FDI in China: An Asian Perspective 9789814345897

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AN ASIAN PERSPECTIVE

The Institute of Southeast Asian Studies (I SEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute's research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), Regional Social and Cultural Studies (RSCS), and the ASEAN Transitional Economies (ATEP). The Institute is governed by a twenty-two-member Board of Trustees comprising nominees from the Singapore Government, the National University of Singapore, the various Chambers of Commerce, and professional and civic organizations. A ten-man Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute's chief academic and administrative officer.

AN ASIA 'N PERSPECTIVE

Yasheng Huang

THE CHINESE UNIVERSITY PRESS Hong Kong

IIEII!ii INSTITUTE OF SOUTHEAST ASIAN STUDIES

Singapore

Published by Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Pai\iang Singapore 119614 Internet e-mail: [email protected] World Wide Web: http://www.iseas.edu.sg/pub.htrnl and The Chinese University Press Shatin, N.T. Hong Kong Fax: +852 2603 6692 +852 2603 7355 Internet e-mail: [email protected] World Wide Web: http://www.cuhk.edu.hk/cupress/wl. htm All rights reserved. No part of this publication may be produced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 1998 Institute of Southeast Asian Studies, Singapore

The responsi bility for facts and opinions in this publication rests exclusively with the author and his interpretations do not necessarily reflect the views or the policy of the Institute or i ts supporters. Cataloguing in Publication Data Huang, Yasheng. Foreign direct investment in China : an Asian perspective. (ISEAS series on China and the Asia-Pacific, 0219-0710; 1) 1. Investments, Foreign-China. I. Title. ll. Series. 1998 sls97-98365 DS501 15993 no. 1 ZTn.10.97 F~r Hong Kong and the USA, ISBN 962-201-849-1 (hard cover) is distributed solely by the Chinese University Press.

For other parts of the world ISBN 981-3055-87-1 (soft cover) ISBN 981-230-010-4 (hard cover) ISSN 0218-0710 are distributed solely by !SEAS The cover photograph is reproduced with the kind permission of "images copyright © 1997 PhotoDisc, lnc". Typeset by Superskill Graphics Pte Ltd Printed in Singapore by Prime Packaging Industries Pte Ltd.

iv

Cont ents

List of Tables

vii

List of Figures

ix

Acknowled gements

xi

Abbreviati ons

xii

Chapter 1

Introductio n

1

Chapter 2

China's FDI Performan ce from an Asian Perspectiv e

9

Chapter 3

Explaining China's FDI Performan ce

29

Chapter 4

Evaluation

53

Chapter 5

Implication s

78

Bibliograp hy

91

Index

99

About the Author

105

v

List of Tables

1.1

Shares of Global Inward and Outward FDI F1ows

2.1

Cumulative FDI FLows, 1988-92

19

2.2

Ratios of the Annual Average FDI In!low for Two Periods

19

2.3

Share of FDI Inflows in GDC Formation

21

2.4

Estimates for the Share of Foreign-Invested Enterprises of the Total Domestic Sales and of the Number of Firms

25

2.5

Cumulative Financial Flows: Shares of Four Types of External Financing

26

3. 1

Concentration Ratios of Investing Countries

32

3.2

Indicators of Inward and Outward Development Strategies

42

3.3

Protection and Import Liberalization on Finished Vehicles in Korea and China

45

4.1

Regression Estimates

60

4.2

Round-tripping FDI under Three Assumptions

62

5. 1

U.S. Trade Deficit and U.S. Import Growth

81

vii

2

List of Figures

4.1

Growth Rates of Chinese Capital and Inflows from Hong Kong and Macao, and from ASEAN, 1986-94

58

4.2

Growth Rates of Chinese Capital Outflows and FDI Inflows from the United States and Japan, 1986-94

