Factors That Determine FDI Inflow In China

This essay intends to analyse the factors influence FDI influx activities in China.

Since the gap and reform policy issued in 1978, Foreign Direct Investment ( FDI ) influx has contributed important proportion to the economic development in China. The FDI influx is defined as the direct investing from foreign companies to host states in order to derive certain permanent involvement. China has been one of the largest FDI receivers states since 2007, with a cumulative FDI of $ 760 billion ( Morrison, 2008 ) . FDI inflow pushes the acceleration of economic development for China efficaciously because it provides important external stimulation, particularly after China jointed WTO in 2001.

There are three chief characteristics of current FDI form in China. First, the FDI activities chiefly concentrate in China ‘s eastern coastal countries. Second, fabricating sector has been the major FDI receiver sector in China, particularly the labour-intensive and comparatively low-technology merchandises pull more FDI than others. Third, most of the suppliers of FDI in China are from developing Asiatic countries, such as Hong Kong and Taiwan.

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The traditional determiners for FDI are derived from internalisation theory and Eclectic ( OLI ) Paradigm ( Dunning, 1998 ) . Internalization theory chiefly explains FDI as a steadfast operation activity that minimizes dealing costs through uniting all concern procedure, i.e. internalise external beginnings in order to avoid external concern fluctuation. Tormenting ‘s Eclectic ( OLI ) Paradigm explains the FDI activity more comprehensively. Internalization theory chiefly focuses on foreign house ‘s position, however, Eclectic Paradigm besides contains the recipient county ‘s position, such as ownership, location, internalisation advantages. In this instance, China ‘s location advantages, for illustration, market growing and size, labour cost and quality, duty, and logistic, have been the cardinal elements for pulling FDI from transnational endeavors ( MNEs ) .

More specifically, this essay identifies several factors that determine the FDI activities in China, chiefly from three facets: economic, political, and cultural. Market size, market growing, and labour cost are considered as indispensable economic factors. Tax policy, Bilateral Investment Treaties ( BITs ) , and rational belongings protection policy are classified as political factor. The last portion discusses the importance of cultural consequence, which plays a important function in pulling FDI in China.

Section 1: Economic factor

1.1 Market size and market growing

One of import ground thrusts FDI from MNEs to China is due to the market-seeking oriented belongings of FDI. The current market size and underlying possible market growing are two cardinal elements for this market-seeking FDI. Market size could be treated as an index of market capacity and the potency on future economic systems of graduated table and range. Normally, GDP or GDP per capita is employed as measuring of market size. Theoretically, big market size indicates low fringy production and distribution cost sing with the economic systems of graduated table and range. The empirical groundss have found a positive relationship between FDI influx and host state ‘s market size ( Herzer, et Al, 2008 ) . Zhang ( 2001 ) besides proves that market size factor is the precedence for FDI from other Asiatic counties to China.

Furthermore, harmonizing to Dunning ‘s OLI Eclectic Paradigm, host states with larger market size ( market base ) , faster economic growing ( market growing potency ) could offer a better platform ( i.e. chance and development ) to pull MNEs put to deathing their FDI, researching their ownership and internalisation advantages. Host state ‘s uninterrupted high economic growing non merely provides MNEs ‘ entry chance but besides raises the foreign investors ‘ outlook on host county ‘s long term development ( i.e. stable high growing could be more attractive ) . In the past decennary, China experienced exceptionally rapid growing in GDP. This strong public presentation in domestic economic growing enhances the buying power of consumers, which efficaciously enlarges the ingestion market base. Although the GDP per capita of China still remains at a comparatively low degree compared to the developed states, high growing has already provoked the market-seeking FDI activities to a certain extent. And China is believed to pull more FDI by the consecutive high GDP growing and speed uping procedure of urbanisation in future. It is reported that the FDI from US, EU and Japan to developing states is taking at market possible growing instead than traditional low labour cost consideration ( Xu, et Al, 2008 ) . Empirical survey done by Casson and Zheng ( 1991 ) shows MNEs from US, EU and Japan invested in China are expected to prosecute the big market size of China and its hereafter strong consecutive growing public presentation.

1.2 Labor cost

Location advantage contained in Dunning ‘s OLI Eclectic Paradigm besides refers to moo local labour cost in many fortunes. Stephan ( 1998 ) studies based on a study on 173 Nipponese fabricating investors, he concludes that the low cost of labor plays a cardinal function in pulling FDI. Lim ( 2001 ) besides shows a positive relationship between inexpensive labour force and inward FDI, he points that lower labour cost straight encourages cost-minimizing FDI. Furthermore, Tseng and Zebregs ( 2002 ) find inexpensive labour force is an influential factor on export-oriented FDI.

