GEOG7102
Geography of Foreign Investment and Trade
in China
(Lecture Notes –
A personal property)
1
Lecture I: Introduction
 China: A World Focus and New Concept
 Underlying
Mechanism
for
the
Global
Economic Transformation: Trade & FDI & MNC
 So, Foreign Investments and Trade in China:
the Course Arrangement
I. China: A World Focus and A New Concept
 Of Commerce, Investment and Trade – A hot place
for business worldwide
 Of Professional Training – A popular subject in
university courses across disciplines and across the
world
 Of Academic Research – A fashionable topic in
academic research in most disciplines and in most
the world
 That matters (or is relevant to) our community, our
daily life and our career
Mainland China together with Hong Kong and
Macau: A Growing New World Giant that will
shock and re-shape the World in next 10-15 year
development
2
China’s GDP, Trade and FDI in Figures 2006:
Year 2006
Int’l Trade
1760.7/USD
Growth Rate
(%)
10.7
Almost 10% for
past 10 years
23.8
Export
969.1/USD
27.2
3
Import
791.6/USD
20.0
3
69.5/USD
-4.1
2
1066/USD
1333/USD by 6/07
10987billion/RMB
30
1
GDP
FDI
Foreign Reserve
Quantity (Billion)
20940.7/RMB
(2668.1/USD)
Domestic
24
Investment in
Fixed Assets
Domestic
16158.7billion/RMB
14.6
Resident
Savings
Domestic Retail
7641/RMB
13.7
Volume
Stock Market
8940.4/RMB
175.7
Capitalization
21898 by 8/07
Per capita GDP
2072/USD
More than 10%
(USD Dollar)
Shanghai 8000
for past ten
Beijing 5500
years
Shenzhen 6000
3
Global % and
Ranking
5.5% and
rank No. 4
PPP No. 2
3
6
Around 70-80th
China’s GDP, Trade and FDI in Figures 2007:
Year 2007
Int’l Trade
2173.83/USD
Growth Rate
(%)
11.4
Almost 10% for
past 10 years
23.5
Export
1218.02/USD
25.7
3
Import
955.82/USD
20.8
3
82.65/USD
13.8
2
43.3
24.7
1
GDP
FDI
Quantity
(Billion)
24953/RMB
(3418.2/USD)
Foreign Reserve
1528.25/USD
Total
13723.9/RMB
Investment in
Fixed Assets
Domestic
17952.6/RMB
Resident
Savings
Sales Volume of
8921/RMB
Social
Consumables
CPI
Stock Market
Shanghai $36943
$17653 by 09/08
Capitalization
(USD)
Shenzhen $7845
$3981 by 09/08
Per capita GDP
2600/USD
Shanghai $8,950
(USD Dollar)
Beijing $7,680
Yuen / USD
(End of 2007: 7.3)
Global % and
Ranking
5.5% and
rank No. 4
PPP No. 2
3
11.1
16.8
Shenzhen $10,850
4
4.8
302.6
6
244.2
20
More than 10%
for past ten
years
Around 70-80th
http://wzs.mofcom.gov.cn/
http://www.fdi.gov.cn
http://chinabiz.mpfinance.com/cfm/list_hg.cfm
China’s International Trade:
5
US$ 100M
16000.0
14000.0
12000.0
10000.0
Export
8000.0
Im port
6000.0
4000.0
2000.0
0.0
1985
1990
1995
2000
2005
Total trade to GDP ratio in China: 1980: 13%, 1995: 41%,
2000: 50%, 2007: 65%, which ranked 5th in the world.
International Trade contributes 30% of GDP in value-added
terms.
Now in China, More than 60% international trade is made by
Foreign Wholly Owned or Foreign Joint Venture companies.
Foreign Direct Investments
China is always the second largest FDI recipient in the world,
second only to the United States; and the largest amongst
developing countries, about 1/3 of total FDI in the Third World
Countries.
In 2000, production volume arises from FDI constitutes around
35% to the total GDP output in China. In 2006, the figure is
more than 50%.
Annual Growth Rates of FDI: 1984-88: 38%, 1989-91: 11%,
1992-2000: 30%, 2001-2005:20% with flat growth in 2006)
6
China problems: Structural in Systems, Quality of
China-made and Safety in food and health care
supplies…..
II.
Underlying Mechanism for the Global
Economic Transformation: Trade & FDI &
MNC
 Global total trade to GDP ratio up to 35-40%
 Trade arise from FDI constitutes 60-70% of the total
global trade volume
 FDI stock constitutes 20-30% of global GDP
 Trade made all trading partner better off and maximize
the global production and consumption
 FDI made both the recipient and the host country better
off and maximize the global production and
consumption
 MNCs are the true vehicles promoting trade and FDI
 Therefore, trade, FDI &MNC are the forces behind the
transformation of the global economy
III. So, Foreign Investments and Trade in China:
the Course Arrangement
See Course Web Page: “Introduction”
Reference:
7
Chapter 1: Berry B.J.L., Conkling E.C. and Ray D.M. (1997), The Global Economy
in Transition (second edition), Prentice Hall Inc., New Jersey, United States.
Lecture II: International trade, FDI and MNC as
dynamics of global economic transaction
The World Is Changing:
Everything (goods and services) is tradable or nothing
cannot be traded
Can you name one thing that must be supplied locally?
Implication:
 Produce (by yourself) or trade?
 If trade, what and from where you are going to buy, and,
most importantly, what and to where you can offer – trade
is a two-way journey!
 Open to new opportunities but new challenges too!
 Optimize and maximize production!
Everything (goods and services) is specialized and
standardized
Can you name one object that cannot be found other place?
Implications:
 Optimize and mobilize production -where you position
your production base that can best secure your market
 Don’t produce and trade final products –
processing/manufacturing in the production base and
assembling in the market
8
 Open to internationalization of production and firms global
strategy, in a macro/corporate-level
 Open to business in a micro/personal-level
 Open to new trade perspective and theory – intra firm
trade
 Open to demand for integrated and comprehensive
skill/knowledge/ability, the specialized and standardized
world is relative simple or less sophisticated.
Superiority of technology, knowledge and local
knowledge
Can you name anything more important that this for a firm to
survive, to compete, to excel?
This is the winning potion and formula!!!
Implication:
 R&D, but who can offer to finance R&D?
 The more money you put, the more market you need to
support
 the larger the better” and “go to the center” and “go
to global”
 Control and transfer of the technology
 the need for FDI and open a new FDI and MNC
perspective and theory
 Needs to tap the local knowledge
 Needs to close to market and to set up remote
subsidiaries and branches
 Open to new perspective and theory of geography of
finance and geography of service industry.
9
Who can take most of these changes? Who can enhance
and advance these changes?
MNE or MNC – open a new way of business that transforms
the world economy and our daily life!
The Nature and Role of MNC
 The MNC is a company that is headquartered in one
country but controls productive facilities and sales
outlets in other countries. Its operations involve
flows of capital, goods, services, and managerial and
technical personnel among its subsidiaries.
Ultimately, it leads the corporations to assume a
global outlook and strategy.
 The world’s 14 richest nations were headquarters to
7,000 MNCs in 1969 and 24,000 in 1994. There total
37,000 MNCs in the world in 1995, accounting for
more than 25% world goods production, 3%
employment in world total and 10% employment in
developed countries, and 50% global FDI and Int’l
trade volume.
 The largest MNC have sales exceeding US$1000
billion annually, more than many countries’ GNP.
Global sales of General Motors or Exxon are more
than GNP of 25 sovereign nations.
 Major roles in transfers of knowledge, technology,
investments, profits, and services among themselves
– intra-firm trade – shipments of parts, components,
subassemblies, rather than finished goods and
10
services. MNCs play dominant role in economic
development, particular in int’l trade and FDI, in both
developing and developed countries, including
Canada, Belgium, France and Italy.
 New perspective to trade theory – firms rather
countries are a prime agent for int’l trade, see
Chapters 11 and 12
 Two advantages:
– Information-gathering ability or scanning
capability – an immediate awareness of
opportunities, problems, and new development;
– Enormous store of capital, technology, and
managerial skills that an MNC can draw upon
Development and Structure
1. Originated from colonial operation
2. Three stages of development:
 A Linear Linkup to Japan (1970s);
 A transitional period of int’l specialisation and mesh (1980s);
 A final stage of global localization – the tetrapolar strategic
division of the world (1990s), see Box1.2
3. Emergence of major trade blocs
Role in Global Redistribution of Factors of
Production
1.
The most significant feature: an efficient agent for
transferring capital, managerial skills, technology, product
11
design, and commodities among countries; Equalizer of
factors distribution; Generator for innovation and
technological change
2. Transfer of managerial skills
3. Transfer of capital – both real (machinery) and financial
4. Transfer of technology
5. Principal generator of int’l trade
Theories of MNC
What causes a firm to go abroad and succeed in a foreign
environment?
What happens to the firm during the course of
internationalization?
- Expectation for greater profits/returns from foreign venture
by possessing four advantages that local firms don’t possess:
1. Superior knowledge – monopoly in knowledge: Leadership in
innovation is the key to compete and succeed in this
information age.
2. Superior size and scope of operation – oligopolistic in market
competition: World-wide resources to manoeuvre for
competition
3. Superior in technology protection and transfers – transfers
within own firms, go with rivalry and “reverse” investment:
competitors and rivalry route/locations, similar culture, legal
and political system, and English-speaking environment are
12
attractive and favourable elements for MNCs to open their
business.
4. Global Strategy:
 Move to exports
 Internationalization of production
 Internalization of organization
 Globalization of outlook: Worldwide recruitment of
Cosmopolitan Executives who are rich in three assets:
concepts – best knowledge and ideas; competence – the
ability to operate at the highest standards of any place in
the world anywhere; and connection – best relationships
inward and outward
 To HK/MACS students – you should also “go to global”
and “go to China”. You must equip or label with both
“Global” and “China” identities and trademarks so that you
can compete and survive in this increasingly competitive
world/job market.
13
Global Competitive Advantage
1.
Four Processes of globalisation:
 Mobility: Mobility of capital (both physical and financial),
labour, idea, and product and service is high.
 Simultaneity: Introduction of a product or service in one
place and its adoption at other place is required to be
“instant” or “simultaneous”.
 By pass: New product or technological alternative can go
around existing structure and barriers.
 Pluralism: Multiple choices
These four processes have together created a globalization
cascade – an efficient and mutually reinforcing feedback loops
that strengthen and accelerated the globalizing forces.
2. Factors: Michael Porter’s (1990) Four Factors of Competitive
Advantages (in contrast to the conventional comparative
advantages):
 Factor conditions: conventionally called “factors of
production”a) Physical resources:
b) Human resources:
c) Infrastructure:
d) Knowledge resources:
e) Capital resources:
14
The five factors can be grouped into basic factors, such as
physical resources, number of peoples, and advanced factors
such as educated personnel and R&D. Basic factors are
endowed, limited and of diminishing necessity and impacts,
while advanced factors are created (through education and
research), unlimited and of increasing significance and impacts.
 Demand conditions: the composition of buyers needs and
the size and pattern of domestic demands –
a) Power comes from influence over consumption, not as
traditional argument, from control over the means of
production
b) Japanese “light, thin, short, and small” product has
international impacts
 The nature of supporting industries: the surrounding
environment that fosters success by providing “dynamic
externalities” –
a) Sweden’s special steels - cutting tool industry; Swiss dye
industry – pharmaceuticals; Italy’s leather – shoes and fashion;
North European Envy for capital gains leads to least capital
accumulation while USA is just opposite
 Firm strategy, structure and rivalry: Good have enemy
3. Four Stages of Economic Development:
 Factor-driven: Developing Countries and China (Labour),
OPEC &Gulf States (Oil), Australia (Gold)/Canada
(minerals)
 Investment-driven: Japan and South Korean, and Taiwan
15
 Innovation-driven: USA
 Wealth-driven: UK and Western Europe
Reference:
Chapter 1 &11: Berry B.J.L., Conkling E.C. and Ray D.M.
(1997), The Global Economy in Transition (second edition),
Prentice Hall Inc., New Jersey, United States.
16
Lecture III: Old and New International trade
Theories
Background - The Necessity for World Trade
Nowadays nations and regions are becoming
increasingly interdependent, not only because of the
differences of their natural and human endowment, but
also because of the difference of their living tastes and
choices –
No country can by itself supply all ingredients for its
people due to their contemporary living standard
enforces them to desire for a diversified choice and
therefore requires variety of goods and services
A retreat to self-sufficiency would so impoverish a
people that no country would find such a course
politically feasible.
The world need trade and the trade change the world
fundamentally:
 A internationalized production process and development
strategy of firms as well as a locational decision-making
process
 A wholesale restructuring of industry
 A revolution in global communication and technology
 A growing dominance of MNCs in variety of aspects,
including cultural and political changes
17
 A shifting fortune of countries and regions and new
international map of commerce and polity (political
powers)…..etc
 A reconsideration of old theories and creation of new
understanding, approaches and new outlook
World Trade and the Energy Crises
The Oil crises 1970s and the global recession triggered
by them in the early 1980s are the most pivotal event of
the last century - Henry Kissinger, former US Secretary
of State
OPEC (Organization of Petroleum Exporting
Countries) – established in 1960, but really come to
power in early 1970s, then created the 2 world oil crises
in 1973 and 1979 and triggered global economic
recession in 1981-83; consisting of 13 countries in two
groups:
 Iran, Algeria, Indonesia, Venezuela, Nigeria, Ecuador, and
Gabon – large population and hungry for money
 Saudi Arabia, the United Arab Emerates, Kuwait, Qatar,
Libya, and Iraq – Small population and keen to preserve the
oil resource
18
OPEC Oil Control - Oil Crises and Global Recession
in 1970s and in the early 1980s
Pre-1973
Characters
World Oil
Control %
of the
Total
Oil Price
$/barrel
1973
The first
Oil Crisis
1979
The
Second
Oil Crisis
1981
1983
Global Recession
30 - 43
85
Less than
3
3
12
41
72
300
Dramatic down
31
50 - 60
Oil
Revenue
7
billion $/y
Oil Export
million
barrel
Balance of
Payment
billion $
After 1983
Compete Control and Monoply
+109
29 - 10
Less
Compete
Control
20 (16
1994; 3038 now)
18
27
-18
Further
deficit
Impacts and Consequences of the Oil Crises:
 Pre-crisis, $3/barrel oil encourage lavish use of oil,
particularly in western countries
 Global inflationary spiral and economic down-turn which
led to global recession
 Non-OPEC countries thrown into a balance-of-payments
deficit – global economic downturn
 Enormous global transfer of fortune and wealth from nonoil counties to OPEC countries – at least $100 billion per
19
annum, creating the world new rich and new poor and
creating great problems for OPEC on deciding areas of
usage of their revenue
 Developed world benefited from recycling of OPEC wealth
and developing world hit hardest with the exception of S.E.
Asia Countries
 Global recession in the early 1980s
 But demand for oil drop, oil price drop and OPEC deficit
rise, new alternatives and new sources (oil fields) results in
and new industrial restructuring
 The largest losers is OPEC itself!
Trade Growth and Structural Change
International Labor Division
Internationalization of production – highly independent
and interdependent production process - 25% of
finished manufactured goods made up from imports
Industrial structure upgrading with manufactured goods
increasingly dominant
The increased interdependence did not result in greater
industry specialization, as conventional theory
suggested, but in greater convergence – the trade
among LCs and NICs has actually become more similar,
differing only in brand name, quality and reputations.
20
Regional Patterns of Global Trade
See transparencies
Looking for Explanation – Old and New Theories
of International Trade
Old Trade Theory: from Classical to Neoclassical
Theory – the Principle of Comparative Advantage
Basic Questions asked:
Why do countries trade with each other?
Is trade beneficial to all trading parties?
What determines the international pattern of
specialization in production and trade?
From Adam Smith to David Ricardo, John Stuart Mill,
Francis Edgeworth, and Alfred Marshall
Mercantilism: exports exceed import – favorable balance
of trade; foreign rather than domestic trade;
manufacture rather than agriculture
Classical Theory:
Fundamental: Free trade – trade that is unencumbered
by any form of governmental intervention – is beneficial
to all trading partners. Why is that?
To measure the effect of trade: Labor Theory of Value –
all cost can be reduced ultimately to units of labor,
21
which are in turn directly related to the price of the
trading products
Classical + geometric technique = Neoclassical
Neoclassical Theory – The Principle of
Comparative Advantage
Basic Rationale: To a householder: never “attempt to
make at home what it will cost him more to make than to
buy (Never make thing unless it is cheaper to make than
to buy); The same applies to a country
Absolute Advantage (Adam Smith, 1776): – As long as
there is a natural advantage for individual countries, it is
advantageous for them to trade among them, and the
trade promotes international division of labor and
specialization of production, and hence maximizes the
world total output and consumption
But, what happen to those countries that have no single
absolute advantage but all absolute disadvantage – no a
single industry in which they can excel?
Comparative Advantage (David Ricardo, 40 years later):
Trade can indeed take place advantageously, even if one
is better than others in every production, as long as they
differ relatively in their capabilities. A country would not
have an absolute advantage to produce everything, so
as a country would not have an absolute disadvantage
of producing everything.
That is to say, the “rich” country’s absolute advantage
over the “poor” country in one product is relatively
22
greater than its absolute advantage in another product.
Similarly, the “poor” has an absolute disadvantage that
is relatively less than its other absolute advantage.
The principle of comparative advantage declares that
countries should specialize in production and export of
those things they can make more efficiently relative to
other nations and should import those goods at which
they are relatively less efficient
Simplified assumptions:
 No transport cost involved;
 No artificial barriers to trade;
 Labor is homogeneous and skill labor is a multiple of nonskill labor;
 Production technology is identical;
 No labor movement
23
Example 1: Absolute Advantage in both Countries
Assumption:
France has absolute advantage over the production of
potatoes
Germany has absolute advantage over the production of
wheat
Production possibilities, domestic exchange ratios, and
production and consumption of potatoes and wheat in France
and Germany before trade
24
Production Possibilities
Domestic Exchange Ratios
Wheat/Potatoes
Potatoes
Wheat
Potatoes/Wheat
90
50
140
60
100
160
1.50
0.50
France
Germany
Total
Production and Consumption
Wheat Total
Potatoes
0.67
2.00
45
25
70
30
50
80
75
75
150
After trade
France
Germany
International Exchange Possibilities
Potatoes
Wheat
90
100
90
100
International Exchange Ratio
Potatoes/Wheat
Wheat/Potatoes
0.90
1.11
0.90
1.11
Production, Trade and Consumption
Potatoes
France
Germany
Total
Wheat
Total
Consu
mptio
n
Production
Exports
Imports
Consumption
Production
Exports
Imports
Consumption
90
-90
45
-45
-45
45
45
45
90
-100
100
-50
50
50
-50
50
50
100
Example 2: Absolute Advantage in One Country Only and
Comparative Advantage in the Other
25
95
95
190
Production and exchange ratios of wheat and olive oil,
Italy and Spain
Italy has absolute advantage over Spain over the production of
wheat
Spain and Italy possess the same production capacity of olive
oil
Before Trade:
Production Possibilities
Wheat
Olive Oil
Italy
Spain
Total
40
20
20
20
Domestic Exchange Ratios
Wheat/Oi
Oil/Wheat
l
2.00
0.50
1.00
1.00
26
Wheat
20
10
30
Production
Olive Oil
10
10
20
After Trade:
Italy
Spain
Total
Production
Wheat
40
-40
Olive Oil
-20
20
International Exchange Ratios
Range of Potential Ratios
Ratios at Point C
Wheat/Oil
Oil/Wheat
Wheat /Oil
Oil/Wheat
2.0 Max
0.50 Min.
1.50
0.67
1.0 Min
1.00 Max
1.50
0.67
Mill’s Law of Reciprocal Demand – An Auction Process settling
the real international exchange rate/price. The actual international
price depends on the strength of elasticity (resposiveness to price
changes) of demand for these goods in each country.
The Gains from Trade - the First Gains from Trade
If trade is “truly” free, all trading partners will benefit from:
 Exchange goods
 International specialization of production and division of
labor
 Maximization of production (total output) and promotion of
consumption
 Specialization further enhances a country’s initial
comparative advantage
Inadequacies of classical and neoclassical theory
 Unrealistic assumptions
 All factors of production being collapsed into a single factor,
labor
27
Factor Proportions Theory and Inadequacies
Effects of Supply Conditions; Land as a Factor; Labor as a
Factor; Enterprise as a Factor; Capital as a Factor; Effects of
Demand Conditions; Cultural Differences; Difference in
Income; Domestic Consumption and Exports
The emergence of the Heckscher-Ohlin model, it states that
each country will export those goods whose production is
relatively intensive in the country’s abundant (and therefore
cheap) factor and import those that are intensive in its scarce
(and therefore expensive) factors. e.g. China’s light
manufacturing industry, Swiss watches, Indonesia wood
products
Empirical Tests: The Leontief Paradox
The theoretical expectations from this model is that US exports
would be capital-intensive and that its imports would be
labour-intensive.
But Leontief’s finding in 1953, suggested the reverse results.
This empirical test raised serious doubts that factor
endowments are in itself a sufficient explanation for trade.
Beyond that, it identifies other elements that are known to
influence trade, but that are excluded in the model.
28
A New Theory of International Trade and
Transactions (Helpman and Paul Krugman
1985)
Basic Fact: The Market and competition is imperfect, but
the emerging and flourishing MNEs and FDI have
completely transformed the worldMNEs responsible major share (up to 60-70% of the total) of
world trade;
The relationship between trade and industrial organization has
been completely changed
Increasing mobility of factors of production and firms assets
The Missing Elements of Conventional Theory
Reliance on Country Difference – Both absolute and
comparative advantages emphasis on country difference and
on country trade – an “arm’s-length” trade
Intra-industry Trade
Intra-firm Trade
Gains from Trade – Though trade tends to increase the GDP of
each participating country, it can be expected to reduce the
income to those of factors of production that contribute little
to its export, while increasing the income of those that
contribute more. But, nowadays it founds that trade has
increased the productivity of all factors of production in
trading countries and it has left everyone better off.
New Assumptions:
29
Individual firms possess unique competitive advantage
Firm assets are mobile among branches of the enterprise
Enterprises engaged in a lot of sectors/branches (“multiactivity”) and the economic functions by branches of a firm
are decided in accordance with the spatial distribution of
the firm assets
Most transactions take placed within the same industries,
between related firms and within multinational hierarchies
of firms
Trade is not entirely free and market competition is not perfect
Firms overcome impediments to operation of a free and open
market by hierarchical internalization
Fundamentals of New Explanation that old
Theory Left out: New Answer to Old question:
Increasing Returns and Overcoming Imperfect
competition (Krugman 1990)What is the Increasing Returns (to scale)?
Verdoorn’s Law (1949):
The greater the rate of increase of output inside a firm, the
greater the increase in productivities - the core value of
Increasing Returns
Kaldor’s Model (1966, 1978):
30
The more a firm produces of a good, the more experience it
gets as it learns by doing, and the more efficient it becomes
at producing not only that good, but other like it.
Productivity increases not only because of economies of scale,
but also because improved techniques arise out of increased
knowledge because of the specialization and concentration
of production.
Two factors are interrelated: Technological knowledge is
acquired by experience, which is in turn a function of the
specialization and concentration of production (that
involves cumulative volume of gross investment).
Such technological progress is internal to the firm, or
endogenous, and it results in a self-propelling spiral of
growth, enhanced productivity, and increasing returns – a
process similar to “positive feedback” and “circular and
cumulative causation”,
The core of increasing returns is the view that the dynamic
relationship between productivity change and output
change involving economies of large-scale production and
technical progress that specialization and concentration of
production generates.
This relationship is the key to the growth of capitalist
economies, and the relationship is self-propelling and
therefore endogenous.
Two interrelated concepts are Dynamic Externalities and
Network Organization
 Dynamic Externalities: Paul Romer (1986) and Robert
Lucas (1988), winner of the 1995 Nobel Prize in
Economics, argue that whereas how endogenous to a firm
and how the interplay occurs between firms, thus external
to them, it is internal to regional industrial clusters, such
as Silicon Valley: The self-propelling growth mechanisms
remain endogenous, but internal to the regional cluster as
31
whole – this result in extending of the principle of
increasing returns from firm to region.
 Network Orgnization
See pp. 266-268, Chapter 9, Berry B.J.L., Conkling E.C. and
Ray D.M. (1997), The Global Economy in Transition (second
edition), Prentice Hall Inc., New Jersey, United States.
The New Explanation:
Market is imperfect, however, MNEs thrive on market
imperfection – Structural Imperfection and Market
Insecurity, which cause a long-term and institutionalized
risk for firms
 Structural: Government restriction, tax, subsidies,
tariff, quota etc
 Market: Capital market insecurity: uncertain of
delivery, volatility of exchange rate, difficulty for
customer checking and evaluation, cost of
negotiation, infringement of intellectual property
rights
The motivation to overcome the market imperfacction
and the pressure to secure market share make
MNCs/firms enter trade with FDI by entering other
countries and setting up their production bases –
internationalization and specialization of production.
However, when MNCs/firms doing so, they find another
great discovery - the opportunities for increasing
returns that specialization and concentration of
production makes possible by increasing its scale
32
economies and technological progress – specialization,
concentration and agglomeration leads to increasing
returns!
 Thus, MNCs/firms and even countries may enter
into trade in order to enjoy the opportunities for
increasing returns, initially due to the market is
structurally imperfect.
 Thus, MNCs/firms and even countries may enter
into trade so as to benefit from increasing returns
that explain the proliferation of intra-industries and
intra-firms trade – a two-way trade, initially due to
the market is structurally imperfect.
Specialization on path dependence – history matters
and trying to make history by setting up a head-start,
which also leads to late comer advantage
The Gains from Trade again – The Second
Gains from Trade:
Imperfect competition make MNCs/firms enter trade and
then allows them discover and enjoy the possibility for
increasing returns that offers extra gains over and
above those obtainable from conventional trade based
on comparative advantage.
Increasing returns also offer extra gains from trade for
those countries having relative same factor
endowments. Trade offers a way for a firm to sell to a
larger market than afforded by its home country and at
the same time, through scale economies, to increase its
33
productivity, efficiency and international
competitiveness.
That is why for the secure of market share so as to
benefit from increasing returns helps to explain the
proliferation of intra-industry trade, intra-firm trade,
intra-region/territory trade – Global/regional economic
integration – free trade block.
34
There are following effects:
Own Production Effects – increasing returns reduce own cost
 Learning by doing and become more experiencing that
reduce the Cost
Concentration Effect of Production – increasing returns
reduce prices worldwide
 Specialization
 Scale economy
 Agglomeration economy
Rationalization and Internal Propelling Effect – increasing
returns increase productivity and efficiency worldwide
 New technology
 New way of product
 Spillover effect
 Self-propelling
Diversity Effect – increasing returns increase diversity
worldwide
 New place --- new opportunity – new products
 Other alike opportunity – spill-over effects or
externalities
 New market
35
This new theory implies that the world as a
whole benefits from trade twice, or even
Three-fold:
Gains from comparative advantage that increases total world
production and consumption – the “arm’s-length” trade
Gains from increasing return resulted in scale economies
agglomeration economies, new technology, new way of
production that multiply productivity , production efficiency,
and diversity of production.
Third Gains: Give chance to catch up from absolute
disadvantage to absolute advantage and give way to late comer
advantage
This is what we call:
‘The mechanism that transforms the world” - The mechanism of
globalization and the definition of “global perspective”,
globalization, and “Go Global”
Grand Implications – Toward A Theory of
International Transaction
36
Multi-agents for trade – Market is only one agent, others are
firms and its structure, consumer groups, national government,
and supranational government.
Integration of Trade and Production
Integration of trade and production and organization:
Organizing Role of Firms, its hierarchies and networking
Integration of Trade and Production and Innovation/
Technological Progress
Complex of Trade – Trade includes every aspects of our lives:
goods, people, capital, technology (skills), information
(experience/management), knowledge (property rights),
policy/regulations….
Organizing Role of National Government
Organizing Role of Supranational Government – GATT and
WTO
The mechanism of globalization, the essence of globalization
process - That is what we mean by the “Global Perspective”,
and “Globalization”
Reference:
Chapter 9 and 11: Berry B.J.L., Conkling E.C. and Ray D.M.
(1997), The Global Economy in Transition (second edition),
Prentice Hall Inc., New Jersey, United States.
37
Lecture IIIa: Trade regimes (WTO), Regionalization
and Global Development: Intervention, Control
and Policy
Trade plays a central role in economic growth, serving as a
means for acquiring necessary factors of production and
technology;
Though trade is essential for development, it poses special
problems for many LDCs. High on the list of problems affecting
national growth and development are physical and political
barriers to trade in addition to unfair international trade terms;
However, all are emulating one another to trade and aim at an
ultimate goal – free trade
Thus, trade policy and intervention promoting or restricting to
trade – trade conflict occurs – trade regimes occurs:
regionalization,
Again, MNEs make all difference – breaking through both
physical and political barriers and demanding WTO
Thus, needs for international cooperation – GATT and WTO overcoming physical cost and political barriers (artificial
obstacles)
38
Trade and Growth
Growth and the Propensity to Trade
Growth through Technology
 The trade effects of technology
 Technology – Invention and Innovation; Invention – new idea and
discovery; Innovation – use of new idea
 Two kinds of innovation – new way (efficiency) and new thing
(complete different new products)
 Technology change every aspects of our life and is the most dynamic
element in today’s world trade picture.
 Creation of technology: Education and R&D, Buy and Theft – Trade

Trade growth and the diffusion of innovation
Trade and Development
Trade problems of LDCs – locked into long-term poverty
Unequal trade terms with industrialized countries
Trade strategies for development

Trade whatever you can and the launch of the industrialization of a country

and then to participate in high level trade and share the benefit of trade
39
Barriers to Trade
Distance

Transfer costs make goods more expensive to importers and less valuable to
exporters – see Figure 12.2

The end result is that transport cost decrease international specialization – USA
produces more and sell less abroad while Canada reduce output though sell
more at home

Bill Gates foresee ahead a world of “friction-free capitalism” in which markets
come close to Adam Smith’s concept of perfect competition and in which the
distance barrier will by and large be removed.

