The reforms of the China markets as opened the economy for foreign investments and supported growth (Sollinger, 2016, 56). FDI is the investments made by a company to a foreign country. In essence, FDI brings new investments and job and thus should promote the economic growth of a country. According to Sharma (2000, 5), FDI has helped India in boosting the export market performance and the economy. In other words, the inflows of FDI into India has helped to increase the export output and promote the growth of the economy. The outward flow of the FDI would be expected to have negative impacts on the growth performance of a country. Outward movement of the FDI means that firms are relocating investments from the host country to another. For the emerging markets of China and India, understanding the role played by the FDI in supporting economic performance is crucial because it gives the basis for economic forecasting and evaluation of the macroeconomic stability.
Problem Statement
The key question that this research paper seeks to answer is factors that have made China attractive to FDI. Index Mundi (2017) ranks China in the third position in FDI inflow. Notably, China leads the park among emerging markets. Emerging markets have the standards of the developed markets. Examples include Brazil, India, and China. The study will also seek to understand the role FDI has played in the economic growth of China. The study will also evaluate the factors that affect FDI and its efficiency.
To understand the role of FDI in China economic growth, it is important to reflect where it was before the economic boom began. As a communist regime, China economic policy was autarkic. In other words, the focus was on becoming self-reliant rather than growing its exports. Consequently, the role and influence of China in the world economy was limited. When China isolation started to end, more companies and corporations started to explore opportunities in the Chinese market. Notably, the large market size makes a convincing case for multinationals to operate in the Chinese market. The new companies setting base in China brought new investments and capital. Consequently, with the increase in foreign investments and capital, China export market grew and its economic transformation began.
Multinationals seeking to set operation base in the foreign countries have two approaches to FDI inflows, domestic and export orientation. In the case of the export FDI, the focus of the foreign firms is on the raw material with the final product being exported out of the country. On the other hand, in domestic or horizontal FDI the focus is to sell the products to the host country. The motivations for export or domestic FDI is different. For instance, in the case of export FDI, the motivations can be the cheap labor and favorable government policies that promote foreign investments (Ren and Pentecost, 2007, 10). The reforms of the China investments law which eventually allowed more foreign companies to set up shop there is another motivation for FDI inflows. In addition, with low labor costs, companies could significantly lower the overhead costs of the business. Domestic FDI would target countries such as United States, Canada, and European country, the focus is not really to export but to satisfy the domestic demand for a given product.
The FDI inflows into China can be classified into different categories. In the early stages of the entry, foreign firms were testing the Chinese market. Therefore, a joint exploration which involves companies carrying unimportant projects to survey the market was undertaken. At this stage, foreign companies seeking to set operations in China explored the market for opportunities and studied possible pitfalls. The other category is equity joint ventures. In this type of FDI, foreign companies made joint investments in the Chinese economy. Notably, through this approach, foreign companies would minimize the risks of losses in the new market. For the Chinese companies, they get technology transfer. Notably, this has been a key bedrock of the FDI inflows into the Chinese economy.
The factors that may have contributed to the FDI inflows to China would be diverse. For example, the market size would be a big factor. The Chinese population is huge, and thus offers a great opportunity for companies to expand. Importantly, the growth of the economy has brought new wealth to the people meaning that they can purchase more goods and services. Therefore, firms setting base in China anticipate that they are anchoring themselves to serving a richer and more prosperous Chinese economy. China middle class had expanded from 29 million in 1999 to 421 in 2013, and it is among the fastest growing in the world (China Power Project, 2017, para 9). The expanding middle class is enough motivation for foreign companies to operate in China. Importantly, the expanding middle class means foreign companies can refocus their FDI from export to domestic to meet the expected surge in demand for goods and services.
The reforms of the legal structures may also act as an attraction to foreign investments. In addition, incentives were given to foreign companies to attract them to set base in China. The combination of these measures made China a new destination of the FDI. The uptake of the FDI in China began in the early 1980s and accelerated in late 1980s making China the to be the second biggest recipient of FDI after US (Ren and Pentecost, 2007, 9). The time when rapid intake of FDI grew China also experienced accelerated GDP growth. Because FDI inflows were followed by China economic boom, it is right to predict that FDI had a positive effect on the performance of China economy.