59

ix

Acknowledgements

I wish to acknowledge support and encouragement from Professor Chan Heng Chee, form e r dire ctor o f the Institute of Southeast Asian Studies (ISEAS) . She hosted my stay as a research fellow at ISEAS in December 1995. I also wish to thank Drs. Carolyn Gates and Ng Chee Yuen, both at ISEAS, and Professor Tan Kong Yan1 at the Business School of the National University of Singapore for discussions and sharing their research. For th.is book, I received financial and logistical support from ISEAS and the Center for International Business Education at the University of Michigan Business School. This work draws from my project on China's integration into the world economy, which has been supported by grants from the Social Science Research Council, the MacArthur Foundation, and the U.S. Institute of Peace. Thanks also to Nancy Hearst at Harvard University for proofreading the text. I also would like to thank Kaja Sehrt and Caroline Kim, both at the University of Michigan, for their excellent research. All errors, however, are those of the auth or alone.

xi

Abbreviations

ASEAN BJC

BKPM CASS CITIC CPE EASA EIU FDI

FIE HKMC IPR MNCs NIEs PECC RMB SEZs SOEs SPC SSB UNCTC

WTO

Association of Southeast Asian Nations Beijing Jeep Corporation National Investment Governing Board Chinese Academy of Social Sciences China International Trust and Investment Corporation Centrally-Planned Economies East Asia and Southeast Asia Economist Intelligence Unit Foreign Direct Investment Foreign-Invested Enterprises Hong Kong and Macao Intellectual Property Rights Multinational Corporations Newly Industrialized Economies Pacific Economic Co-operation Council Renminbi Special Economic Zones State-Owned Enterprises State Planning Commission State Statistical Bureau United Nations Centre on Transnational Corporations World Trade Organization

xii

Introduction

C

hina's impressive economic perfom1ance has led a number of authors to conclude that China is the latest East Asian newly industrialized economy (NIE). 1 Although there are striking sinularities between China and other East Asian NIEs, there are also striking differences. This study focuses on one area of these differences-differences in the roles and management of foreign direct investment (FDI) inflows into China as compared with a number of East Asian and Southeast Asian newly industrialized econonues (EASA NIEs) . The importance of this topic is underscored by two facts. First, the rise of China as an econonuc power and as a large recipient of global FDI flows pronuses to bring about fundamental changes in the location of Asian manufacturing sites and in trade relations between East Asia and the Uruted States. Second, the EASA NIEs are beco ming important sources as well as recipients of global FDF The FDI supply from these regions is aided, in no small measure, by the increasingly active fmancing and production roles of what Wells 3 calls "mobile exporters"-overseas Chinese corporations in the AsiaPac ific region . These two facts-China as a large recipient of FDI and the EASA econonties as in1portant suppliers and recipients of FDI-are shown in Table 1.1.

FD! in China

TABLE 1.1 Shares of Global Inward and Outward FDI Flows (In percentages) (1)

(2) ShaTe of Total Flows Sha1·es of D eveloping CountTies JnwaTd I nvestment

China

1986-90 1991 1992

1.98 2.8 8.01

12.6 10.6 22.5

5.5 6.62 8.67

34.78 41.9 32.5

EASA NIEs

1986-90 1990 1991 Other countries: United States

1986-90 1991

36.5 15.4

Japan

1986-90 1992

0.3 1.9

NOTE:

EASA NIEs refer to Hong Kong, Taiwan, Korea, Singapore, Thailand, Malaysia, Indonesia, and the Philippines. SOURCE: Adapted from JETRO (1994, Table I-1.1 and Table I-1.2) .