However, there is still other kind of intervention – political interference
40
Political Interference
Incentives for intervention

Incentives for intervention – Why do governments intervene?

Nationalism
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Balance of payment – Equal between the total export and import of goods and
services including visible trade and invisible trade

Visible trade – merchandise goods that is physical

Invisible trade –all kinds of services – transportation, tourism, financial service
(banking and insurance), investment service (international transfer of interest,
dividends, profits), and professional service (consultancy), and technological
service. It also includes foreign exchange from gifts, private charities, money
sent by individual expatriates, governmental one-way transactions (government
loans, foreign aid, pension payment), and long-term capital flows (FDI and
mutual fund portfolio investment – making loans to or purchasing stock in
foreign countries).

Nowadays, balance of payment is very hard to measure and tends to not much
important in making national trade policy

Political interference includes trade exhibition fairs, government subsidies, loan
guarantees, tax rebates, and other incentives to exporters
Tariffs (both import and export)

Two main reasons: to earn revenue and to protect domestic producers, especially
industries where the countries is on the early developmental stage – the “socalled” infant industry

see Figure 12.3

Imposition of tariffs has a protection effect, a consumption effect, and an
income-redistribution effect. Tariff is basically a way of taxing foreigner.

Tariff leads to retaliation, hence reduce trade, trade specialization, production
and consumption
41
Quotas – a specific limitation on the quantity of exports or
imports, particularly the latter

Quota system makes domestic plants gain at expense of both domestic
consumers and foreign suppliers. The effects are inflationary for the importing
countries and at the same time they could possess monopoly control of
production, hence the price of that good, in which it holds monopoly

Quota is extremely arbitrary

Quota yields no revenue to government

Quota leads to uneasy feelings and retaliation, because of its inherent unfairness
Other Non-tariff Measures

State exchange control and distribution

State monopolies in specific commodities such as alcoholic beverages, sugar,
tobacco, cocoa, grains and other agricultural products

Special labeling and packaging

Sanitary and safety regulations (Japan and Europe in agricultural prodacts
protection are using this excuse)

Special measures and specifications
42
Effects of Trade on the Factors of Production
Factor Prices and Quantities
Factor Mobility

With today’s globalisation trade, factors of production have increasingly become
mobile but the degree of mobility of different factors are different – capital,
asset, entrepreneurship, technology, labour (unskilled labour), local
culture/tradition/habit having different mobility.

In conventional theory, trade will equalize prices, but the MNEs and FDI may
do the opposite – because of circular and cumulative causes giving rise to
increasing returns
43
Lecture IV: China’s Foreign Trade
Overview
1980
1985
1990
1991
1995
1998
China’s Foreign Trade, 1978-91 (US $ Million)
Ministry Data
Customs Data
Total
Imports Exports
Total
Imports Exports
37.8
19.6
18.3
38.1
20.0
18.1
60.3
34.3
25.9
69.6
42.3
27.4
84.1
32.4
51.7
111.6
53.4
62.1
99.5
38.5
60.9
115.4
63.8
71.9
N/A
280.1
132.1
148.0
N/A
324.0
141.0
184.0
China’s Foreign Trade Growth, 1980-91
Average Annual Growth
Rate (%)
China’s trade:
Ministry Data
Customs Data
Memo items:
China’s growth of gross national product
World Trade Growth

9.2
12.3
8.8
5.5
In the pre-reform era, exports were selected without much consideration
of China’s comparative advantage → As a result, expanding exports
might contribute little or nothing to economic growth
 Development economists have long argued that countries pursuing
externally-oriented development strategies achieve higher rates of
economic growth, because
 They attain higher rates of savings and investment
 More efficient use of scarce resources
 Allow technological upgrading
 A source of rapid productivity growth
 China exports $152.3 billion yuan worth of goods and services in 1998
 The most impressive export performance in China has been from the
foreign-funded enterprises and Chinese firms engaged in export
processing (township and village enterprises rather than state owned
enterprises.
44
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The output of foreign funded enterprises, along with that produced by
firms with a variety of less important forms of ownership, constitutes
from about 1% of output in 1985 to 7% by 1992.
The contribution of foreign-funded enterprises to annual incremental
exports rose from 4% in 1986 to an average of 3/5 in 1992-94.
Comparatively, state owned firms, which produced 2/3 of all
manufactured goods in 1985, have contributed a rapidly declining share
of annual incremental exports.
In 1986 and 1987 they accounted for more than 4/5 of the growth of
exports, in 1991-92, they still accounted for fully half of all manufactured
goods production, their contribution was only a fifth
By 1994 foreign funded enterprises accounted for 15 times more exports
than would have been expected on the basis of their contribution to
output
China began its economic reform with virtually no external debt
A very large share of the exports of foreign-funded enterprises are
processed products such as machinery, electronics and garments
Export earnings are largely used to pay for imported components and
assemblies used in the production of these goods, therefore, the imports
were mostly financed by export earnings
After the launching of the economic reform, China had been trading
predominantly with Western market economies for almost two decades
China has not borrowed significant amounts on international markets
China charged a relatively high tariff, which would change after China’s
accession to the WTO
The state-owned industries have not participated proportionately in the
growth of China’s exports, and they are heavily insulted from
international competition, and are protected heavily (for example: The
chemical industry receives an effective rate of protection from imports of
more than 110%) They appeared to be ill-prepared to compete with
foreign firms in China’s domestic market
Effects on Foreign Invested firms on Trade

The small amounts of foreign direct investment in the late 1970s and
early 1980s initially made a negligible contribution to China’s total
exports
 As late as 1985, six years after the passage of China’s foreign investment
law and five years after the establishment of special economic zones, the
exports of foreign invested enterprises were only $320 million, barely
45
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over 1% of China’s total exports, → Expanded dramatically, reaching
about $35 billion by 1994.
Exports produced by foreign invested firms are predominantly products
assembled from imported parts and components.
Many Chinese firms also produce processed exports using parts and
components supplied by or purchased from foreign firms
Total processed exports grew to $57 billion in 1994, almost half of
China’s exports
They comprised about 60% of $100 billion in manufactured goods
exports that year
In recent years about half of these exports have been produced by
foreign-funded firms
Foreign Borrowing and Foreign Equity Investment
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It is China’s second largest source of foreign capital
China’s total external debt rising from well under $1 billion in 1978, to
$93 billion by the end of 1994
China is the only transition economy, except for the Czech Republic, that
enjoys an investment grade rating on its sovereign debt, allowing it to sell
its bonds internationally with a lower interest rate than the market would
otherwise demand
It was the ready access to international borrowing which made China to
enjoy the luxury of running relatively large trade deficits in the first three
years of economic reform
China’s external debt is only modestly smaller than the two most heavily
indebted upper-middle income economies, Mexico and Brazil
At the end of 1993, China’s total external debt was $83.6 billion, a little
over $10 billion was owed to the World Bank and other lending agencies
Borrowing from private creditors on commercial terms comprised only
about three-fifths of China’s total external debt
B shares in China, which are priced in domestic currency but paid in hard
currencies, began in 1992, in Shenzhen and in Shanghai.
The listing of nine Chinese state owned companies on the Hong Kong
stock exchange beginning in 1993
In 1994 gross capital inflows exceeded $53 billion, including about $17
billion in borrowing from commercial banks, international organizations,
bilateral development banks and international bond markets, there is
about $2.5 billion in equity investments→ These figures suggest that
46
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China is heavily dependent on foreign capital to finance investment and
thus to generate the rapid economic growth of the 1990s.
At least to the end of 1994, foreign capital appears to have been an
insignificant source of investment in China. The reasons:
 Capital inflows may be used to finance a current accounts deficit
or may added to the foreign exchange holdings of the
government, enterprises or individuals.
 Capital inflows must be measured on a net basis, outflows of
capital must be taken into account
Official holdings of foreign exchange by the People’s Bank of China
more than doubled in 1994, from $21.2 billion throughout 1993 to $51.6
billion throughout 1994
Individual holdings of foreign exchange in the Bank of China and other
banks authorized to accept foreign exchange deposits, which since
August 1992 have not been included in China’s official foreign exchange
holdings, grew by about $6 billion in 1994.
Retained foreign exchange earnings of the Bank of China and other
financial institutions presumably also rose.
It is instructive to examine China’s current account, ignoring for the
moment changes in reserve holdings, any current account deficit must be
financed with a capital inflow. In short, net capital inflows must be used
either to finance a current account deficit or be added to foreign exchange
holdings.
After adjusting for changes in holding of foreign reserves, China’s net
capital inflows over time can be measured by its cumulative current
account deficit
On a year-by-year basis China’s current account surplus of about $13
billion in 1991 was only 3.7% per cent of GNP
The average current account deficit or surplus over the 12 year period
was less than half that of 1991→ China’s average current account
position has been quite modest
From the beginning of 1982 to the end of 1993 it was actually a positive
$5.846 billion
This does not mean that China experienced a net outflow of capital, for
changes in China’s foreign exchange reserves have been ignored
Over the same period China’s total foreign exchange reserves rose by
$44.2 billion.
Therefore China’s cumulative capital inflow over the period is the
difference between the increase in reserves and the current account
surplus or about $38.4 billion.
47
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As China’s cumulative GDP from 1982 to the end of 1993 was $4,100
billion, the cumulative net foreign capital inflows would amount to less
than one per cent of cumulative output
Because purchasing power parity estimates Chinese output in 1990 place
GDP at from 3.5 to 8 times the level calculated on the exchange rate
If the same relationship holds over the entire world, China’s cumulative
net capital inflow over 12 years could have been as low as one-tenth of
1% of Chinese GDP
Cumulative net foreign capital inflow relative to cumulative output of the
Chinese economy over the 12 years was less than 1% and may have been
vanishingly small
The contribution of net foreign savings to gross domestic investment
varies; in some years it is positive and in others negative. Contrary to
what one might believe on the huge foreign capital flowing into China,
on a net basis such inflows have not contributed to domestic capital
formation in China.
Foreign capital has not made a major impact on China’s savingsinvestment balance, it has contributed significantly to the transfer to
China of advanced technology and managerial practices in many
industries, to the expansion of China’s trade; and indirectly to the supply
of foreign exchange
Explaining China’s Export Growth
Chinese Exports of Crude Oil and Refined Petroleum Products, 197790
Millions of tons
Billions of US$
1977
11.1
1.0
1980
17.5
4.3
1985
36.24
6.7
1990
29.25
4.3
48
Questions Explaining The Growth of Exports in China
Although the pace of China’s trade expansion is clear, its sources are not.
Various questions have been raised to explain the growth of exports in China.
The questions are:
 Has the growth of exports been the result of decentralized decisions
by firms and/or trading companies responding to economic
incentives?
 Or has the rapid expansion of trade occurred largely within the
traditional system of central planning?
 Are increases exports identified primarily through export planning
and managed through nationally-run monopolistic foreign trade
companies?
 What is the role of foreign-invested firms?
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The sources of China’s trade growth have changed significantly over the
past dozen years.
The surge in the value of exports in the late 1970s and early 1980s came
largely from decisions of the state at the central level.
A major source was increasing exports of petroleum, one of the key
things identified to “finance foreign purchases.” It is the single product
ategory accounted for one-third of China’s incremental export earnings
After 1985, as petroleum is no longer served as significant sources of
export growth. Trade decision making was becoming more decentralized
and it became increasingly sensitive to economic factors
In the first-half of the 1980s, primary products (including agricultural
products and minerals) regularly comprised from 45 to 50 percent of
China’s exports → A little change from the period from the mid-1960s to
1980 when they accounted for just over half
The Commodity Compositions of Chinese Exports, 1980-91 (%)
Primary Products
Manufactured Products
1980
50.2
49.8
1981
46.6
53.4
1985
45.0
55.0
1990
25.6
74.4
1991
22.5
77.5
1998
11.7
88.3
49
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Due to the rapid growth of exports of textiles and other light
manufactured goods, after the mid-1980s, share of primary products in
China’s exports fell continuously and the share of manufactured goods
rose from half in 1985 to over three-quarters by 1991
The production of textiles and other light manufactured goods tends to be
much more labour-intensive than the production of primary goods, such a
shift suggesting China’s underlying comparative advantage in labourintensive products
There is a strong inverse correlation between the growth of exports
during 1985-90 and the ratio of capital to labour used in production.
Chinese exports were increasingly labour-intensive after 1985
Between 1980-1985, there appears to belittle correlation between relative
capital intensity in production
Capital Intensity in Production of China’s Largest Incremental Export,
1985-90
SITC Trade Category Description
Changes in Assets per
Exports 1985- worker
90
(yuan)
(US$ billions)
D84 Apparel
4.31
5,222
D65 Textile yarn and fabrics
3.49
8,621
D89 Miscellaneous manufacturers
1.47
6,832
D76 Telecommunications and sound
1.41
20,277
Recording and reproducing equipment
D85 Footwear
1.36
6,178
Mean of all export categories
0.45
13,991
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There is a strong inverse correlation between export performance in
1985-90 and capital intensity in production
 The difference in the second half of the decade shrank in relative and
sometimes absolute terms
 Three consequent of three critical developments of the evolvement of the
composition of Chinese exports:
 Decentralization of decision-making in foreign trade
 Reforms in the pricing of traded goods,
 The abandonment of an over-valued exchange rate
50
Decentralization of Foreign Trade
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Pre-reform era: The co-ordination of the flow of raw materials and
intermediate goods among major state enterprises and ensured that the
production of each good was sufficient to meet both inter-industry
demand and final demand for consumption, investment and export
Planners used imports to fill the difference between planned demand and
final demand for consumption
Exports sufficient to pay for these imports were then identified, starting
with goods for which domestic Exports sufficient to pay for these imports
were then identified, starting with goods for which domestic supplies
exceeded planned demands
By the mid-1950s foreign trade was a complete monopoly of the central
government.
A handful of specialized foreign trade corporations, some created as early
as March 1950, was responsible for implementing the plan
Lack of competition since each of the foreign trade corporations was
responsible for carrying out trade in specified, non-overlapping product
areas
The continued dominant role of these firms in the early years of reform is
reflected in their share of China’s exports and imports
In 1981 national foreign trade companies subordinate to the Ministry of
Foreign Economic Relations and Trade accounted for 91% of exports and
87% of imports.
By 1984 their shares were 79% and 65% respectively
Trade reforms in the mid-1980s substantially altered it. Shown by two
indicators:
 The growing number of foreign trade corporations
 The declining scope of the foreign trade plan
The State Council, in 1984, called for an end to the monopoly power of
the specialized national foreign trade companies→ The creation of a
large number of small and medium sized trading companies.
Within two years the Ministry of Foreign Economic Relations and Trade
had approved the creation of more than 800 separate import and export
corporations
Many of these were created by converting the provincial branches of the
national foreign trade companies into local companies carrying out trade
in the same product lines.
51
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Later province and municipalities established many general trading
companies authorized to handle a much broader range of goods
By the late 1980s the number of companies has soared to more than
5,000
China had long enjoyed a high reputation for fulfillment of trade
contracts.
Some of newly-created companies, however, lacked adequate experience
and funding or were not able to acquire domestically the goods they had
contracted to export
Non-performance of trade contracts became a matter of growing concern
to China’s trade partners
The State Council reassert central control over the process of approving
the creation of new trading companies and, subsequently, to dissolve or
merge existing companies to be unqualified or illegal in May 1988 and
March and November 1989
The resulting cutback still leaves substantial room for competition among
these firms
By the spring of 1990 roughly 70% of all foreign trade corporations had
been examined and only 800 had been either closed or forced to merge
with another corporation
From 1985 foreign trade plan was divided into mandatory and guidance
portions.
Mandatory plan imports and exports were specified in quantitative terms
and were usually the responsibility of the head offices of the national
foreign trade companies
Guidance plan imports and exports were generally specified in value
terms, giving local trading corporations more flexibility  This allowed
them to take economic factors into account when determining the precise
mix of imported and exported products within each category
Pricing of Traded Goods

