1. Presented by Gabor Czeyda-Pommersheim (I24021) due to 3 rd of December 2009 1

2. 1. Foreign Investment 2. FDI in the Chinese Economy 3. “Zones”: the gradual liberalization of the Investment Regime 4. The Investment Regime Today 5. Sources of Investment in China 6. The China Circle 7. FDI in Context 7.1. Sectoral Composition of FDI: The WTO Impact 7.2. Modes of Capital Inflow 8. Conclusion 2

3.  FDI ( 外國直接投資 ) is a measure of foreign ownership of productive assets, such as factories, mines and land.  FDI is a measure of growing economic liberalization.  FDI investor- individual, incorporated, unincorporated entity, public or private company, enterprise, government body  Biggest FDI receivers- US, UK, Hong Kong, France, Germany 3

4.  China is major FDI receiver. Investment began to pour in 1992. Annual inflows over US$40 billion since 1996. FDI inflows US$63 billion both in 2004 and 2005.  China has accounted for one-third of total developing country inflows in recent years, the created global manufacturing networks will play critical role in world economy.  Three distinctive characteristics of investment in China: ▪ FDI predominant form in which China accessed global capital ▪ Unusually large proportion of Chinese FDI inflows in manufacturing industry (opposed to services or resource extraction) ▪ FDI inflows predominantly from EA economies (Hong Kong, Taiwan) 4

5.  The dominant role played by cross border restructuring of export-oriented production networks developed in other EA economies.  New patterns are expected to emerge.  Predominance of FDI shows that China hasn’t made much use of other foreign investment. China has potential to tap world savings. China’s entry to WTO (December 11, 2001) began the process of liberalizing access to many service sectors.  Since 2002 beginning of capital inflows outside of FDI. These are surprising because they have come before the formal liberalization of the Chinese capital account. 5

6.  China decided to accept FDI in 1978 and broke with the socialist orthodoxy in establishing SEZs in 1979 and 1980.  Through the 1980s policy and institutional changes were cautious, incremental and geographically localized.  Incoming FDI grew steadily and brought important changes in the regional economies of Guangdong and Fujian. Nationwide the impact was limited until early 1990s.  Investors from Hong Kong and Taiwan became quantitatively most important. Other developed country investors followed. Fundamental transformation of the Chinese economy. 6

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8.  Deng Xiaoping ‘s Southern Tour ( 南巡 ) in the spring of 1992  For more than one decade China gradually built credibility with foreign investors, gaining experience and building institutional infrastructure  Muting the impact of Tiananmen through FDI friendly policies.  New sectors were opened (real estate). Manufacturers could sell their output on the Chinese market. 8

9.  FDI share of Chinese GDP  During 1980s didn’t exceed 1% of GDP  In 1991 exceed 1%  In 1994 briefly exceeded 6% then it settled back to 5%  Averaging 4% between 1996 and 2002  Slipped below 3% in 2005  China relatively open to incoming FDI, contrast with development forerunners (Japan, Taiwan, Korea) 9

10.  China’s reliance on FDI similar to developing Southeast Asian economies of Malaysia, Thailand, Philippines, Indonesia (inflows around 4-6% of GDP)  China fits into the “Southeast Asian” pattern in which economies are quite open to FDI  Particularly in export-oriented manufacturing with different degrees of protection in trade policy  Similar levels of development and policy orientation have led many to perceive China and SEA countries are being in competition for a limited total amount of FDI since 1998  Some regions in China more opened to FDI  Inflows into Guangdong and Fujian from 1993-2003 the average annual incoming FDI/GDP ratio was 13% for Guangdong and 11% for Fujian  Other regions: inflows to Shanghai 9% to Jiangsu and Beijing 7% of the GDP. 10

11.  FDI impact is multifaceted  FDI contributes to overall investment and structural change  Total amount of FDI is large: in 2004 the cumulative inflows of actually realized investment surpassed US$500 billion  China’s domestic saving rate is high so less dependent on FDI for saving than many other developing countries. In China Gross Domestic Capital Formation surpasses 40% of the GDP. Incoming FDI in 1999-2001 accounted for 11% of total capital formation. Less than the average for UN developing countries (15%).  China’s GDP growth has been more rapid than the growth of FDI inflows, share of FDI in GDP is drifting downward  FDI brings  Management experience, marketing channels and technology  FDI predominant source of technology transfer  Central role played by FIEs in China’s export expansion (2/3 of increment) 11