Aims/Objectives
The study sought to accomplish the following objectives
1. Demonstrate the significance of FDI in economic growth and development
2. Evaluate the role of FDI in China economic growth
3. Assess the determinants of FDI in China
4. Investigate the factors that affect the FDI and its efficiency
Research Questions
1. Who are the emerging markets and which of them are on the top?
2. How is FDI beneficial for the country?
3. What are the factors that influence FDI in China?
4. How does China become the biggest recipient of FDI?
5. Is China politically and economically a suitable for hosting FDI?
Literature Review
Economists expect that FDI will have a positive effect on the economic growth of a given country. Indeed these views are supported by a large body of literature that shows a positive correlation between FDI inflows and economic growth. Singh and Fredericks (2005, 7) investigated the factors influencing FDI inflows into the Malaysian service sector. According to the results of the study, abundant cheap labor was the initial attraction of the foreign investments into Malaysia service sector (Singh and Fredericks, 2005, 13). Therefore, early FDI inflows in Malaysia focused on the manufacturing sector. However, with the rapid growth of the Malaysian economy, the wages rose, and firms found it less profitable to set up operation base there. Consequently, Malaysia government changed the economic policy from production to knowledge-based as the future of the growth (Singh and Fredericks, 2005, 23). Using the empirical approach, the authors demonstrated that FDI supported the economic expansion of Malaysia and that the outflows of the FDI had a negative effect (Singh and Fredericks, 2005, 27).
The Malaysia situation is not different from the Chinese one. Companies setting base in China focused mainly on manufacturing, thanks to the abundance cheap labor. However, as the productivity of the people has increased, the cost of labor has also increased. It would be expected that with the increase in the labor costs, companies would start relocating their operations to other destinations with lower labor benefits. Importantly, these outward movements of the FD outflow of the FDI would have depressing effects on the economy. Notably, with the economic slowdown, more foreign firms will seek other lucrative markets thus leading to more outflows. For instance, the decline of the FDI inflows in Malaysia resulted in the economic slowdown (Singh and Fredericks, 2005, 27). The Singh and Fredericks (2005) study show that FDI inflows accelerate economic growth and that the outward movement causes reverse effects. Importantly, the study supports the held view that FDI should boost the economic performance of a country.
Chen (2010) study compares well with Singh and Fredericks (2005) on the influence that FDI has played on the development of the China tourism sector. The findings of Chen (2010) study shows that FDI has supported the development of the tourism industry especially in the coastal towns where the FDI were first allowed. Using an empirical method to conduct the study, Chen (2010) found that coastal cities experienced the faster development of the tourism industry compared to the inland regions. The consequence of the time delay in opening China tourism sector to FDI inflows is unequal development. In other words, the coastal cities, which were the first to welcome FDI have better-developed tourism industry as compared to the inland provinces. The implication is that FDI was crucial in supporting the development of the tourism sector in China.
Chen (2010) empirical finding that coastal regions that were first to welcome FDI experienced a higher quality of the tourism sector is also supported by Lian and Ma (2010) study. Lian and Ma (2010) study evaluated the role played by FDI in the economic development of China and explored differences. In other words, they evaluated whether the FDI contributed to complete economic growth and development of China. The study found that per capita income was higher in the coastal towns which attracted the FDI compared to the other regions. Lian and Ma (2010) argues that while phase-in FDI has contributed to the economic leap of China, it is not integrated into the China mainstream economy. Consequently, uncontrolled FDI has not given optimal results. Therefore, caveats should be put in non-guided FDI to minimize the spillovers and the negative effects that would be experienced in the China economy.
Ali and Guo (2005) study evaluated the determinants or factors that led foreign companies to set up base in China. The authors found that the size of the China market was a crucial factor of the foreign investments into China. Notably, China population is huge, and the middle class has been expanding with the growth of the GDP. Therefore, Ali and Guo (2005) found that the appetite to serve the Chinese market is a key determinant of companies setting base in China.
