Chinas International Flow of Capital

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Chinas International Flow of Capital

• Lecturer Zhigang Li

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Outline

• Modes of Capital Inflow to China
• FDI in China
• Consequence of FDI --- technology spillover

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Modes of Capital Inflow

• Early 1980s Borrowing from government and
  international organizations was the most
  important form of capital inflow to China.
  
• Since 1993 FDI has dominated capital inflow.
• China maintained strict controls on foreign
  borrowing through most of the 1990s. Chinas
  financial markets were virtually closed to
  portfolio investment.
• Although China maintained restrictions on capital
  account convertibility, the restrictions appeared
  to be nominal and were not very effective.

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Some Terms

• Balance of payments
• Current account Payment for goods and services
• Capital account Transfer of assets
• Capital account convertibility
• While an exporter or importer can freely convert
  RMB to foreign exchange with presentation of
  trade documents, individuals and businesses
  cannot simply buy or sell domestic or foreign
  currency.

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FDI in China

• FDI in China surged after 1992
• Deng Xiaopings Southern Tour in the spring of
  1992.
  
• From 1992, China began selectively opening its
  domestic marketplace to foreign investors.
  
• Annual FDI has exceeded 40 billion dollars since
  1996.
  
• China has accounted for about one-third of total
  developing-country FDI inflows in recent years.

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Characteristics

• FDI has been the predominant form for China to
  access global capital (as opposed to portfolio
  capital or bank loans).
  
• FDI focused on manufacturing sector
• FDI inflows have predominantly come from other
  East Asian economies, especially Hong Kong and
  Taiwan.

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FDI as a Share of GDP

• FDI/GDP (Percent)
• 1983 .3
• 1991 1.1
• 1994 6
• 2005 2.9

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Sources of investment

• In 1985-2005, Hong Kong, Taiwan, Macau and all
  tax havens (British Virgin Islands, Bermuda, and
  Cayman Islands) have accounted for 60 of total
  FDI in China.
• Hong Kong 42 of FDI in 1985-2005
• The developed country accounted for 25 of the
  investment in 1985-2005.
  
• U.S. investment has been on a downtrend since
  2002.
  
• Japanese investment has been surprisingly small
  but has improved substantially since 2003.Korean
  investment in China started late but has grown
  extremely rapidly. Both Japan and Korea invest
  heavily in northern provinces.

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Restructuring Within the China Circle

• The China Circle Mainland China, Hong Kong, and
  Taiwan
  
• Restructuring
• The industrial labor force of Guangdong and
  Fujian has increased from 6 million in 1985 to 11
  million by 2001.
  
• The Hong Kong industrial labor force peaked just
  below one million and had declined to 172,000 by
  June 2003.
  
• The manufacturing labor force of Taiwan reached
  2.8 million in 1987 but leveled off and was at
  2.59 million at the end of 2003.

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Top Ten Exporters of High-tech Products in 2003
(Table 17.1)

• Company Parent Parent Home Export
• Tech-Front SH Quanta TW 5.2
• Hongfujin Precision Hon Hai TW 4.2
• ASUStek Suzhou ASUStek TW 3.2
• Motorola China Motorola US 2.8
• Great Wall Intl Great Wall/IBM CN/US 2.6
• Dongguan Export Dongguan CN 2.6
• Dell China Dell US 1.7
• Mingji Diantong BenQ TW 1.7
• Intel SH Intel US 1.6
• Seagate Wuxi Seagate US 1.5

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FDI Structure

• Manufacturing has been the main component of FDI
  to China (70 of Chinese FDI inflows in 2003 is
  manufacturing and 27 to services)
  
• In other economies, the share of manufacturing in
  FDI is typically less than 40.
  
• This was probably due to the restrictions that
  China has maintained on foreign entry into many
  serice sectors.
  

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The Effect of WTO

• The impact of WTO membership should be the most
  dramatic in opening service sectors, even more
  than the impact on trade.
  
• Share of service in FDI in other developing
  countries
  
• Wholesale and retail trade (7.4)
• Transport and telecommunications (8.0)
• Finance (11.5)
• In China, FDI in the service sector is highly
  concentrated in real estate sector (10),
  wholesale and retail (2.1), transport and
  telecommunication (1.6), finance (0.4).