The shares of China and of the EASA NIEs grew rapidly in the 1990s in terms of inward flows. China's global share in 1992 was about four times its average in the 1986-90 period; the share of the EASA NIEs increased by 60 percent during the same period. The East Asian gain has been at the expense of both the United 2

States and the developing countrit>s as a wholP. The ll.S. share declined by more the:m half; China and the EASA NIEs dominated FDI inflows to developing countries. China and the EASA NIEs together recf'ived -!7..! pf'tTt>nt. in the 1986-90 period and 52.5 percent in 1991 or tht> entire FDI inflow into the developing countries.' According to the Chirwse Ministry of Foreign Trade and Economic Co-operation (MOFTEC), in H196 China received FDI inflow totalling US$40 billion, making it the second largest FDI recipient after the United Statesr' This study focuses on FDI inflows into China and the EASA NIEs and suggests a mm1ber of reasons why FDI control in China appears to be more liberal than it is in the EASA NIEs and why the level of FDI i.n!lows into China is higher. A standard perspective on FDI into China-popular especially in the business press and boardrooms-points to China's advantageous economic fundamentals: the large wage differences between China and the EASA NIEs, China's fast economic growth, and the putative attractiveness of the Chinese domestic market." The present study does not dispute these claims; instead the purpose here is to raise questions about the explanatory power of this perspective and to suggest a number of considerations that have been ignored. The standard perspective, implicitly at least, draws from the "location" theory of FDI. The location theory of FDI states, simply, that there are cettain advantages that firms reap from locating production in particular foreign sites. The advantages include, among many others, proximity to the sources of demand for their products and/or to the sources of their input, reduction of labour costs, and developing better information about local conditions (Dunning 1988). However, not all the locational advantages are a function of purely economic variables. For exan1ple, compared with Latin American countries, in the 1970s and 1980s, while the East Asian

3

FDI in Chi na.

NIEs offered attractive economic fundamentals to foreign firms, their stiingent policy restrictions sharply reduced advantages to foreign firms setting up operations in these economies. FDI inflows are not an automatic function of the economic fundamentals of a country and the FDI regulatory regime can have a powerful and independent effect on FDI flows. It is in1portant to recall that the rapid growth of the roles of foreign companies in China is of relatively recent vintage. The real surge in the FDI inflows took place in 1992; the cumulative FDI inflows between 1992 and 1994 accounted for some 73 percent of the FDI stock between 1979 and 1994. During the 1980s, the FDI grew steadily, but not at a spectacular rate, even though the Chinese economic growth was already quite impressive during this period. FDI policies of host countries can be promotional or restrictive and these policies have a big in1pact on the levels of the FDI. This is abundantly clear when one examines the history of FDI in Japan and in the East Asian newly-industrialized economies (NIEs), countries with largely sound economic fundamentals. Japan, the world's second largest economy, has a level of FDI inflows lower than that of Greece. 7 The FDI regulatory framework is a more direct measure of a country's preferences for FDI than the FDI levels per se. When the FDI regulatory regime is included within the traditional explanation, it is, often implicitly, treated as exogenously given and used to explain the surges of the FDI inflows in the early 1990s. But it is quite possible that changes in the FDI regulatory regime and in the FDI levels can be a function of a third common variable which is omitted from the standard perspective. The standard perspective on FDI is based on an "absolute" notion of locational advantages when in fact the relative advantages are more pertinent. To be sure, 4

/11/rort u r'l i n n

good economic fundamentals induce more investment, but why have there been more fore·1:gn investments? Strictly speaking, an account of the FDI growth is not about FDI growth per se but is about why foreign fim1s have invested more than domestic firms (as the increasing share of FDI of domestic capital formation indicates). Thus our story has to start with explaining why, over time, foreign firms have gained advantages relative to domestic firms and in particular how China's institutions and policies may have enhanced or, as the case may be, reduced these relative advantages. A further problem is that the standard explanation usually ignores the significant liabilities of investing in China. China's lack of a rule of law, high inflation, and high variance in economic growth rates (not to mention political uncertainties) would normally deter FDI inflows to some extent.R Wage differentials have always existed but the truly accelerated FDI growth is of more recent vintage. An important reason for the accelerated FDI growth is related to the supply side- the entry of new overseas investors into China since the early 1990s. The surge of FDI inflows in the 1990s can be partially accounted for by the entrance of two new investors, Taiwan and Korea. In the 1980s, for political reasons, Taiwan and Korea had zero investment positions in China, but by 1995, FDI inflows from these two regions accounted for 9 percent of China's total FDI inflow in the case of Taiwan and 2.77 percent in the case of KoreaY The standard perspective also ignores the differences between the overseas Chinese investors in the 1980s and those in the 1990s. Traditionally, investment from Hong Kong and Taiwan was dominated by firms producing light, labour-intensive products, using sin1ple production techniques and processes. 10 Since 1992, the new investors have been Asian multinational corporations. These firms do not necessarily specialize in labour-intensive sectors