India and China are the major emerging markets in Asia. The debate is divided over whether India should compete with China in attracting the FDI. Analysts argue that FDI is central to India economic growth and development but observes that home-grown investments could be far more essential in supporting the long-term growth of India than relying on FDI (Huang and Khanna, 2003, 74). Others see a subtle difference in the strategies of India in attracting MNEs to operate there. China relied on SEZs to launch its economic transformation. India has used an almost similar approach especially in attracting pharmaceuticals. Huang and Khanna (2003, 75) introduce another factor as driving China economic growth and development-the wealthy diaspora Chinese communities willing and eager to invest in the motherland. While Huang and Khanna (2003, 75) are critical of the Chinese a[[roach of export-oriented FDI, which has effectively not allowed nascent domestic firms to flourish, they observe that investors have more confidence in the Chinese economy in the long-term over India. The implication is that market reforms and the commitment to free markets is a crucial factor influencing the decision of the multinationals to operate in one country as compared to another.
Buckley et al. (2010, 81) exploratory study evaluated the factors that influenced the decisions of the multinationals to settle in China. The study using data from the approving agency (SAFE) found that the reintegration of China to the world economy and the open door policies were crucial in informing the multinationals to operate in China. For the manufacturing which was a key driver of investments in China, the comparative advantage of China and low labor costs were essential in influencing the decision to set base in China (Buckley et al., 2010, 82). The future growth of the investments in China cannot be the low labor costs. Notably, as the economy has expanded the productivity has increased, and the labor costs have jumped. Moreover, the Chinese population is aging, meaning the cheap, abundant labor is declining. Therefore, future growth has to rely on technology and innovation. Moreover, as the China economy moves from export-led to consumer-driven growth, FDI will have to be re-oriented towards the domestic market.
Luo et al. (2008) study evaluated the factors that influenced the decision of foreign firms to set base in inland China. Like previously mentioned, the opening up started in the coastal cities, and inland regions remained out of bound for multinationals. However, gradual reforms have been taken to make the inland provinces attractive to foreign investments. In addition, Luo et al. (2008) study found that incentives and the agglomeration of the industries were most significant factors for firms choosing to invest in the inland China rather than the southeastern coastal cities. The findings of the study are significant. In essence, the findings suggest that foreign investments in China are no longer driven by abundant cheap labor and natural resources. The policy incentives, in this case, refer to things such as tax breaks, land allocation among other things.
Demirbag, Tatoglu, and Glaister (2007) evaluated the effects of the performance perception in influencing the decision of foreign firms to operate in a given country. The study used an integrative approach to assess data from 145 affiliate western MNEs in Turkey (Demirbag, Tatoglu, and Glaister, 2007, 310). The study found that government regulations, the input quality, and comparative cost advantages were key factors in influencing FDI (Demirbag, Tatoglu, and Glaister, 2007, 314). The study implies that the perceived quality of the local affiliates and the comparative cost advantage rather than the political risks and cultural differences influences the decisions of MNEs to relocate to a given country. In the case of China, building the capacity of domestic firms to improve the quality of their product is essential in maintaining and growing FDI.
FDI has spillover effects on domestic firms. In other words, the flow of better managerial skills, industrial practices, and technology boost the capacity of local firms thus making them competitive. Therefore, the effects of the foreign investments in China economy can be analyzed by looking at the overall spillover effects on the Chinese industries. Growth in China was concentrated in the southeastern coastal cities. Therefore, the central and western region did not experience the economic boom that took place in cities such as Shanghai. Zhang and Felmingham (2010) evaluated the spillover effects of inward FDI in supporting the regional development of China. The study found that FDI had a positive effect as it led to the output expansion from southeastern provinces to Central and Western China (Zhang and Felmingham, 2010, 163). In other words, inflows of FDI in the east led to the companies exploring new opportunities in the central and western China. However, the contestation is whether the policy of favoring the southeastern provinces had led to unequal development and growth of the China provinces. Brun et al. (2002, 166) study found there was insufficient spillover development of the central and western China from the southeastern inward FDI. The study analyzed panel data from 1981-1998 which are the period China experienced accelerated market reforms, started by Mao and advanced by the Deng regime (Brun, Combes, and Renard, 2003, 167).