The pre-reform trade regime world market prices had little or no effect on
the Chinese domestic prices of tradeable goods.
 This led the World Bank to characterize China’s traditional trade regime
as an “airlock system”
 Foreign trade corporations purchased goods specified by the plan from
domestic producers at officially established prices
 Producers received the same prices whether goods were sold
domestically or in the international market
52
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They received none of the foreign exchange income from the sale of the
goods abroad nor did they have any direct claim on it to purchase goods
abroad for their own use Little economic incentive either to sell on the
international market or to expand production of goods for which there
was strong international demand
Domestic prices of imported goods also tended to be unconnected to the
world market since after 1964 the prices of 80% of China’s imports were
set at levels comparable to similar domestic goods. Imports were sold
at prices significantly below world prices
Reforms, especially in the latter half of the 1980s, transformed the
pricing of traded goods
Domestic sale prices of a growing share of imported goods began to be
based on the world market price
The State Council’s 1984 foreign trade reform document called for the
widespread adoption of the “agency system” in which foreign trade
corporations undertake transactions on behalf of domestic firms and
charge them a commission
The agency system applies to imports the importing firm pays the world
market price (converted to domestic currency at the official exchange rate)
plus shipping and port fees, a commission, and any tariffs that apply, this
system is known as “foreign trade agent price formation”
By 1986, the domestic prices of four-fifths of all imports were based on
import cost with only 28 commodities continuing to be priced according
to comparable domestic goods
After 1988 this list was reduced even further, including, during 1989, the
removal of two of the most important commodities: from January timber
and plywood, and from November most imported steel and nonferrous
metals
By the end of 1989 the list contained only 14 commodities so that the
domestic prices of 90% of all China’s imports were based on world
market prices
In late April 1990 there were only eight commodity categories left:
chemical fertilizer, wood pulp, alkyl benzene, five sodium compounds,
nonionic surface active agents, grain, phosphorous ore, and titanium
dioxide and intermediates for producing agro-chemicals
The domestic prices of well over 90% of al goods imported into China in
1991 were based on world market prices
The old pricing regime, which provided a high degree of protection to
some import competing industries or a high degree of subsidy to
domestic users of some imported commodities, had largely faded away
53
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The initial pace of change in the domestic pricing of export goods
appears to have been somewhat slower than that for imports
By the late 1980s, the state used the pre-reform pricing system for only
21 export goods
These planned exports accounted for only 20% of the value of China’s
total exports in 1988, and 55% of total exports in 1988 fell outside the
plan in the same year
The exports outside the plan are the proliferation of competing foreign
trade companies sought to bargain for the most favourable prices
Initially these corporations sought to exploit the producers’ lack of
knowledge of world market conditions by paying them low prices for
their goods
The growing number of trading companies, the degree of competition
increased, tending to move domestic prices closer to world market prices
Producers of the 21 commodities that fell within the export plan could
take advantage of this competition by producing quantities of goods
above the planned level
Over plan production could be sold internationally on a decentralized
basis and producers bargained with foreign trade corporations for more
favourable domestic prices for that portion of their output
As the scope of the foreign trade plan shrank and competition among a
growing number of foreign trade corporations increased, the influence of
international prices on domestic prices of exports rose
The Exchange Rate and Exchange Control
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The price of foreign exchange had little effect on the volume of either
imports or exports in the pre-reform era
Thus, as in other centrally-planned economies, the exchange rate was a
largely passive policy instrument
Chinese domestic currency was highly over-valued in the pre-reform era
and the resulting excess demand for foreign exchange was handled
through a rigid system of exchange control
The domestic currency cost of earning foreign exchange was persistently
higher than the official exchange rate, making most exports financially
unprofitable
The Ministry of Foreign Trade reallocated the profits that were made by
some foreign trade corporations on their sale of exported goods
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The effective exchange rate varied from corporation to corporation and
sometimes even on a product-by-product basis
This phenomenon, which has called the “price-equalization mechanism”,
was common in centrally-planned economies
Compensating for the divergences between domestic and foreign prices
undermined the incentive for trading companies to exploit comparative
advantage trade opportunities
Reforms of the exchange rate and relaxation of exchange control were
among the most dramatic changes in China during the last decade
The Chinese authorities devalued the currency from a rate that averaged
1.6 RMB per US dollar in the late 1970s to an average of 5.3 RMB in
1991
The Yuan-Dollar Exchange Rate, 1978-91
Year
Yuan per Dollar
1978
1.68
1980
1.50
1985
2.94
1990
4.78
1991
5.32
2001
8.80
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Changes in the official exchange rate had only a modest effect on trade in
the first half of the 1980s under these reasons:
 Since the reform of traded goods pricing was just beginning, the
exchange rate had little effect either on the domestic currency
earnings of most export producers or on the prices paid by most
consumers of imports
 Changes in the official exchange rate did not really affect the foreign
trade corporations which were responsible for most trade transactions
 In their transactions with the bank of China they cleared their
accounts at exchange rates that differed from the official rate but did
not necessarily change when the latter changed
 Foreign trade corporations frequently received financial subsidies to
cover domestic currency losses from foreign trade transactions.
 From 1985, changes in the exchange rate had a greater effect on trade
 This was partly because changes in the pricing of traded goods meant that
exchange rate adjustments had a direct effect on the domestic prices of an
increasing number of imports and exports
55
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The value of the currency fell significantly in the second half of the
1980s
By the end of 1990, the official rate remained at 3.72, from the middle of
1986 to near the end of 1989, the average exchange rate received by
exporters improved significantly since they could convert a rising share
of their export earnings to domestic currency at a more favourable swap
market rate
By the end of 1990 the real value, i.e. adjusted for relative inflation in
China and the rest of the world) of the Chinese currency was 61% of that
in 1985 when the value is calculated on a trade weighted basis.
Combined with the reform of the pricing of traded goods this devaluation
reduced substantially the bias against exports and the subsidy to imports
of the pre-reform foreign trade and payments regime
The resulting reduction in the excess demand for foreign exchange made
possible a significant reduction in the rigidity of the exchange control
system
The process of relaxation began as early as 1979 with a modest foreign
exchange retention system that provided firms producing export goods
with a claim to use a small share of the foreign exchange earnings their
products generated
The scheme expanded steadily in different dimensions.
The average share of retained earnings grew from less than 10% of
export earnings in 1979 to more than 40% by 1988
Secondly, the opportunity to trade these foreign exchange use rights,
which was introduced in 1980
Formal parallel markets existed as early as 1985
By 1988, there were parallel auction markets for foreign exchange in
about 40 Chinese cities
The volume of trading in foreign exchange steadily expanded over the
decade
The volume of transactions soared from $4.2 billion in 1987 to $13.2
billion by 1990.
In the first 11 months of 1991 it grew by more than 50% to reach $18.175
billion
Initially there was a substantial gap between the official exchange rate
and the market price of foreign exchange, reflecting the continued
overvaluation of the domestic currency at the official exchange rate.
But, as the volume of transactions on the parallel market for foreign
exchange expanded and the State Administration of Exchange Control
devalued the official exchange rate further in December 1989 and
56
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November 1990, excess demand for foreign exchange at the official rate
ebbed
In late 1990, when the official rate was 5.2 yuan per dollar, the parallel
market rate was only 5.4 yuan per dollar, the parallel market rate was
only 5.4 yuan per dollar.
In 1991 the State Administration Exchange Control began a policy of
frequent but small adjustments in the official exchange rate
These adjustments, which led to an official exchange rate of 5.4 by the
end of the year, appear to be partly guided by developments in the
foreign exchange market
For example, by the third quarter of 1991 the parallel market rate had
increased to 5.83
But because the official rate has been devalued further, this represented a
premium of under 10% over the official rate at that time
The role of the swap market in allocating foreign exchange grew as a
result of reforms of the foreign exchange retention system introduced in
1991
Before this each province had a fixed quota of foreign exchange to be
delivered to the center and was allowed to retain 80% of all foreign
exchange earnings above this amount
For the other 20%, they were paid in RMB at the official exchange rate.
Retained foreign exchange could be used to finance imports outside the
plan or could be sold on the swap market for domestic currency
The 1991 reform of the foreign trade contract system abolished the
distinction between quota and over-quota foreign exchange earnings,
substituting instead a requirement that half of all foreign exchange must
be remitted to the center
This effectively raises the marginal rate of remission from 20% to 50%
The centre agreed to pay for the increased flow at the swap market rate
rather than the official exchange rate, that is it will buy two-fifths of
remitted foreign exchange at the official exchange rate and three-fifths at
the swap market rate
As a result the swap market price has become even more important
Before the 1991 reform, approximately half of all foreign exchange was
priced, either implicitly or explicitly, at the swap market rate
From 1991 this fraction rose to four-fifths
According to one prediction made early in 1991, the total amount of
foreign exchange priced explicitly at the swap market rate in 1991,
including that which the centre would pay for at the swap rate, would
57
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reach $25 billion. The net sales of the foreign exchange swap market
rose from $442 million in 1988 to more than $3 billion in 1994
The net result of these reforms was to erode substantially the bias against
exporting
Exporters on average received a much more favourable exchange rate for
that share of their earnings they were still received the remainder in the
form of a use right
That use right either could be sold for domestic currency in a market
where the degree of official intervention appears to have diminished
significantly in the past five years or could be used to buy foreign goods
On the import side, the implicit subsidy available to users of planned
imports shrank dramatically as more and more goods were imported on a
decentralized basis and priced according to the world market price
converted to yuan at a more realistic official exchange rate or at the
parallel market price for foreign exchange
China appears to be within striking distance of achieving internal
convertibility of the RMB in trade transactions. Among the socialist and
former socialist states, only Poland matches this pace of reform.
Unlike Poland, China’s reform was not backed by writing off and
restructuring foreign debt or standby loan agreement with the IMF
Regional and Sectoral Export Trends
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The three reforms analysed briefly above created the conditions in which
decentralized trade based on economic incentives could flourish. This is
evident in the kinds of enterprises that became the most successful
exporters by the late 1980s
Particularly significant is the growing share of China’s exports produced
by rural township and village enterprises and joint venture enterprises.
This trend was most obvious in the second half of the 1980s when the
three reforms really began to take hold
Rural enterprise exports jumped from about four to more than 12 billion
dollars between 1985 and 1990 and joint ventures exports from around a
quarter of a million dollars in 1985 to 12 billion dollars in 1991
These two decentralized sectors of the Chinese economy accounted for a
large share of the growth of exports in the second half of the 1980s when
the opportunities for decentralized exporting clearly emerged
58
Exports of Rural and Joint Ventures Enterprises, 1985-91 (US$ billions)
Rural Enterprises
Joint Venture Enterprises
1985
3.9
0.3
1990
12.5
7.8
1991
N/A
12.1
1998
N/A
19.5
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Additional evidence of the new conditions comes from an examination of
the regional pattern of export growth within China
The Guangdong province is the most notable example
In 1978, Guangdong was a second-tier exporter selling 41.4 billion in
world markets, about half the level of Shanghai
Up to the middle of the 1980s, Guangdong’s share of China’s total
exports actually fell slightly Guangdong is not a significant producer
of crude oil, refined petroleum products or the capital-intensive
manufactured goods that were the main sources of China’s export growth
up to the mid-1980s
After 1985 Guangdong’s share rose significantly. Exports more than
quadrupled from just under $3 billion in 1985 to $13.69 billion in 1991
The average annual rate of growth of Guangdong’s exports over this
period was 29% compared to 13% for the rest of the country
Gunagdong’s share of China’s exports rose from 11% in 1985 to 21% in
1991
In the process Guangdong eclipsed Shanghai to become China’s largest
exporter
Exports of Shanghai-produced goods rose only 10% between 1981 and
1988
It is easy to say Guangdong’s success is entirely on its proximity to Hong
Kong and its large share of China’s foreign-invested enterprises
Exports of foreign-invested firms in 1990 did account for a third of the
province’s earnings with processing and compensation trade bringing
another 6%. But half the growth between 1985 and 1990 was due to
expanded international sales by indigenous firms in the region, so other
factors must be involved. Several cases can be suggested:
 Guangdong manufacturing firms were on average only half the
size of Shanghai’s and they were much less likely to be stateowned.
 In 1988 the two regions produced almost identical levels of
industrial output, measured by gross value, but the number of
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firms in Guangdong was twice that in Shanghai. Guangdong
firms were smaller and capable of responding more quickly to
changing international market conditions
The advantage of small size was reinforced by the modest role of the
state in the ownership of Guangdong’s industry. Only one-quarter of
firms were state-owned. Three-quarters, producing by 1988 60% of
manufactured goods output, were urban collective, township and village,
private or joint venture firms
They were far more entrepreneurial than state owned firms, purchasing
most of their inputs and selling most of their output on the market rather
than working through the state’s material distribution and wholesaling
systems
On the contrary, in Shanghai, entrepreneurial firms in 1988 produced
only one-third of industrial output
Large-scale, state-run establishments dominated the municipality’s
manufacturing sector
The second critical difference was that Guangdong, having had a low
priority in the state’s plans for economic development since the 1950s,
had a more market-oriented economy than Shanghai, even before reform
With fewer state-owned firms tied to the state’s system of material
distribution, enterprises in the province were more likely to buy raw
materials, machinery and other producer goods on the market. By 1991
this had expanded further and more than 80% of all producer goods (i.e.
machinery, equipment and other capital goods) used in the province were
purchased on the market, whereas nationally the figure was only about
half
Many of the capital goods used in Guangdong came from other provinces
The development of markets and the use of marketing agents with welldeveloped extra-provincial ties were critical to the success of
Guangdong’s firms
In contrast, Shanghai’s industries were dependent largely on the state’s
system of material distribution
At this system eroded in the 1980s, some state-run industries declined as
they lost their primary source of raw material supplies and were unable or
unwilling to develop alternative sources through the market, especially in
the textile industry
As central government’s deliveries of raw cotton to the city’s factories
fell sharply in the second half of the 1980s, the industry fell into a slump
still not recovered
60
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Coal is another commodity that signifies the differences between
Shanghai and Guangdong, neither of which has any major local deposits
In 1989 the central government provided three-quarters of Shanghai’s
coal requirements through the system of planned allocation
The municipality purchased the remainder on the open market
But in Guangdong in the same year, the central government’s allocations
provided only 32% of the requirements and 68% had to be purchased on
the market outside the province
As a result Guangdong paid substantially more for its coal, and passed on
the cost to its customers in higher electricity rates
While Guangdong suffered power shortages, they appeared modest given
the pace of industrial development in the region
Guangdong development reliable extra-provincial supplies of coal
through market channels and built additional thermal-powered generating
capacity financed largely by local resources, more than doubled its output
of electric power between 1985 and 1990, meeting rapidly rising demand
both from industry and from domestic consumers as electric appliances
became common in both urban and rural areas
Shanghai’s electric power output rose only 10% over the same period
Guangdong was able to compensate for what initially appeared to be a
disadvantage, its low priority in the state’s plan for the distribution of key
industrial commodities, by increasing its reliance on the market
The rapid growth of Guangdong’s trade contributed to a structural change
of the province’s industry as well as an acceleration of its economic
growth
Between 1978 and 1990 industrial output in the province expanded by an
average of 16.3% per annum in real terms, more than4% per annum over
the national average
But Guangdong’s light industry grew even more rapidly, on average
18.8% per year, so that its share of total industrial output rose from 57 to
69%
This structural change was largely a result of the province’s rapidly
growing exports and evolving export structure
Guangdong’s traditional exports were predominantly live pigs,
vegetables and other agricultural goods sold primarily to Hong Kong
In 1985, 41% of the exports of indigenous local firms (excluding joint
venture firms and firms engaged in processing and compensation trade)
were agricultural and processed agricultural products
By 1990 this had fallen to only 25%, mirroring a 15% point increase in
the share of light and textile industry exports
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The dramatic rise in the latter reflected huge increases in the exports of
shoes (rising 41 times between 1985 and 1990), garments (up six-fold),
cotton piece goods (up seven-fold), silk piece goods (quadrupling),
plastic items (up 18-fold), toys (quadrupling), and tools (up five-fold)
There is no evidence that trade played a similar role in transforming
Shanghai’s industry over the same period
Industrial output grew by only 6.9% per annum, little more than half the
national average
Between 1978 and 1990 light industry advanced only marginally more
rapidly than heavy industry, and indeed for the period 1981-90 heavy
industry slightly outperformed light industry
Thus after 1981 the share of heavy industry increased almost 3% points
to reach 45.3% of industrial output in 1990, proportionately half again as
large in Guangdong.
The Pace of Trade Reform
China’s Balance of Trade, 1983-98 (US$ billions)
1983
+0.8
1984
-1.3
1985
-14.9
1986
-12.0
1987
-3.8
1988
-7.7
1989
-6.6
1990
+8.7
1991
+8.1
1998
+16.6
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The reform process was slowed down or even set back in two periods,
from the second quarter of 1985 until 1987, and from mid-1989 into 1991
 Liberalization of foreign trade, particularly of imports, in the fourth
quarter of 1984 led to a growing trade imbalance
 China framed the foreign trade liberalization passed by the State Council
in September 1984 from a position of a trade surplus
 In the fourth quarter imports grew at an astounding rate of 50% and the
trade balance turned sharply negative
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The trend accelerated throughout 1985 leading to an all-time record
annual trade deficit of $14.9 billion
The second period of significant trade imbalance began in 1988. As
previous administrative measures had brought the merchandise account
closer to balance by the end of 1987, controls on imports were relaxed.
An upsurge of consumer expenditure in 1988 led to rapidly rising imports
Although the government moved to reduce domestic credit expansion
from the fourth quarter of 1988 to cool down an overheated economy, the
flow of imports was not interrupted
Indeed increased imports of consumer goods, particularly durables, may
have been seen as a means of mopping up excess purchasing power that
was contributing to an unusually high rate of inflation in the latter half of
1988
As a result in the 12-month period ending in June 1989, the trade deficit
reached $12.3 billion, almost matching the previous record 12-month
deficit in 1985
In both periods the state adopted a variety of administrative measures to
restrict imports and promote exports in order to reduce the trade
imbalance
In 1985 a major way of cutting back on decentralized imports was a
freeze on the use of retained foreign exchange
Localities and export-producing enterprises were subject to “quota
controls on the use of retained foreign exchange” that drastically reduced
their use a fraction of the foreign exchange they had earned
By the end of 1986, $19.1 billion in retained foreign exchange had been
“borrowed” by the central government, which used it in part to finance its
own trade deficit
When the system of retained foreign exchange “borrowed” by the centre
was never repaid
In response to the second period of a burgeoning deficit, the central
authorities imposed substantially increased restrictions on imports,
particularly after mid-1989
There was a ban on the import of many types of consumer goods, an
expansion of the scope of import substitution restrictions on imports, and
a recentralization of control of decision-making on some types of imports
Imports of foreign luxury cars, cigarettes, alcohol and canned beverages
were banned from the first half of 1989
The list of import substitute products, which cannot be imported without
the permission of the Ministry supervising domestic production of
competing goods, expanded significantly
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That led to de facto bans on some imports even when the foreign goods
were cheaper than or technologically superior to the domestic product.
The state also reassert central control of imports of a broad range of
products, including wool, some types of steel products, plywood, colour
television components, scientific measuring devices, various types of
building materials and chemical fertilizer
At the same time the state stepped up efforts to provide preferred access
both to raw materials and to credit to assure the continued growth of
exports
Assured credit supplies for exporters were particularly important in the
fourth quarter of 1988 and in 1989 because the central monetary
authority was pursuing an overall restrictive credit, exports would have
been severely restricted
The effect of these measures on the trade balance was dramatic
By the third quarter of 1989 imports were falling in absolute terms,
reducing the quarterly trade deficit to $700 million, less than a fifth of the
deficit in the second quarter.
In the final quarter of 1989, the deficit was only $100 million. In 1990
China achieved trade surpluses that grew greater in each quarter
For the year as a whole, imports fell $5.8 billion, exports rose $9.5 billion,
and the trade surplus was $8.74 billion
By the end of 1990 Chinese foreign exchange reserves had risen to $28.6
billion, more than twice the level of mid-1989
The reduction of the deficit should have set the stage for a renewed
relaxation of controls on imports
Imports did begin to grow in the last quarter of 1990 and continued to do
so at double-figure rates in the early months of 1991
But exports moved up even more rapidly leading to substantial monthly
trade surpluses
In the first half of 1991 the trade surplus grew almost 50% compared to
the first half of 1990
China’s trade strategy had changed fundamentally from a genuine policy
of “opening up” and “trade liberalization” towards a policy of “continued
emphasis on export growth without import liberalization”
Compared with the same period a year earlier, China’s balance of trade
surplus fell sharply in the second half of 1991
It appears likely that this trend will accelerate in 1992
Chinese trade practices became a matter of growing concern in the US
since what was a modest bilateral trade deficit with China in the mid1980s grew to
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$6.2 billion in 1989 (the sixth largest American deficit on a worldwide basis
 $10.4 billion (the third largest) in 1990
 $12.76 billion (the second largest) in 1991
These deficits were related to a dramatic shift in the direction of China’s
trade, particularly on the export side, with the United States becoming an
increasingly important market
The United States share of China’s exports went from 6% in 1979 
14% in 1985  26% in 1991
In contrast, the share of China’s exports going to Japan actually declined
during the 1980s
Japan absorbed $4 to $5 billion annually in Chinese products in 1980-82,
approximately 24% of all Chinese exports
By 1988-90 Japanese actually declined during the 1980s
Japan absorbed $4 to 45 billion annually in Chinese products in 1980-82,
approximately 24% of all Chinese exports
By 1988-90 Japanese imports from China were $10-$12 billion annually,
but that was only 19% of China’s then much larger export volume
Japanese exports to China plunged from a peak of $12.5 billion in 1985
to only $6.1 billion in 1990
Thus from the late 1980s Japan too incurred a deficit in its trade with
China
China’s trade deficit with Japan is different from her trade deficit with
the United States in two respects
Even at its peak in 1990 of $5.9 billion Japan’s deficit was only about
half that of the US
Japan’s deficit narrowed to $5.6 billion in 1991 because of a 40%
increase in exports combined with an 18% increase in imports (Japan’s
share of China’s total exports stabilized), while the United States’ deficit
continued to widen
The growing bilateral trade deficit between US and China has led the US
to initiate a formal bilateral discussions on market access issues in mid1991 with the expectation that the Chinese authorities would reduce the
number and severity of administrative barriers they imposed on imports
These included import licensing requirements; selective quantitative
restrictions on imports; onerous technical barriers, mainly product testing
and certification requirements; and a lack of transparency (i.e. many
internal regulation not available to foreigners) in China’s trade regime
Bilateral negotiations on China’s protection of intellectual property rights
also began around the same time, in late May 1991
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The US government believed that if copyright and patent protection
provided by China were raised to world standards American firms would
be more willing to sell computer software, chemicals, pharmaceuticals
and so forth Increase American sales to China, thus reducing the
deficit
The first two rounds of bilateral discussions on market access took place
in Beijing in June and in Washington in August 1991
President Bush (Senior) promised to initiate trade sanctions against
Chinese imports into the US market if these efforts were not successful
In October the US administration launched an investigation of China’s
trade practices under Section 301 of the United States Trade Act of 1974
Under the provisions of the law China had until 10 October 1992 to
satisfy specific American complaints or face prohibitive tariffs on some
of its exports to the US
Only a few weeks later the United States would impose prohibitive tariffs
on specified Chinese exports
This step is allowed under the special 301 provision of the US trade law
dealing with foreign violations of American patents and copyrights
Although many observers predicted that China would not respond to the
threat of sanctions, an agreement was reached in mid January 1992, only
hours before a final deadline for the imposition of punitive tariffs
Under the agreement China undertook to provide stronger protection of
patents and copyrights, particularly for pharmaceuticals and other
chemical products, computer software and sound recordings.
Conclusion
 China foreign trade has made stunning advances since economic reform
began in the late 1970s
 Initially trade expansion was heavily state directed
 From the mid-1980s onward this was gradually displaced by a more
market determined pattern of trade
 The proliferation of new trading companies that could compete with the
handful of national foreign companies, which hold monopoly on trade
before, and far-reaching reforms in the pricing of traded goods and the
RMB created the economic environment in which decentralized trade
decision-making based on economic incentives became increasingly
important
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The growing role of trade after 1985 in regions such as Guangdong
Province, where the system of state-owned firms and their associated
supply and marketing is relatively modest, highlights the character of
China’s trade reforms
The emergence of large trade deficits, once in the middle of the decade
and once near the end, led to some retrogression as the centre increased
its reliance on administrative intervention to curtail imports
The main limitation on China’s trade reform is the partial nature of
domestic economic reform
As Lardy (1995) suggested although there is nothing wrong for relying
foreign-funded enterprises to push the rapid export growth, but combined
with the protection provided to state-owned industries, it has inhibited
productivity growth, especially in intermediate input industries where
prices are still above international levels.
Export growth from foreign invested firms A large share of which is
export processing Limited backward linkagesDomestic content of
exports is very low Export industries appear to be enclaves and
China’s state-owned industries have underparticipated in export growth
by a wide margin.
Periodic burgeoning trade deficits reflect the centre’s difficulty in
exercising macroeconomic control of a semi-reformed domestic economy
The traditional system of controlling aggregate demand has atrophied
significantly and the development of market-oriented fiscal and monetary
policy instruments has just begun
The sources of export growth, particularly in the second half of the 1980s
and early 1990s, underline the limitations of domestic reform
State-owned industrial enterprises account for a disproportionately small
share of China’s export growth
If China can address these problems successfully there seems little doubt
that the reforms of the second half of the 1980s will provide the basis for
the continued growth of Chinese exports and thus of imports as well.
References:
Lardy, N.R., (1995). "The Role of Foreign Trade and Investment in China’s
Economic Transition” The China Quarterly, No.144, December, pp10651082.
Lardy, N. R., (1996) “Chinese Foreign Trade”, in Ash, R.F. and Kueh, Y.Y.,
(eds), (1996) The Chinese Economy Under Deng Xiaoping, Clarendon
Press, Oxford, UK
67
Lecture V: Theories of FDI in the Context of China
What is FDI?
 The Majority of foreign investment is composed of
 Direct Investment
 Portfolio Investment
 The motivation of the investor is the determinate feature of the type of
investment
 FDI is the lasting interest by a foreign investor in an enterprise to
obtain an effective voice in the management of the enterprise
 For the international harmonization of the statistics, the lasting interest
is identified with a numerical guidance of at least 10% ownership by
the foreign investor (as opposed to portfolio investment for which the
motivation of the investor is different)
 The 10% rule is the basic guidance for the classification of FDI
statistics.
Two schools on the role of FDI:
 As a Dynamic force in the host country
 DFI makes a positive contribution to the economic
growth of the host country through:
 An increasing capital supply,
 Technology Transfer,
 Training
 Productivity gains
 As a Tool of International Exploitation by MNCs
 Investment by MNCs  The ultimate economic
dependence by the host country on MNCs,
 Undermines the host country’s economic authority
 MNCs are to exploit the natural resources and cheap
labour
 The benefits of FDI mostly went to the MNCs through
transfer pricing for imports and exports
 The Newly Industrialized Economies in East Asia, using foreign
investment to promote export-oriented economic development.
 But FDI is less influential in Latin America and Africa.
68
 FDI and multi-national corporation allows economic growth and
development. It is necessary to incorporate the theories of FDI and
MNCs into economic development theories.
 The theories of FDI and MNC are essentially micro-economic growth
and development theories of analyses of transnational investment
enterprises.
Theories of Foreign Direct Investment
There are six theories of Foreign Direct Investments.
 Neoclassical theory of capital mobility
 The industrial organization approach
 The transaction cost or internalization theory
 Location theory
 Dunning’s eclectic theory
 Kojima’s macroeconomic theory
Neoclassical theory of capital
 Characteristics:
 It is part of the theory of international factor movements
 It implies the international movements of factors of production,
including foreign investment, are determined by the different
proportion of the primary production inputs available in different
countries.
 Flow of investment: Countries where capital is relatively abundant →
countries where capital is relatively scarce
Movement of capital: Countries with low margin of productivity →
Countries with high marginal productivity of capital
Such international investment (or capital movement) may benefit both
the investing and host countries
 Host country benefit from foreign investment. The productivity of the
investment, as reflected in the income created, exceeds what foreign
investors take out of the host country in the form of profit and interest
69
Weakness:
 The neoclassical theory assumes:
 Perfect competition,
 Zero transaction costs,
 Perfect competition
Which fails to:
 Fully account for investors’ motivations and behaviour
 The impacts of investment on a real world with imperfect markets and
uncertainty.
 It does not distinguish FDI from other forms of capital form
 It fails to explain the two-way capital flows between capital abundant
countries, for instance, FDI between the US and Japan or between the
US and Britain.
 It failed to highlight the social and economic consequences of FDI.
Industrial Organization Theory
 Movement of capital associated with FDI is not a response to higher
interest rates in “host” countries but takes place in order to finance
international operations.
 Firms move abroad are based on a theory of firm and industrial
organization.
 It is primarily concerned with the characteristics of multinational
corporations and the market structures in which they operate.
 Market structure and competition conditions are the determinants of
the types of firms which engage in FDI.
 Firm-specific advantages, such as a firm’s market position, to explain
the international investment of the MNC’s. These firm-specific
advantage include:
 Patents,
 Superior Knowledge
 Product Differentiation,
 Expertise in Organizational and Management
Skills,
 Access to Overseas Markets
 To Credit
70
 Such advantages made certain firms have over competitors in the
home country can be extended into foreign markets through
international direct investment.
 Hence, FDI, in this theory, is regarded as oligopolistic MNCs seek to
close out market competition by the erection of barriers to entry and
firm-specific advantages
Location Theory
 It places emphasis on country-specific characteristics.
 It explains FDI in terms of relative economic conditions in both the
source and host countries.
 Two subdivisions of the approach:
 Input-oriented
 Output-oriented
 Input-oriented factors are associated with supply
variables, such as:
 Labour,
 Raw Materials,
 Energy
 Capital
 Output-oriented factors are the determinants of market demand,
including:
 Population Size,
 Income per capita,
 Openness of the Markets
 The country-specific factors not only determine where MNCs make
direct investment, but also can account for the different types of FDI
such as domestic-market-oriented investment and export-oriented
investment.
The Transaction Cost or Internalization Approach
Characteristics:
71
 The activities of MNCs are a response to market imperfection which
causes increased transaction costs.
 It explains the better outcome of efficiency resulted from
internalization
 Through FDI, two types of market imperfection may be internalized:
Structural and the market of transaction costs.
 Structural: Market imperfection associated with regulatory aspects,
such as:
 Tariffs or subsidies
 Foreign Exchange Controls
 Import Quotas
 Income Taxes
 Restrictions on profit repartriation
 MNCs to internalize this type of market imperfection for a rentseeking purpose.
 Market imperfection also relates to market transaction costs,
especially for an intangible asset transaction such as technology
transfer.
 MNCs prefer FDI rather than trade or licensing the use of their firmspecific intangible assets.
 The transaction cost or internalization theory is a model pf private
welfare maximization.
 Weakness:
 It allows little room for social welfare considerations
 It fails to account for the macroeconomic impact of FDI.
Dunning’s Eclectic Theory of International Production
Characteristics:
 It combines the industrial organization approach with both the
location theory and internalization theory to explain FDI and
international production activities.
 It is also known as OLI theory
72
 It applies to entry-mode selection states that firms will choose the
most appropriate form of entry into a international market by
considering the following
 Their ownership advantages
 The location advantages of the country under
consideration
 The internalization advantages of the particular situation
Ownership Advantages
 Ownership (O) advantages are firm-specific competitive
advantages (Porter, 1980) that the firm may possess
 These ownership advantages are created through
 A firm’s international experience,
 Size,
 Their ability to differentiate their product or service,
 The adaptability of the product or service,
 The service intensity and the technology intensity of their
offerings (Dunning, 1993)
 Examples of ownership advantages might include
 Unique products or services which cannot easily be
duplicated by competitors, or
 The possession of financial and experiential resources which
provide a method for entry into otherwise closed markets.
 Ownership advantages need to be both unique and sustainable in
order to provide the firm with a competitive advantage in entrymode selection (Porter, 1980)
Locational Advantages
 Locational (L) advantages are country-specific factors related to
the market under consideration – market potential and market risk
(Root, 1987) and are available to all firms in that particular market
(Dunning, 1988).
 However, some firms are better able to utilize these location
advantages then other firms, thus enhancing their competitive
advantage either within the new market, for example through better
coordination of within country activities, or internationally, for
example providing lower cost labour which would result in a cost
advantage in all markets where the firm’s products are sold
(Dunning, 1998)
73

Measures of location advantages include sales demand and
potential demand, differences or similarity in culture, economic,
legal, political and trade policies, similarity of market
infrastructures and the availability of lower production costs
(Dunning, 1993)
 Finally, the internalization (I) advantages are concerned with the
costs of choosing a hierarchical mode of operation over an external
mode (Dunning, 1993, 1988)
Internalization Advantages

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
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





The internalization advantages are concerned with the costs of
choosing a hierarchical mode of operation over an external mode.
(Dunning, 1993, 1998)
The internalizing of international operations comes at a cost.
These costs must be compared with the costs of finding and
maintaining an external relationship to perform the same functions
in the international market.
Willliamson (1981) refers to these costs must be included in
consideration of entry-modes (Contractor, 1990; Hennart, 1989,
Gatignon and Anderson, 1988)
They unfortunately cannot be accurately calculated before the
international operation has been established (Dunning, 1993)
Because of this inability to calculate internalization advantage, we
have excluded this factor from the present study
Dunning (1993) has recently suggested that the motivation for foreign
market expansion may influence the entry-mode selection process,
despite perceptions of the OLI advantages.
Motivations can include market-seeking, resource-seeking,
technology-seeking, cost-reduction seeking, and client-following
activities.
Some preliminary evidence on the influence of motivational factors
can be found in a few previous entry-mode studies (Kim and Hwang,
1992; Erramilli and Rao, 1990)
Dunning’s motivations for engaging in FDI (Foreign Direct
Investment) were not included in this study because, based on our
understanding of the dynamics of the industry.
For example, most US software firms appear to have the same motive
for foreign entry, market-seeking.
74



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






Due to the US dominance in technology and resources, Resourceseeking and technology-seeking activities tended not to motivate
foreign investment in the past
However, technology seeking may begin to motivate foreign
investment due to the continuation of the shift of the software industry
to other countries, e.g. US software firm Symantec’s merger of
Delrina of Canada, to inject Delrina’s technology into Symantec
Due to the requirement of high skilled personnel (which is
concentrated in the US) in the software industry, Cost reduction
seeking motivation is of a minor concern.
Client-seeking activities do not require in the software industry, as
the software industry is highly mobile easily crossing national borders,
and packaged software can be exported to the whole world quickly.
US software firm expansion appears to be driven primarily by
motivation of seeking new markets for existing products.
In other words, according to this model, three conditions are
indispensable for FDI:
A firm must possess net ownership advantages over rival firms in
the host country’s market,
It must be more profitable for the firm to maintain these
advantages internally, rather than to sell or lease them to foreign
firms,
The firm must believe that its advantages can be better exploited by
using location-specific factors (such as labour and market) in the host
countries than by simply exporting to foreign markets.
It combines the aspects of each of the theories mentioned above.
It provides a more comprehensive explanation of the nature and
characteristics of FDI initiated by a MNC.

