Promoting Foreign Direct Investment China’s Experience Qimiao Fan, the World Bank

Presentation Outline Why Worry About Foreign Direct Investment (FDI) What Matters to Foreign Investors Is China Relevant for Madagascar China’s Experience in Attracting FDI Some Possible Lessons

Why Worry About FDI? FDI is an important source of capital for developing countries. In 2000, FDI amounted to 4 % of GDP (inflows) 32% of GDP (stock) 11% of total domestic investment FDI inflows has continued to increase over the past two decades, however the rate of increase has slowed down. Developing countries’ share of total World FDI shows a declining trend.

FDI Transfers Knowledge and Diffusion of Ideas Drives Growth Foreign firms bring in new technology or upgrade existing technology Technical and managerial skills and ways of doing business are transferred directly to local employees Foreign firms introduce best practices to local firms that enable them to compete as suppliers to the foreign firms This is true for firms in all industrial sectors with the exception of textiles and apparel where the technology is more standardized.

FDI increases imports and exports • FDI Contributes to Better Integration of Developing Countries into the World Economy: Investment by foreign firms can bring about convergence in environment, labour, product, safety and technology to international standards FDI increases imports and exports FDI and foreign trade are good indicators of integration. Foreign trade has grown substantially in the past decade.

What Matters to Foreign Investors The Investment Climate Macroeconomic or country-level environment Political and economic stability (inflation and interest rates) Policy towards FDI and trade including foreign exchange rate policy Regulatory framework and governance Entry and exit regulations Taxation Environmental, health, labour and safety regulations The quality and quantity of infrastructure Physical infrastructure (e.g. power, telecommunications and transport) Financial infrastructure (banking system, capital market) Human capital (e.g. skills and education level)

Share of developing Country FDI Percentile Rank Above 50 1999 Political Stability Regulatory Quality China 16.3% Yes Brazil 11.5% Hong Kong 9.9% Argentina 9.7% Mexico 5.1% Singapore 4.8% Bermuda 3.8% S. Korea Chile 3.7% Poland 2.9% Countries with better investment climate tend to attract more FDI Studies have shown that the investment climate matters for FDI and for firm productivity Most of the top ten countries with the largest share of FDI ranked in the top fifty percent in both political stability and regulatory quality. The rankings are from the Governance Indicators (2002). Argentina was the outlier, ranking below 25 percent in both indicators. The top two countries in this list, China and Brazil, only ranked above 50 percent in one indicator. Percentile Rankings are for all countries (developed and developing). Studies such as FIAS study on Strategies of MNC and competition for FDI.

Is China Relevant for Madagascar? China and Madagascar Value Added by Sectors, % of GDP In 1980 Agricultural shares were similar in Madagascar and China. Industry is clearly more important in China and Services dominate in Madagascar.

China and Madagascar Employment by Sectors, % of Total In terms of share of employment, China and Madagascar are very similar with the bulk of workers employed in the agricultural sector at the start of reforms.

China and Madagascar GDP per capita in US$

China and Madagascar By Most Measures, China Has Been Successful in Attracting FDI In 1980, Total FDI was US$57 million in China and US$ million in Madagascar. In 2002 FDI was over US$50 billion in China compared with US$ in Madagascar FDI was equivalent to 4% of GDP in China compared with 2% for Madagascar FDI per capita was US$37 in China compared with US$7 in Madagascar FDI accounted for 10.1% of total fixed investment in China compared with 1.6% for Madagascar The other top ranking countries in order of FDI are US, UK, France, Belgium-Luxembourg, and the Netherlands. These figures are for FDI inflows.

Both China and Madagascar are low-income developing countries Similar initial conditions in late 1970s and early 1980s with economy dominated by agriculture and state-owned enterprises Despite similarities in initial conditions, performance differed significantly in the past two decades in the two countries Policies do matter

China’s Experience in Attracting FDI The National “Open-door Policy” With the Encouragement of FDI as a Key Component Ensuring a Stable Political and Economic Environment for FDI Investing Heavily in Infrastructure The Special Economic Zones (SEZs) The Role of Local Governments The Role of Overseas Chinese FDI has clearly been an important policy tool in its efforts to promote development and growth. Guangdong and Fujian Provinces put forth a plan that would allow the local governments more flexibility in economic policies to promote foreign trade and investment. These provinces were poor but their location close to Hong Kong, Macao and Taiwan provided advantages.

