level. Large families with a low income spend most of that income on food, clothing and housing, leaving little to buy the luxury items that the country produces for export. As long as local demand for domestic products is low, a country remains dependent on export which in turn means foreign investment.
Examples like Singapore and Japan show that as soon as the internal market starts developing the economy becomes more self sufficient and less dependent on FDI. Singapore’s Direct Investment Abroad (DIA) now constitutes more than 4 billion dollars while DIA is a little more than 3 billion. Singapore has a well developed service sector, excellent medical facilities and a robust internal economy. Despite the gap in income between Chinese middle class families living in Beijing, Shanghai or Shenzhen and families living in China’s rural provinces the growing prosperity is visible. According to the IMF, China’s GDP in 2007 was $3,248,522 versus a US GDP of $13,794,221. China has a population of 1,321,851,888 while the US has about a third of that number. This means that if the Chinese can raise the average wealth of the population, the internal market potential is enormous.
Has the Chinese government maximized the benefits of their FDI policy?
Despite the establishment of SEZ’s there still exist significant issues for foreign investors to enter the internal Chinese market. Despite the economic freedom enjoyed within the confines of the SEZ, China still remains a communist country. The policy of “one country, two systems” has allowed the Chinese government to benefit from the economic growth of the capitalist enclaves while keeping the old fashioned centralized communist rule intact. As shown recently by the hard handed suppression of the Tibet protests, the government isn’t willing to give up its power just yet. The FDI policy attracts companies because of the liberal tax and economic climate it creates but because of the relatively underdevelopment of the rural provinces most of these companies are export oriented. The increase in buying power for Mainland Chinese has mostly been confined to the SEZ themselves and the surrounding areas. The further you go away from the SEZ’s the lower the average income and the poorer the countryside.
As the name suggests, FDI allows for foreign investment, which does little for China’s local capital markets. China has one of the highest savings rate in the world and this money isn’t invested locally but instead exported to countries like the US. The result is that local manufacturers and other SME’s benefit little from the FDI policy and since they are not allowed to establish a presence inside the SEZ’s can’t compete with the foreign firms. The lack of domestic economic development will slow the development of the local market keeping China dependent on foreign investment down.
Another issue that isn’t addressed by the FDI policy is the lack of sharing of technological knowledge. US companies like Apple use cheap Chinese labor to make their iPods and Macs but don’t share the know-how behind the manufacturing. Concerns about protection of intellectual property keep most foreign investors from forming equal partnerships with local companies.
More liberalization of the FDI policy will attract more foreign investors. The question is if this will benefit China’s economy. The marginal value of additional investors will be less because China’s economy is already on the point of overheating. Extending the FDI regulations to (selected) local companies as well as stimulating domestic investment would be more beneficial.
Investing in China from a foreign perspective.
1. Construction primarily relies on attracting and utilizing foreign capital
2. Primary economic forms are sino-foreign joint ventures and partnerships as well as wholly foreign-owned enterprises
3. Products are primarily export-oriented
4. Economic activities are primarily driven by market forces
The results were astounding. In 1999, Shenzhen's new-and high-tech industry became one with best prospects, and the output value of new-and high-tech products reached 81.98 billion yuan, making up 40.5% of the city's total industrial output value. Nowadays, the city rivals Hong Kong in size and scope. Guang Dong Province has become a major hub for electronic and industrial manufacturing mainly geared towards exports. According to a report by DTZ, there are over a hundred Fortune 500 companies established in Shenzhen with a total of about 84,000 foreign expatriates. In terms of FDI, Shenzhen has maintained a high rate of growth in the last few years, with FDI in 2006 registering 10.6% higher than the year before.
China’s vast labor market, low wages, good infrastructure and relatively disciplined work ethics have led to the largest manufacturing engine in the world. Foreign Direct Investment is crucial to the building efforts of Chinese manufacturers as well as foreign companies establishing a presence in Mainland China. The development of local economies goes hand in hand with the establishment of Special Economic Zones and shows a strong relationship with FDI.
The role of FDI in the development of a country.
In colonial times, foreign investment was a matter of domination. When the Dutch established their trade colony in the East Indies, they didn’t come as partners but soon took the reins of government from the local rulers. In modern times, this has made countries like China and India weary of foreign investment. Wherever Western countries have economic interest, they want to establish political and legal authority as well. The efforts of the US to push for reforms in China’s legal and economic system are not inspired by bilateral equality but by US interests alone. Still the beneficial effects of FDI on China’s economy are so great that China’s government can’t disallow it without risking severe economic and political repercussions. However, the story of FDI in China is not quite as rosy as these summary sentences suggest. By all accounts, the policy environment for foreign direct investors in China is difficult, and much anecdotal evidence suggests that some of these investors are becoming discouraged by this environment while other potential investors have been deterred by it.