The theories mentioned above are applied to a particular type of firm,
that is, the multi-national companies, and provide a micro-economic
analyses of the nature, causes and types of FDI and of the
transnational business behaviour of the MNCs, while macroeconomic
analyses are often being ignored.
 Therefore, the approaches mentioned above failed to explain
international differences in FDI by MNCs from countries with
different cultural backgrounds and macroeconomic structures.
 The theories, however, fails to provide a framework for analysis of
the macroeconomic impact of FDI in the host country.
75
Kojima’s Macroeconomic Theory of FDI
Characteristics:
 He has proposed a macroeconomic theory of FDI within the
framework of relative factor endowments
 Two different types of FDI: Trade-oriented and anti-tradeoriented.
 Trade Oriented: FDI from a comparatively disadvanxtaged industry
in the investing industry, it will harmoniously promote an upgrading
of industrial structure on both sides and this will accelerate trade
between the two countries.
 Comparative profitability in trade-oriented FDI conform to the
direction of potential comparative costs and therefore complement
each other.
 Example: Japan investments in developing countries in Asia
 Anti-trade oriented FDI: It can be evidenced those from the US
 The US investments abroad are concentrated in capita-intensive and
high echnology industries in which it has comparative advantages
 They do not conform with the comparative profitability formula
 They work against the structure of comparative advantages, because
these new industries
 Set-up foreign subsidiaries,
 Cutting off their own advantages, and
 Leading to trade-substitution effects
Weakness:
 Although Kojima’s macroeconomic theory of FDI provides a basis for
the analysis of the relationship between FDI and trade, his
classification of two types of FDI makes his macroeconomic approach
less valid for assessing the economic impact of FDI in an empirical
sense.
 An investigation of the macroeconomic impacts of FDI shall be on
how and on what extent FDI affects the conditions and
determinants of economic growth and development.
76
 Dunning (1988) argues, the scale of benefits of FDI depend on
 The type and nature of the investment,
 The economic conditions and characteristics of the host
country,
 The macroeconomic and organizational strategies and
policies pursued by host country governments.
Economic Impact of FDI: Supply-side View
 FDI may affect the supply of productive resources including
 Financial Capital,
 Equipment and Machinery,
 Technology,
 Management Expertise, and
 Labour Training.
 It can influence the aggregate demand of the host country
 Both the classical and neoclassical economic theories explain
economic growth and development in terms of:
 The stock of productive resources available for an economy, and
 The utilization of these resources.
 The productive resources include capital, labour, technology,
management skills and natural resources.
 According to Ricardo’s classical theory of growth, an increase in
capital and labour would result in growth of output.
 In the Harrod-Domar Model of growth, change in capital stock
(investment) + incremental capital-output ratio (ICOR) determine
the growth of national income. in investment   in income
(output); For a given amount of capital, income is determined by
marginal capital productivity (the inverse of ICOR).
 In Solow’s neo-classical model, stock of capital and labour and the
capital-labour ratio determines economic growth.
77
 Capital increases faster than the increase in labour (termed capital
deepening) the capital-labour ratio   in a growth of labour
productivity.
 Technology and exports shall also being included in economic
growth models.
 The critical factors influencing economic growth are:
 Technological progress
 Capital deepening
 Export orientation
 Rational Management
 Development Strategies

Many argued economic development is restrained by the shortage of
 Capital (both financial and physical)
 Technology
 Skilled labour
 Management Expertise
 Foreign Exchange
 The shortage of these production factors, cause the bottlenecks in
economic development of developing countries.
 It is the key for these countries to achieve economic growth and
modernization by removing such bottlenecks.
 FDI may positively affect the economic growth of developing
countries through the following channels
 FDI may positively contribute to the capital formation of
the host country,
 FDI, as a type of foreign capital inflow, represents an
addition to the domestic savings of the host country,
 FDI may bring advanced equipment and machinery to
the developing host country or finance the importation of
capital goods that cannot be produced in the host country,
thereby contributing to its capital formation
78
 FDI improves infrastructure in the host country and
creates good investment financed by domestic savings,
leading to the promotion of domestically-financed
investments
 In addition of foreign capital may also relieve pressure on
the rate of interest charged in capital markets in the host
country, and provide an incentive for domestic investment

Weakness
 FDI may displace indigenous investment in the host
country. If FDI is financed from the local financial
market and results in a higher interest rate, it may crowd
out domestic investment.
 The net impact of FDI on capital formation in the host country
depends upon its effect on the domestically-financed investment.
 FDI may promote productivity of the domestic sector of the host
country through technology transfer and the training of local labour,
technicians and management personnel.
 The induction of technology progress, transfer and diffusion are
the most important contributions of FDI to the economy of the host
country.
 It is widely believed that the new forms of FDI, especially joint
ventures, facilitate the transfer and diffusion of technology in the
host country.
 Through the forward linkage effect, foreign-invested enterprises
(FIEs) supply equipment, machinery and other intermediate products
to domestic firms.
 The products made by FIEs may also substitute for imported
products,  helping the host country to alleviate reliance on imports
 reduce trade deficits.
 FIEs are seen to contribute to the host Government’s tax revenue.
79
 However, the net contribution depends on whether the tax revenue
paid by FIEs is larger than the expenditure by the host government for
establishing and improving infrastructure for FDI. In this regard,
transfer pricing manipulated by MNCs in order to avoid tax is an
important factor affecting the host country’s tax revenue.
Economic Impacts of FDI: Demand-Size View

The economic growth in a country depends not only on its productive
capacity, but also on the extent to which that production capacity is
actually utilized, together with the strength of demand.

An  in any component of aggregate demand  a  of GDP and
income level.

FDI may contribute to the economic growth of the host country
through positively affecting aggregate demand.

Subsequent demand by foreign-invested enterprises for inputs of
production is even more important after initial investment demand

As the MNCs need to employ local labour and management personnel
and pay them wages and salaries, this employment creation by FDI
is important for many developing host countries where the rates of
unemployment and underemployment are high.

It provides not only income to employees and thus additional
savings to the host country, but also helps improve labour
productivity of traditional sectors (such as agriculture) by absorbing
underemployed or surplus labour from these sectors.

Another effect: Backward linkage effect. Through buying locally
made materials and intermediate products, foreign-invested
enterprises can create additional demand for products made by local
firms.

Initial FDI generated demand  Multi-rounds of subsequent demand
through industrial backward linkage effects  Stimulation by
domestic suppliers to produce more output  Growth of the entire
80
economy encouraged by the increased aggregate demand initiated by
FIE’s local purchases.

FDI, especially export-oriented FDI, promotes the exports of the
host country. Taking advantage of an abundant and cheap labour
resource in the host country, together with their own marketing
channels and expertise, foreign-invested enterprises are able to expand
export of their products.

The impacts of FDI on the demand and supply sides are
amalgamated rather than separate.

The impact of FDI on the host economy can be classified into
macroeconomic and microeconomic impacts.

Macroeconomic impacts refers the impact of FDI on the
macroeconomic variables, such as:

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

GDP growth,
Total Fixed Investment
Employment
Exports and Imports
Aggregate consumption
Government expenditure
Tax revenue

Microeconomic impacts concerns with the impacts of FDI on the
economic behaviour of individual units including firms and family,
such as labour productivity and technical efficiency of a domestic firm.

While some impacts of FDI can be quantitatively measured, others
cannot be directly measured.

Although the effects of FDI on GDP growth, capital formation,
employment, exports and government tax revenue are measurable,
whereas the following are difficult to quantify:
 Technology transfer and diffusion efficiency
 Environmental pollution
81
 Access to foreign markets
 Demonstration effects

Some economic variables are affected simultaneously by multiple
factors, including political, cultural and economic firms, and it is
difficult to separate one factor’s effect from that of others.

Income distribution, industrial structure change, environmental
pollution, and inter –regional economic disparity fall into the above
group.

With some impacts such as transfer pricing, it is difficult to acquire
reliable and sufficient data although this issue is theoretically clear
and quantitatively measureable.

Major Concerns on FDI:

National level: State sovereignty, political
control and independency and cultural
change/confrontation

Macro-Economic level:
o Economic Exploitation: resources and profit
repatriation
o Economic Security: Strategic sectors – resources,
basic industries, agricultural, high value added
financial & service, telecom & internet & IT
o But, what is “strategic” is very debatable and is a
changing concept
Individual/Personal level: Income inequality, urban new
poors, including middle class, caused by structural
restructuring

82
References
References
Dunning, J.H., (1988) “The Eclectic Paradigm of International Production: A Restatement and
Some Possible Extensions”, in Journal of International Business Studies, Vol. 19:1, pp.1-31
Dunning, J.H., (1993) Multinational Enterprises and the Global Economy, Addison-Wesley, New
York
Dunning, J.H., (1995) “Reappraising the Eclectic Paradigm, in an Age of Alliance Capitalism”, in
Journal of International Business Studies, Vol.26:3, p.461-491
Dunning, J.H., (1998) “Location and the Multinational Enterprise: A Neglected Factor?”, in
“Journal of International Business Studies”, Vol.29:1, pp. 45-66
Organization of Economic Co-operation and Development, (2000), “Recent Trends in Foreign
Direct Investment”, in Financial Market Trend, No.76
Sun, H.S., (1998), Chapter 1, Foreign Investment and Economic Development in China 19791996, Ashgate, Aldershot
83
Lecture VI: FDI In China: Characteristics

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
Total actual FDI inflow in China between 1979-1999 amounted to
US$306 million.
The amount is equivalent to
 10% of direct investment worldwide
 30% of the investment amount for all developing
countries
China is the largest recipient of FDI in the developing world
China’s growth of FDI has been subject to considerable fluctuations
at different times.
Such fluctuations of FDI reflect adjustments in the Chinese
government’s economic policies and resulting changes in the
investment environment.
In general, when China has evidenced a sound macroeconomic
performance and economic liberalization is to the forefront, FDI
tends to grow rapidly.
On the contrary, poor economic performance (low growth and high
inflation), has tended to dampen economic reform and halt the
liberalization process foreign investment declines.
The development of FDI in China has undergone three phases during
the last 20 years, reflecting changes in economic conditions,
investment environments and government policies. Phase One is from
1979-1985, Phase Two 1986-1999 and Phase 3 1990-1999
Phase 1 (1979-1985)
 The Chinese government promulgated the Joint Venture Law, it
established the principles and procedures for foreign investment.
 Under this law, foreign investments are permitted and
encouraged in selected fields.
 The Chinese government set up four Special Economic Zones
(SEZs), where preferential economic policies were pursued to
utilize foreign investment.
 As a result, foreign firms flocked to China to explore the new
business opportunities.
 However, the regulatory environment is still quite restrictive, with
restrictions on foreign equity share in joint venture (generally less
than 50 percent), and industrial scope (FDI at that time, was not
permitted in
84
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


Finance and banking
Transportation
Telecommunications & Post
Retail
 Restrictions on FIEs’ access to the domestic markets as well as
their use of local labor and land are imposed
 As a result, FDI in China grew sluggishly, especially during the
first four days.
 In 1983, legal clarification of the status of the joint ventures
through the Joint Venture Implementing Regulations. It also
provided a great detail about China’s policy on

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

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


Profit Repatriation
Technology transfer
Foreign Exchange
In April 1984, the Chinese government announced that 14 coastal
cities would open to foreign investment, expanding the open-door
policy from SEZs to other coastal regions.
The pledged value of FDI grew at 53 percent and 124 percent in
1984 and 1985 respectively, while the realized FDI grew at 98
percent and 32 percent respectively.
Two features of the 1984-1985 boom:
 More hotel joint ventures were approved, “non-productive”
(service) investment projects dominated FDI in China
 The size distribution of investment projects was highly skewed.
 At the one extreme, many joint ventures were of small
capital size, especially those established by Hong Kong
firms in service and manufacturing industries, with most
of these being capitalized at less than one million dollars
 At the other extreme, some projects were large, with
capital exceeding several million dollars. These larger
projects were typically investments in hotels, oil
exploration, automobile and machinery industries.
A sharp decline in the growth rate of both pledged and realized
FDI followed the 1984-1985 boom. (See chart on next page)
The main reasons for this sharp fall is due to the high inflation and
a growing trade deficit in China. This situation led the Chinese
85
government to severely curtail domestic spending of foreign
exchange and to tighten approval of so called “non-productive”
FDI projects.
 Many joint venture are exacerbated by:
 A limited domestic market access
 A low labor productivity
 Excessive government bureaucracy.
120000
100000
80000
60000
40000
20000
0
94
19
92
19
90
19
88
19
86
19
84
Pledeged FDI
Realized FDI
19
19
82
Value
Trend of FDI in China
Year
Growth Rate of FDI In China
400
Realized FDI
Growth
Pledged FDI
Growth
200
100
0
-100
19
83
19
85
19
87
19
89
19
91
19
93
19
95
%
300
Year
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 Phase 2 (1986-1989)
 Response to the sharp fall: “Provision for the
Encouragement of Foreign Investment” in October 1986.
 These provisions not only clarify the legal environment for
FIEs, but also provided the solutions to some major
problems like:
 Foreign exchange imbalance in FIEs was
solved by establishing swap markets between
enterprises.
 In addition, joint ventures were offered tax
benefits and greater autonomy for their business
management.
 Greater autonomy for their decision making at the local level
occurred after 1986.
 Provinces and cities provided their own sets of investment
incentives in addition to the incentives granted by the central
government. These incentives included:
 Exemption of local tax
 Lower land use fees
 Lower charges for using public utilities.
 To promote foreign investment, almost all open coastal
cities set up Economic and Trade Development Zones
(ETDZs) designed for high technology industrial projects.
 In the ETDZs, extra tax breaks were offered, in addition to
lower land-use fees and other incentives.
 Pledged FDI  by 31% in 1987, and a further 43% in 1988
(see table above)
 Realised FDI  by 24% in 1987 and 38% in 1988, (see table
above)
 85% of the FDI projects involved in the manufacturing
industries in 1988, and many of these projects were aimed at
China’s domestic market
 The economy got “overheated” in 1988, to reduce a twodigit inflation, the government introduced “austerity
program” in late 1988.
 Such program made the FIEs geared towards then domestic
market found it very difficult to sell their products due to the
tightened local loans and the stagnant market demand.
87
 The squeezed credit also limited the ability of prospective
local partners in joint ventures to raise capital. Many joint
ventures ran into financial and marketing difficulties.
 All these factors, plus the effects of the 1989 crackdown on
the student and workers movement, have resulted the
following:
 The number of joint ventures approved in 1989
decreased by 692 compared to 1988
 The growth rate of the pledged FDI value also  to
5.7% in 1989, while realized FDI only by 6.2% in
1989, and a even low figure of 2.8% in 1990.
Phase III: 1990-Present
 In order to lure back FDI: Amendments to the Joint Ventures
Law in April 1990. Particularly important was the elimination
of the duration limit applied to some ventures, and granting of
permission for foreigners to act as joint venture board chairmen.
 In April 1991, the Income Tax Law for Enterprises with
Foreign Investment and Foreign Enterprises (the Unified
Income Tax law) was passed.
 It standardized the income tax rates for different forms of FIEs,
and eliminated the prior tax discrimination against the wholly
foreign owned enterprises (WFOEs), which had previously
been subject to unfavourable treatment.
 The improved investment environment and expansion of
domestic credit facilitated the recovery and growth of foreign
investment in China after 1990.
 Deng’s 1992 southern tour  further opening the economy to
foreign investment The policy of FDI became more
favourable.
 The new policy permits foreign companies to invest in fields
such as
 Retailing,
 Real Estate,
 Trading,
 Transport,
 Finance and Banking,
88
 The establishment of stock-holding companies and secondary
business to foreign affiliates are also permitted.
 In September 1992, the “socialist market economy” strategy
is adopted, a legal framework to standardize market operations.
 Regulations covering
 Corporation Law,
 Bankruptcy Law,
 Individual Income Law,
 Stock Exchange Law
 Some other commercial regulations have been passed since
1993.
 Uniting the “two track” system of foreign exchange rates
(officially regulated rates and market rates)
 Allowing the Chinese currency to be convertible for
transactions in current account.
 Privatization of SOEs by selling their shares to the public, and
lowering tariff for imports
 All the above are further liberalizing the Chinese economy and
aiding the emergence of high economic growth and favourable
business environment.
 As a result, foreign investment has boomed unprecedented.
 Since 1992, FDI inflow into China have accelerated to reach the
peak level of USD 45.5 million in 1998.
 From 1994 to 1996, realized FDI increased by 14.6% on
average per annum
 A Rise in the ratio of the realized value to the pledged FDI
value:
1992
18.9%
1993
24.7%
1995
41.0%
1996
57.0%
 Average capital size of foreign investment projects:
1994
1.75 million dollars
1995
2.47 million dollars
1996
2.98 million dollars
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Types of FDI in China
 Three major forms of FDI in China:
 Equity Joint Venture (EJV),
 Contractual Joint Venture (cooperative joint venture) (CJV),
 Wholly foreign-owned enterprises (WFOE)
 These three forms of FDI are referred to as “foreign-invested
enterprises” (FEI)
 In addition, the joint exploration of oil or coal.
Equity Joint Venture (EJV)
 EJV is the dominant form of foreign investment in China.
 Creation if limited liability companies with equity and
management shared by foreign and Chinese sides according to
their equity shares
 A foreigner’s capital contribution to a joint venture may be
between 25% to 99%
 More rapid growth than CJV since 1986, as the open-door policy
spread to other coastal areas
 From 1987-1996, pledged FDI in EJV grew by 36.9% per year
on average, higher than that of CJV (26.5%)
 Since 1990, EJV outweighted CJV as the principal form of FDI
Wholly Foreign Owned Enterprises (WFOE)




Established by a company, using entirely on capital
Assumes sole responsibility for its risks, gains and losses.
It enjoys flexibility and autonomy
Legal framework covering WFOEs  Law on Enterprises
Operated Exclusively with Foreign Capital (1986) and its
Enforcement Regulations (1988).
 From the 1990s, FDI in WFOEs displayed a strong growth
momentum. Pledged FDI in WFOEs increased by 56.7% per year
on average from 1987 to 1996.
 Due to improvement in legal condition for WFOE and Taiwan’s
investment surge
90
 Since 1988, Taiwanese investment in the mainland has increased
rapidly. As Taiwanese investment largely took the form of
WFOEs, it contributed to the growth of WFOEs
Contractual Joint Venture (CJV)
 An arrangement whereby the Chinese and foreign partners
cooperate in joint projects and activities according to the terms and
conditions stipulated in a venture agreement
 Those terms and conditions spell out the liabilities, rights and
obligations of each partner
 Unlike EJV, a CJV is not a legally independent “entity” no need
to form a separate “legal person” from the partner companies.
 Investing partners in a CJV do not assume the risk or share profits
according to their respective capital contributions
 In the first stage of the open-door policy (1979-1985), CJV was the
most important type of FDI, accounting for 55% of pledged FDI,
 But from the 1990s, its dominance has been overtaken by EJV.
 All forms of FIEs are subject to standardized tax rates and are
eligible for a two-year tax holiday and a three-year tax reduction.
Share of Different Forms of FDI Between 1979 and 1997
EJV
WFOE
CJV
Number of
Contracts
61.3%
24.7%
14.0%
Contracted
Amounts
46.0%
30.0%
23.2%
Joint Exploration of Natural Resources
 Contains features of both the contractual joint venture and
compensation trade
 The risk sharing and distribution of output according to agreed
shares
 It enables China to access equipment and technical assistance from
foreign companies in return for a portion of the resultant output.
91
Major Investors of China’s FDI
 Large number of countries have made direct investments in China
 High concentration of FDI among several large investors.
 These investors are in
 Hong Kong,
 Taiwan,
 United States,
 Japan,
 Singapore,
 Britain,
 South Korea,
 Germany,
 Canada, and
 Australia.
 Hong Kong has been the largest investor in China since 1979, and
played a leading role in investment. Between 1983 and 1998,its
accumulated FDI was US$140 billion, accounting for 52% of the total
FDI in China.
 The figures for the other major players are as follows:
Japan
US
Taiwan
Singapore
South Korea
22.3 billion
21.7 billion
21.0 billion
11.9 billion
7.4 billion
8.30%
8.09%
7.85%
4.42%
2.78%
 Although as a recent entrant of China’s FDI, Taiwan made huge
contribution to China’s FDI development. Between 1983 and 1998, its
accumulated FDI was US$21 billion, accounting for 7.9% of the total.
 Each of the major investors has distinct characteristics:
Hong Kong
●
Hong Kong investment was dominated by assembly and
processing projects.
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●
●
●
●
●
●
Small in capital size and concentrated in labor-intensive
manufacturing sectors.
During 1983-1991, average capital size of Hong Kong FDI
projects was $1.12 million.
As Hong Kong investments have partially shifted to some large
infrastructure projects, its average capital size increased 
US$ 1.51 million in 1993 and US$ 1.91 million in 1994.
Reasons for Hong Kong’s FDI into China: Structural
transformation from labor-intensive industries to technologyintensive industries in Hong Kong , the increasing openness of
China’s domestic market, and the geographic and cultural
proximities to Hong Kong facilitate investment activities
Shift of manufacturing in Hong Kong to southern China
36% of Hong Kong’s manufacturing industry had been moved
across the border to the Pearl River Delta.
Hong Kong Chamber of Commerce estimated that over 80 (85)%
of Hong Kong labour-intensive manufacturing industry has
been relocated to southern China by 1996 (2000).
Taiwan
●
●
●
Before 1987, Taiwanese investment in China was officially
prohibited.
The Chinese government’s promulgation of the Regulations of
Encouragement of Investment by Compatriots from Taiwan in
1988 has accelerated such development.
Three main characteristics of Taiwanese investment projects:
1. They are centered in labour-intensive export
manufacturing industries such as, as the labor costs
are only one-third of those in Taiwan
● Plastic and rubber products,
● Electronic and electrical appliances,
● Bicycles,
● Food processing and beverage,
● Footwear and toys,
● Textiles,
● Garments and small service industries
2. Due to geo-cultural proximity, Taiwan’s investment is
largely located in Fujian province,
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●
3. Wholly-owned enterprise is the primary mode of
Taiwan’s investment in China.
The reasons for growth of Taiwanese investments, similar to that
of Hong Kong, including:
1. The increase in labor costs and industrial
transformation from labor-intensive to capital and
technology-intensive production. This has forced
Taiwanese and Hong Kong manufacturers to shift
labor-intensive production to regions where labor
costs are lower.
2. Geographical proximity and similarities in regional
Chinese culture promote Hong Kong investment in
Guangdong and Taiwanese investment in Fujian.
South Korea
●
●
●
●
An important investor in China since diplomatic relations
between the two countries was officially normalized in 1991.
South Korea surpassed Britain, Germany, Canada, Thailand and
Australia and became the sixth largest investor in China.
If the current trend continues, South Korea’s investment status
will rise further in the future.
The characteristics of South Korean investment appear similar to
Hong Kong and Taiwan
Southeast Asian Countries
●
●
●
●
Investors from Southeast Asia are mainly overseas Chinese
businessmen
Ancestral ties and the lure of long-term profits are major forces
driving them
They are similar to Hong Kong and Taiwanese investments in
terms of their small size of investment projects and preference for
close cultural connections.
Distinguish features:
 They are motivated not so much by China’s cheap labor cost
and abundant land, but are more motivated by China’s
expanding consumer demand
 Their investment flows mainly into China’s primary
industries and infrastructure constructions
94

These businessmen tend to locate their projects in their
ancestral towns and provinces, which are scattered
widely in China, therefore they could advance into towns
or provinces often ignored by other foreign investors
 Overseas Chinese are reputedly cash-rich and debt-free,
and therefore able to commit to long-term investment,
rather than seeking the quicker profits to be had from export
processing
US and other Western Countries






They differed significantly from those of Hong Kong, Taiwan and
Korea
They invest largely in capital and technology intensive
industries, and were generally of high technology content  the
average size of American and European investment projects are
larger than those of Asian investments
Most investment projects are aimed at the Chinese domestic
market, as access to China’s huge consumer population is the
principal motivation for many multinational corporations from
the US and other industrialized countries  Differs from Hong
Kong and Taiwan investments, which are largely oriented to
exports using cheap labour
China’s economic reforms, trade liberalization and increasing
openness of the domestic market to foreign investment are
important reasons for US and European investments
Rather than locating in the SEZs or other coastal areas, many
American and European companies prefer to put their projects
in major industrial and commercial centers such as Beijing,
Shanghai, Tianjin, Guangzhou, Wuhan and Shenyang  Between
1979-1989, only 47% of US EJV located in coastal areas, Hong
Kong 67%
The duration of US joint ventures is longer Average duration of
US EJV is 15 years, 2 years longer than the average duration of all
sampled EJVs.
Japan

Interested in Chinese domestic market, have placed less emphasis
than US and European investors on manufacturing and more on
property development
95





Their investment is diversifying into capital intensive industries
such as electrical equipment, electronics, precision machinery and
transportation equipment, the weight of labor-intensive and
resource-based industries remains high.
Japanese investment in the wholesaling, retailing and
warehousing industries has increased remarkably, as the
Chinese government has relaxed restrictions on the industrial
scope of FDI
In terms of regional distribution, Japanese investment has
concentrated in northeastern China and east coast cities such as
Dalian, Tianjin, Beijing, Qingdao and Shanghai
As costs of labor and land have risen in these cities, Japanese
investment has spread gradually to nearby areas
Many Japanese investment projects have been of small or
medium scale, which differs from US and European investments
Regional Distribution of FDI

Great disparity among regions
 From 1983-1998, FDI in the east region took up 87.8%, central
8.9%, west 3.3%
 Within the eastern region, the share of FDI are as follows,
between 1989-1996:
 Guangdong 30.2%
Jiangsu
11.3%
Fujian
10.4%
Shanghai
8.6%
Shandong
6.7%
Liaoning
4.4%
Beijing
4.0%
Tianjin
3.3%
 Two major reasons for the imbalance of the regional
distribution of FDI in China.
 The bias of the open-door policy to the coastal region
since 1979
 The advantages of the coastal region over the inland
regions in economic conditions and investment
environment.
96
The bias of the open-door policy to the coastal region since
1979






The Chinese government initiated the open-door policy by
establishing four SEZs where special policies favourable to
foreign investors were implemented.
In 1984, the government opened 14 coastal cities and granted
them similar policies to the SEZs  A significant shift of FDI
from the SEZs to other open coastal areas
In 1986, the Chinese government extended the “open region” to
the “three deltas” including the Pearl River Delta, the Minnan
Delta (the south of Fujian) and the Changjiang (Yangzi River)
Delta.
In 1988, Hainan Island became the fifth SEZ.
In the early 1990s, Pudong New Area in Shanghai became a new
focus of foreign investment, with support by government
preferential policies.
Local initiatives strengths the regional emphasis of the opening
policy in the coastal areas
The advantages of the coastal region over the inland regions

According to Dunning (1977, 1981 and 1988), location-specific
factors account for a particular pattern of locational
distribution of foreign investment
 The limited extent of the spatial diffusion of foreign investment
and that most of foreign investments are concentrated in major
economic centers or more developed regions are common
features in most developing countries, it is because economic
and social infrastructures in major economic centers are more
developed than other regions.
 According to the transaction cost theory (Williamson 1973,
1979 and 1981), the advanced facilities help the investors to
reduce information and other relevant costs by improving the
efficiency of production and marketing
 In the Chinese case, the coastal region and major economic
centers such as Beijing, Shanghai, Guangzhou and Tianjin are
more developed in heir industrial facilities education and
communication systems than the inland regions.
97

The coastal region was more developed than the inland regions
in economic structure, industrial infrastructure, public utilities and
cultural facilities.
 In the past 18 years, the coastal-oriented opening policy and
economic reforms have further improved the investment
environment of the coastal region.
 Therefore, the gap between the coast and the inland in
economic conditions and investment environment has widened.
 The concentration of FDI in the coastal region, especially
major economic centers, can be attributed to the cost
advantages associated with superior physical and social
infrastructures and liberalized economic conditions.