In analyzing the growth of the China FDI inflows, scholars often disregard or ignore the role played by the China exchange market. For instance, evaluating the effects of the devaluation of the Renminbi on the attractiveness of China to the foreign companies wishing to operate in the Chinese market. Yuqing (2006) study evaluated the foreign exchange rate as a determinant of foreign investments into China. The study found that devaluation of the Yuan increased the FDI inflows from Japan (Yuqing, 2006, 207). Moreover, the study found an elastic relationship between FDI inflows and exchange rate (Yuqing, 2006, 208). In other words, the inflows reacted comparatively to the changes in the exchange markets. A study by Takagi (2011) used panel data between 1987-2008 to estimates the effects of the exchange market volatility and FDI outflows from Japan to the Asian markets. The study found that depreciation of the Yen against the receiving country currency and that FDI increased with market volatility (Takagi, 2011, 268). The study implies that China exchange market influenced the FDI inflows especially from its Asian neighbor Japan.
Another study by Cambazoglu and Gunes (2016) evaluating the relationship between FDI inflows and exchange rates in Turkey support the Takagi and Yuqing findings. Cambazoglu and Gunes (2016) study used time series data and ARDL model analysis to investigate the relationship between foreign investments and the exchange rates in Turkey and the market volatility. The previous study by Yuqing and Takagi had shown an elastic relationship between the exchange rates and attractiveness of a country to foreign investments. For instance, the devaluation of the Renminbi increases the attractiveness of China to foreign investments by Japan (Takagi, 2011). Equally, devaluation of Japanese currency compared to target country affected the inflows of the FDI from Japan. Turkey is among the emerging markets of Europe and thus could exhibit similar trends to China, Brazil, India among other markets in attracting the FDI-this makes Cambazoglu and Gunes (2016) study relevant. The study found that there are a co-integration relationship market volatility and the inflows of the FDI into Turkey (Cambazoglu and Gunes, 2016, 288).
A key aspect of analyzing the contribution of the FDI into China economy is the improvement in the efficiency of the industries. In essence, the new firms setting base in China should help in improving technological advancement by using spillovers from FDI. Wei and Liu (2006) study undertook to analyze any productivity spillovers to China productivity resulting from FDI. The study used panel data from 1998-2001 and to analyze the spillovers from FDI within the manufacturing (Wei and Liu, 2006, 553). The study found that there were positive spillover effects in the manufacturing sectors from R&D of the foreign firms setting base in China (Wei and Liu, 2006, 555). The findings imply the economic development of China and increasing the productivity of the indigenous Chinese firms. In particular, the study illustrates that China indigenous industries will benefit from FDI by leveraging on the spillovers of R&D of foreign firms. Consequently, the industrial productivity of China would be expected to improve from the spillover of the foreign firms investing in China. Importantly, the study suggests that R&D contribute significantly to ensuring the efficiency of the FDI in China.
Yao and Wei (2007) study used an analytical approach to investigate how foreign investments promoted the growth of the economy. The authors concur that investments brought by foreign firms have a positive effect on the growth of the economy. The study found that FDI played a dual role in the economies of emerging markets. The first role is that FDI act as a mover of production helping moves the efficiency from actual to steady production. The second role played by FDI occurs when the FDI is embedded with advanced technology and know-how. In that case, FDI helps in shifting the country production frontier. The implication of the Yao and Wei (2007) study is that FDI is essential in promoting efficiency and technological advancement of a given country. In particular, it helps in boosting the productivity of a country, especially in the industrial frontier. This is especially the case for China, which has been able to expand its industrial capacity to export more manufactured goods.