5

Fnl iu

rei! ino

to take advantage of th e wage diiTer('nces. Tlwit investment p01t.folio includ(:'S real est.ate, infrastruct.ural devel opment, finan cial services, and manufacturing . It i ~ their entrance that. has co ntributed to the recPnl investment. surge because t.he amount. of cap ital commitment has been mu c h greater.'' Li Ka Shing's Cheung Kong Holdings, a Hong Kong conglomerate, aft r to Lh e I 977 and I 985, p ri ods and ar cak ulateu from Lim and J"ong (199 1, T able 3, p. 34) . SL•1tisLi ·s fur China art• drawn from State Statistical Bur~'crf'tariat ( 1993), Gillis ( 1994 ), Elll (1995a.), and Elll (l995e), in addition to vruious issues of Crmnfry Rr port: Indonesia by tlw EIU . This part of the disc uss ion is basf'd on thE' following sources: Platt ( Wf\2), UNC'TC ( IH~12) , Haggard and Chpng ( 1987), Elll (1986). Dt>part.mt>nl of C'onunPrcf' (1 99fib), and EilJ ( 19H5c). This part o f tlw disc uss io n is basl:'d on t.hf' foll ow ing sourcE's: Stallings llfiDO), Yu ( WD ·n . Dt>partment of Commerce ( W95n ), Platt l W82) . UNCTC' ( W92), and EIU ( 19fl5d ). Ell! ( 19H5f), p.3. "Feeling upbPat" (1995). EIU (199q(). Fi na·n cial Tim es, 1 Jmmary 19n7. The n' arE' ce rtain issues that are of obvious concern to forPign inws tors about iiWE'sting in China. ThesE' issues include concerns about gem'ral political stability during the post.-Deng t'ra, m1d C'hlna's inflation. These issues are not discussed in detail hPre . UNCTC' t\ 992) , p. 12. Wang ( 1HH3). For a df'scription of the problems affecting FDI data, see Stopver ( 1988). Ca.lculatPd from State Statistical Bureau ( 1988) and State Statistical Bureau ( 1996). Whether substitution or complemt>ntarity t>ffects are strongN depends on the complt>x mamwr with which domestic tinus tinance their shmt's nf capital contributions and on th e institutional relationship between foreign investors on the one hand and tht> host govenunents on the other. It shlHIId be nult'd lwrt' that China had a much larger shru·e llf F'Ul stuck in tlw primary St>dor at the beginning of the ea rly I ~l80s wht>n foreign direct investment was. first pt•nnittt•d. In W83, tlw primary sedor claimed 66.9 percent

FDI i11

18 19

h iuo

of the total FDI stock. This was in part because of the numerous policy restrictions by the government on entry into the manufacturing sector at that time. These statistics are drawn from UNCTC (1992, pp. 21-23). See Nunnenka.mp (1993). See Kueh ( 1992), pp. 656--61.

