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Business
FDI: Any lessons from China?
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Foreign direct investment in China was not the result of `shock therapy' as in `transition economies'.
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UNTIL THE late Nineties, economists were divided into two camps: those who swore by foreign direct investment (FDI) as a panacea for growth in developing countries and those who looked upon it with scepticism. Even nationalists (read Swadeshis) find it difficult to be critical of FDI as all debates are settled by referring to China and its high level of growth and exports. Even UNCTAD, which is generally known to safeguard the interests of developing countries, seems to have changed gear and pleads for a role for transnational corporations (TNCs) in its World Investment Report 2002 (WIR02) to improve the competitiveness of developing countries. Do we have a good understanding of FDI in China?
There are myths and legends about FDI in China. Luckily, we have the benefit of extensive research done by several scholars.
Vintage development theory suggests a role for FDI in augmenting capital resources in developing countries. In China, FDI did not have this role. The Chinese saving rate has been very high in recent years, around 40 per cent of gross domestic product and its domestic investment rate is 35-40 per cent of GDP. Though FDI is around $40 billion lately, it is 4 per cent of GDP and 10 per cent of gross investment. The International Monetary Fund (IMF) had a valuable debate on this. ("Foreign Direct Investment in China: What do we need to know?" www.imf.org/external, Transcript of an Economic Forum, May 2, 2002.)
Foreign direct investment in China was not the result of `shock therapy' as in `transition economies' or imposed under Fund/Bank programmes. It was home-made and the Chinese authorities set the policy, the contents, timing and the phasing. It was steered in an institutional context and sought to improve economic efficiency by creating incentives and competition and to make the reform process acceptable. They created transitional institutions.
The dual-track approach regulated private enterprises and kept their operations in line with plan targets. Yingyi Qian of Berkeley has a fascinating monograph on this theme. ("How Reform Worked in China", University of Berkeley, August 2002.)
Creation of township-village enterprises (TVEs) was another instance. TVEs played a major role in the early years of reform. In a society imbued with anti-private property ideology, TVEs introduced the commercial spirit through common-ownership instead of trying to create private property rights. Their role was in regional development and to transfer tax revenues to the Central Government. They were so successful that, in later years, foreign investors formed joint ventures with them.
State-owned-enterprises (SOEs) dominate the Chinese economy and form the "iron rice bowl". Though they are said to be inefficient, technologically backward and corrupt, the Chinese authorities were reluctant to privatise them or sell them to foreign investors as what Paul Krugman calls `fire sales'. This is due to the ideological preferences among top party leaders and the public. However, allowing them to form joint ventures with foreigners created an escape route. There are scandals attached to the creation of joint ventures such as 'creative accounting' or kickbacks and to the nexus between political leaders, army generals, apparatchiks and foreign investors.
Role in exports
On exports, the role of FDI is complex. In the early years, overseas Chinese played a major role. Historically, the presence of Chinese in several parts of Asia and their trading and financial networks are known. It was the long-term strategy of the Chinese Government to try to build economic bridges with Hong Kong in advance of its accession in 1992.
The creation of special economic zones (SEZs) in south China suited the overseas Chinese. They could identify items for production, partners for joint ventures, invest huge amounts and lift the products for export through their own networks. It was synergy at its best. It was estimated that, in the early years, FDI from overseas Chinese constituted 80 per cent of total FDI and has declined to 50 per cent in recent years. It is also known that around 50 per cent of this investment is `round tripping' or money dubiously coming from the mainland and going back to get concessions as FDI. How sustainable are these in the long run?
The role of FDI in Chinese exports is not a fairy tale. Initially, it was the success of the SEZs that attracted other investors. Chinese exporters in the private sector had the skills to produce traditional handicrafts, garments, shoes and toys and did not need foreign technology. What they really needed was capital.
If China was flush with capital as suggested earlier, why were they capital constrained? This was because, until 1998, government-owned banks in China were prohibited from lending to private firms and had to confine their lending to SOEs. Private firms depended entirely on internal sources for survival and, with luck, for expansion. When the FDI window was opened, they rushed into it headlong.
They ceded markets and equities to foreign companies, big and small. FDI was a substitute for what in other countries is covered by bank loans. In turn, foreign equity financed the import of equipment or components irrespective of their intrinsic value as exporters had the freedom to balance outflows and inflows as long as they were in balance. It was indeed a paradise for transfer pricing!
There is the myth about freedom for FDI operations in China. In contrast to the freedom given in coastal areas, the Chinese are schizoid over FDI operations elsewhere. Foreign firms are subject to severe regulations. They have to achieve industrial policy goals and conform to performance requirements like local procurement from specified agencies. Their operational zones are also specified. The idea is to protect national enterprises from foreign firms. This duality in treatment creates several distortions within China, which pose a threat to its long-term economic and political stability.
There is a grave disparity between various regions. Coastal regions have grown extraordinarily rich and other regions do not have a share in their growth. Unemployment in other regions is rising and includes those leaving farms and others retrenched by SOEs. Some 115 million migrant workers are seeking jobs as migrants in booming cities along the coast. The Far Eastern Economic Review recently carried a lucid account of urban poverty in China. (Nothing More to Lose, FEER, November 7, 2002.)
Part of the reason for this chasm is the manner of FDI operations in export zones. They are not integrated into the mainstream economy but remain processing platforms performing labour-intensive operations on imported goods for re-export. What started on a small scale in the early Ninetiesw has turned into an avalanche and distorts the flows of investment and patterns of trade which prevailed in Asia prior to the Asian crisis. They belie the earlier assumptions (flying geese patterns) that though China might capture low-end items, other East Asian countries could move up the ladder.
Indonesia has lost not only its shoe production to China and Vietnam but also a number of engineering items. Nike and Reebok are shifting to China and Vietnam. China has become the foremost producer of consumer durables like cameras, air-conditioners, televisions, washing machines and the like.
As FEER (October 17, 2002) reported, Chinese products have a deflating effect on world prices. Every big TNC is present there. But then how sustainable are these with China's newly acquired WTO obligations? Even Nick Lardy, a top China expert with Brookings, cannot make a prediction. The prospects for other countries appear dim. The WIR02 was over-optimistic in suggesting that TNCs could be accessed by developing countries to reach the higher ends of the global value chain.
K. Subramanian
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