12.  The establishment of the SEZs ( 經濟特區 ) in 1979 as visible signal of commitment to economic opening  Today much foreign investment is still located in zones of various kinds, and the rules are different inside the zones.  Permitted incremental progress within a rigid system.  Commitment to external liberalization, enhanced the credibility of the reform process.  Shenzhen SEZ as the symbol of Chinese liberalization. Other SEZs in Zhuhai, Shantou, Xiamen 12

13.  The initial SEZs were similar to EPZs (that spread in Asia since 1970s)  Regions where foreign investment was encouraged by lower tax rates  Fewer and simplified administrative and customs procedures  Duty free components and supplies  The SEZs were part of the early development of the export processing regime. Test beds for domestic economic reforms.  Wholly owned foreign subsidiaries were permitted in the SEZs long before they were allowed elsewhere.  Important contribution, exemplified pattern of Chinese policy making during the first era of reform (dual track, incremental reforms)  The start was slow, disappointing and infrastructure construction was expensive.  SEZs were attacked for facilitating smuggling and corruption  FDI quickly began to leak out into surrounding countryside 13

14.  The EP agreements being signed with small firms throughout the Pearl River Delta sometimes involved foreign businesses providing equipment and technology being repaid with finished product (a type of FDI)  Second wave of liberalization began in 1984  Visit to Shenzhen SEZ by Deng Xiaoping, he proclaimed Shenzhen as a successful experiment  14 new “Open Cities” –including Shanghai- were designated along the coast, they set up Economic and Technological Development Zones (ETDZs)  ETDZs to bargain aggressively with potential foreign investors to facilitate investment inflow  Shanghai quickly improved the application of 3M corporation to set up a wholly owned subsidiary (there was no provision in law for foreign ownership) 14

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16.  Dramatic proliferation of “zones” began  Hainan island in entirety was designated as SEZ  Existing SEZs at Zhuhai, Shantou and Xiamen expanded rapidly  Pearl River Delta in Guangdong, Yangtze river delta around Shanghai  Total population 160 million  Third wave of opening of the Chinese economy at beginning of 1990s  Creation of Pudong (East Shanghai) Special Zone  18 new ETDZs were approved in 1992-1993, new type of zone, high technology development zone  Urban real estate was opened up to foreign investment  By 2003 over 100 recognized investment zones  Six SEZs  54 national level ETDZs  53 nationally recognized high tech industrial zones  Launching of the Western Development Program (for interior provinces) 16

17.  China provides generally favorable regime for investors today  Taxes are moderate  Investment protection agreements are in place with most countries  Apparatus for arbitration is available  Most legal provisions are adequate in principle  The currency is convertible in the current account, few problems with repatriation of the profit  The most striking features of the Chinese investment regime:  Relatively decentralized nature, high degree of discretion retained by government officials. Every investment contract has to be approved by some governmental level.  Hundreds of local investment boards. Provinces and zones usually have authority to approve projects valued up to US$30 million.  County governments are able to approve smaller projects (below US$10 million). 17

18.  The decentralized regime often favors the foreign investor.  Foreign investors can play localities off against each other in search of favorable package.  Localities have incentives to attract foreign investors through lower taxes.  Eager municipalities may provide concessionary terms on land rental and utility rates.  Local governments collude with investors to classify large projects as multiple small projects in order to evade government monitoring.  Foreign investors have strong incentives to survey options in different localities and exploit the particularities of the investment system.  The statutory enterprise income tax rate in China is 33% (30% national plus 3% local)  Productive enterprises in SEZs and ETDZs are taxed at 15%, coastal cities and provincially established zones set the rate at 24%  Enterprises that export more than 70% of their output, designated as “high technology” (they can enjoy further reductions, below 10%)  Within zones a tax holiday is granted for the first two years, and tax rates are half the long term rate for years three to five 18