The major investing countries show different spatial patterns:
Hong Kong
41.7% in Guangdong, 10.9% in Fujian,
Taiwan
19.1% in Fujian, 18% in Jiangsu, 13.6% in
Gunagdong, 8.2% in Shandong
US
Jiangsu 16%, Guangdong 13%, Shanghai
11.1%, Shandong 11.1%, Beijing 10%,
Liaoning 6.2%, Tianjin 5.6%
Japan
Liaoning 17%, Jiangsu 13.8%, Shanghai 12%,
Gunagdong 11.2%, Beijing 7%
The spatial patterns of these countries’ investments can be
explained by
 Variations in geo-cultural links,
 The technological nature of investment projects,
 Motivations for investment.
 Geographical and cultural proximity are the major reasons for
Hong Kong investment in Guangdong, where the local people
share the same language (Cantonese) and have close ethnic
links with Chinese people in Hong Kong,
 Taiwan and Fujian province are geographically adjacent to
each other and speaking the same dialect (Minnan language).
 Hong Kong, Taiwanese and Korean investors are taking
advantage of the abundant supply of cheap labor in China to
produce goods for export markets, which requires short
distances from production sites to seaports for exports  An
additional important reason for Hong Kong, Taiwanese and

98





Korean investments’ concentration in Guangdong and Fujian
provinces.
Geographic proximity and historical reasons made Japanese
investment went to Liaoning, Shandong and Shanghai
American and other Western investors are not significantly
affected by geo-cultural factors. They are affected primarily by
industrial and technological factors and market orientation.
American and European investments are largely in technologically
advanced industries, using capital and technology intensive
production methods Requires a developed industrial base
and relevant linkage industries
Large cities in China, especially those in the coastal region
such as Beijing, Shanghai, Guangzhou, Tianjin and Nanjing,
are relatively more advanced in industrial structure and technology,
and therefore fit the requirements of American and European
investment in technological conditions and industrial linkages
As American investments target China’s domestic market,
making investments in highly populated large cities is an easy
way to access local consumers, and thus effectively facilitate
investors; marketing strategies and promote their sales in the
domestic market.
FDI Dynamic Investment Paths in China:
1. Trade & Export-orientated FDI:
Cultural link and geographical proximity  Sea Port/Container
Port  OEM clusters  Super Service Hub and Financial
Centre
This FDI mainly utilizes the country and locational specific
advantages (cheap labour, land and natural resources) and
engages in standardized manufacturing (low technology
assembling)
2. Domestic Market-orientated FDI:
Wealthy Region and Major cities and established industrial bases
 Industrial Clusters and Transportation node  large
population centre and mega cities
This is technology and capital intensive FDI that can overcome
the cost in large cities and require high skill labour and
sophisticate infrastructure and supporting industries.
3. IT-orientated FDI:
99
Good Natural Environment and Cultural/historical cities  IT
clusters and enclaves
This is intellectual/knowledge/brain intensive, not necessary
capital intensive, FDI that will go with intelligent brains and
innovation clusters, which are normally cultural and historical
centres with good natural environment.
4. Grand convergence of the above 3 FDI:
Diversified Clusters and Super Service Hub – Super/Mega Cities!!!
Sectoral Composition of FDI
●
By the end of 1998,
Share of Number of Project Share of Contracted Value
Manufacturing
73.01%
59.6%
Real Estate
9.92%
24.6%
Distribution Industry
6.23%
6.0%
Construction
2.58%
3.1%
Primary Sector
2.79%
1.8%
● Within the manufacturing industries, about half of the recorded FDI
was directed to sectors characterized as labour intensive. Technology
intensive (26.9%) and capital intensive sectors (22.7%) almost
equally share the rest
● The figure for the manufacturing industry suggests a main
motivation of foreign companies is to profit from China’s low unit labor
costs. The technology intensity in FDI differs according to source
countries, Emerging countries used to invest in labor-intensive
production technologies and in the production of standard manufactured
products, while mature economies are more prone to invest in high
technology sectors and differentiated products.
● In the early stage of the open-door policy, FDI was concentrated in
oil exploration, hotels, tourism, and assembling and processing.
● Since 1984, the government policy has changed, and FDI has
diversified its
sectoral composition. The industrial sector has become increasingly
important as a recipient of FDI.
● Later on, FDI in real estate, tourism and the relevant service boomed.
The primary focus of this sector was investment in real estate
100
●
●
(especially hotels), tourism, and associated services which the
government hoped would earn foreign exchange
After 1985, the government began to discourage investment in
tourism and real estate in favour of high technology and export-oriented
manufacturing investment by using different tax rates and approval
control, and it loosened the restrictions on foreign investors’ access
to the domestic market and on the requirement for foreign
exchange balances in joint ventures, As a result, FDI in the industrial
sector increased steadily
During 1992-1993, due to the ‘real estate fever” resulted from the
housing reform, FDI in real estate increased remarkably again. FDI in
real estate continued to grow by 142.1%  The share of FDI in real
estate increased to 31.1% in 1992 and 39.3% in 1993
Industrial Composition of FDI by Country of Origin
●
●
●
●
●
●
The industrial distribution of FDI vary by country of origin.
According to Dunning’s eclectic theory (1977, 1981, 1988), industryspecific factors and especially firm-specific advantages in technology
and production efficiency are the principal determinants of the
industrial structure of investment abroad
Capital and technology-intensive investment projects were less
successful compared to labour-intensive and export-oriented
investment projects.
Market-oriented FIEs have difficulties unless they use locally made
inputs.
The main propositions of Dunning’s eclectic theory of international
production, with location-specific, industry-specific, and firm-specific
factors leading to advantages for certain types of firms in certain
environments.
Locational factors, especially regional economic and social
environments and geographical distance, largely determine the
locations of investment.
References
Organization of Economic Co-operation and Development (2000), Recent Trends and Main
Characteristics of Foreign Direct Investment in China, in Financial Market Trend, No.77
Organization of Economic Co-operation and Development, (2000), “Recent Trends in Foreign
Direct Investment”, in Financial Market Trend, No.76
101
Sun, H.S., (1998), Foreign Investment and Economic Development in China 1979-1996, Ashgate,
Aldershot
102
Lecture VII: Entry Modes of Multinational
Corporations into China
●
●
●
●
●
●
Entry modes are defined as the forms of capital participation in
international enterprises. They are modes in which MNCs enter the
intended host country through investment
In terms of property rights, entry mode is the ownership structure of a
foreign subsidiary. There are two basic entry modes: wholly-owned
subsidiary and joint venture
Three kinds of joint venture sub-modes, based on the percentage
ownership of equity:
● Majority JV,
● Balanced JV, and
● Minority JV
The wholly-owned subsidiary and the Joint venture mode can be
realized by MNCs through acquisition of an existing enterprise or
setting up a new enterprise in the host country
The transaction cost theory has been broadly employed to explain
MNC’s international investment activities. They argue that
transaction costs are major determinants of MNC’s entry modes. A
MNC tends to choose an entry mode that minimizes transaction costs
There are three primary factors affecting MNC’s entry:
● The sociocultural distance between MNC’s home countries and
the host country
● Technological nature of investment projects, and
● The institutional and business environments and policies of the
host country.
Sociocultural Distance
●
●
It refers to the difference in social culture between the home and host
countries.
Due to an unfamiliar cultural environment MNCs have little
knowledge of the local market and business practice. Sociocultural
distance creates enormous information needs, hence high information
costs for intending MNCs. MNCs also would find it difficult to
transfer home technologies and management techniques
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●
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●
This disadvantage may be avoided by forming joint ventures with
local firms and turning management partially over to local partners.
Secondly, operating in a foreign culture at a distance increases business
uncertainty and unpredictability This raises MNCs’ propensity to
form joint ventures with local firms.
Bivens and Lovel (1966) disagrees with this proposition, they
suggested that some firms react to sociocultural distance by
demanding rather than avoiding ownership so they may impose their
own operating methods. Such firms do not trust local management or
local partners, and prefers to “do it their way”.
Sociocultural links between China and other countries are highly
related to geographical adjacency.
Three groups based on geographical adjacency and sociocultural
links.
● The investors from Hong Kong and Taiwan
● Investors from other East Asian countries
● Western investors
Investors from Hong Kong and Taiwan
●
●
●
●
●
Most of them are Chinese
They share the same or very similar culture with people in the
Mainland
In contrast to true “foreigners”, these Chinese investors have
advantages in language, cultural traits and ethnic links, and in access to
Chinese society
These advantages allow easy entry into Chinese domestic market with
less reliance on local firms.
Investors in this group are expected to be less dependent on local
firms for local management and market information. In many cases, it
is unnecessary for them to form joint ventures with local firms to
reduce transaction cost associated with an unfamiliar operating
environment
Investors from other East Asian countries
●
●
●
They include Japan, Singapore, Malaysia and South Korea
These Asian neighbouring countries have close cultural ties to china
due to geographic proximity and historical links
In contrast to the Western investors, they have some advantages in
sociocultural linkages.
104
Western Investors
●
No sociocultural linkages
Research and Development Intensity
●
●
●
●
●
●
●
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Proprietary knowledge is an important type of specialized asset.
Research and development (R & D expenditure to total sales) is
usually used to measure the intellectual proprietary content of a
product or process
Stopford & Wells (1972) and Coughlan & Flaherty (1983) find a
negative correlation between R & D expenditure and the proportion of
subsidiaries organized as joint ventures rather than wholly-owned
affiliates. A higher degree of control is more often employed for
technically unsophisticated products.
This implies that firms tend to employ a completely-controlled entry
vehicle in order to protect their interest in proprietary knowledge
Anderson and Gatignon (1986), and Kim and Hwang (1992) argues
that, entry modes offering higher degree of control are more efficient
for highly proprietary or poorly-understood products and processes.
Newer technology is likely to be handled by wholly-owned
subsidiaries which offer high control
Anderson and Gatignon (1986) argues that “the more mature the
product class, the less control firms should demand of a foreign business
entity”.
Williamson (1979) points out, old technology is likely to be licensed or
handled by a joint venture (lower control)
In terms of bargaining power, foreign firms with proprietary
products and high technology are in a favorable bargaining position
with the host country. They may force the host government and
partners to allow them to have more ownership.
As the product matures, the advantage erodes, creating pressure to
give up control. Therefore, a foreign investing firms if its technology
is standardized
The Host Country’s Conditions, Risks and Policies
●
“Country risk” = The volatility (unpredictability) of the firm’s
environment.
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●
●
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●
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●
Various forms, e.g. political instability, the lack of a well-defined
legal systems, economic fluctuations, price and foreign exchange
controls and nationalization threat.
In a highly unpredictable environment, MNCs tend to limit their
equity involvement by avoiding full ownership in order to diversify the
business risks.
At the same time, they may want to get greater control to compensate
for high risks.
As Anderson & Gatignon (1986) maintain, the greater the
combination of country risks, the higher the appropriate degrees of
control over the subsidiaries, and the lower the MNCs inclination to
establish wholly-owned subsidiaries
In terms of the transaction cost theory, country risk and the
uncertainty of business environment may increase the information
need and management cost for MNCs to operate fully-owned
subsidiaries in the host country.
For investments oriented to the host country, domestic market and
investments based on the host country’s resources, local partners
are essential for foreign entrants since they have expertise in
exploring domestic markets, managing local labor and organizing
local suppliers of raw materials and intermediate products.
Apart from country risk and business uncertainty, the host
country’s economic conditions and policies may considerably affect
MNC’s capital involvement.
The economic growth trend and domestic market size of the host
country would strengthen its attraction for foreign investment.
Empirical Investigation of MNC’s Entry Modes
●
●
Wholly foreign owned enterprises is becoming more important as an
entry mode of MNCs into Chinese market
For instance, during the period from 1987 to 1992, the proportion of
FDI in EJVs to the total FDI by Hong Kong is 47% on average,
compared to 84% for Western Europe. This indicates that the
larger the sociocultural distance with the host country (China), the
higher the propensity for investors to use EJV as the main entry
mode→ Sociocultural difference positively correlates to the
frequency of equity joint venture
106
●
●
From 1987 to 1992, 42% of Taiwan’s investment and 39% of
Japanese investment were in WFOEs, much higher than the
Western European (10%), and US (24%) investments. This is due to
the cultural similarity allows Asian investors to have an adequate
knowledge of Chinese market and business practice, which facilitate
their investment activities with less need for local partner
There is a positive relation exists between the cultural proximity,
capital involvement and the use of WFOE as MNC’s entry mode.
Entry Mode by Industry
●
●
●
●
The technological nature and content of a product or process are
highly correlated with the ownership structure of foreign subsidiaries
The higher the technological content, the higher the equity share of a
MNC requires in its foreign affiliates, and also the higher a MNC’s
propensity to set up wholly-owned subsidiaries.
For technologically sophisticated products or services, MNCs prefer
full ownership or majority ownership in order to control their
subsidiaries efficiently and to protect their proprietary rights.
As technology matures and standardizes, less control and protection is
needed. Therefore, a joint venture become the favoured vehicle by
which MNCs enters the host country market.
Entry Mode by Region
●
The table below shown a liberalized economic environment and
lower business uncertainly and less risks in the Southeast coastal
region tend to encourage foreign investors to form wholly-owned
enterprises
Regions
% the FDI in the
Regions as EJV
% of FDI in the
Regions as CJV
% of FDI in the Regions
as WFOE
Southeast Coast
Other Coast
Inland Region
National Total
39.4%
74.3%
69.7%
57.5%
30.5%
11.0%
13.5%
20.4%
30.0%
14.6%
16.0%
22.0%
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Findings of FDI in China
●
●
●
●
●
●
●
●
●
●
●
●
●
●
The cultural links between investing countries (or regions) and the
host country (China) positively affect the foreign equity share in FIEs
This further confirms the hypothesis that cultural proximity is
positively correlated with the wholly-owned foreign enterprises and the
foreign equity share in FIEs
The larger the cultural distance between investors and China, the
lower the foreign equity involvement in FIEs
Secondly, high technology positively related to the foreign equity share
in FIEs
Thirdly, economic environment and government policy is the most
important determinant for the entry mode (i.e. the ownership of FIEs)
of MNCs
In the Southeast coastal region, foreign investors prefer majority joint
ventures or wholly-owned subsidiaries rather than minority joint
ventures.
The closer the cultural backgrounds of investors in FIEs. The
sociocultural distance between the home countries and the host
country discourages MNCs to invest in wholly-owned subsidiaries.
Therefore, joint venture is the suitable entry modes for MNCs from a
country at cultural distance from the host country
The technology intensity of investment projects and liberalized
economic environment positively affect the foreign equity share in
FIEs and MNCs capital involvement,
These findings are consistent with the major theories of multinational
corporations, especially the eclectic theory (Dunning 1977 and 1981).
The investment behaviour and entry mode of MNCs are primarily
determined by firm-specific advantages especially proprietary
technologies and also location-specific factors.
For foreign firms whose technology is standardized, equity joint
venture is the most suitable mode to invest in China
This is particularly true for those investments oriented to Chinese
domestic market or natural resource-based investment projects.
Joint venture mechanism will help to minimize the external business
uncertainty associated with the cultural distance and the lack of
knowledge of local market, and therefore facilitate foreign firms’
access to local markets.
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A joint venture may diversify business risks and produces net benefits
from economies of scale.
A WFOE is a favoured investment vehicle by MNCs investing in high
technology industries
Finally, a pre-condition for running a WFOE successfully is that
investors (or their managers) have a sound knowledge of the legal
system, market structure, business practice and economic and
policy conditions of the host country.
References
Organization of Economic Co-operation and Development (2000), Recent Trends and Main
Characteristics of Foreign Direct Investment in China, in Financial Market Trend, No.77
Organization of Economic Co-operation and Development, (2000), “Recent Trends in Foreign
Direct Investment”, in Financial Market Trend, No.76
Sun, H.S., (1998), Foreign Investment and Economic Development in China 1979-1996, Ashgate,
Aldershot
109
Lecture VIII: Impacts of FDI on Capital
Formation, Economic Growth and
Employment
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FDI can affect the total capital formation of the host country in
various ways:
● As a source of foreign capital inflow, FDI can augment total
financial resources available for investment, thereby promoting
capital formation in the host country.
● In addition, FDI can dynamically influence domestic investment by
creating new investment opportunities for local firms in leading
industries or by easing economic growth bottlenecks such as
shortages of infrastructure, investment capital and foreign
exchange.
● FDI may take a physical form such as equipment, machinery,
instruments and technology, which cannot be made
locallyessential for domestic capital formation in a developing
country.
● FDI can also stimulate domestic investment through industrial
linkage effects By buying locally made inputs from, and
providing intermediate inputs to, local firms.
● FDI may increase the host country’s exports, which would have a
positive effect on domestic savings and investment.
● FDI may have “crowd out” effects on domestic investment if
foreign firms compete with local firms both for the use of scarce
physical and financial resources and also for product markets.
● These factors may affect one another, with the net effect
depending on their relative strengths.
Several studies on the effect of FDI on domestic investment:
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In Canada, Lubits (1971) and Noorzoy (1979) found that FDI had a
complementary effect on the domestic investment
Areskoug (1976) concluded that FDI’s effect on domestic investment
in most developing countries was partially substituting,
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Lee, Rena and Iwasaki (1986) found out that FDI had a significant
positive effect on gross domestic product (GDP) growth and a
positive, but not significant effect on domestic savings.
Ruffin (1993) confirms that foreign investment played a positive
role in the economic growth of Asian and Pacific region.
In Taiwan, Tu (1990) and Schive (1990) examines the effects of FDI
on macroeconomic variables such as GDP, private fixed investment,
private consumption, total exports and imports, and found that FDI
stimulated private fixed investment and increased exports without
significantly affecting private consumption and imports.
As all the above mentioned studies investigated the impact of FDI in
market economies.
By comparison, China has some unique characteristics, which make
an investigation of the impact of FDI more complex and difficult.
The reasons are as follows
● Previous studies of this issue in the context of market economies
provide limited information for a study of the Chinese economy
which is characterized by
● A large population,
● Unbalanced regional development,
● A long history of self-sufficiency
● Isolation from the outside world
Conclusions and implications drawn from studies of small open
economies have less relevance to China, which has experienced a
relatively short period of opening up of FDI since 1979.
The studies of the role of FDI in China are as follows:
● Kueh (1992) pioneered the study by using the rising share of
FDI in the total fixed capital investment, he confirmed that
the contribution of FDI to the total capital formation in the
open coastal region of China was increasingly important.
● Kueh also found that foreign invested enterprises have
become important players in the industrial development and
export expansion of China’s coastal region.
● However, his study lack macroeconomic variables
● Chen, Chang and Zhang (1995) assessed the role of FDI in
China’s post-1978 economic development.
● They discussed the effects of FDI on the growth of GDP,
domestic savings, fixed capital investment and exports of
China.
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They also briefly assessed the influence of FDI on China’s
transition to a market economy.
They concluded that FDI has contributed to China’s post1978 economic growth by augmenting resources available for
capital formation and promoting exports.
A Systematic Analysis of Macroeconomic Model in the
Contribution of FDI
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A more systematic analytical model by Sun (1998), implementing
the hypothesis that FDI positively influenced GDP growth and
domestically-financed investment in China.
The results from the analytical model indicate that Domestic savings
is the main determinant of economic growth. A 1 percent increase in
domestic savings would give rise to a 0.5% increase in GDP.
Foreign capital plays an important role in Chinese economic growth. A
1 percent increase in FDI would lead to a 0.047% increase in GDP.
Labor force also shows a positive and statistically significant impact
on economic growth. A 1 % increase in the labor force tends to give
rise to a 0.31% increase in GDP.
With regard to domestic capital formation, a 1% increase in income
per capita would result in a 0.351% increase in the domestic capital
formation.
FDI positively contributes to domestic investment. A 1 % increase
in FDI would lead to a 0.137% increase in domestic investment. As
FDI grew at 41.65% on the annual average for the period 1983-1995,
it would induce a 5.71% (=0.137x 41.65) increase in domestic
investment
The result also indicates a complementary relationship between FDI
and the domestically financed investment, which is also observed in
some studies of other Asian countries.
In the case of China, FDI can complement and stimulate domesticallyfinanced investment in various ways.
The formation of Sino-foreign joint ventures enables domestic
investors to gain financial and physical resources for investment in new
projects.
Without foreign capital participation, many investment projects,
particularly those requiring a large capital outlays and advanced
technology, would be impossible to carry out.
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The joint venture mechanism offers an important channel to
transfer foreign technology, management and marketing skills to
local partners, with positive impacts on investment opportunities in
new products
FDI, especially in infrastructure projects such as airports, seaports,
power stations, highways, and other transportation and
telecommunication facilities, improves the investment environment,
thereby enhancing the domestic investment.
Recently, the proportion of FDI in these infrastructure projects has
increased steadily.
The bottlenecks for economic growth have been eased, and
domestically-financed investment has been encouraged.
FDI not only adds financial resources to the host country, but also
exerts a dynamic and positive effect on domestically-financed
investment.
The effect of other foreign capital inflows (mainly foreign loans) on
domestically financed investment is positive but statistically less
significant.
This can be accounted for by the fact that some foreign official loans
are matched to domestic capital while some foreign private loans
may replace domestically financed investment. This results in an
insignificant influence of foreign loans on domestically financed
investment.
The share of foreign investment in the total fixed capital investment
of China increased from 3.8% in 1981 to 11.5 % in 1995.
In the coastal provinces the contribution of foreign investment to
total capital formation is more important
Foreign investment constituted 16.2% of Guangdong’s total fixed
capital investment for the period from 1986 to 1992
Its share in the provincial total fixed capital investment further
increased to 22.4% in 1994
In Hainan Province, foreign investment accounted for 11.9% of
total fixed capital investment in 1990 and reached 13.3% in 1992.
Since capital formation is the most important determinant of
economic growth, as argued by development economists, FDI has
promoted the economic growth of China through its contribution to
domestic capital formation.
FDI and Industrial Production
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In terms of growth rates, FIE’s achievement is even more
impressive. During1988-1995, the GOVI produced by FIEs grew at
65.8% per annum (calculated at 1988 constant prices), which is five
times higher than the average growth rate of national GOVI
(13.8%).
Over the same period, the GOVI produced by state-owned
enterprises grew only by 5.7% per annum, which is less than half of
the national average growth rate. As a result, the share of stateowned enterprises in the national GOVI declined remarkably from
56.8% in 1988 to 34.0% in 1995. It clearly indicates that FIEs
have become a dynamic leading force in the industry sector and play
an important role in accelerating the industrial growth of China.
As for the regional distribution, the industrial activities of FIEs are
largely concentrated in the coastal region where they contribute
markedly to the regional industrial to the regional industrial growth.
FIEs in the coastal region produced 820.7 billion yuan of goods and
services, contributing 25.5% in value of the total industrial output.
In Guangdong and Fujian provinces, FIEs produced 50.3% and
53.7% respectively of the total industrial output in 1995.
The share of SOEs in the total industrial output declined to 19.2%
in Guangdong and 23.7% in Fujian
In Tianjin, FIEs produced 40.4% of the total industrial output in
1995, and it has overtaken SOEs as the most important player in the
industry sector
Without FIE’s dynamic participation, it would be impossible for
China to achieve the exceptional industrial growth of 14.9% per
annum over the past 17 years
The role of FDI in Chinese industrial development can also be
examined by investigating the share of FIEs in the total value of
output of various manufacturing industries
In 1995, 21.2% of the total value of output of the manufacturing
sector was produced by FIEs.
In the electronic industry and the industry group of clothing,
footwear and other fabric products, FIEs have become the
dominant producers, producing60% and 51.5% respectively of the
total output
Similar figures in the precision instruments and office equipment
industry (40 percent), plastic and rubber products (30.1%),
transportation vehicles (24.6%) and the electrical products (24.3%)
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Similarly, FIE’s industrial linkages especially backward linkages
with local Chinese enterprises are an important element of FDI. By
buying locally made intermediate inputs.
FIEs provide a strong growth stimulus to Chinese domestic sectors.
FDI has been concentrated in the industries with high backward
linkage indices, such as electronics and electrical products, textiles,
clothing, footwear, machinery and transformation vehicles.
The potential linkage effects on FIEs on the domestic sectors are
significant.
FIEs increasingly use locally made parts and materials in their
production, the potential backward linkage effects are being
realized.
In this process, the campaign for localization of intermediate inputs
used in FIEs which is supported by the Chinese government, should
further promote the potential backward linkage effects of FDI on
the domestic sectors to realize.
FDI and Employment Creation
● 1.35 million people were employed by FIEs in this industry,
accounting for 21% of all employees in the industry.
● Total employment from sectors by FIEs:
Electronics
27.5%
Clothing, footwear
20.6%
Plastic Products 14.9%
Furniture
12.2%
Office Machine 11.9%
Electrical Product
11.3%
● Total employment from provinces by FIEs:
Guangdong
23.8%
Fujian
19.6%
Shanghai
13.9%
Tianjin
10.7%
Beijing
10.4%
Conclusion
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FDI promoted the domestically-financed investment and economic
growth of China by contributing financial and physical capital and
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encouraging local investment, FDI positively contributed to the capital
formation in China
In addition, FDI has advanced industrial production and has been an
important catalyst driving Chinese industrial development
FDI has also played an important role in creating new employment
in China especially in the coastal region and in labour-intensive
manufacturing industries
The Chinese experience with the use of FDI in economic
development has valuable policy implications for other developing
countries.
First, FDI can effectively influence the major determinants of
economic development, such as domestic savings and capital
formation, technology and productivity, employment
FDI can significantly affect the economic growth and development of
a developing country→ An indispensable factor towards its
development
References
Organization of Economic Co-operation and Development (2000), Recent Trends and Main
Characteristics of Foreign Direct Investment in China, in Financial Market Trend, No.77
Organization of Economic Co-operation and Development, (2000), “Recent Trends in Foreign
Direct Investment”, in Financial Market Trend, No.76
Sun, H.S., (1998), Foreign Investment and Economic Development in China 1979-1996, Ashgate,
Aldershot
116
Lecture IX: Foreign Investment and Regional
Economic Growth
Introduction
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China’s economic growth has been regionally uneven and characterized
by increased inter-regional economic disparity and income inequality
between the Eastern (coastal) and Western (far inland) regions
The imbalance in economic growth between the two regions has been
exacerbated since China further opened the coastal regions in 1984
The economic growth rate of the Eastern region was 12.1 % on average
from 1984 to 1995, compared with a 9.1% for the Western region.
In 1995, the GDP per capita of the Eastern region was 2.4 times that of
the Western region
The inter-regional economic gap has widened due to economic reforms
and open-door policy in favour of the Eastern region, different economic
structure and resource conditions, coast-oriented regional policy, and the
differential impact of foreign trade and foreign investment
Economic Dualism
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Economic dualism is a typical structural feature of developing countries
especially for those countries at a lower level of development
It refers to the coexistence of two disparate structural segments within
the geographical territory of a country (Dutta, 1991)
Forms of dualism include regional dualism, urban and rural dualism and
industrial dualism
At a less-developed stage especially during the period of transition from
non-market to a market economy, a certain degree of dualism may be
inevitable for many countries.
As the economy passes a certain stage of development, the degree of
dualism may eventually diminish, resulting in the convergence of
development between regions or sectors.
China’s economic development has been historically marked by regional
dualism, i.e., the existence of the relatively developed Eastern (coastal)
region and the less-developed Western (far inland) region.
During the Maoist period (1949-1976), the inter-regional disparity
transfers from the Eastern region to the Western region. It is the result of
the government strategies of the Chinese government for economic
development and national security.
In the reform or post-Maoist period, inter-regional economic disparity
and income inequality have been enlarged.
Therefore, regional dualism has become a basic feature of the
contemporary Chinese economy.
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The increase in income gap demonstrates inter-regional economic
disparity.
During the 1978-1995 period, GDP per capita in the Eastern region grew
at 9.6% per year on average (at 1978 constant prices), compared to 7.8%
for the Western region,
As a result, the inter-regional gap of income per capita has been further
widened.
The trend of income inequality between the two regions has become more
evident since China further opened its eastern (coastal) region to foreign
investment in 1984.
As shown in the table above, GDP per capita at 1978 constant prices ↑
from 784 yuan in 1984 to 2315 yuan in 1995 in the Eastern region, with
an annual growth rate of 10.9% being reached.
In comparison, the GDP per capita in the Western region during the
same period increased from 432 yuan to 942 yuan, growing at 7.9% per
year.
The remarkably differential growth rates of GDP and GDP per capita
resulted in a larger income gap between the two regions.
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In 1984, the GDP per capita ratio between the Eastern and Western
region was 1.853.
By 1995, this ratio increased to 2.458, indicating that the income
inequality aggravated between the Eastern and Western regions.
Population growth is another direct factor influencing income per capita
in each region
The annual average growth rates of the population---Eastern 1.54%,
Western 1.46% during 1984-1995.
Since the population grew slightly faster in the Eastern region that in the
Western region, it did not contribute to the widening income per capita
gap between the two regions.
As a result, it is the regional divergence in economic growth rates that can
be identified as the principal cause for the inter-regional income disparity.
In fact, many factors contributed to the differential growth rates of the
economy in the two regions.
Apart from the government regional development strategy and policies
that were favorable to the Eastern region, structural factors and
differential economic openness, especially the coastal-oriented
distribution of direct foreign investment has played a crucial role in the
rise of the dualistic growth pattern of the Chinese economy.
Structural Characteristics
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Various structural characteristics are connected to the dualistic growth
pattern of the Eastern and Western regions
Three such characteristics are industrial structure, openness of the
economy, and investment structure.
The different structural characteristics in the two regions shape the
growth conditions and disparate growth pattern, resulting in income
inequality between the two regions.
The income gap in turn further reinforces the disparity of capital
formation and regional dualistic growth pattern.
Industrial Structure
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Three sectors—primary, secondary and tertiary (service) industries,
Primary industry constitutes a large share of GDP and total employment
when the economy is at a lower stage of development.
As economic development in a country or region reaches a higher level,
the secondary and tertiary industries tend to become more important an
account for large shares in GDP and total employment.
In the case of China, the industrial structure has experienced remarkable
changes since the later 1970s.
The share of primary industry in GDP declined from 28.4% in 1978 to
20.9% in 1995, while the share of secondary industry rose from 48.6% to
49.2% during the same period.
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The tertiary industry’s share of GDO increased from 23% to 31.6%.
Although structural change occurred in all regions, the pace and extent to
which the economic structure changed are significantly different between
the Eastern and Western regions.
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As shown in the table, the share of the primary industry in the GDP of
