Foreign Direct Investment in China

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Foreign Direct Investment in China

• Hong Kong China Business
• Week 3

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How To Explain Foreign Direct Investment?

• The Hymer-Kindelberger proposition there must be
  market imperfections if FDI is to take place
• The location approach different places have
  different advantages in terms of costs and
  revenues
• The internalisation approach firms need to
  make some transactions internally
• Dunnings eclectic model the OLI model

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• 1. the imperfect market approach
  (Hymer-Kindleberger)
• Departure from perfect competition in good
  markets
• (product differentiation, marketing skills)
• Departure from perfect competition in factor
  markets
• (access to patented knowledge, discrimination
  in access to capital and skill
  differences embodied in firm)

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• Internal/external economies of scale
• (including those from vertical integration)
• Government intervention
• (particularly those from restricting output or
  input)
• In short, this approach suggests that
• the MNC must possess firm-specific advantages
  that are internationally transferable.

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2. the location approach Emphasised on the
specific factors or advantages of a host
economy. (a) a large domestic market (b)
cheap labour supply leading to offshore
production facilities (c) good geographical
location (d) incentive packages
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• 3. the internalisation approach
• The advantages of internalisation (and therefore
  of control by the firms versus the market
  solution) include
• exploitation of market power by discriminating
  pricing
• avoidance of bilateral market power transaction
  problems
• avoidance of uncertainties in the transfer of
  knowledge between parties the need to protect
  brands and technology
• avoidance of potential government intervention,
  e.g. tariff

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Dunning's Eclectic Approach The OLI Model

• A synthesis of
• imperfect market approach
• foreign direct investors must have ownership
  advantages (something they own that gives them an
  advantage over local firms) - technology,
  management skills and routines, brand names
• location approach
• there must be a reason for using the ownership
  advantage in a new location
• internalisation approach
• it must be better to transfer the advantage
  internally within the firm, instead of licensing
  it to another firm

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• II. Foreign direct investment in the PRC
• By the end of 1998, over 227,800 FDI projects has
  been registered in China. Foreign ventures were
  estimated to be responsible for about 41 of
  China's total exports in 1997
• 1. Forms of FDI
• (Equity) Joint ventures
• Co-operative operation (Contractual Joint
  ventures)
• Wholly foreign-owned ventures
• Joint exploration
• Three foreign-invested enterprises first
  three forms

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Joint ventures Two basic types (i) Equity joint
ventures Two or more firms join together to form
a new firm. It is a limited liability company,
whose profit distribution is determined by the
equity contributions of various parties.
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(ii) Contractual joint ventures (Co-operative
operations)

• Via a contract, two or more firms agree to
  undertake some economic activities.
• Investment in a contractual joint venture does
  not determine profit sharing. The rights,
  liabilities and obligation of the various parties
  are determined in a contract, as is each party's
  share of the goods produced and profits
  generated.
• Legal liability is unlimited and rests with the
  parties involved.

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Different contractual forms a. Processing and
assembly agreement The Chinese party provides a
factory, power and labour, whilst the foreign
party normally supplies raw materials or
knock-down parts. The equipment may be provided
by either side. The foreign party takes the
finished goods for sale in his own markets.
b. Compensation trade (also known as product
buyback) The foreign party provides any
combinations of services, equipment, training
know-how and technology, and receives payment
over a two-to-five year period in the form of
goods produced as a result of his contribution.
This method is usually used to upgrade the
existing enterprises.
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Foreign wholly-owned companies Foreign companies
are permitted to establish wholly-owned
subsidiaries in China. Joint ventures used
to be the more widely adopted form but now the
option of wholly-owned venture is gaining
popularity among foreign direct investors.
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2. Investment incentives (a) exemption and/or
reduction of the following i. income tax ii. land
use fees iii. construction tax iv. withholding
tax on remitted profits
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(b) other preferential treatments i) priority
access to water, power, gas, heating, transport
and communications facilities and/or at prices
consistent with those paid by state-owned
enterprises ii) foreign employees permitted to
pay in RMB for accommodation, food
transportation, communications, medical and other
costs iii) investors may purchase domestic
enterprises, stocks and bonds, and directly
purchase real estate and land use rights iv)
might sell the (consumer) products in the China
market
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3. pattern a. by industry manufacturing real
estate and hotels b. by place of origin Hong
Kong Japan Taiwan Two distinct types of FDI
into China A.Chinese Family Business Investment
small, low-tech, export-oriented, in the South,
labour-intensive assembly work, short-term focus-
Hong Kong in the 1960s, moved over the border -
profitable B. Western and Japanese larger,
wider range of industries, China market-oriented,
more capital-intensive, long-term focus, not too
profitable
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4. foreign involvement in service sectors a big
issue for WTO a. accounting b. advertising c.
legal services d. surveying The PRC
government has been more selective towards FDI
with emphasis on the attainment of hi-tech and
foreign exchange income generating capabilities
in PRC. 5. opening up the retail and
wholesale sectors (gradually)
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III. Possible Benefits of the FDI to the PRC 1.
supply of capital 2. supply of necessary and more
advanced technology 3. supply of
entrepreneurship 4. transfer of marketing skills,
promotion of manufacturing exports 5. creating
linkage effects, promoting local industrial
development
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6. generating tax revenue 7. Improving income
distribution through the payment of higher wages
and generation of employment 8. Increasing the
PRC's international contact through the global
network of foreign firm 9. Stimulating
INSTITUTIONAL CHANGES. Reform of the legal
system, accounting system, was originally driven
by the recognition that foreign investors
required improvements. But then the improvements
spread to all firms in China
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IV. Role of HK HK is the largest direct
investor, especially in the southern provinces of
PRC. This is explained by rising labour and
rental costs, geographical, kinship and
historical reasons. The investment mainly
concentrates on light industries. There has been
some criticism of the low-tech, sweatshop
nature of HK FDI into China. But it is well
suited to the PRCs comparative advantage.
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V. The PRC direct investments in HK 1.
background Meanwhile, PRC has increased its
overseas investments substantially since 1979.
In 1982, the amount was only US 80 million. It
then increased nearly 65 fold to US 5.13
billion, with investments in more than 120
countries regions in 1992. With an amount of
US 3.7 bn, the PRC was the third largest direct
investor in the manufacturing industry of HK in
1991, after US and Japan. The investment has been
mainly in transport equipment, chemicals,
electronics and clothing.
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Moreover, with an overall stock investment coming
to US 12 billion, PRC is reported to be the
largest source country. Whilst the Bank of China
group has the greatest investment of around US 5
billion, others are estimated to have invested at
least US 7 billion. The firms are now
undertaking diversified investment activities, in
addition to the manufacturing industry, to import
and export, hotel, real estate, infrastructure
and construction.
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2. Problems a. incentive incompatibility governme
nt officials as the managers of the Chinese
companies in HK b. agency problems difficult
to monitor the behaviour of managers of the
Chinese companies in HK by the mainland
authorities
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VI. Policy and Prospects 1. the PRC a. attraction
of the big MNEs,. especially those from developed
countries b. more selective towards the hi-tech
firms c. continuing improvement in the legal and
infrastructure framework d. open up the retail
sectors
2. HK a. attraction of the firms from the PRC b.
compliance of those firms with the HK laws