Promoting Foreign Direct Investment

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Promoting Foreign Direct Investment

• Chinas Experience
• Qimiao Fan, the World Bank

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Presentation Outline

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

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Why Worry About FDI?

• FDI is an important source of capital for
  developing countries. In 2000, FDI amounted to
• 4 of GDP (inflows)
• 32 of GDP (stock)
• 11 of total domestic investment

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• FDI Transfers Knowledge and Diffusion of Ideas
  Drives Growth
• Foreign firms bring in new technology or upgrade
  existing technology
• Technical and managerial skills and ways of doing
  business are transferred directly to local
  employees
• Foreign firms introduce best practices to local
  firms that enable them to compete as suppliers to
  the foreign firms

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• FDI Contributes to Better Integration of
  Developing Countries into the World Economy
• Investment by foreign firms can bring about
  convergence in environment, labour, product,
  safety and technology to international standards
• FDI increases imports and exports

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What Matters to Foreign Investors

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

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Share of developing Country FDI Percentile Rank Above 50
1999 Political Stability Regulatory Quality
China 16.3 Yes
Brazil 11.5 Yes
Hong Kong 9.9 Yes Yes
Argentina 9.7
Mexico 5.1 Yes Yes
Singapore 4.8 Yes Yes
Bermuda 3.8 Yes Yes
S. Korea 3.8 Yes
Chile 3.7 Yes Yes
Poland 2.9 Yes Yes

• Countries with better investment climate tend to
  attract more FDI
• Studies have shown that the investment climate
  matters for FDI and for firm productivity
• Most of the top ten countries with the largest
  share of FDI ranked in the top fifty percent in
  both political stability and regulatory quality.

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China and Madagascar
Is China Relevant for Madagascar?
Value Added by Sectors, of GDP
9
China and Madagascar
Employment by Sectors, of Total
10
China and Madagascar
GDP per capita in US
11
China and Madagascar

• By Most Measures, China Has Been Successful in
  Attracting FDI
• In 1980, Total FDI was US57 million in China and
  US million in Madagascar.
• In 2002
• FDI was over US50 billion in China compared with
  US in Madagascar
• FDI was equivalent to 4 of GDP in China compared
  with 2 for Madagascar
• FDI per capita was US37 in China compared with
  US7 in Madagascar
• FDI accounted for 10.1 of total fixed investment
  in China compared with 1.6 for Madagascar

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

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Chinas Experience in Attracting FDI

• The National Open-door Policy With the
  Encouragement of FDI as a Key Component
• Ensuring a Stable Political and Economic
  Environment for FDI
• Investing Heavily in Infrastructure
• The Special Economic Zones (SEZs)
• The Role of Local Governments
• The Role of Overseas Chinese

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

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

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• Ensuring a Stable Political and Economic
  Environment
• China has been able to maintain relatively low
  inflation rates since the start of reforms
• Average annual inflation was 5.8 between 1980-90
  and 7.1 between 1990-2000. In 2000, inflation
  was 0.9.
• The political environment has also been
  relatively stable

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• Investing Heavily in Infrastructure
• Both central and local governments have withdrawn
  from investing in competitive assets and
  redirected public investment to infrastructure
• FDI and domestic private investment are also
  allowed into infrastructure

1990 2000
Electric Power Consumption (kwh per capita) 471 759
Electric Power Transmission and Distribution Losses (in percent of output) 7.5 7.0
Air Transport, freight (million tons km) 818 3900
Roads, Goods Transported (billion tons km) 336 613
Telephone Mainlines (per 1,000 people) 5.9 112
Mobile Phones (per 1,000 people) 0.02 66
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• The Special Economic Zones (SEZs)
• Important part of the open-door policy
• Set up in the coastal provinces to experiment
  with various reforms, to attract FDI and to
  promote exports
• The key policies are liberalization allowing both
  foreign and domestic private investors to invest
  in most sectors, enjoying fewer regulatory
  barriers and preferential tax treatment
• Local governments in the SEZs have significant
  autonomy over policies, regulations and
  investment approval

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

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

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• The Role of Overseas Chinese

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

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Some Lessons from China

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