CHAPTER3

Explaining China's FDI Performance

A

comprehensive exp lanation of China's FDI performance relative to other EASA NIEs should focus on resource e ndowm e nts, stages of economic development , eco nomi c and political institutions and government policies. This book limits itself to the institutional and policy factors behind China's FDI performance. An obvious institutional and policy factor is the liberalization of FDI controls. The increasingly important role of FDI in financing Chinese economic development is a ftmction of removals by the goverrunent of the geographic and sectoral restrictions on the FDI activities. But this observatfon begs the obvious question: Why should policy-makers in China liberalize the FDI control regin1e and choose a heavy FDI-dependent financing scheme? I will try to analyse those institutional and policy factors that are neglected in other analyses of FDI. The conventional rationale for FDI is that it brings capital and technology to the host economies. While this is an important motivation for FDI, it is also not the whole story. For one thing, it is important to note . that there are important tradeoffs between absorbing FDI and

29

FDJ in Chi1w

making market conc£'ssions and ct>ding national coni rol to foreign finns. Some govemnwnts, notably Korean and Japanese govemments, han• traditionally lwen unwilling to make this kind of trad ts a nd business organizations . First, flow data meas ure changes in foreign ownership rather th a n tlw dl'gree of fon·i g n ownership peT se. Thus, a lthou gh China has bet'n thl· largest recipi ent of FDI am ong developing cuu.ntrit>s in the last few years, thi s do es not imply that fon·i g n control of th e Chinese economy is twcessarily grt>att•r than that in other developing countries. China has had a

G4

Evaluation

much shorter history of allowing FDI; the degree of foreign control is more precisely reflected in FDI stock data. A more nagging problem involves the ambiguous concept of "foreign control". The degree of foreign control not only depends on the equity position of the foreign investor but also on the control stmcture of the firm itself. If the control structure is diffuse, then a foreign firm can have a significant say over the operations of a company with the largest equity position. Majority position is not required to establish operational control. 4 This raises a comparability issue between China and the EASA NIEs. While a majority position is necessary to establish foreign control in China because of the highly concentrated control structure of Chinese state-owned enterprises, it may not be necessary for some of the other EASA economies. Thus the "threshold" for establishing foreign control is higher in China. The bias also exists in the other direction as well. The IMF reports FDI data as consisting of new equity investments and reinvested earnings, but obviously foreign firms can establish control also via raising local debt. As will be pointed out later, the debt/equity ratio in foreign-in vested flrms in China is very high. Rather than comparing China with the EASA NIEs, I focus on the changes over tin1e. One measure is the share of wholly foreign-owned FIEs of the total FDI inflow. By this measure , foreign control has increased quite appreciably. In 1985 , wholly foreign-owned FIEs accounted for 0. 77 percent of the total FDI int1ow; in 1995, the share rose to 36.9 percent (all on an approval basis).5 A more difficult task is to determine the Chinese share of equity in the other two forms of FIEs, equity joint ventures and co-operative joint ventures. While the equity share roughly corresponds to shares of operational control in equity joint ventures, in co·operative joint ventures the profit-sharing ratio and

55

FDI in Chino

operational control are determined by negotiations rather than by equity contributions . There is also a problem with the data. Detailed Chinese/foreign breakdowns of equity shares are not available. The following calculations rely on Chinese/foreign breakdowns of the registered capital of the FIEs. In 1993, the foreign share of the registered capital was 47.3 percent in the equity joint ventures and 74.4 percent in the co-operative joint ventures. The wholly foreignowned FIEs have a 100 percent foreign equity share; thus its increase suggests that foreign control is bound to increase as the FDI regulatory fran1ework becomes more liberal. There is also evidence that foreign control is either close to or has already reached the majority position in FIEs as measured by registered capital. The overall importance of the FIEs, however, is still dwarfed by the much less efficient state sector. FIEs in 1995 accounted for 16.5 percent of the industrial output value, as compared with 47 percent by the SOEs and only 0.8 percent of the labour force (State Statistical Bureau 1996, pp. 30-31).