19.  While multiple provisions may benefit the foreign investor, they also create difficulties.  Not always clear who has the ultimate power to approve a given set of tax rates or land use agreements.  Regions compete therefore foreign investors may have to navigate surprisingly uncooperative and complex relationships between different regional or sectoral authorities.  The quality of local government offices varies enormously (from professionalism to high levels of corruption, lack of training and transparency)  Problems with the enforcement of the IPR (Intellectual Property Rights). Local governments in many cases have no incentive to enforce national regulations, and may have incentives to violate them.  Navigating the complex institutional environment can be costly for foreign investors.  The contractual forms have evolved toward modes that permit the foreign investor a higher level of control. 19

20.  In the early 1980s FDI was dominated by contractual joint ventures (JVs) and joint development projects.  Contractual JV ( 契約式合資企業 ) flexible agreement of association that don’t nec essarily create an enduring legal entity.  Useful in situations in which investment is combined with some kind of service agreement (such as hotels)  Profit can be divided among contracting parties in any form that is mutually acceptable.  Joint development projects, form of contractual joint venture tailored to oil exploitation.  After the mid-1980s China began to encourage the use of equity joint ventures (EJVs), which became the dominant mode of investment.  Foreign partners were concerned with earning profit or establishing market share.  Chinese managers were often concerned with maintaining employment, building a larger firm, and accessing foreign technology.  Finally move toward operate independently, form of wholly foreign owned subsidiaries (in 2004 2/3 of total realized FDI inflows). 20

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22.  Four large stable source groups  By far largest ones: Hong Kong, Taiwan, Macau  Hong Kong accounted for 42% of cumulative total in 1985-2005  Since 1998 investment from various tax havens ( 避稅港 ) increased  In 2005 US$12.3 billion in incoming FDI from British Virgin Islands, Bermuda, Cayman Islands  In 2004-2005 US$35 billion annually  1985 to 2005 period 60% of total FDI (from Hong Kong, Taiwan, Macau and all tax havens) 22

23.  The developed country triad: US & Canada, Japan, EU accounted for 25% of cumulative FDI in China in 1985-2005  Unusual feature, worldwide developed countries accounted for 92% of FDI in 1998-2002  The relative weight of each leg of the developed economy triad regions is comparable around 8% investment each (1985-2005)  The US was the third important investor, but since 2002 on downtrend  Japan’s investment is only 1/8 of Hong Kong, Taiwan and Korea’s together. Japanese investment grew to US$6.5 billion in 2005  EU in recent years larger investor than US, US$5 billion in 2005  Korea and Singapore most important among Asian investors  Korean investment started late, but grew rapidly, in 2004 it was third largest investor. Both Korea and Japan investing heavily in northern provinces (Shandong, Liaoning and Jilin). 23

24.  Hong Kong is largest investor with special role  July 1, 1997 the former British colony of Hong Kong became Special Administrative Region (SAR) of China ( 香港特別行政區 )  HK has dramatically different economic and administrative system from China  Much higher level of economic development that the rest of the Mainland, SAR government has decision making authority, independent member of international organizations (WTO)  Hong Kong center of manufacturing, finance and trade. Growing out to Mainland territories. Better information on policy changes than other investors.  After three waves of liberalization (1979, 1987, 1992) HK share of FDI reached 68%  January 1, 2004 Closer Economic Partnership between PRC and HK SAR (HK subsidiaries of MNCs will enjoy earlier access to some of sectors being opened up in China as part of WTO accession)  Many subsidiaries of corporations in HK (1000 foreign company regional headquarters, 256 from US, 198 from Japan, 106 from China)  “Round tripping”- Parent companies in China channel investment from subsidiaries back into China, headquarter of large firms owned by Beijing 24

25.  中國圈 : Close economic association between PRC, Hong Kong and Taiwan  Basis of emergence is the successful development of Taiwan, HK labor-intensive manufactured exports (light industries)  Transferring of labor intensive export production to Mainland China (transaction costs were low, common language, customs)  HK and Taiwan specialized in high value services and technology-intensive production 25

26.  Restructuring moved quickly for traditional labor-intensive manufacturing (garments and footwear) completed by early 1990s.  Taiwan firms moved their footwear production to China, in US imported shoes from China displaced imported shoes from Taiwan.  Similar restructuring of electronics industry began in 1990s.  In recent notebook industry (2002-2003)  In PC and components industry, production of keyboards and power supply units came first followed by production of monitors and motherboards, and expanding range of IT hardware products  In result the Mainland coastal provinces have been industrialized rapidly while Taiwan and HK deindustrialized.  HK and Taiwan lost one million manufacturing jobs while Guangdong and Fujian gained about five million  Both HK and Taiwan experienced success in upgrading to higher skilled activities while experiencing steadily rising incomes and low unemployment.  HK services, finance, transportation, telecommunications  Taiwan moved to technologically more sophisticated products 26