the Eastern region ↓ from 27.2% in 1984 to 16% in 1995, the Western
region ↓ from 37.3% to 26.8% in the Western region.
Although the secondary and tertiary industries increased their
importance in the Western region, their share in GDP are still lower than
that of the Eastern region,
By 1995, the secondary industry produced 41.5% of GDP in the Western
region, compared to 49.8% in the Eastern region.
Similarly, the tertiary industry contributed 31.7% of GDP in the Western
region compared to 34.2% in the Eastern region.
The industrial structure tends to significantly affecting the overall
economic growth rate of each region reflecting the different industrial
makeup.
During 1984-1995, the GDP produced by the tertiary industry grew at
16.6% annually in the Eastern region, compared to 12.1% in the Western
region.
The GDP produced by the secondary industry grew at 11.8% in the
Eastern region, compared to 9.7% in the Western region.
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The growth rates of the primary industry were similar in the two regions
(6.0% and 5.7% in the Eastern and Western regions respectively).
As the secondary and tertiary industries produced over 84% of GDP in
the Eastern region, their relatively higher growth rates contributed to a
higher rate of GDP growth.
The secondary and tertiary industries only contribute 73% of the GDP in
the Western region.
The Openness of the Economy
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The openness of the economy can be measured by the sum of exports and
imports as a % of GDP in an economy.
Openness increasingly being viewed as an important attribute to ensure
steady economic growth in less developed countries, especially following
the successful experiences of East and Southeast Asian regions.
In the case of China, the openness of the economy has ↑ sharply since the
‘opening up’ and economic reform process.
The sum of exports and imports as a % of GDP has risen from 10.3% in
1979 to 22% in 1996 (calculated at 1984 constant prices and the 1984
constant exchange rate).
However, the government’s ‘open’ policy has been heavily biased in the
Eastern region. Consequently, the openness of the Chinese economy is
subject to a remarkably regional disparity.
This is reflected in the table below. During 1984-1996, both the Eastern
and Western regions made a considerable progress in opening their
economies.
However, there is still considerable disparity in the economic openness
between the two regions. (e.g., 17% of the total output of the Eastern
region was sold in the overseas markets in 1995, while only 3.1% of
output did so in the Western region.
Greater openness especially in the expansion of exports can be expected
to promote economic growth in various ways.
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Exports guide countries (or regions) to produce in which they have
comparative advantage through the specialization in such industries or
products, a country or region can achieve higher productivity and a lower
real cost of production.
Trade can also induce economic resources to flow from less productive
sectors with comparative advantage, thus increasing the overall allocative
efficiency of resources.
In addition, trade facilitates a country or region to access new technology
and overseas markets, which in turn can be expected to have positive
effects on productive and management efficiencies.
A greater openness and interregional into the world economy is one of the
principal factors explaining the economic growth of the Eastern region in
the past 20 years.
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The impact of exports on economic growth in the Western region is less
significant than in the Eastern region, due to the much smaller share of
foreign trade making up its GDP.
Although exports grew slightly faster in the Western region is less
significantly than in the Eastern region, the exports per capita in the
Eastern region were far larger.
The figure was US$44.8 in the Eastern region in 1980, compared to
US$1.2 in the Western region,
In 1995, it reached US$284.3 in the Eastern region compared to only
US$21.1 in the Western region.
The different degrees of openness of the economy in the two regions are
an important contributing factor in the differential economic growth
rates, and thereby the resulting income gap between the regions.
Foreign Investment and Capital Formation
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Since the early 1980s, FDI has played increasingly important role in
China’s capital formation and economic growth.
The arrived FDI in China grew at an annual average 33.9% between
1984-1996, with the accumulative total value increasing from US1,258
million to US$41,726 million.
In 1995m FDI accounted for 11.5% of the total fixed capital investment of
China
FDI has thus become a dynamic part of domestic capital formation,
promoting Chinese economic growth.
However, the regional distribution of foreign investment is highly uneven.
During the period of 1979-1995, over 90% of FDI was in the Eastern
(coastal) region, with only 6% in the Central region and 4% in the
Western region.
The regional distribution of FDI is primarily determined by the
investment environment and return on capital in different regions,
The investment environment in a region is affected by a number of social
and economic factors, which in terms of the theory of international
investment are termed location-specific factors.
The factors include infrastructure, transportation, economic structure
and the development level, economic policy, legal system and resources
endowment.
In the case of China, location-specific factors differ considerably between
the Eastern and Western regions.
In general, the Eastern region is more economically developed, with
considerably superior infrastructure, especially in its transportation and
communication systems.
China’s major economic centers including major seaports and airports
have been concentrated in the eastern coastal region.
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Better service facilities and human resources make the investment
environment in the Eastern region superior than that of the Western
region.
In terms of economic structure, the Eastern region is also more developed
than the Western region, with the manufacturing and tertiary industries
having led the economic growth in this region.
The existing advantages of the Eastern region over the Western region
have been reinforced by coast-oriented economic reforms and open door
policy since the early 1980s.
The Chinese government committed a large amount of capital to the
Eastern region to improve infrastructure, such as transportation,
communications, public utilities and service facilities.
Furthermore, the government granted a package of perferntial policies to
the Eastern region, including favourable policies on taxation, foreign
trade and investment, and more autonomy in economic decision making,
all of which resulted in a favourable investment environment.
In particular, the open-door policy has been pursued with a remarkable
spatial dimension.
In 1979, the Chinese government initated the open-door policy by
establishing four SEZs in the southeast coastal region.
These SEZs were initially designed as laboratories for the use of foreign
investment, where SEZs policies were adopted,
The spatial proximity to Hong Kong, the source of about 80% of the total
FDI In China
In the initial stage, FDI was highly concentrated in the four SEZs
(Shenzhen, Zhuhai, Shantou and Xiamen) and during the period 19791983, 80% of total FDI projects was located in the four SEZs.
As the government used administrative regulations to isolate the SEZs
economically from the rest of the country, the SEZs in essence became
foreign enclaves with few economic linkages with other regions.
In 1984, 14 coastal cities were opened to foreign investment. A series of
special economic policies were introduced in these open coastal cities
(OCCs).
This helped FDI to diffuse spatially from the SEZs to the fourteen OCCs
across ten coastal provinces.→ The contracted FDI in the fourteen OCCs
exceeded that in the SEZs.
Since 1986 FDI has gradually spread to the other regions, including the
other coastal areas and the vast inland regions.
In 1990, the new emphasis of open policy shifted to the Shanghai Pudong
New Area, Changjiang (Yangtse River) Delta and Minnan Delta.
A rapid expansion of FDI to the inland regions after Deng Xiaoping’s
‘southern tour’ in early 1992.
As a result, FDI diffused quickly to the inland regions and spread widely
across the country.
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Due to the favourable investment environment in the Eastern region, FDI
has been concentrated in this region since the beginning of open-door
policy.
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During the period of 1983-1996, 87.9% of the arrived FDI in China was
located in the Eastern region, with 8.8% and 3.4 % in the Central inland
and the Western inland regions respectively.
Although FDI has gradually spread to the inland regions since the mid1980s, the Eastern region is still the primary location of foreign
investment.
E.g. the Guangdong province is the single largest recipient of FDI in
1983-1996.
FDI in this province amounted to US$50.9 billion, which accounted for
30.6% of the national total.
In the initial stage (1983-1985), 61% of total FDI flowed into Guangdong.
The province has remained the most important location for FDI although
its share in the national total has declined since the mid-1980s.
Jiangsu Province is second only to Guangdong, with FDI amounting to
US$19.1 billion during the 1983-1996 period and accounting for 11.5% of
total FDI.
This is followed by Fujian Province, whose FDI amount accounted for
10.6% of the national total.
In contrast, both the Central and western regions receiv4ed a very small
share of FDI.
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These two inland regions (including 19 provinces) received less than 40%
of the FDI which had flowed into Guangdong, the single province, during
the 1983-1996
FDI which flowed into the Western region (9 provinces) was amounted to
only 11% of FDI in Guangdong Province over the same period.
The table above indicates the differing contribution of FDI to total capital
formation in the two regions.
In some eastern provinces, especially those in the Southeast region, by
1995 FDI had overtaken the government investment budget and become
the largest capital source of total fixed capital investment.
FDI, as a share of the total fixed capital investment in Fujian and
Guangdong was 51% and 38.2% respectively in 1995.
In other coastal provinces, the contribution of FDI to total capital
formation has also been important.
In Tianjin and Jiangsu, FDI as a share of total fixed capital investment
was 33.1% and 25.4% respectively.
As a result of the large foreign capital inflows, the investment rate (total
fixed capital investment as a share of GDP) in the Eastern region has
been constantly higher than in the Western region. The table below
illustrate
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this.
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As a result of its uneven regional distribution, the contribution of FDI to
total capital formation is significantly different between the Eastern and
Western regions,
Foreign capital as a share of the total capital reached 22.3% in the
Eastern region in 1995, which is much higher than the correspondent %
in the Western region (3.9%).
During 1984-1995, fixed capital investment as a share of GDP was 34.6%
on average in the Eastern region, while the investment rate in the
Western region was just 29.1% on average.
There is no single year over this period in which the investment rate of
the Western region was higher than that of the Eastern region.
The Eastern region has continually headed the Western region in capital
formation and this has been the most important determinant of the
differential rates of economic growth in the two regions.
Domestic capital flows from the Western region to the Eastern region is
also a factor influencing regional capital formation.
Due to preferential economic policies pursued by the Chinese government
and the favourable investment environment in the Eastern region,
companies and government agencies in the Western region tend to make
investment in eastern provinces, especially open coastal cities or
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provinces such as the five Special Economic Zones (Shenzhen, Zhuhai,
Xiamen, Shantou and Hainan), Guangdong, Fujian and Shanghai. This
results in domestic capital flows from the Western region to the Eastern
region. For example, Shaanxi Province invested over 270 million yuan in
eastern provinces in 1992, resulting in a net capital outflow of 225 million
yuan.
In the past few years, some other Western provinces have also
experienced net capital outflows. Such inter-regional flows of domestic
capital have a differential impact on capital formation in the two regions.
They increase capital supply and stimulate capital formation in the
Western region.
This contributes to different investment rates in the two regions.
To conclude, foreign investment, through its contribution to domestic
capital investment and its positive effects on technology transfer and
export growth, has accelerated the economic growth of the Eastern region.
By contrast, the contribution of foreign investment to capital formation in
the Western region has been slight, and hence its impact on the economic
growth of the region is less significant.
Rural Industry Development and Inter-Regional Economic Disparity
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Rural industry growth has been an important factor promoting the
economic development of China in the past two decades.
It has become the most dynamic part of the Chinese economy and plays
an increasing role in economic growth, especially in rural development.
As a principal indicator of rural industry, industrial enterprises run by
townships and villages developed dramatically in the past 17 years.
During the period 1978 to 1995, the total output value of township and
village enterprises (TVEs) grew at annual average 24.8% (at 1978
constant prices).
This growth rate is almost 10% higher than the growth rate of the gross
output value of China’s industry.
The development of rural industry is also subject to regional imbalance.
The total output value of TVEs in the Eastern region increased from
120.4 billion yuan in 1985 to 1221.3 billion yuan (at 1984 constant prices)
in 1995, with an annual growth of 23.5%.
In terms of labour productivity, the value added produced by each
worker in industrial TVEs was 16,046 yuan in the Eastern region, some
60.5% higher than that of the Western region (9,997 yuan).
The differential growth of rural industry aggravates inter-regional
economic disparity, especially the income per capita gap.
This is because rural industry provides the primary source of income for
the rural population, which makeup 80% of the total population of China.
The table below shown the difference in the growth of rural industry
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Due to the different growth of rural industry, the inter-regional gap of
TVEs’ output value per capita in 1995 has been further widened from
250.7 yuan in 1985 to 2263.6 yuan (at 1984 constant price).
In terms of value added, the TVEs’ value added per capita was 1526 yuan
in the Eastern region in 1995, compared to 322 yuan in the Western
region.
Rural industrial growth has contributed significantly to rural economic
development and income growth in the Eastern region where industrial
enterprises run by townships and villages have now become dominant
players in rural economic growth.
Since 1987, the industrial output value produced by TVEs in this region
has surpassed the gross output value of the agriculture sector (including
farming, forestry, animal husbandry and fishing).
By 1995, it was 3.86 times as much as the gross output value of the
agriculture sector.
The rapid growth of rural industry has played a leading role in rural
economic development of the Eastern region.
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In the Western region, however, the rural industry has developed
relatively slower and its role in promoting the overall economic growth
has been less important.
By 1995, the industrial output value produced by TVEs was still less than
that of the agriculture sector in the region.
In terms if the income effect, the differential development of the rural
industry has contributed greatly to the income gap between the Eastern
and Western regions, especially in rural areas.
In 1995, there were 42.85 million rural workers employed by industrial
TVEs in the Eastern regions, which accounted for 26.3% of the total
rural labour force.
The total number of employees in all types of TVEs reached 63.72 million
people, accounting for 39.1% of the total rural labour force.
A massive participation of rural labour force in TVEs’ industrial and
commercial activities contributed directly to the income growth of rural
population in the Eastern region.
For instance, the average wage income earned by each worker in TVEs in
the region was 2064 yuan in 1995.
On average each worker in TVEs produced a pre-tax operating profit of
2933 yuan.
By comparison, the contribution of TVEs to the economic development
and income growth of the Western region has been less significant.
There were 9.66 million people working in industrial TVEs in 1995,
accounting for only 8.4% of the total rural labour force.
With the inclusion of employees in TVEs of other sectors, the total
employees in the TVEs of the Western region numbered 21.17 million
people, which accounted for 18.4% of the total rural labour force.
In terms of income effect, the annual average wage for employees in
TVEs was 831 yuan in 1995, which was only 40% of that of the Eastern
region was 1101 yuan in 1995, which is also much less than the
corresponding indicator for the Eastern region.
This indicates that the differential development of rural industry in the
two regions has further contributed to the inter-regional income
inequality.
Regression Analysis
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Using econometric modeling techniques, the section investigates
fundamental factors determining the divergent economic growth of the
Eastern and Western regions.
The production function to be measured in this model is assumed to have
the properties of the Cobb-Douglas production function, a basic and
widely used form of production function.
Due to the nature of data, all variables are aggregates at the provincial
level.
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Output is expressed by gross domestic product (GDP), and inputs include
capital and labour.
Capital input can be divided into two components: domestic and foreign
capital.
In this model, domestic capital input (DK) is expressed by domestically
financed fixed investment.
FDI represents foreign capital. It can also be regarded as an important
indicator of the openness of the economy.
In addition, as FDI is highly related to the transfer of foreign technology
and management skills, thereby promoting technological progress in
joint ventures and other firms, it can capture the impact of technology on
production to some extent.
Therefore, the production function can be written as:
In terms of economic methodology, the model used here is a Kmenta
Model (Kmenta, 1986), that is a cross-section and time-series model.
This model is suitable and efficient for a regression analysis using crosssection and time-series data since it takes a cross-sectional
heteroskedasticity and timewise autocorrelation into account, producing
a reliable econometric output.
To measure the variation in the effect of independent variables on the
dependent variable (GDP) between the Eastern and Western regions, a
dummy variable (D) is used.
It takes the value 1 for the Eastern region and 0 for the Western region.
Thus the regression formula is expressed as follows:
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where c1 is the intercept for the Western region; c2 is the differential
intercept for the Eastern region. The coefficients α1, β1 and γ1 are the
estimated elasticity of GDP with respect to DK, FDI and L in the Western
region. α2, β2 and γ2 are the differential coefficients of DK, FDI and L for
the Eastern region.
If α2, β2 and γ2 are significantly different from zero, the effects of changes
in DK< FDI and L on GDP growth will be significantly different between
the Eastern and Western regions, i.e. the responsiveness of GDP to
changes in DK, FDI and L will be significantly different between the two
regions, being stronger in the Eastern region than in the Western region,
This is due to the fact that FDI has been concentrated in the Eastern
region during the past 18 years.
It is hypothesized that increases in domestic investment, FDI and labour
will affect GDP growth positively, and therefore, the coefficients of DK,
FDI and L are expected to be positive in both the regions.
However, the impact of FDI on GDP growth is expected to be
significantly different between the two regions, being stronger in the
Eastern region than in the Western region.
This is because FDI has been concentrated in the Eastern region during
the past 18 years.
Data and Spatial Spread
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The data used in this regression analysis are the provincial data of 19
provinces for the 1984-85 period.
The spatial coverage is of 10 provinces in the Eastern region (Guangdong,
Fujian, Jiangsu, Zhejiang, Shanghai, Shandong, Hebei, Beijing, Tianjin and
Liaoning) and 9 provinces in the Western region (Shaanxi, Sichuan, Qinghai,
Yunnan, Guizhou, Gansu, Ningxia, Inner Mongolia and Xinjiang).
The sources of data for the period 1984-1993 are from provincial statistical
yearbooks for each province, with data for 1994 and 1995 being from the
Statistical Yearbook of China 1995 and 1996.
As the data include 19 provinces over a 12-year period, each variable has 228
observations.
In order to remove the influence of inflation on the variables and their
relations, GDP, DK and FDI are expressed in constant prices (1984=100).
The current values of GDP and DK and FDI are expressed in constant prices
(1984=100). The current values of GDP and DK are converted into real
values using the 1984 constant prices for each province.
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The value of FDI, which are originally expressed in current US dollar, are
deflated using US GDP implicit price deflators.
Regression Results and Implications
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The effects of FDI on GDP growth is positive in both the Eastern and
Western regions.
However, there is a significant difference in the impact of FDI between the
two regions, being stronger in the Eastern region than in the Western region.
This supports the hypothesis about the effect of FDI on regional economic
growth.
In terms of the elasticity coefficient, a 1% increase in FDI would generate a
0.0914% growth of GDP in the Eastern region, while a 1% change in FDI
would lead to a 0.0356% change in the GDP of the Western region.
As the elasticity coefficient reflects the percentage change in GDP in
response to a 1% change in FDI, its low level implies that the % change in
FDI is much larger than that of GDP.
During 1984-1995, GDP grew at 12.1% per annum in the Eastern region,
while FDI grew at 37.1% per annum.
In the Western region GDP and FDI grew at 9.1% and 34.9% respectively.
This suggests that to estimate the actual impact of FDI on GDP growth, the
actual growth rate of FDO must also be considered.
Domestically financed investment is the most important determinant of
economic growth in both the Eastern and Western regions.
The elasticity coefficients of DK are statistically significant, indicating that
the responsiveness of GDP to changes in domestically financed fixed
investment is positive and strong in the two regions.
A 1% growth in DK will lead to a 0.394% growth of GDP in the Eastern
region, and to a 0.523% growth of GDP in the Western region.
A higher elasticity coefficient of DK for the Western region suggests that the
economic growth in the region is more responsive to changes in domestically
financed investment. This indicates that the economic growth of the Western
region is more dependent on domestic investment in comparison to the
Eastern region.
There is a significant difference in the elasticity of GDP with respect to labor
change between the two regions. A 1% increase in labour force is associated
with 0.481% growth of GDP in the Western region, while the corresponding
coefficient for the Eastern region is 0.377%. This implies that the economic
growth of the Western region is more dependent on labour input, and the
production process is more labour-intensive compared to that of the Eastern
region.
The differential intercept of production function for the Eastern region is
significantly different from zero (0.9432), indicating that other factors such
as technology, economic structure and management have played a greater
part in the economic growth of the Eastern region than in the Western
region.
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A higher intercept in the production function (i.e. a higher position of the
isoquant curve) suggests that technological and structural factors
contributed more to economic growth in the Eastern region than in the
Western region.
 Using the estimated elasticity coefficients of GDP with regard to DK, FDI
and L, the relative contributions of these inputs to economic growth in the
two regions can be identified.
 During 1984-1995, the average annual growth rate of GDP was 12.05% in
the Eastern region, and the average growth rates of DK< FDI and L are
13.79%, 37.06% and 2.37% respectively.
 Over the same period, the GDP of the Western Region grew at 9.12% on the
average, DK, FDI and L grew at annual rates of 10.8%, 34.9% and 2.4%
respectively.
 Thus, the estimated GDP growth functions for the Eastern and Western
regions can be expressed respectively as:
 (1) For the Eastern region:
GDP = 2.814 + 0.394 DK + 0.091 DFI* + 0.474 L*
= 2.814 + (0.394 x 13.79) + (0.091 x 37.06) + (0.377 x 2.37)
= 2.814 + 5.433+ 3.634 + 0.893
= 12.774
where asterisk denotes average proportional change with respect to time.
GDPr /GDP* = 12.05 / 12.774 = 0.943
where GDPr is the real GDP growth rate and GDP* is the estimated growth rate.
Therefore, the relative contributions of the factors of production to GDP growth for
the Eastern region are respectively:
DK* / GDP* = 5.433 / 12.774 0.425, or 42.5%
DFI */ GDP* = 3.634 /12.774 0.285 or 28.5%
L */ GDP*
= 0.893 / 12.774 = 0.07, or 7.0%
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These figures suggest that:
Domestically financed investment (DK) is still the largest contributor to the
economic growth in both regions.
In the Eastern region, 42.5% of GDP growth was accounted for by the
increase in domestically financed investment from 1984 to 1995.
In the Western region, domestically financed investment is even more
important in determining economic growth, contributing to 57% of GDP
growth over the same period.
This implies that the economic growth in the Western region is more
dependent on domestic investment than in the Eastern Region.
FDI is an important factor contributing to divergent economic growth rates
between the Eastern and Western regions.
Between 1984 to 1995 period, FDI contributed 3.634% points of the GDP
growth rate of the Eastern region, which accounted for 28.5% of the
economic growth (12.05%).
In other words, nearly 1/3 of the GDP growth in the region was brought by
FDI.
FDI has become the second largest contributor to the economic growth of the
Eastern region.
In comparison, FDI contributed 1.24% point of the GDP growth rate in the
Western region, accounting for 12.5% of the GDP growth (9.12%).
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This suggests that FDI alone resulted in a 2.392 % point difference (3.6341.242=2.392) in the growth rates of GDP between the two regions.
This can explain 81.6% of the overall difference in growth rates (12.059.12=2.93) between the Eastern and Western regions (i.e. 2.392/2.93=0.816).
This indicates that FDI is the most important factor contributing to the
differential economic growth and income inequality existing between the
Eastern and Western regions during the reform era.
Labour force (L) contributes to economic growth differently in each of the
regions.
In the Eastern region, 7% of GDP growth was generated by the increase of
labour force compared to 11.6% in the Western region.
This suggests that economic growth in the Western region is more responsive
to and more dependent on an increase in the labour force.
The relative contribution of the labour force to economic growth is more
significant in the less-developed Western region than in the Eastern region.
The estimated coefficient for the constant ‘c’ of the production function for
the Eastern region is significantly higher than that for the Western region.
This points to other factors especially technology, management and economic
structure having played a more important role in the economic development
of the Eastern region than in the Western region.
The above findings spell out that the differential growth rates of domestically
financed investment, FDI and improvement of productivity are the primary
reasons for the divergent economic growth of the Eastern and Western
regions.
A higher investment rate, increased openness of the economy especially FDI,
technological progress, macro and micro-economic reforms and industrial
structural changes, contributed significantly to economic growth in the
Eastern region.
Therefore, the divergence of the economic growth rate and income inequality
between the two regions have further widened in the past 18 years.
The increased inter-regional economic disparity reveals that the economic
boom of the Eastern region has not diffused effectively to the Western region.
The diffusion of growth (the ‘trickle down effect’) from the Eastern region to
the Western region has not happened or has not been empirically evidenced.
The major reasons for the deficiency of the diffusion of growth is the lack of
effective inter-regional industrial linkages and the lack of an integrated and
well-functioning domestic market.
Under the open-door policy, the Eastern region has been encouraged to be
more involved in the international markets for both the export of products
and the imports of inputs.
This development strategy was formally confirmed at the 13th Congress of
the Chinese Communist Party in 1987.
Consequently, the economy of the Eastern region become more foreign
market-oriented.
This is particularly the case in Guangdong and Fujian provinces.
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Their economic integration with Hong Kong and Taiwan has developed
rapidly in the past ten years and is an important characteristic and major
cause of economic development of the Southeast Region of China,
As the coastal region has increasingly shifted emphasis to overseas markets,
the economic linkages between the coastal region and inland regions
including the Western region have weakened.
In addition, the less-developed domestic market has worked against
developing effective regional economic linkages.
Since the early 1980s, the Chinese economy has been undergoing a
transformation from the traditional centrally-planned system to a market
economy.
The market-oriented reforms are more progressive and far-reaching in the
Eastern region than in the Western region.
The regional imbalance in progress towards economic reforms and opening
has impeded the formation and development of the integrated domestic
market and restrained the economic linkages and cooperation between the
two regions.
Even at the current stage, regional market segments still prevail in China,
As a result, economic growth in the Eastern region cannot effectively diffuse
to the Western region, as the ‘dualism’ theory predicts.
Consequently, the inter-regional economic disparity and income inequality
has widened.
Conclusion
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In the reform era since 1979, the Chinese economy ahs experienced rapid
growth and a widening disparity in economic indicators between regions.
Many factors have contributed to the regional divergence in economic
growth and increased income inequality.
The factors contributed to the inter-regional differences in economic growth
and income per capita are:
● Industrial structure and resource conditions,
● Coast-oriented foreign investment and economic openness,
● Regional development policy with emphasis on the Eastern
region,
● The unbalanced growth of exports and foreign direct investment,
● Rural industrial development, and
● Domestic capital flows from the Western region to the Eastern
region
Using production function analysis, we has found that
● The higher rate of domestic investment,
● Enormous inflow of foreign direct investment, and
● Greater openness are the major reasons for the higher economic
growth rate of the Eastern region compared to the Western
region.
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Without a large amount of FDI inflow and greater openness, the economic
growth rate of the Eastern region would not be significantly higher than that
of the Western region.
This suggests that foreign investment, exports and greater involvement in
international market have promoted capital formation and productivity,
which are the major determinants of a higher rate of economic growth in the
Eastern region.
As a result of divergent growth rates, the economic gap and income
inequality between the Eastern and Western regions have been further
widened in the reform era.
The disparity which has arisen is also closely related to the regional policy of
the Chinese government.
In essence, the regional policy throughout the reform era was based on
regional comparative advantages.
Under this policy, the coastal region, due to its superior geographic location
and factor endowment, has been given a pivotal role as ‘growth pole’ or
‘engine of growth’.
To promote the growth of this region, the central government implemented
special economic policies and committed a large amount of capital to
improve infrastructure.
As a result, the investment environment in the coastal region was more
attractive than in the inland.
Domestic and foreign capital therefore flowed into the coastal region,
accelerating its regional economic growth.
However, due to the lack of effective inter-regional industrial linkages and a
well-functioning domestic market, the economic boom in the coastal region
has not noticeably spread to the inland, further resulting in a widening interregional economic disparity and income inequality.
Policy Implications
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Some implications can be drawn from the Chinese experience.
First, inter-regional disparity is unavoidable in the process of economic
development, especially for a developing country.
Since the conditions for development for development in each region are
different, the regional policy based on comparative advantages tends to
reinforce the existing regional difference.
Thus, regional ‘equality’ and ‘efficiency’ of development are two primary
issues faced by the government of a developing country.
In the initial stage of development, a government may place priority on a
coastal (well established) region which can lead to rapid growth of the
national economy as a whole.
Second, a government should pay particular attention to the growing interregional disparity,
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In order to facilitate the diffusion of growth from the booming region to a
relatively stagnant region, inter-regional economic linkages should be
promoted through a series of policy tools and encouragement of economic
cooperation across different regions.
The artificial barriers to inter-regional economic linkage and integration
should be removed, and in the Chinese context, some regulations which
isolate the SEZs or other coastal areas from the inland regions should be
eliminated.
Furthermore, bilateral trade, investments and other linkages between the
coastal and the inland regions should be promoted, rather than the coastal
region being encouraged to rely solely on foreign markets.
Another important point for a less-developed market economy or for one
undergoing the transformation from a central planning system to a market
economy, is the enhancement of the market mechanism.
As a well-developed market can allocate resources efficiently, the overall
efficiency of an economy can be significantly improved.
However, since market forces may fail to facilitate a balanced growth and
may even result in regional inequality in the first stage of development, a
suitable regional policy is critical.
The government should foster market efficiency and domestic market
integration and promote economic linkages and cooperation between regions.
Therefore, the role of the government in achieving a balanced growth is
important.
Third, as the coast-oriented open policy has tended to widen the economic
gap between the Western and the Eastern regions, it is necessary for the
Chinese government to standardize the open policy in all regions and to
eliminate the existing regional discrimination in foreign trade autonomy.
The open policy should be extended as much as possible to the vast inland
regions where a huge potential for development exists.
This would enable the Western region to improve economic conditions and
explore its great development potential.
Finally, improvement in transportation and communication facilities is
essential for enhancing inter-regional economic linkages and cooperation.\
The central government should allocate funds to finance some important
transportation projects, and should also encourage local capital to invest in
infrastructure so as to improve the local investment environment.
Some special programs stimulating investment in the Western region are
necessary.
Reference
Chapter 6: Industrial Linkage Effects of FDI on Domestic Sectors, in Sun, H. S.,
(1998), Foreign Investment and Economic Development in China: 1979-1996, Ashgate,
Aldershot, UK
139
Lecture ??: Trade regimes (WTO),
Regionalization and Global Development:
Intervention, Control and Policy
International Organization for Trade
Two most extraordinary but seemingly contradicted phenomena: global
agreement and regional economic integration
Bretton Woods Agreement 1944 (still in WWII) made by US, Britain and their
western allies (in New Hampshire) decided to form three institutions:

International Monetary Fund (IMF) is to ensure the convertibility of
currencies…now helping the rich

International Bank for Reconstruction and Development (the World Bank) is to
facilitate the international flows of capital… now mainly helping the poor;

International Trade Organization (ITO) to reduce the barriers to world trade.
ITO died in 1947-48 due to being too ambitious: Although it was ratified by
participating countries (54), but they perceived it as a threat to their sovereignty.
But GATT (General Agreement On Tariffs and Trade) immediately emerged in
1948, which was in about 45 years later, replaced by WTO in 1995.
GATT – General Agreement on Tariffs and Trade
Initial 23 countries reconvened in Geneva to find an alternative way to
bring order to world trade and produce GATT which went effect in 1948. It
committed the participating countries to reduce tariff on 45,000 items and
laid down a set of rules and principles governing trade among the
signatories:
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Reciprocity: One reduce tariff to others and the respecting side must do the
same.

Non-discrimination: No preferential treatment to each others and all are treated
as the most favoured – known as the Most Favoured Nation rule – China got this
status from USA permanently just in 2000

Transparency: replace non-tariffs with tariffs, which subject to scrutiny and
reduction by further negotiation

Developing countries – special provision for developing countries
Great Success: Membership grew steadily and now covered majority of
trading nations (134 in 1999). After series of “Round” of negotiations, tariff
cut from 40% to 10% in mid 1970s and further cut to an average 5%. Now
tariff rate in DCs is about 5-7% (or less than 10%) and in LDCs about 1520%. However, in this period regional integration aim at protectionism also
grew rapidly and caused growth rate of trade not to be increased
considerably.
Weaknesses: Original design is to reduce tariff and enforce rules for trade
in manufactured goods. It has increasingly become inadequate and
unsuitable for today’s world trade scene, such as the important agricultural
product and internationally tradable services not covered at all by GATT.
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Thus, the far-reaching Uruguay Round of trade negations resulted in 19861990-1994:

Agricultural Trade: most difficult talks but far-reaching breakthrough – USA
free trade victory

Textiles and clothing: the most nasty conflicts of trade between DLs and LDCs.

Intellectual property: patent and copyright protection, such as computer
software, semiconductor designs, biotechnology, musical recordings, books –
against fierce pirating and counterfeiting activities which cause the loss of
billions of dollars of revenue for holders of intellectual property rights.

Services: the fastest-growing sector in advanced economies, constituting 90% of
jobs and substantial trade volume. Internationally traded services include
banking, insurance and other financial services, tourism, advertising,
architecture and construction engineering, planning, consultancy, transportation.
And telecommunications (now the internet) – will besthe most lucrative business
for trade in the coming decades

Investment: National policy distorted international capital flow and foreign
investor, such as joint-venture rule and limitation of the area to foreign
investment.

Dispute settlement
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The Uruguay Round failed to reach anything by the deadline in 1990, but
the whole world felt the cost and resumed the talks and finally reached
agreement that was also ratified by all participation countries.
The 2200-pages GATT treaty of Uruguay Round is the broadest, most farreaching trade pact in world history – agricultural breakthrough, two new
agreements on telecom sector and on service sector. But the contents of
the GATT are now far beyond the regulation “Tariff” – thus, a world
supranational organization born - WTO.
WTO - a world supranational organisation, literally for trade, in
fact for almost every thing!

Tariffs: One-third cut on the whole, developed cut by 36% and developing by
24%

Quotas: Illegal and should be eliminated

Health and Safety: Cannot be used to against trading partners, thus it ends the
most pervasive technology used by bureaucrats to exclude a wide range of goods,
from foodstuff to motor cars.

Intellectual property: All signatories must protect patent, copyright, trade
secrets and trademarks and to commit to end the wholesale pirating and
counterfeiting of software and series of products relating to intellectual property
rights.

Local content: prohibits members from requiring a high local content in
products manufactured within their borders.

Landslide effect on world trade:

Europe and Japan – agricultural good, while US manufactured and auto goods;
The rich countries phase out Quotas, while the poor commit to more
transparency;

The pact also calls for free trade in financial services – the Financial Services
agreement (FSA).

The pact also call for opening in telecom, internet markets and audiovisual
product - - the Information Technology Agreement (ITA) and the
Agreement on Basic Telecommunications (ABT)
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Again, great success: the pact will add US$510 billion into global economy,
of which US gain US$122, Europe US$164, Japan $27, LDCs $116. The
world as a whole shall benefited more.
Controversy: Sovereignty, Environment, Labour, Equality, Sanitary and
safety…
Regional Economic Integration
Why integration?

To achieve growth through the enlargement of the market

To raise standard of living and to reduce regional disparity

To strengthen bargaining power in global polity and economic affairs

To develop cooperative solution for a variety of social and political problems
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Integration Theory

Integration is a form of selective discrimination because it combines elements of
free trade with greater protection – free trade with members and restrictions on
trade with non-members

Five levels of integration: Figure 12.5

Elements conducive to successful integration: Parallel economies, Proximity,
Contiguous countries within a compact area, Large combines territory with
many small countries, Best customers and suppliers, Major world trader and
high trade barriers;

The “second-best solution” to world trade problems

Trade creation (good) and trade diversion (bad)

Most importantly, benefit from scale economy and “increasing returns” - the
bigger the better; creating new trade and making trade diversion is not
necessarily “bad”

Integration for Development

But one dilemma: less than one-fifth of all LDC trade is with other LDCs, most
trade is DCs with DCs and LDCs with DCs.
Great Success in Europe: The European Union
The Global competitiveness of US High-Tech Industries
Reference:
Chapter 12: Berry B.J.L., Conkling E.C. and Ray D.M. (1997), The Global Economy
in Transition (second edition), Prentice Hall Inc., New Jersey, United States.
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Lecture IV: China's WTO Accession, State Enterprise
reform, and Spatial Economic Restructuring
Background:
After a 13-year conscientious bid and serious negotiations,
China has at last been able to enter WTO this year,
congratulations! This is a great, in fact the greatest, historical
event for China. Its significance is comparable to, or even
larger than, China's first-attempt of reform and the
implementation of open-door policy launched in 1978. The
fundamental meaning of China's WTO accession is far
beyond "trade" or "market opening/access." It has been
Chinese Premier Zhu Rongji's last-ditch effort to break
through the many formidable impasses and deadlocks he
encountered in pushing his grand reform packages that have
by and large remained unsuccessful so far. That is, China's
WTO accession can be seen as the panacea that Zhu Rongji
or China desperately needs to transform China's whole
economic system in general, and to reform the deadwood
state enterprise sector in particular. In essence, it is about
fundamentally transforming China's existing "socialist"
system and about building-up a newly internationalized
system, harmonizing its rule with "outside" rules or “the
global way”, with the help of foreign or international forces foreign capital, competition, and experiences and networks.
Hence, its implication is far-reaching and goes beyond the
economic, social, political, geographical, and even in the
“rule of law”, personal freedom and human right realms. With
a brief introduction to this general background, this talk will
focus on the interrelationship between China's WTO
Accession and state enterprise reform and their profound
impact on China's spatial economic restructuring, including
the possible rise and fall of China's regional economic
centers, such as Shanghai, Beijing, and even Hong Kong, and
sectoral regionalization.
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Euphoria of China's WTO Accession:








A long-waited for the door opened, a real
breakthrough
A Win-Win deal for both China and USA; HK
people says a Win-Win-Win deal plus Hong
Kong; Politician says a Win-Win-Win deal for
Zhu Rongji, Jiang Zemin and Bill Clinton
To Chinese: "If we say that Deng Xiaoping
opened China to the world in 1979, we can say
that this time China has entered the world."
To Foreigner: "With Deng's open policy, you can
“see” China, now you can do business in
China"
Entry to the WTO should integrate the mainland
economy into a global capitalist system that
offers both tremendous growth opportunities
and, potentially, ruinous competition.
What we concern and interested:
What this means for us, from American farmers
to the AT&T boss to Chinese farmers to China
Telecom directors?
And particularly to our geographers, what this
means to us spatially - to our places, HK,
Shanghai, Beijing, Guangdong, Northeast, and
Sichuan?
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1. Theoretical Framework and China’s
Economic Backgrounds:
A. Old&New Trade Theories - The world double/triple
gains/benefits from trade:
Trade is always beneficial to the both sides of the trading parties or
multi-trading participants. The world as whole will benefits from trade
twice/triples:
 Comparative Advantages that maximizes the outputs and
consumption for both or multiple sides of trading countries (Smith 1937;
Ricado 19??) - As long as there is trade, no one lose or every trading
country will be better off; This is called "arm-length trade".
 Increasing Returns embedded in FDI and MNE enhance on
specialization and concentration and increase the trade volume
second time from intra-firms/sectors/industries trade, hence
maximize output/benefits for firms/sectors/industries (Krugman
1990) - trade for the trade sake and every trading party/firm will be
increasingly better off; This is MNE or own trade
 Trade embedded in both MNE and joint-venture corporations
gives rise to opportunities for a relative disadvantage
catching up with an absolute advantage or breakthrough the
dominance and superiority of the absolute advantages (Simon Zhao
20??; Porter 1990) - Japanese car industry and China's WTO
accession and market opening.
B. Trade is not mere "trade" or more precisely "trading of
goods" - Nowadays Trade becomes very comprehensive and
complicate – A world of “no boundaries” for the
manufacturing, service and finance sectors.
In fact, today’s world includes everything, particular services. Global
Trade organization is a supranational and suprastructural organization.
In the face of globalization era, IT and internet and time-space
transcending to conversion era, every thing can be traded and trade
instantly - trade finance, trade service, trade information, trade
technology, trade intellectual property, etc. Trading in this area
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becomes more important, crucial and more profound in this postmodernism era, in which huge amount of financial capital flows
instantly transfer around the world and easily leave a national economy
in ruins. Facing this new or super trade form, the “border” and
sovereignty of every nation is increasing under threat and hence every
sovereignty nation seeks a global supranational organizational structure
that can govern this modern, new and super trade form. Thus, global
trade organization, namely WTO, is increasingly become such a
supranational organization. There are three major and strategic
multilateral agreements negotiated since the Uruguay Round –

the Information Technology Agreement (ITA),

the Agreement on Basic Telecommunications (ABT), and

the Financial Services agreement (FSA).
But, the power of these three agreements is just calling for free trade
and open market in these three areas, without a concrete measure and
provision for enforcing these agreements.

In these three strategic areas - IT, BT, and FS, and particular the service
sector, Mainland China is one of the largest but the most “closed”
markets to which foreign companies have been for years trying to gain
the access but failed so far.
China also renowned with bad practice in intellectual property
protection, counterfeiting and piracy of foreign goods and technology.
That is why Seattle Round of WTO Negotiation is very important and
that is why US and the whole world are so eager to bring China to this
“world trade club”.
C. China's bid for WTO accession is not merely for trade. In
essence, it is about fundamentally transforming China's
existing "socialist" market system and about integrating
China into the global system, harmonizing its rule with
"outside" rule, with the helps of foreign or international forces
- foreign capital, competition, and experiences and networks,
as well as market accountability.
149
It has been Chinese Premier Zhu Rongji's last-ditch effort to break
through the many formidable impasses and deadlocks he encountered
in pushing his grand reform packages that have by and large remained
unsuccessful so far. That is, China's WTO accession can be seen as the
panacea that Zhu Rongji or China desperately needs to transform
China's whole economic system in general, and to reform the deadwood
and “incurable” state enterprise sector in particular.
Let’s take a look at the basic facts and background:
 Consecutively two years of unprecedented deflationary spiral,
with severe lack of demand in consumption and huge amount
of inventory;
 A substantial drop in both foreign trade and foreign
investment, particular FDI: 20% drop in August 2000, but now
there is a sign of recovering - year-on-year 6.2% decline by
September 2000. By 1998 China accumulate foreign
investment worth US$300billion, with amount of US$40 billion
each year with this year 30 billion.
 Huge non-performing loan and bad loan in state-own
enterprise (SOE) sector: Current total SOE fix assets
amounted 9600 billion yuan, but dead/bad loan in the Central
Bank amounted to 5800 billion yuan, accounts for about 60%
debt/equity ratio. Totaling 29,000 SOEs has current capital
less than 3000 billion yuan; Many many SOEs and banks
virtually bankrupted.
 Chronically and extremely poor efficiency in SOEs - more
than 50%, some says 70% firms lost-making, compounded
with massive redundancy - 10% unemployment rate and
massive off-duty workers - about 50% urban workers and
cadres under off-duty threat;
 Extremely poor social security and welfare systems
 GDP stagnant around 7% (7.4% in the first 3 quarters) China's 7% growth means no or low growth and normally 8%
to 9% regarded as OK - catching up employment needs and
social security needs.
 Currency under devaluation pressure
 All Zhu Rongji's grand reform packages - reforms in civil
servant or government sector, financial sector (banking,
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insurance, security), food marketing sector, urban housing
sector, and SOE sector - by and large remained unsuccessful
(Only one thing Zhu has done so far can be regarded as
successful is his anti-smuggling South China tour in early
2000)
 But Chinese citizens holds 6000 billion yuan deposit saving,
this accounts for more than 60% of GDP in China, and 1000
billion cash in hands;
 But how China could solve these “crisis” with the emergence of
the WTO accession?
D. Integration Theory - Increasing returns by specialization,
agglomeration and spatial economic grouping/restructuring
2. Terms of China's WTO Accession:
China's offers - Nov terms:
 Overall tariffs: Significant cuts in tariffs that will be completed
by January 2004. Overall average for agricultural products will
be 17 per cent and for US priority products 14.5 per cent.
China will make significant liberalization on importing
agricultural products, especially wheat, corn, cotton and
other bulk commodities. According to the bilateral
agriculture-trade agreement, China would eliminate all
quantitative restrictions on agricultural bulk commodities.
 For industrial products, tariffs cut to an average of 9.4 per
cent overall and 7.1 per cent on US priority products. It will
cut tariffs on imported cars from the current 80-100 per cent
to 25 per cent by 2006 and allows foreign financial institutions
to finance the purchase of cars by Chinese citizens.
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 China will eliminate non-tariff quotas within five years, some
in two to three years.
 It will allow 49 per cent foreign investment in
telecommunications firms from the date of entry, rising to 50
per cent in two years, and will allow foreign banks to conduct
local currency business with domestic companies two years
after accession and with domestic individuals five years after.
Beijing also agreed to lift the ban on foreign investment in
Internet related businesses.
 These are substantial concessions and, if fully implemented,
will give foreign firms far greater access to the China market
than they currently enjoy.
USA offers:
In return, Beijing received a concession on textiles, with
Washington backing down from its demand that quotas on
China's exports remain until 2010. Instead they will end in 2005,
but with an "anti-import surge" mechanism remaining for a
further four years, to prevent a flood of exports. USA have
already granted the “Permanent Normal Trade Relations” (PNTR)
status to China in late 2000, which is formally known as “Most
Favorable Nation” (MFN) status.
Summary (based on both Nov. and the April
Version) (also See Appendix I)
 Market Access and Tariff Reductions: Overall 17% from
current 22%; farm goods 17% and 14.5% to US product;
Industrial goods tariffs cut to an average of 9.4 per cent
overall and 7.1 per cent on US priority products; and phaseout most Tariff Rate Quota (TRQ) system for bulk
commodities by 2005/6;
 Bindings for all tariffs and no export subsidies;
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 Decentralization of Trade Right and Distribution (wholesaling,
retailing, to both private sector and foreign firms;
 Opening up the strategic and lucrative sectors and market for
foreign investor and investment with 50-50 joint venture and
foreign majority control (some up to 100% ownership - hotel
or reinsurance): telecommunications & internet, banking,
insurance, securities, travel & tourism, and professional
service (legal, accountancy, taxation, management
consultancy, architecture, engineering, urban planning,
medical &dental, I.T.-related services)
 Opening up audiovisual and intellectual property market to
foreign investment and investor who can build and run video
and sound recordings shop and cinemas with joint or own
ventures.
 Binding China to comply with all WTO rules and particular the
three agreements (ITA, ABT and FSA); Guarantee private
participation; impose SOE reform and act on a commercial
basis without any privilege power