The National “Open-door Policy” With the Encouragement of FDI as a Key Component The open-door policy, the encouragement of FDI and commitment to a market economy have been enshrined in the Communist Party Charter and the country’s Constitution Even in the face of crises, China has maintained its commitment to opening up and encouraging FDI Commitments are reaffirmed whenever there is doubt and uncertainty (e.g., when a new leadership comes in or after major political events) Officials are trained and educated about the national policy to ensure implementation at all levels Although initially only a small number of regions and sectors were allowed for FDI, the number of regions and sectors have been rapidly expanded

Foreign investors are allowed to invest in most industries including infrastructure The majority of FDI went to the manufacturing sector, half of it to labor-intensive manufacturing and half to technology-intensive and capital-intensive manufacturing. Source, Tseng and Zebregs.

Ensuring a Stable Political and Economic Environment China has been able to maintain relatively low inflation rates since the start of reforms Average annual inflation was 5.8% between 1980-90 and 7.1% between 1990-2000. In 2000, inflation was 0.9%. The political environment has also been relatively stable China started with almost no inflation at the start of reforms. Rates have risen over time. It has stabilized recently. China has understood the importance of external financing to meet their development goals. China has relied more and more on FDI rather than external borrowing. FDI has also been an important source of foreign exchange reserves needed to pay for imports of capital equipment.

Investing Heavily in Infrastructure Both central and local governments have withdrawn from investing in competitive assets and redirected public investment to infrastructure FDI and domestic private investment are also allowed into infrastructure 1990 2000 Electric Power Consumption (kwh per capita) 471 759 Electric Power Transmission and Distribution Losses (in percent of output) 7.5 7.0 Air Transport, freight (million tons – km) 818 3900 Roads, Goods Transported (billion tons –km) 336 613 Telephone Mainlines (per 1,000 people) 5.9 112 Mobile Phones (per 1,000 people) 0.02 66

The Special Economic Zones (SEZs) Important part of the open-door policy Set up in the coastal provinces to experiment with various reforms, to attract FDI and to promote exports The key policies are liberalization allowing both foreign and domestic private investors to invest in most sectors, enjoying fewer regulatory barriers and preferential tax treatment Local governments in the SEZs have significant autonomy over policies, regulations and investment approval

The SEZs were “economic laboratories for the market economy” and “a bridge to outside world” Most reform policies were first implemented in the SEZs But successful policies, experiences, best practices and managerial and technical know-how quickly extended to the rest of the economy The SEZs attracted some of the most innovative and entrepreneurial managers, workers and civil servants, but many managers and workers returned to their home region to start their own business – knowledge transfer The SEZs set the standards and provide competition to the rest of the enterprise sector including the SOEs

The Role of Local Governments Despite a uniform macroeconomic environment and national policy, FDI performance differs significantly across regions and SEZs Local governments in both the SEZs and other regions are allowed significant autonomy and initiative The coastal regions attracted over 90% of total cumulative FDI as well as large amount of domestic investment The regional differences in FDI are largely a result of differences in the quality of the legal and regulatory environment and infrastructure Almost half of all fixed asset investment came from local governments primarily in infrastructure

The Role of Overseas Chinese FDI from Hong Kong and Macao and Taiwan accounts for the majority of total FDI into China Overseas Chinese played an important role in early FDI due to the language and culture But their share is declining as FDI from the US, EU and other Asian countries increases

Some Lessons from China Maintaining a Stable Economic and Political Environment Through Prudent Macroeconomic Management and Careful Sequencing of Reforms Maintaining a Consistent and Credible National Policy and Ensuring Its Implementation Through Imbedding Key Policy Elements into Laws and Training of Officials Investing in Infrastructure Through Redirecting Public Expenditures and Private Sector Participation Extending Rapidly the Reforms and Successful Policies from SEZs to the Rest of the Economy and Maximize the Role of SEZs in Knowledge Transfer Making Use of the Bridging Role of the Diaspora But Ensuring Equal Treatment for Investors Creating a Good Regulatory Environment and Infrastructure More Important Than Fiscal Incentives