An aspect that has been used in measuring the contribution of the FDI inflows in China is whether it has supported the diffusion of knowledge. In essence, diffusion of knowledge means that China long-term growth can be maintained. Dees (1998) study evaluated both the determinants of the FDI inflows to China and the overall contribution to the China economic growth. Using an empirical approach of data analysis, the researchers found that the size of the China market was a crucial factor in the location of the FDI in China (Dees, 1998, 175). In addition, the market size and the connection of China to the global economy also contributed to the inflows of the FDI (Dees. 1998, 182). The implication of the study is that the market size was a key influencer of the decisions of foreign firms to invest in China. Therefore, as the China middle class expands, more FDI can be expected to flow in to satisfy a growing demand. Dees (1998) study also found that there was a positive diffusion or transmission of ideas from the multinationals to the Chinese firms. Importantly, this transmission of the ideas was seen as having an overall positive effect on China long-term economic growth. In essence, the foreign firms can be seen as supporting technology transfer thus helping to build the capacity of the Chinese firms, which will sustain the long-term growth of the economy.
Cheng and Kwan (2000) study used the case study of China to investigate the determining factors of the location of FDI in China. The study used the panel data from 1985 to 1995 to evaluate the determinants of FDI in China (Cheng and Kwan, 2000, 387). The study found that infrastructure was a key aspect that influenced foreign investments by firms in a country. Therefore, with the expansion of the infrastructure, the efficiency improves and the country becomes more attractive to FDI. The study also found that preferential policy also attracted foreign investments into China (Cheng and Kwan, 2000, 387). Essentially, preferential policy implies giving incentives to the foreign businesses to attract them to invest in the country. Notably, this was the case with China southeastern cities where SEZs were created. Foreign businesses operating in SEZs had tax breaks and other incentives which made them attractive to foreign enterprises. The study also found that increase wage cost negatively affected the inflows of FDI. The implication is that as the China wages rise the FDI inflows will reduce especially in the manufacturing sector. Because manufacturers relocating to China are looking for comparative advantage provided by the wages, it is no surprise that increase in wages negatively affect the flow of foreign investments into China.
Another aspect that has been analyzed with regard to the location of the foreign business in China is the access to supply. In other words, whether companies seeking to operate in China can easily access raw materials. Notably, efficiency in accessing the raw materials reduces the overall cost of production by cutting on things such as inventory, transport among others. Amiti et al. (2008) study investigated the determinants of foreign firms to China. The study used Chinese industries to reflect the new economic geography in China. The study found that market and suppliers in the province of entry are significant factors when foreign firms are considering relocating to China (Amiti and Javorcik, 2008, 142). The results of the study show consistency with the reality of the economic geography of China which has been concentrated mainly in the southeastern regions. Notably, these regions have access to the sea; thus shipping of the raw materials and finished products is made easy. Importantly, improvement of the infrastructure in the central and western provinces would likely expand the markets and increase access to the raw materials thus making them attractive to foreign investments.
Another metric that has been used in evaluating the effect of the foreign investments to the China economic growth is technological development. Notably, technology is essential for foreign firms in improving the efficiency of their production. If the efficiency of foreign firms is improved, the overall performance of the China economy can be enhanced. A study by Liu and Wang (2003) evaluated the contribution of foreign investments in improving the technology of China. As previously discussed, one of the expected spillovers of FDI in China has been improving the technological capabilities of Chinese firms. The cross-sectional study investigated whether FDI inflows into China improved the total factor productivity (TFP). In essence, the study evaluated whether foreign investments had an impact in improving the productivity of Chinese industries. The results of the study showed that firm size and the level of R&D of the relocating firm were the most significant factors affecting the TPF of the Chinese firms (Liu and Wang, 2003, 938). The study implies that FDI from large firms is more important to China industry total factor productivity as compared to small FNEs. In essence, the large MNEs invests in R&D whose spillover can help in boosting the productivity of the Chinese firms.
Zhang (2008) study evaluated the factors attracting the multinational corporations in China. Attracting investment by multinationals is essential in supporting the economic growth of the country. The reforms of China economy from autarkic policies to introduce market liberations. The study measured whether the introduction of the open door policy attracted investments by multinationals into China economy. Zhang (2008) used cross-sectional panel data to assess the attraction of the multinationals in China. Zhang (2008) found that location characteristics and the government policies contributed significantly to the foreign firms relocating in China. What the government policies in this regard refer to the reforms initiated by the government to open up the China economy. The improvement of the infrastructure was also found to play a part in attracting foreign multinationals to China (Zhang, 2008, 344). The market size of the China economy remains a key determinant of FDI inflow to China.