In short: China's WTO accession not only allows
American/foreign goods and capital enter China, but
American/foreigner, American/foreigner interest/firms into
China, and into the most strategic and lucrative sectors,
where they can open or build up their own business in an
environment similar to their home.
4. China's WTO Accession's Impact on Economic
Sectors - Industries Hit Hardest and China's Selfdefense
Mainland industries that have been cushioned from international
competition are expected to be hit hardest. Agriculture,
automobiles, banking, telecommunications, insurance and
distribution would experience the greatest competitive pressure,
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1) Agriculture:
Analyst at China International Capital Corp (CICC) Shawn Xu
Xiaonian estimated the value of the country's agricultural imports
would be double that of last year under the Sino-US Agricultural
Agreements signed in April. He said that, even if the value of grain
imports increased threefold after the mainland's entry into the WTO,
the country's grain self-sufficiency ratio would drop only from 97 per
cent to 92 per cent.
The Chinese government controls the rights of trade and distribution in
key products such as wheat, corn, rice, cotton, surgar, and chemical
fertilizers. All these goods are under TRQ control and China Food Corp.
is the sole agent to trade and distribution
2) Car industry:
High tariffs and government protection have made car-production one
of the Mainland's least efficient industries. China has more than 120 car
factories could be facing closure because of the Mainland's entry into
the World Trade Organization.
China has 120 car factories and produced 1.6 million cars annually , less
than any of the world's top 10 car-makers. Toyota, Japan's largest carmaker and the world's third-biggest, made 5.3 million vehicles last year.
In China only three automakers (Shanghai auto, No.1 auto and No.2
auto) produce more that 0.1 million, most of them around 1000; last
year three factories produce nothing and 30 factories produce 100 cars
The mainland's 10 biggest plants make more than 90 per cent of
national output. Beijing wants to centralize production in these 10 but
cannot because of the protection of local governments and special
interests which see cars as a pillar industry.
48 per cent lost money last year, up from 42.3 per cent in 1997. Total
losses rose 175 per cent to 2.2 billion yuan (about HK$2.05 billion) and
profits fell 55.4 per cent to 3.44 billion yuan. Inventory rose 15.7 per
cent to a record of 114,000 vehicles.
154
WTO terms: It will cut tariffs on imported cars from the current 80-100
per cent to 25 per cent by 2006 and allow foreign financial institutions
to finance the purchase of cars.
The difference of price between the Mainland and foreign cars in same
rank is about 50%, which means to buy a similar model of car in the
Mainland, a consumer need to pay double the price as purchasing the
same car in the overseas market
But:
(1) China import 40,000 vehicles last year, occupying 2.4% market, but
smuggled 100,000-150,000 cars annually (10% output/market). With 10
to 15% growth quota and 5 to 10% reduction in tariffs annually in
opening its market for about 7 years, The number of foreign import
cars are less than or may just amounted to the smuggling cars.
(2) China hold firmly the rights of car trading (right of import and
export - not open at all), foreign car cannot “flooded” into China
markets
(3) It is still the best way for foreign car makers to enter mainland
market through joint-venture in car industry with FID or under the
Debt-to-Share scheme. This will be a win-win deal for the Chinese and
the foreign side.
(4) The Chinese civilian purchasing power is still too weak for to the
purchase and usage of the private CAR, which is currently most luxury
consumer goods in China – The market is not as large as others thought.
3) Similar to cars, China hold the rights of trade and distribution
in petroleum and petrochemical goods; foreign petroleum is much
cheaper than in China e.g. cost for one barrel oil in China is amounted
to US$13.5 and in USA, US$8.8. China should import more foreign
petroleum, which is much cheaper.
4) Telecommunications and internet (lucrative
market):
After China’s ascension to the WTO, foreign investors could take
controlling stakes in the Mainland's telecommunications sector and also
open the door for investments in the Internet sector. The mainland is to
allow up to 50 per cent foreign ownership and control in its telecom and
Internet markets sooner than previously agreed.
155
The timetable had called for 25 per cent maximum foreign ownership in
value-added services such as Internet-related services by next year in
Shanghai, Beijing and Guangzhou, expanded to 51 per cent of
nationwide services by 2004.
As for Mobile services, 25 per cent of foreign ownership would be
allowed in the three areas by 2001, extending to 49 per cent of
nationwide services by 2005.
As for Fixed-line businesses in the three key areas, 25 per cent foreign
ownership by 2002 would be allowed, growing to 49 per cent of
nationwide networks by 2006.
During talks in 2000, US negotiators reportedly insisted on 51 per cent
of foreign ownership rights in the mainland's telecom sector but Beijing
refused to go beyond the allowance of minority holdings for foreign
investors.
But:
All telecom/internet business cannot be sole foreign own. Foreign
control power up to 49% in 2 years and to 50% later. It will be a 50-50
joint-venture business in the telecommunication sector.
5) Banking:
Although foreign banks are allowed to conduct local currency business
with domestic companies two years after accession and with domestic
individuals five years after, Beijing may impose restrictions on the
number of branches a foreign bank can operate in an individual
province or city. "If a foreign bank is allowed to have just one branch in
a city like Beijing, how can it compete with China Construction Bank,
for example?"
All financial and service firms cannot be sole foreign owned. Foreign
control stakes in banks shall be up to 33% in 3 years and to 49% 3 year
later.
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6) Insurance, Financial and Professional Services:
The provision of insurance, financial and professional sector is very
weak in China. The foreign entries in such industries provide massive
room for development in these areas. In the WTO agreement, foreign
entry to this sector shall be a 50-50 joint-venture business and it would
be again operate under a “one-city-one-office basis.
In summary:




China has largely opened its goods market but
less openness or even no openness in the
service and distribution market for goods- the
right of trade and distribution;
China hold the controlling stake in most
business and investment; Compared to April
version, China offers more tariffs cut in return
of more control or US gets more market
opening but less control power in businesses
and joint ventures
50-50 Joint-venture is the most likely form and
the best form for foreign business and
investors to march in the vast Mainland markets.
And this is a win-win deal for all parties
according to economic and trade theories - FDI
and MNE, rather than goods itself, are the best
way to export one’s goods to other markets.
No foreign goods shall flood in, but there a
chance of foreign capital buyout
157
5. Package of Further SOE Reforms
Background: Existing China's Stock Market establishment and Sharefloating Firms Development - An act of Nationalization, rather than
privatization
Reform Package:
 Privatization scheme - withdraw the state majority control from
51% share-holding to 30% (legal shares) and the “grand” sell-out the
remaining shares to the private markets, including institutional and
private investors; Listing of the large and strategic companies, such
as China Unicom, China petroleum, China Natural Gas etc in foreign
markets with the encouragement of substantial foreign ownership
 "Hold the large and release the small" scheme - State owns,
controls and operates 1000 the country's largest and strategic
SOEs/companies and let others SOEs go, and therefore the shares of
these SOEs are available to the markets for both foreign and
domestic investors.
 Debt-share Swapping scheme (or called Debt-to-equity
conversions scheme) - China's largest SOEs with huge debt and
negative assets can convert their debts to shares which can be bought
or owned by both domestic and foreign investors (selling them into
markets). Along with this scheme, the Ministry of Finance is
considering a massive sell-out of SOE assets which is largely in debt
(5800 billion yuan out of 9600 billion yuan or 60% of SOE assets are
debts) for recovery of the fiscal capability of the central government.
 Cases: H share Anshan Iron and Steel Complex, one of the
Mainland's largest state-owned steel firms, has signed a 6.85 billion
yuan (about HK$6.39 billion) debt-for-equity swap agreement with
creditors. Xinhua news agency said Anshan's swap agreement was
the largest so far signed between a state-owned enterprise (SOE) and
the asset-management corporations Beijing set up this year to
liquidate non-performing loans at state-run commercial banks.
Creditors included the China Huarong Asset Management
158
Corporation, China Development Bank, China Cinda Asset
Management Corporation and the China Oriental Asset
Management Corporation. China's many large SOEs, for example,
publicly listed in HK H-share companies Jilin Chemical (China’s
largest Chemical company), Jinwei Textile and Qinling Motor are
under this scheme,
 Share-option scheme - the payment shares, as a bonus, to
successful SOE senior managers. This is performance-linked bonus
scheme
 Private Company Listed Scheme - Allowing private companies
publicly listed in stock market and encouraging private enterprise
development and protecting their interest. Such private assets worth
about 7000 billion (70% GDP) yuan
Implications:
 Grand and massive sell-out of assets of SOE, but who
bought it and where was the money came from?
 For big caps: conditional sell-out – that is, no foreign
majority control in the large or the largest strategic
industries or in the manufacturing sector. Foreign
investor, particular big players, must become jointventure in order to tap mainland market in a massive
way.
 For small caps: unconditional sell out - SOEs can be
sell-out to both private and foreign investors. This
means foreign investors can solely own their
business in a wide range of manufacturing sectors,
and in some in agricultural sectors (?)
 Joint-venture with FDI and MNEs is still best way to
go to China. As long as in this way, China's industry
has the chance to grow - that is the relative
disadvantage can catch up the absolute advantage
where Joint-venture of FDI and MNEs hold.
159
6. WTO Pact and SOE Reform package Combined
- Spatial Impacts (WTO goods+ services and SOE
manufacturing):
Grand Opening China's manufacturing and
service sector, also including agricultural sector,
not only the market but in investment:
Massive Chinese and foreign encounter in almost all fronts; agriculture,
manufactury, service, hi-tech etc. That is, the fundamental meaning of
China's WTO accession is the last-ditch effort of the Chinese Premier,
Zhu Rongji, to break through the many formidable impasses and
deadlocks he encountered in pushing his grand reform packages that
have by and large remained unsuccessful so far, with the helps of
foreign or international forces - foreign capital, competition, and
experiences and networks.
What will happen from now on, in both short and long turns? Along
with the big surge of trade volume, at least three waves which are
mutually inter-related or cause-and-effected, can be foreseeable in neat
future:
A wave of deals/business/investment in manufacturing,
telecommunication & internet, IT sectors will first emerge, in
which corporate activities (enterprise buy and sell, mergers and
acquisitions) will be very active. Along with this wave, enterprise
listing/floating will boom. Many big players as well as small players,
both private and foreigner, queue to shoot as playing field levels out.
This is particularly attractive for big foreign caps aiming at tapping the
mainland market in the largest and most strategic industries, such as in
iron and steel, petroleum, chemical, cars, telecommunication and
internet industries through joint-venture and debt-to-share schemes.
This wave is particular good for China's Northeast region, where is
dominated by heavy industries, and many urban manufacturing centers.
In this wave, American, Japanese and European firms are relatively the
major actors. The availability of jobs shall come down and moving up,
but shall be dominated by “moving up” .
160
A wave of deals/business/investment in financial and service
sector will unprecedentedly emerge, following the first wave. Many
financial institutions, both foreign and domestic (as required in 50-50
joint venture rule), such as banks, investment and development banks,
stock and equity brokers, insurance companies, securities firms, will be
spring out. Immediately following this outburst is another
unprecedented boom of professional services: legal, accountancy,
taxation, management consultancy, architecture, engineering, urban
planning, medical & dental, computer-related services, environmental
services, and travel & tourism. In this boom Hong Kong and America
are relatively the active players. Huge amount of job opportunities will
be created.
A wave of new regulatory rules/laws/policy and vast information
and innovations will subsequently emerge, in which Beijing is
the absolutely major or even sole player. A new round of licensing
and franchising, redistributing/reallocating TRQs (ensuring private
and foreign firms participation), decentralizing trading rights and right
of distribution, is intensively encountered by government, both central
and local, particularly ministerial (China's industries are still under
ministerial management). Establishment of new governing bodies, both
official and sectoral, and of new rules/laws and new policies governing
all these new activities in trade, manufacturing, and service sectors is
urgently needed. Sectoral and civil management organizations handling
industrial disputes and civilian complaints, both international and local,
are also needed accordingly. Along with this wave of regulatory
measures establishments, vast information and innovation, both
regulatory and business, are induced and float around China major
cities, particular Beijing and Hong Kong. Many jobs will be created.
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So, what is the spatial impact of all these three
wave? Which place is winner or loser, comparable
to their gain and loss, and in what areas?
Overall Outcomes:

The largest is the best and The worst is the best - Large
SOEs bailed out by foreign capital, and agriculture/husbandry
also have chance to upgrade their efficiency and productivity
by foreign participation and competition.

Hong Kong, Beijing, Northeastern and Western regions are
the relative winners while Shanghai and East region (Jiangsu,
Zhejiang) are the relative loser;

Hong Kong will maintain and even advance its dominance in
financial services, trade, transportation (port and airport), IT,
hi-tech development, tourism and a service center as a whole;
Hong Kong will grow into the world’s third largest
international financial center, just right next to New York and
London (Tokyo is now the third largest financial center but
not an “international” one)

Beijing will overtake Shanghai and emerge as China's
Financial Center, economic center, IT and Hi-tech industrial
base – Beijing would still maintains to be China's No. 1
political and economic center, and will emergence as the
No.1 financial and hi-tech center as well;

Shanghai benefits greatly from textile production and export,
high value-added and large-scale manufacturing, such as car
and aerospace industries. Thus, Shanghai will China's
manufacturing center. But, apart from those advantages it
holds, Shanghai is an overall loser. It is not only because the
manufacturing sector is a loser generally in this WTO deal,
but also because Shanghai loses its position as a financial
and service center to Beijing, and it suffers from lack of
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transportation, IT and telecommunication and hi-tech
development - the most strategic and lucrative sectors for the
new millennium.

The outlook of WTO deal for Guangdong (GD) is mixed, but
GD is a relative winner, comparable to other provinces.
Why?
Spatial Economic Structure restructuring: Heavy
Industry and possible agriculture are winner and manufacture is definitely
the loser in this deal - The largest and worst SOEs will have a chance to be
bailed out by foreign capital; while agriculture/husbandry also have chance to
upgrade their efficiency and productivity to face foreign participation and
competition.




Northeast – with a heavy industry like the South Korean
development model and agriculture base: H share Anshan Iron and
Steel Complex and Jilin Chemical, China’s largest Iron and Steel
and Chemical producers respectively, have completed the Debt-toequity scheme, and therefore, could maintain as a competable force
facing foreign competition.
South (HK + Guangdong): Financial/Service, trade, IT and Hi-tech
development, and low & high value added manufacturing;
West (Sichun + Xinjiang) Agriculture, husbandry and materials and
tourism
East (Jiangsu, Shanghai Zhejiang) low and high value-added
manufactory, machinery, textiles
Shanghai has completely sidelined in this surge of financial and service
development. No doubt, most foreign and domestic big players will set
their headquarters first in Hong Kong and second in Beijing. Now a
sudden outburst/emerge and flourishing of Beijing Financial Street and
the 10-year bleak of Pu Dong, so called China's No 1 financial center are
the best evidence. In Beijing's Financial Street, located both the
headquarters of Chinese and foreign banks, the State Stock and
Security Commission - China's governing body for company's
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floating/listing, for stock exchange and for financial regulation, China's
first investment bank - China International Capital Corp (responsible
for corporate listing, mergers and acquisitions), and China's most
largest firm in the management of shares - Everbright Security and
many financial institutions are also flourishing in. Beijing is also the
home for the most headquarters of Red-chips and H-share companies
(China's largest companies listed in HK; they are all subsidies of or
affiliations to the State Council and various ministries). Beijing is also
the center for the grandfathering for all WTO term implementation and,
in fact, all business activities. This is the result of the peculiarity of
Chinese economic system - sectoral/ministerial management. Hong
Kong dominates in its enriched international, trading and financing
information and Beijing national and regulatory. Both are financial
center but at different levels - international and national. It seems
Shanghai is being “casted out” in this context.
Precondition of IT and Hi-tech industrial Development:
Excellent telecommunication infrastructure, competitive economic
system (free trade and stable currency), rule of law and intellectual
property right protection, highly educated people who renowned for
scientific innovation and business entrepreneurship.
Many Hi-tech directors, including Microsoft, Intel, Yahoo, AT&T etc
said Hong Kong has every ingredient for IT and hi-tech development.
Hong Kong plus Shenzhen will be China's major IT and hi-tech center.
Beijing shall be in the second place. Shanghai again is left behind
because of its disadvantageous position it is in and the lack of
ingredients for IT and Hi-tech development.
Shanghai will also suffer because it shall became less influential in
China's foreign trade position as a result of its reduced volume of
foreign trade and its lack of natural conditions for container port
development. Guangdong now accounts 40% of China foreign trade
and Hong Kong's container port and Shenzhen's Yantian port are and
will be the largest port in the world and in China. In addition, Shanghai
suffers from the unprecedented vicious circle of real estate – the
financial development in the past decade, which has severely
undermined both the municipal government and the commercial fiscal
ability, and the city’s financial vitality (its annual construction volume
of office buildings for once was equal to the same volume for ten year in
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Hong Kong), and its total number of office space constructed is more
than HK, in just in a 8 year construction spree. But the vacancy rate in
Shanghai is about 70% in office building and 50% in residential
buildings – the world largest real estate bubble). Shanghai also suffers
from the long-term strict central control, which so far has not relaxed
much. To the worst, Shanghai has profoundly suffered from its unique
or peculiar “Shanghainese Culture”
Guangdong (GD) is one step ahead for capitalism and the WTO
entry, with least SOEs and most developed market system – widely
practices privatization well ahead the central reform plan. GD occupies
40% total China foreign trade with 4 major categories: machinery,
electronics, textile/garments/toys and watch/clocks/small metal tools ,
with the first two accounts 50% and the last two 50% of the total trade
volume. The category of Machinery manufacturing shall suffers after
China’s entry to the WTO; the category of electronics neutral or slightly
positive (GD electronics is very competitive and export around the
world, particular developing countries); the category of textile &
garments & toys shall be in a very positive position (as now it suffer
from both mainland central quota auctioning system, which means 10%
increase in cost, and quota restriction from other countries; the category
of watch/clock and Small metal/tools shall perform neutral or slightly
positive. Overall, the entry to the WTO helps trade, which in turn helps
GD. GD has also benefit substantially from its superiority in overall
infrastructure in general and telecommunication structure in particular.
Just recently, the central government designated GD as China’s IT and
telecom industrial center and Shenzhen as a hi-tech center and high
valued added manufacturing center, in which a “China hi-tech fair”
held in Shenzhen annually. Hence, in a longer run, GD will be again one
step ahead to meet the challenge of WTO and grow into China’s major
trade and IT center.
Appendix I Ten Market Breakthrough for China with China's WTO Accession
Nov 17,1999 - 13:50:44 HKT
Accession to the WTO means China will open its various sectors for foreign
participation. It is expected that China will soon:
1. Reduce its average tariff on foreign goods to 17% from 22.1%.
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2. Open the market for agricultural products including wheat, rice and
cotton;
3. Ban its dumping of goods to other foreign countries.
4. Open its retail market and allow US companies to have more distribution
rights and after-sales services.
5. Open the professional services market covering the legal, accounting and
medical sectors.
6. Open its market for foreign films. The number of imported foreign films
will be doubled to at least 20 every year.
7. Open its automobile market. Tariffs for automobiles will be reduced
yearly.
8. Open its telecommunications industry. Two years after China has entered
the WTO, foreign investors can invest in the Internet market.
9. Open its banking industry. Two years after the WTO entry, foreign banks
can operate RMB business for mainland enterprises; and
10.Open its securities industry. Foreign financial companies can hold up to a
33% stake in fund management corporations.
Spot the Difference - the Deals between April and Nov. versions (see transparency)
Appendix II Sino-USA Economic Relation and
WTO Trade Impact:
1) China's trade 60% processing trade and 40% ordinary trade;
China-US trade US$60 billion with 600million surplus; China is US the 4th trade
partner and US is China the 2nd trade partner. China is No2 FDI recipient country
next to US and US is the 2nd largest FDI investor next to HK. Mainland China
occupies 7% US commodity market, plus Taiwan and HK 12% of the market.
Currently about 200 thousand jobs and 18 billion export in US depends on
Mainland China trade, according to the US Chamber of Commerce.
2) According to a recent report of ITC (International Trade Commission), the
Impact of China's Accession to WTO to both parties:
GDP Growth
To China
4.1%
To USA
0.05%
To Hong Kong
about 10%
Export Growth
12.2%
10%
about 10%
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To Hong Kong
Very positive for
HK's service export
to mainland
overall 10% growth
at least
Import from
USA/China
14.3%
7%
3) Large trade deficit of USA to China is not a problem for America, in stead is a advantage for
The peculiarity of Sino-US trade:
Re-export trade increases value 30% to 40%
US$3 out to China > 2 > 3 > 10 back to USA
USA MNE trade and large sell to China by this firms
FID and MNEs prevailed
Reference:
Zhao, X.B., S.P. Tong, and J.M. Qiao (1999) “China's WTO Accession, State Enterprise
reform, and Spatial Economic Restructuring" paper presented in the Colloquium Series of
Geography Department, Univ. of Washington, USA, under review by World
Development.
Zhao, X.B. (2000) “Spatial restructuring of financial centers in the region of mainland
and Hong Kong in the face of China’s WTO accession: a theoretical framework of
geography of finance perspective” paper presented in the 29th International Geographical
Congress, Seoul, Korea, under review by Economic Geography.
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Lecture V: Geography of Money and Finance – An
Overview and Introduction
The Emergence of An Entire New Sub-discipline
of Economics and Geography:
August Losch (1939 and 1954) The Economics of Location
Richardson (1972, 1973) attributed the neglect of money in regional economics
to the fact that regional economists borrowed too readily from neoclassical
growth theory
Gunnar Myrdal (1957) directed attention to the question of regional financial
flows in his theory of cumulative, uneven regional development
Kerr’s (1965) empirical paper on the geography of finance and the rise and
decline of financial centers in Canada was alone
Even in most 1980s, the “geography of money” remained an underdeveloped
subject. However, since beginning of 1990s, both geographers and regional
economists have begun to remedy that neglect.
In economics, regional economists focused on topics of regional interest rate,
inter-regional fund flow and regional credit availability, while economist made
significant advances in theorising the geographical structure and spatial evolution
of financial systems. One strand of this is the geography of banking and credit
allocation and another is the growth of, and competition between, financial
centers.
In geography, the recent years in 1990s have seen increasing recognition of the
theoretical and empirical importance of finance and money for understanding the
forces shaping the economic landscape. The general inquiries of geography of
money and finance are:

Key role of finance in David Harvey’s Marxist theorisation of the uneven
development and crisis-prone tendencies of capitalist space economy;

Spatial organisation and operation of particular financial institutions, service
and markets, such as banking, venture capitalism, stock markets and pension
funds;
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
Economic, political and social dynamics of the world’s major international
financial centers, such as London, New York and Tokyo and off-shore centers;

Links between regional flows and regional industrial organization and
economic development
Now, in late 1990s, it seems valid to argue that the “geography of money/finance”
is firmly established as a new subdiscipline, or called the “end of the beginning”
of the development of the subdiscipline
Why Geography ? - Landscapes of Money and
Finance
Locational Structure of the Financial System
Institutional Geography of the Financial System – interlocking locational structure,
from the local, regional, national, international to the global
Financial System are also Regulatory Space (US dollar-based Bretton Woods
System in 1945-73 – currency boards; off-shore centers such as Bahamas, Hong
Kong and Singapore)
Public Financial Space of the State
The four interrelated geographies of the financial system shape the flows of
money across space
The Background and Dynamics of the Change
Three intersecting and mutaully reforcing processes of change, namely
deregulation, technological innovation and globalization
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Deregulation

In the year of 1973 saw the collapse and abandonment of the post-war
Bretton Woods System of pegged exchange rates, dollar convertibility
and capital controls.

During the course of the 1980s and 1990s, a tidal wave of deregulation
(re-regulation) swept across the globe, beginning in the Unite State and
the UK but quickly spreading to other developed and developing
countries.

A process of “competitive deregulation” in a “race to the bottom” to
free money and finance from regulatory structure.

Restrictions on capital movements were relaxed or abolished; stock
market were deregulated; financial market and product boundaries were
dismantled; control on the operation of banks and other financial
institutions were removed; and large sections of state-owned activities
were sold off /privatized.
Technological Innovation

A historic process of TI has been transforming money and capital
markets – cashless society, electronic or “virtual” money combined
with sophisticated telecommunication networks – make every
transaction and transfer electronically, instantly, globally, and in
massive scale

Money has always been mobile and now it is truly hypermobile!
Globalization

Globalization refers to the increasing integration, hybridization,
convergence and stretching of economic relation across space.
Rendered by the force of globalization, the world has now increasingly
become “homeless”, “seamless”, and “stateless”. It is particularly in
financial sector – deregulation, technological innovation and
globalization makes the financial world truly “stateless” and “boundaryless”.

Thus, it is argued by O’Brien (1992), the resultant effect is the “end of
geography” as far as monetary relationship and transactions are
concerned.

As O’Brien put it: “The end of geography….” See transparency
170

However, opposite direction is also evident in this IT and globalization
age – centralization and concentration forces, paralleling the forces of
decentralization and dispersal, are equally powerful and sometime
override the decentralization force.

Nowadays, under deregulation, IT innovation, and globalization,
financial market have become increasingly volatile and crisis-prone, and
individual financial markets have increasingly become geographically
unstable.

The Dynamics and Global Changes of Financial Landscape – See Table
1
What we want to learn from the Geography of Money and Finance Focuses of the book
Ch2: Stages of Banking development
Ch5: The Development of Financial Center – Geography of Finance
Ch8: Venture Capital – Financing entrepreneurship
Ch9: Corporate Finance
Ch12: Pension Fund Capitalism – retreat of the state
Ch6&Ch11: Hypermobility of capital and Crisis of Territorial Control
Reference:
Ch1: Martin R. (eds) (1999), Money and the Space Economy, Wiley, England.
Above Ch.s: Martin R. (eds) (1999), Money and the Space Economy, Wiley,
England.
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