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Investment Zones

• Over 100 investment zones have been recognized by
  the central government of China by 2003.
  
• They include
• Special Economic Zones (SEZ) Shenzhen, Zhuhai,
  Shantou, Xiamen, Hainan, Pudong
  
• 54 national-level Economic and technological
  Development Zones (ETDZ)
  
• 53 high-tech industrial zones
• 15 Bonded Zones (in which commodities can be
  legally parked outside the countrys customs
  borders)
  
• There are also hundreds of zones run by local
  governments without central support.

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Main Features of SEZs

• Low tax rates
• Fewer and simplified administrative and customs
  procedures
  
• Duty-free import of components and supplies
• Laboratories for new policies (flexible wage
  systems, tender bidding, equity markets)
  
• SEZ governments have unusually high levels of
  autonomy (revenue retention of tax, customs, and
  foreign-exchange revenues).

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Size Comparison (1990)(square kilometers)

• Shenzhen 327.5
• Zhuhai 121.0
• Shantou 52.6
• Xiamen 131.1
• Kaohsiung, Taiwan 0.7
• Penang, Malaysia 1.2
• Batam Island, Indonesia 36.6
• Bataan, Philippines 3.4

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Cross-jurisdiction Arbitraging in Investment

• A relatively decentralized system Approvals of
  FDIs in China can be granted by hundreds of local
  investment boards --- the governments.
  
• Foreign investors can play localities off against
  each other in search of a favorable package.
  
• Effective tax rates can differ significantly for
  different localities.

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Impact of FDI

• Contribution to investment
• Incoming FDI accounted for 11 of capital
  formation in China, less than the 15 in other
  developing countries.
  
• FDI brings a bundle of management experience,
  marketing channels, and technology

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Why could FDI Affect Innovation?

• Local firms can learn about the designs of the
  new products and technology, e.g. through reverse
  engineering, and then improve upon them to come
  up with new innovations (the Japan Experience).
• Inward FDI can cause spillovers to local firms
  through labor market turnover whereby skilled
  workers move to local firms.
  
• Demonstration effect

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How could FDI Help Spread Technology?

• Horizontal, Intra-industry Spillovers
• Competition by firms within the same industry
• Human capital shifting employment
• Informal exchange between managers
• Vertical, Inter-industry Spillovers
• Channels above
• Vertical linkages with suppliers and buyers in
  up- and down-stream industries

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The Effect of FDI on Innovation in China (Cheung
and Lin, 2004)

• Evolvement of the patent law in China
• 1985 The patent law of China was enacted
• 1993 The patent law was substantially amended,
  with major revisions including
  
• Extending patent length from 15 to 20 years for
  invention patents
  
• Extending patent length from 5 to 10 years for
  utility model and external design patents
  
• The enforcement of the patent law has also been
  greatly improved since 1993.
  
• 2000 The second revision eliminated the old
  provisions that prevent SOE to sell their
  patents. New provisions are also offered to
  reward enterprise employees to innovate.

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Empirical Evidence

• Data
• Use the province-level number of patent
  applications as a measure of innovations.
  
• Findings
• FDI only has robust and significant positive
  effect on applications for external design
  patents a 1 increase in FDI inflow lead to a
  0.15 increase in the number of applications.
• This is consistent with the demonstration effect
  of FDI.

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Clustering of FDI and Enhanced Technology
Transfer (Thompson, 2002)

• Hypothesis FDI into geographical industry
  clusters should transfer technology more
  effectively than FDI in the same sector but which
  is geographically dispersed.
• This is found to be the case for garment firms in
  Peru Firms within a tight geographical cluster
  performed better than those that were dispersed.

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Empirical Evidence

• Hong Kong businesses generally account for nearly
  60 of total investments in China by value during
  1979-92.
  
• The Garment industry accounts for the largest
  sectoral proportion (20) of Hong Kong derived
  FDI to China by number of firms.
  
• Data
• The initial sample includes all the firms listed
  as members of the Federation of Hong Kong
  Industries.
  
• Four surveys were carried out on these firms in
  1992, 1993, 1995, and 2000.
  
• The authors themselves surveyed about 300 firms
  with a 38 response rate.
  

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