Dan Steinbock

China is no longer just a destination for foreign direct investment (FDI) — it is the home for Asia's new multinationals. As the Chinese experience demonstrates, it is the external reforms that are truly critical. With the right mindset, comparable accomplishments are now within India's reach as well.

IN JANUARY 1975, Deng Xiaoping and Zhou Enlai drafted China's modernisation initiatives in agriculture, industry, science and technology, and national defence. The transition from import substitution to export orientation led to China's `reform and opening'.

China is no longer just a destination for foreign direct investment (FDI) — it is the home for Asia's new multinationals. The Chinese experiences offer pertinent lessons to another emerging great power — India.

1980s: From low-tech to natural resource development

As foreign corporates entered China around 1979, a few state-owned trading companies and technology firms began to invest overseas, typically on the basis of existing overseas trade linkages in Southeast Asia.

By 1985, only 143 Chinese enterprises had established and invested $170 million in some 45 countries — that is, less than 3 per cent of China's total inflow of FDI. These businesses were mostly in low-tech services, as exemplified by Chinese restaurants, which were located in the major cities or Chinatowns of host countries, including the US, Japan and Thailand.

In the latter half of the 1980s, some 620 new Chinese businesses invested over $860 million in over 90 countries.

Now natural resource development projects, along with assembly and transport, dominated Chinese overseas investments. The growth rate of Chinese FDI was almost 50 per cent faster than the growth rate of multinationals worldwide. However, China accounted for only 0.1 per cent of total outward FDI worldwide.

1990s: From manufacturing to electronics

After the Tiananmen Squre events, the Chinese Government introduced market-oriented reforms to re-attract American and other investors. Now, China also showed up on the radar screens of US corporations. Over the latter half of the 1990s, US capital flows to China averaged $1.1 billion annually.

Through foreign multinationals — the so-called foreign-invested enterprises (FIEs) — FDI has played a critical role not just in China's economic reforms and opening, but in the rise of Chinese multinationals. After the mid-1990s, the FIEs replaced the small- and medium-size enterprises of the overseas Chinese as major investors. Capital inflows soared from $11 billion in 1992 to $50 billion in 1999.

After the mid-1990s, two-thirds of the US investment in China was directed at the manufacturing sector, especially industrial machinery and electronic equipment — the very same sector and segments the Chinese government was now promoting in overseas investment.

Rise of Chinese challengers

During the past decade or so, China, along with the US, has been one of the most attractive country market for inward FDI worldwide. Meanwhile, Chinese challengers have emerged in industries as different as mobile communications, car manufacturing, detergents, oil, petroleum and petrochemicals.

In 2004, BusinessWeek's Global 1000 List featured 423 US companies with a combined market capitalisation of $10.8 trillion. Japan had 137 companies with a market cap of $2 trillion.

Hong Kong's 15 and China's six companies, meanwhile, had a market cap of $190 billion and $104 billion, respectively. China was just behind Russia's nine companies with $196 billion, but it did better than, say, Mexico's six companies with $79 billion, India's eight companies with $75 billion, or Brazil's five companies with $71.2 billion.

Global competitiveness indicators tell the same story. In business competitiveness, the US leads worldwide. During the past few years, Japan (8th) has steadily improved its position, but China (45th) remains behind. FDI of Chinese multinationals is barely 6 per cent of the foreign capital inflow.

Lessons

The Chinese experience may offer important lessons to Indian reformers. First, the Special Economic Zones were set up close to Hong Kong and the bamboo network of the overseas Chinese.

In the same fashion, Indian reformers can take advantage of the expatriates, particularly Americans of Indian descent who have played a substantial role in the US technology revolution.

The second lesson underscores the dual nature of China's economic liberalisation. In China and India, reforms arrived only after the failure of decades of socialist experimentation.

In India, however, the winds of change have focused on internal economic reforms, which is necessary but not sufficient for full transformation. As China's experience demonstrates, it is the external reforms — opening of the economy — that is truly critical.

Unlike Japan and East Asia's Tiger economies, China has opened its domestic market and is not building an export powerhouse behind a wall of protective tariffs, but growing a massive marketplace that promises extraordinary opportunities worldwide. With the right mindset, comparable accomplishments are now within India's reach, as well.

The third lesson involves the two-fold nature of foreign direct investment.

During the past quarter of a century, the goal of China's reformers has been to attract FDI into China, while stimulating the emergence of Chinese FDI abroad. Still, it was the arrival of world-class multinationals that stimulated the rise of Chinese challengers.

India has already given rise to several world-class multinationals, particularly in ICT software and services.

From the standpoint of the national economy, however, these companies form a thin layer. It is only when sheltered industries are opened to international competition that Indian challengers can emerge across industries.

These, then, are the key lessons for India.