Round-tripping FDI Round-tripping FDI inflow refers to Chinese capital that first goes to Hong Kong and then re-enters China in the form of FDI. AB indicated at the beginning of this book, as compared with the other EASA economies, China has the unusual combination of both large capital inflows and outflows. Much of the Chinese capital outflow is destined to Hong Kong. The number of Chinese firms investing in Hong Kong rose from 400 in 1991 to 2,000 in 1994 and their cumulative investments reached US$20 billion by 1993. By 1993, China had surpassed Japan as the number one investor in Hong Kong.0 Most of the 56

E1 >a.lua tion

Chinese firms in Hong Kong are unlisted ; in 1993, thirty-nine companies listed on the Hong Kong Stock Exchange were controll ed by fim1s from China. Their total market capitalizatio n value amounted to US$ 15.8 billion and accounted for 6 percent of the total capital marketizatio n value of the Hong Ko ng Stock Exchange. One common practice is for Chinese firms to acquire poorly-perf orming firms at attractive pri ces and to establish controllin g shares. Typ ically the s hares of these firms have not been ac tivel y traded prior to their acquisition. These shell companies are then used as vehicles to charmel investments into China in order to capture the gene rous policy b e n efits available to FIEs. Roundtripping FDI of this form is believed to accmmt for a significant portion of the FDI inflows from Hong Kong, although its precise magnitude remains tmknown.' Here I attempt to estimate the size of Chinese rotmd-tripping capital. The basic idea be hind my approach is that there should be some correlation s between Chinese capital outflows and its capital inflows. but the direction and the significance of this relationship vary by the sources and the cmmtries of 01igin of the capital inflows. Since Hong Kong is the major so m ce of the round-trippi ng FDI, the relationshi p between Chinese capital outflows and capital inflows from Hong Kong should be positive and significant. However. the relationship of outflows with capital intlows fr o m the United States, Japan, and ASEAN cmmtries should be indetennina te and loose. I graph th e annua l growth rates of Chinese capital outflows with FDI intlows from Hong Kong and Macao and from ASEAN cow1tries in Figme ..t.l and with FDI in!1ows from the United States and Japan in Figme 4.2. The Chines e c apital outtlow consists of direct and pmtfolio investments . The data are only available for the 1985-94 period as the Chinese have only published 57

~

FIGUR E 4.1 Growt h Rates of Chines e Capita l O~tflows and Inflow s from Hong Kong and Macao , and from ASEAN , 1986-9 4

~

~-

----------~

-----300 ,-----------------------------------------

...........

2SO

\ ..

- - - Capiral ourflow -··-·-·· U.S. Oft Inflow - - - - Japan DFI inflow

200

/\

150

.// \\

en

00

;'

\

/

100

\

\

50

0

I

,

f

T

'-=--

\

\

'\ ,· - .. - ,~

'I

-...,

- ~0

-----r-------r------~------~-A

·100~------,-------,-------~--

1986

1987

19811

1989

1990

1991

1992

1993

2 \5

FIGUR E 4.2 s from Growt h Rates of Chine se Capita l Outflo ws and FDI Inflow 94 1986, Japan and States the United 'll> ~

---, ,---- ----- ----- ----- ----- ----- ----- ----- ----- --y-:\ f \ ! \

uo

I

\>

!

\

I

- - Capital owflow ·-· ·-·-·- U.S. DFI inflow

>

I

- - - • Japan DA inflow

'

I

/ ;

200

I

' I~

01

'

..rport growth . In 1980, the FIEs only accounted for 0.05 percent of the Chin ese export; in 1995, however, the share had grown to 3 1.5 percent.'" However, it is important to note that the FIEs themselves incur large import bills relative to their export receipts and they have run consistent trade deficits. Moreover, their trade deficits have increased in the 1990s even though China's global trade balance has been positive in all the years except in 1993 during this period. The trade balance of FIEs in 1990, 1991, 1992, 1993, 1994 and 1995 were, respectively: -US$4.49 billion, -US$4.86 billion, -US$9.02 billion , -US$16.6 billion, -US$18.22 billion, and US$16.06 billion. 16 The FIEs' trade deficit itself is a. purely an accounting phenomenon. FIEs' import bills incorporate three activities. One is the importation of equipment converted to equity contribution in lieu of capital. The other is the intra-firm trade whereby FIEs import from their parent firms inputs and raw materials for their operations in China. The third is the direct import activities engaged in by the FIEs themselves. FIEs' import bills necessarily exceed their export receipts because of the equipmentcum-equity component in the FIEs' import bills and the double-counting involved. However, the increasing levels of the FIEs' trade imbalance needs some explanation. One reason is that foreign firms increasingly contribute equipment in lieu of capital. According to China's Customs Statistics, in 1993, 48.4 percent of FIE-related imports were importscum-equity contributions, as compared with 33 percent the previous year. 17 Another reason may be the growth of the tariff-induced FDI. The import bills are large even for FIEs with long histories of operations in China and for those with governmentally-backed localization programmes. Two FIEs in Beijing are revealing in this 68