27. Chinese CompanyParent CompanyParent HomeExport value (US$ billion) 1. Tech Front Shanghai QuantaTaiwan5.2 2. Hongfujin Precision Industry Hon HaiTaiwan4.2 3. ASUStek computer Suzhou ASUStekTaiwan3.2 4. Motorola ChinaMotorolaUS2.8 5. Great Wall International Great Wall/IBMChina/US2.6 6. Dongguan Export Processing DongguanChina2.6 7. Dell ChinaDellUS1.7 8. Mingji DiantongBenQTaiwan1.7 27

28.  FDI has enormous impact  Transferring manufacturing capability, jobs and export markets  EA economies with leading of the China Circle created competitive, flexible and low cost manufacturing networks  Challenge for China  To expand the benefits receiving from openness to foreign investment  More sectors should be opened to foreign participation  Manufacturing ( 製造業 ) is much larger part of FDI than for the rest of the world  Accounted for 70% of inflows in both 2003-2004 for China, for services only 27% in 2003  Only for 38% of the stock for other developing countries in 2002, while for services 55%  Accounted for 62% of registered foreign capital  Chinese restrictions on foreign entry into most important service sectors ( 服務業 ). 28

29.  Access to WTO means commitments to dramatically lower the barriers, most dramatic in opening service sectors  The share of investment of manufacturing has increased, Chinese comparative advantage remained strong (while India is getting strong in services)  Three service sectors for large proportion of FDI (in 2001-2002 for developing countries)  Wholesale and retail trade (7.4%)  Transport and telecommunications (8.0%)  Finance (11.5%)  By contrast in China incoming FDI concentrated in real estate ( 房 地產 )  Especially Property development  Accounted for 10% of total investment in 2003 29

30.  The sectors to open due to WTO accession  Wholesale and retail trade (2.1%)  Transport and telecom (1.6%)  Finance (0.4%)  Only 4% of total inflows in China (for world developing country inflows 27%) (P:420)  Wholesale trading rights granted (2003-2005)  Transport and telecom opened to foreign ownership (2005-2008)  Financial sectors open to foreign participation with bank market opening in 2007 30

31.  In the early 1980s borrowing from governments and international organizations were form of capital inflow to China (role of banks)  From 1993 FDI’s growing role  One reason is China’s financial markets were closed to portfolio investment  Policy makers preferred because it has brought technology, commercial expertise and capital  China maintained strict controls on foreign borrowing in 1990s  China’s total foreign debt was US$194 billion (14% of GDP) while it had US$403 billion foreign-exchange reserves (2003)  US$77 billion short term, US$52 billion borrowed from governments or IOs.  China maintained restrictions on capital account convertibility.  Exporter/importer can freely convert RMB, individuals/businesses can’t do in large amount. 31

32.  Despite nominal lack of convertibility on capital account, liquid capital flows to and from China are quite large.  Reflects that individuals and businesses in the absence of capital account convertibility utilize many different channels to move money into and out from China  Standard way to look at balance of payments is to break it down into the current account (payments for goods and services) and the capital account (transfers or assets).  When there is a surplus in the private transactions in the balance of payments it must be equal to the accumulation by the Central Bank of official foreign exchange reserves.  For China balance of trade positive above 2% of GDP since 1996, it jumped in 2005.  FDI inflows stable, 3-4% of GDP since 1996  “All other component” huge and volatile  From 1997-2000 net outflows of liquid capital over 6% of GDP  Flows then turned around in 2003 surpassed 5% of GDP inflow 32

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34.  Volatility of capital flows during Asian financial crisis of 1997-98 highlights China’s reliance on FDI  China was exposed to volatile flows of financial capital like other EA economies, it enjoyed a more reliable inflow of FDI  The investors made a long term commitment, their assets were not the type that could be quickly liquidated.  Less vulnerable to financial crisis because of “patient capital”  Challenge for China to move for greater openness (service sector), at same time China will be production base with expanding capabilities for global manufacturing networks. 34

35. Thank You for listening! 35