An explanation for the effect of FDI on a country’s development can be found in an analysis of the local economic situation. Countries like China, India, Brazil and Mexico have a vast population but a relatively low income level. Large families with a low income spend most of that income on food, clothing and housing, leaving little to buy the luxury items that the country produces for export. As long as local demand for domestic products is low, a country remains dependent on export which in turn means foreign investment.
Examples like Singapore and Japan show that as soon as the internal market starts developing the economy becomes more self sufficient and less dependent on FDI. Singapore’s Direct Investment Abroad (DIA) now constitutes more than 4 billion dollars while DIA is a little more than 3 billion. Singapore has a well developed service sector, excellent medical facilities and a robust internal economy. Despite the gap in income between Chinese middle class families living in Beijing, Shanghai or Shenzhen and families living in China’s rural provinces the growing prosperity is visible. According to the IMF, China’s GDP in 2007 was $3,248,522 versus a US GDP of $13,794,221. China has a population of 1,321,851,888 while the US has about a third of that number. This means that if the Chinese can raise the average wealth of the population, the internal market potential is enormous.
Has the Chinese government maximized the benefits of their FDI policy?
Despite the establishment of SEZ’s there still exist significant issues for foreign investors to enter the internal Chinese market. Despite the economic freedom enjoyed within the confines of the SEZ, China still remains a communist country. The policy of “one country, two systems” has allowed the Chinese government to benefit from the economic growth of the capitalist enclaves while keeping the old fashioned centralized communist rule intact. As shown recently by the hard handed suppression of the Tibet protests, the government isn’t willing to give up its power just yet. The FDI policy attracts companies because of the liberal tax and economic climate it creates but because of the relatively underdevelopment of the rural provinces most of these companies are export oriented. The increase in buying power for Mainland Chinese has mostly been confined to the SEZ themselves and the surrounding areas. The further you go away from the SEZ’s the lower the average income and the poorer the countryside.
As the name suggests, FDI allows for foreign investment, which does little for China’s local capital markets. China has one of the highest savings rate in the world and this money isn’t invested locally but instead exported to countries like the US. The result is that local manufacturers and other SME’s benefit little from the FDI policy and since they are not allowed to establish a presence inside the SEZ’s can’t compete with the foreign firms. The lack of domestic economic development will slow the development of the local market keeping China dependent on foreign investment down.
Another issue that isn’t addressed by the FDI policy is the lack of sharing of technological knowledge. US companies like Apple use cheap Chinese labor to make their iPods and Macs but don’t share the know-how behind the manufacturing. Concerns about protection of intellectual property keep most foreign investors from forming equal partnerships with local companies.
More liberalization of the FDI policy will attract more foreign investors. The question is if this will benefit China’s economy. The marginal value of additional investors will be less because China’s economy is already on the point of overheating. Extending the FDI regulations to (selected) local companies as well as stimulating domestic investment would be more beneficial.
Investing in China from a foreign perspective.
So far, the Chinese FDI policy has been a great success in attracting foreign capital. However there are severe issues for foreign investors to consider when investing in China. The lack of transparency and regulatory oversight makes investing beyond the SEZ’s let alone tapping the Chinese market a risky business.
Doing business in China isn’t a matter of quick in, quick out. Establishing relationships with government officials, suppliers and local business partners is very important and can take a long time. Networking is an aspect of doing business around the world, but it takes on added importance in a society with a complex bureaucracy and a weak legal system. A web of guanxi helps firms navigate China's bureaucratic and distribution challenges.
China is a very diverse market with varying levels of development and regional industrial strengths. A mistake made by many investors is to consider the Chinese market as homogenous. Each region has its own consumer preferences and business needs. Some industries are spread all over the country, some are clustered, and others are heavily concentrated in one area.
The continuance of China’s FDI policy means that foreign investors are relatively sheltered from direct competition by local Chinese companies. If China decides to expand the SZE’s or allows economic freedom to extend beyond the zones, the effect on foreign investors can be profound. Local companies often have an established guangxi network, can benefit from an established presence and know the local market. If they can compete on equal footing and with equal access to foreign capital they have a head start in China’s local market. So far local capital is either locked up in savings accounts or has been invested abroad. If China changes or abolished it’s FDI policy in favor of more economic freedom this could lead to an influx of capital to boost local firms. Already domestic companies like Lenovo, China Mobile and Bosideng dominate the local markets. According to a survey conducted by the Business Brand Institute, International Advertising magazine and the Communication University of China Chinese consumers prefer local brands to foreign ones, with domestic products the top choice in 39 of 57 categories, or 68 percent. Foreign investors should take this into account when making a decision to invest directly or put their capital in local Chinese companies.
Remaining issues for direct foreign investors are labor and sustainability issues and their potential for reputation damage. So far, the low wages and willingness to work long hours under sweat shop conditions have given China’s workers the edge over their US and EU counterparts. As wages and prosperity increase so will the calls for better working conditions. The special tax and financial breaks that investors get through China’s FDI policy do not extend to domestic demands for a fair and equal working environment. US and EU regulations can apply to manufacturing conditions abroad which can negate the beneficial effects of the FDI policy.
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