regard . The Beijing-Panasonic Color Kinescope Co. Ltd. in 1992 reached 80 percent domestic content but its per month foreign exchange deficit was US$2.5 million. Initially, the Beijing Jeep Company generated a large import bill because of the need to import completely knocked down kits to be assembled in China; but with 60 percent localization, it still incurred an import bill totalling some US$300 million in 1992. 1 ~ The foreign exchange earnings of the Beijing Jeep Company in the same year were only US$82 million. An auxiliary implication of the import dependency of FIEs is the high sensitivity of the profit margins to foreign exchange rate movements . BJC's foreign exchange earnings were US$82 million in 1992. This means that a foreign exchange deficit of US$2 18 million had to be financed through RMB conversion. According to Lardy, t fl the pre-tax BJC profit was about 262 million yuan (or US$47.43 million. based on the 1992 exchange rate), a thin margin against financing a foreign exchange deficit of US$218 million. Assuming that there was no new foreign exchange injection from the parent company and that no transfer pricing was involved between Chrysler and BJC, the entire pre-tax profit would have been wiped out to finance the difference resulting from the depreciation in the exchange rate from 5.5 yuan to 6. 7 yuan. The wide movements in the Chinese exchange rate in recent years and the fact that the exchange rate of 5.5 in 1992 carried a considerable premium do not give rise to confidence in the profitability of FIE operations in China. If FIE operations behind a tariff wall lead to a large import demand, it is rather surprising that FDI inflows originating from overseas Chinese sources-the very FDI that is supposed to boost exports and to have relatively low import requirements-actually increase the FIE trade deficit. When the FIE trade deficit-defined as FIE 69

FDI i? t Ch'ina.

export earnings minus FIE import expenditures in dollars-of twenty-eight provinces in 1993 is alternately correlated with the FDI dollar amount from Taiwan and HKMC in the san1e twenty-eight provinces in that year, the Pearson-coefficient is -0.627 and -0.956, respectively. Thus each dollar that Hong Kong investors bring in results, roughly, in about one dollar of provincial FIE trade deficit. Two r e asons may ac c ount for this phenomenon. First, China classifies compensation trade as a fom1 of FDI (often referred to as other FDI inflow in Chinese statistical sources). This form of FDI is highly import-intensive. According to World Bank calculations, the import c ontent of processed exports was 77 percent. 20 Another reason might be the widespread use of transfer pricing in FIE operations, which leads to import over-invoicing among FIEs. According to a SPC report in 1994, price quotes by FIEs exceeded actual quotes by 42 percent in cases found by the Guangdong government between 1985 and 1992. The earnings on account of inflated price quotes amounted to 19.7 billion yuan between 1979 and 1992, larger than the taxes on the earnings of FIEs that Guangdong province collec ted between 1988 and 1992, 17.4 billion yuan. According to one estimate, the value of Chinese FDI can fall by haJJ iJ the overvaluation of imported equipment is appropriately corrected for. 2 1 Since monitoring transfer pricing rests with local approval authorities, th eir ince ntiv e to exercise vigilance is weakened by the sizable policy benefits conJerred on FIE qualification.