China is known as a state with low labour cost. Ceglowski and Golub ( 2007 ) province that Chinese labour cost, particularly in fabricating industry is merely 25 % to 40 % of the cost in US, this is due to the excess labour force, idle production capacity and limited domestic demand, which together drive exported-oriented FDI in China to turn quickly. The spread outing export market will pull more and more investors to increase investing in China. Take Hong Kong and Taiwan for illustration, Sun, Tong and Yu ( 2002 ) illustrate that because of higher and higher labour cost in these parts, investors begin to reassign their concern to mainland China in order to derive more net income. Furthermore, Sokchea ( 2006 ) besides reports during the last 12 old ages, because the mean existent net incomes of China ‘s urban employees are doubled, many foreign labor-incentive industries have reduced their investing in China. More specifically, he finds when labour cost additions by 10 U.S. dollar, the possibility of foreign investing will be reduced by 30 % . All of the above statements back up the positive relationship between inexpensive labour force and inward FDI.

Section 2: Political factor

2.1 International FDI policy

As for international FDI policy, it will concentrate on the treatment of the Bilateral Investment Treaties ( BITs ) . Sokchea ( 2006 ) defines BITs as “ an understanding between two signer states supplying investors with just and just intervention and legal protection ” . In the 1990s, BITs developed so rapidly that to a great extent influenced the public presentation of FDI in China. Broadman and Sun ( 1997 ) show the growing of BITs between 1992-2007 which rose from 675 to 3393. They besides find China holds the first place in footings of cumulative BITs signed. One of the grounds for the impact on FDI by BITs is that BITs signal to investors the information that authorities is doing attempt to supply favourable investing clime, which serves as a important function in pulling foreign investing. In BITs, investors could happen contents about how investing are protected, including commissariats on the range and definition of foreign investing, admittance of investing, just and just intervention, every bit good as difference colony, etc. Furthermore, extra new commissariats about transparence of national Torahs, public presentation demands could be found by investors late, which improve the current investing state of affairs to a big extent. Harmonizing to Lemoine ( 2003 ) , BITs are believed as the most of import pacts in protecting international foreign investing, though for different parties, the content of each BIT may be different because of assorted demands and supply.

However, in some literature, the findings are non consistent with the above statements. Hallward ( 2003 ) studies that BITs merely works when the quality of establishments is high and the belongings rights are strong, so he concludes that the relationship between BITs and FDI is non that obvious. Neumayer and Spess ( 2005 ) disagree with Hallward ( 2003 ) ‘s consequences, asseverating that BITs are more influential when the institutional quality is lower, and BITs helps developing states in pulling FDI instead than developed states. As for China, Wu ( 2003 ) supports that FDI influxs are affected by BITs, but he besides finds in developed states this consequence is more evident. Furthermore, Erskine ( 2004 ) shows that even an extra BIT ratified could increase 2.1 % of FDI in China. Therefore, the fact that BITs do assist advance FDI in China could non be rejected.

2.2 Tax inducements

Before foreign investors decide to put into the host state, most of them would exam the financial policy, particularly the revenue enhancement policies foremost. Foreign-invested companies in China are expected to pay 33 % corporate revenue enhancement, nevertheless, due to the being of favourable revenue enhancement policies, they so pay much less than they should. There are chiefly three revenue enhancement grant policies designed for them. The first 1 is that fabricating companies are allowed to be to the full exempted from revenue enhancement in the first two old ages, followed by a 50 % revenue enhancement grant in three old ages thenceforth. The 2nd one is known as the location-based grant, which indicates that besides the revenue enhancement freedom policy, fabricating companies that located in the Particular Economic Zones are given entree to another 15 % revenue enhancement decrease. Third, if the companies construct port, airdrome or rail in China, they will be free from revenue enhancement payment for the first five old ages, and so a revenue enhancement decrease every bit much as 50 % in the following five old ages ( Ernst and Young, 2006 ) . From the above analysis, it could be found that because of the obvious revenue enhancement benefits provided by authorities policies, foreign investors are more likely to set their money into China than other topographic points. Research workers are besides interested in to what extent the revenue enhancement influences investors ‘ determinations of FDI. Harmonizing to Buettner and Ruf ( 2005 ) , if the revenue enhancement rate is increased by 10 % , the foreign direct investing will be about reduced by 20 % . Furthermore, they report that a 1 % addition in the revenue enhancement rate will convey in a decrease in FDI by about 3.7 % .

Furthermore, OECD ( 2008 ) illustrates that due to the increasing mobility of capital, late, FDI has become more and more sensitive to the revenue enhancement rate. In malice of this, we may happen some OECD states which have comparatively high revenue enhancement rate but still have succeeded in pulling FDI, from which we could reason that the significance of revenue enhancement as a determiner of FDI should non be overstated. And merely when the low revenue enhancement rate combines with other superior local-specific properties, can it act upon the investors ‘ pick of FDI.