A lot of studies have focused on evaluating the reason why China has become an attraction for the location of foreign investments. Sun et al. (2002) study investigated the determinant of foreign investments into China. The study relied on the panel data from and categorized it according to the different provinces of China (Sun, Tong and Yu, 2002, 94). The categorization is essential because it helps in analyzing the impact of foreign investments in each region. Importantly, this can help in differentiating the factors that make one province more attractive as compared to another. The study found that cumulative FDI and domestic investments had a negative impact on the flow of new FDI (Sun, Tong and Yu, 2002, 95). In essence, cumulative FDI in one province coupled with domestic investments make the operational base for new FDI smaller. The study thus recommended that provincial officials had to improve the investment environment to make it favorable for new FDI (Sun, Tong and Yu, 2002, 98). The study helps explains why the coastal provinces attract more FDI as compared to the central and western provinces.
The review of the literature shows that foreign investments have had positive effects on the economy of China. In particular, they have helped in boosting the industrial capacity, increasing the productivity of Chinese workers and the overall efficiency of the China industries. The factors that have played a role in the location of the FDI are mainly incentives policy, wage cost benefits, easy access to raw materials, integration of the China market to the rest of the world economy among others.
Methodology
The method of research is a case study. The focus of the study is on the factors influencing FDI inflows into China. A multidimensional approach involving quantitative and qualitative approach will be used in the data analysis. The quantitative data analysis can help in quantifying the overall effect that the foreign investments have had on the China economy. For instance, one of the key objectives of this study is to evaluate the role of FDI in the economic growth of China. Panel data which evaluates performance over a given period can help in estimating the effects of the foreign investments. For example, if GDP is used as the measure of how the economy has performed following the inflows of the FDI, a comparison can be made. In other words, the performance of the economy before the flow of the FDI and after can be analyzed. If the analysis shows an increase in the GDP, then it can be concluded that FDI has a positive impact on the growth of the economy. Notably, GDP is a key econometric in evaluating the performance of the economy.
Another objective of the study is to evaluate the determinants of the FDI inflow to China. This objective will be analyzed through a qualitative approach. In essence, this objective measures the perceptions of Chinese markets by foreign investors. Therefore, the views of the investors are crucial in analyzing the determinants of the location of FDI into China. One approach of gathering the views or perceptions of the foreign investors about China is through interviews. This research relies on secondary data. Therefore, using peer-reviewed research articles and media reports about the subject, a meta-analysis will be carried out to evaluate the determinants of the location of FDI to China. The quantitative approach, in this case, can help in analyzing the effects of the reforms on the FDI inflows to China. For instance, using panel data before the start of the policy reforms and after, a comparison can be made on the effect of the reforms to the flow of FDI. For example, quantitative data can help in evaluating whether the entry of China into WTO increased the inflows of FDI into China. Equally, the introduction of open door policy can be evaluated quantitatively on whether it increased the inflows of the FDI. If the open door policy had a positive effect on the flow of FDI, a comparison could be made between before and after the introduction of the reforms to determine the overall impact.
The use of multi-dimensional, mixed research method in this case study is important. For example, quantitative approach gives a close-ended analysis of the information which may not best present a good analysis of the issue. Each approach brings specific advantages to the analysis of the issue (Malina, Nørreklit and Selto, 2011, 49). Therefore, the mixing of the quantitative approach allows for the greater depth, understanding, and corroboration of the data, thereby minimizing the weakness presented by the individual approach. In other words, the use of the mixed approach in this research will ensure that the validation of the data and information is sound. Importantly, such a sound analysis of the issue allows giving a good picture of the issue. For instance, it will help to give a good perspective of the role played by the FDI in the China economy. In addition, the use of this broad approach will help understand the overall factors that have contributed to the inflow of FDI into China. Importantly, this approach allows for the triangulation, which will allow in the better and accurate presentation of the research question (Yv