Chinese FDI Policy Goals After seventeen years of first allowing and then actively encouraging FDI inflow into China, it is possible to make a preliminary evaluation of the FDI inflow by the two 70

Ev alu ation

initial criteria of Chinese policy makers: to upgrade China's technological level via technology transfer in F1E operations and to raise much-needed capital for China's modernization requirements. If one is to understand technology in terms of hardware, it is quite plausible to argue that Chinese FDI policy has failed (or that tl\e Chinese Government set unrealistic goals). The far more challenging-and probably more appropriate-criterion is to measure the "software" that FDI embodiesorganizational technology and managetial skills. China's FDI policy of encouraging tariff-protected FDI is part of its industrial policy to develop future "pillar" industries for the country. The East Asian experience shows that industrial policy is successful only if it successfully "creates" dynamic comparative advantages. More importantly, the experience shows that picking winners is not easy: East Asian countries have failed notably in a nwnber of industlies the government wished to promote. Also, successful industrial policy not only targets the "right" sectors-sectors with high income elasticity-but also enforcement depends on the ability of the govenmwnt to be flexible and willing to forego the wTong policy quickly. 22 The ability to pursue a "targeted" industlial policy and to shield industrial policy making from rent-seeking pressw·es is considerably weaker in China as compared with other East Asian NIEs. Singh ( 1992) notes that the Chinese Government's developmental list contains nun1erous and diverse sectors, most likely the result of an upward aggregation bureaucratic process in which flrms and bureaux submit and lobby their requests. The automotive industry is a notable example . Because developing an automotive capacity is clearly inconsistent with China's static comparative advantage, FIE operations in this sector thus require targeted and sustained policy support from the Chinese Govenm1ent,

71

FDI in Cli i11 u

as did that of the Korean Government at a comparable stage of development. But there is considerable dispersion in China's automotive industry. The small scale of production at Shanghai Volkswagen is emblematic of the country as a whole; according to the Ministry of Machinery Industry, there are 122 automotive companies in China, producing only 1.4 million vehicles in 1995, easily the smallest scale in the world. 2:J The regulatory framework e ncourages this industrial dispersion. The Ministry of Machinery Industry, the ministry in charge of the automotive sector, has a more limited FDI approval authority as compared with the coastal provincial authorities. The former can approve projects up to US$10 million whereas the latter can approve projects up to US$30 million. 2'1 The decentralized FDI regulatory framework and, in general, China's decentralized economic regulatory framework create a built-in incentive to build smaller than optimal projects and the high rents accumulated behind tariff protection make it politically difficult for the central government to implement a co-ordinated national policy on fresh entry into the automotive sector. 25 It is no secret that most of the FIE operations in China are labour-intensive rather than technology-intensive. Even in Shanghai, which has been most successful in attracting large MNCs, 80 percent of the FIE operations are judged to be "labour intensive". The country of origin of the FDI flows can be an indication of the labour/ technology content. In 1995, FDI from Taiwan accounted for 8.4 percent and FDI from Hong Kong and Macao accounted for 54.5 perce nt of the total FDI inflows. 26 Although this pattern of inv es tm e nts accords with China's static comparative advantage, it is unclear why such a generous package of fiscal incentives is necessary to induce this type of FDI inflow from Taiwan and Hong Kong. One might very well argue that a more productive

Euo/uutio11

poli cy a lte rn at ive wo uld be to e ns ure that Chin ese e ffi ciency labour costs are tmly co mpetitive in Asia. This would require training and the removing of the residt,al restrictions curre ntly placed on the labour market. In addition, since most fiscal concessions are offered at the lo cal leve l, they can be quickly matc hed by simila r concessions from other localities. This has a distributive effect o n FDI inflo w amo ng Chin ese provinces, with unclear consequences on the level of FDI inflow into the country as a whole. It is also not clear whet her such policy benefits are ab le to influe nce the locational decisions of U.S. multinational corporations, which are uuced on a global basis and which are subj ect to home taxation beyond their foreign tax liabilities. Thus the net bene ficiary of the Chinese aggressive fiscal incentives to woo foreign investo rs is in fact the U.S. Treasm y. The labor-intensive FDI fl ows from the East Asia