2.3 Intellectual belongings

Intellectual Property ( IP ) refers to the creative activities of the head: innovations, literary, artistic work, symbols, names, images, and designs which all are used in commercialism ( China Association of Enterprises with Foreign Investment, 2008 ) . Harmonizing to CAEFI, during the period 2001 to 2007, the instances related to IP and FDI had increased by 58 % ( CAEFI, 2008 ) . This figure good explains the ground that why many transnational endeavors treat IP issue with more cautiousnesss than earlier, and why they think the most ambitious job they meet in China is IP. Therefore, the state ‘s statute laws against protecting IP will act upon foreign investors ‘ determination on FDI. It is reported that an improved statute law and increased quality and measure of IP protection, particularly in the industries where inventions are the most of import characteristic, will increase the entire sum of FDI in China. Sing the benefits brought by a stronger IP protection system, Chinese authorities has proposed new policies to better the bing ordinances and Torahs, which aims to be consistent with the international criterions, for case, the new Patent Law that amended in 2000 makes the patent system in China be harmonious with the patent systems in other WTO member states.

However, in some literature, statements about the negative consequence caused by IP could be found. they question the likely consequences origin from the impermanent monopoly led by IP. Notwithstanding, we still believe that IP will go more and more critical in pulling FDI to China.

Section 3: Cultural factor

Tormenting ( 1998 ) finds that besides the host state ‘s economic, institutional and regulative conditions, it should take the importance of cultural features into history, because it will besides impact investors ‘ location pick. Zhang ( 2005 ) illustrates that due to the grounds of lingual, cultural and geographical propinquity, most of the FDI in China comes from investors who are Chinese beginning. Harmonizing to the consequences conducted by State Statistical Bureau of China ( 2001 ) , during the clip period 1979 and 2001, China ‘s FDI influx from Hong Kong and Taiwan is 56.5 % on norm. Furthermore, Zhang ( 2005 ) further shows Hong Kong, Taiwan and Singapore ‘s portion of outward FDI to China are 89.5 % , 76.8 % and 91.8 % severally, while merely 2 % semen from the developed economic systems, such as EU, US, Canada and Japan.

Recently, another two factors that influence the inward FDI has been reported by some literature, which is the foreign houses ‘ cognition transportation and public presentation that are both affected by civilization. China is deemed as a state with a low degree of uncertainness turning away and a high degree of trust, while uncertainness turning away refers to the perceptual experience of menaces from unsure state of affairs. Foreign investing ever prefers these two belongingss, particularly the high trust, which is claimed to assist heighten the relationships interpersonal and inter-organisational. Yao and Wei ( 2007 ) find that trust ever means “ self-generated sociableness, greater velocity in relationship formation, outlooks of decreased self-interest, and perceptual experiences of lower monitoring costs ” , which could assist pull more FDI into the host states. Inversely, high degree of uncertainness turning away may negatively impact investors. Competitive disadvantages to local companies, favoritism by authorities are two good known facets that may drive the foreign investors into a dearly-won manner when they are making concern in host states. Japan is one of the typical illustrations. It is known as a serious ethnocentrism state. FDI is considered as uncertainness and external competition by many Nipponese, traditional imposts and the negative attitude by the society deter the foreign investing. Furthermore, some surveies unwrap that people in a higher trust environment are likely to contend for the common intents in group and organisations. Furthermore, foreign houses tend to increase the investing when they achieve their former ends and execute good in old old ages. Meanwhile, this will give rise to a signal consequence which may pull other foreign investors to come to follow them, because most of the houses would wish to copy the procedures of other houses that they consider as successful, so due to the herd consequence, FDI location determinations have been found to be influenced by the behaviour of other foreign houses ( Fisman and Khanna, 1999 ) . In China, the Yangtze Delta Regions and the Zhujiang Delta Regions are the countries where foreign investings chiefly engage.

Decision

To reason, the factors of market-size, labour cost, BITs, tax-incentive policy, IP protection and civilization all could act upon foreign investors ‘ determination on FDI. Through the comparings, we can calculate out that the first two are the most of import 1s considered by investors. Recently, as economic system grows in China at a high velocity, and income has been increased to a higher degree, market-size is going more influential than earlier. BITs convey information to investors that the authorities is doing attempt to better the investing environment, which could assist pull FDI to China. The financial policy, particularly the tax-incentive policy besides may impact the location pick of FDI, and due to chief three revenue enhancement grant policies, foreign investors prefer to puting in China instead than other states. Finally, from the literature we find both the improved IP protection system and particular civilization and tradition in China have contributed to inflow FDI.

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