Foreign Investment in Rapidly Growing Countries

Also by H.S. Kehal

DIGITAL ECONOMY: Impacts, Influences and Challenges(co-edited with Varinder Pal Singh)

FOREIGN INVESTMENT IN DEVELOPING COUNTRIES

Foreign Investment in Rapidly Growing CountriesThe Chinese and Indian Experience

Edited by

H.S. Kehal

Editorial matter and selection © H.S. Kehal 2005Introduction and Chapters 1–11 © Palgrave Macmillan Ltd 2005

All rights reserved. No reproduction, copy or transmission of thispublication may be made without written permission.

No paragraph of this publication may be reproduced, copied or transmittedsave with written permission or in accordance with the provisions of theCopyright, Designs and Patents Act 1988, or under the terms of any licencepermitting limited copying issued by the Copyright Licensing Agency, 90Tottenham Court Road, London W1T 4LP.

Any person who does any unauthorized act in relation to this publicationmay be liable to criminal prosecution and civil claims for damages.

The authors have asserted their rights to be identified asthe authors of this work in accordance with the Copyright,Designs and Patents Act 1988.

First published 2005 byPALGRAVE MACMILLANHoundmills, Basingstoke, Hampshire RG21 6XS and175 Fifth Avenue, New York, N. Y. 10010Companies and representatives throughout the world.

PALGRAVE MACMILLAN is the global academic imprint of the PalgraveMacmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd.Macmillan® is a registered trademark in the United States, United Kingdomand other countries. Palgrave is a registered trademark in the EuropeanUnion and other countries.

This book is printed on paper suitable for recycling and made from fullymanaged and sustained forest sources.

A catalogue record for this book is available from the British Library.

Library of Congress Cataloging-in-Publication Data

Foreign investment in rapidly growing countries : the chinese and indian experience / H.S. Kehal, editor.

p. cm.Includes bibliographical references and index.

1. Investments, Foreign—China. 2. Investments, Foreign—India.3. International business enterprises—China. 4. International business enterprises—India. 5. China—Economic policy. 6. India—Economic policy.I. Kehal, Harbhajan, 1942–

HG5782.F685 2004332.67�3�0951—dc22 2004054709

10 9 8 7 6 5 4 3 2 114 13 12 11 10 09 08 07 06 05

ISBN 978-1-349-52094-7 ISBN 978-0-230-55488-7 (eBook)

DOI 10.1057/9780230554887

ISBN 978-1-349-52094-7

Softcover reprint of the hardcover 1st edition 2005 978-1-4039-4168-8

In memory of my parents Chaudhry Harkishan Singh Kehal andSardarni Harnam Kaur Kehal who have taught me to be positiveand enthusiastic for the success of new endeavours

This page intentionally left blank

Contents

List of Tables ix

List of Figures xi

Preface and Acknowledgements xii

Notes on the Contributors xv

List of Abbreviations and Acronyms xx

Introduction xxivHarbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney

1 The Anatomy of a ‘Growth Miracle’ 1Earl A. Thompson

2 Foreign Direct Investment: A Brief Overview of the Micro Issues 23Sumon Kumar Bhaumik

3 China’s Experience with Foreign Direct Investment: Lessons for Developing Economies 46Leonard K. Cheng

4 A Normative Model to Evaluate China’s FDI Regime 64Ramin Cooper Maysami and Wayne Lim

5 China’s Development: Foreign Direct Investment, Accession to the WTO and Future Perspectives 101Jurgis Samulevicius and Tong Xiaoshuang

6 Issues of Japanese Affiliates in Chinese Economy 119Takeshi Otsu

7 Technology Upgrading Strategies and Level of Technology Adoption in Japanese and US Firms in Indian Manufacturing 137Rashmi Banga

8 Digitalization and Foreign Direct Investment: An IndianCase Study 153Madhu Bala

9 The Causal Nexus between Foreign Investment and Economic Growth in India 168K. Sham Bhat, C.U. Tripura Sundari and K. Durai Raj

vii

10 Trends and Determinants of Foreign Direct Investment in Emerging Economies of Asia 180Rekha Mehta and Santosh Bhandari

11 International Mobility of Human Resources of Science andTechnology and its Complementarity to Foreign Direct Investment and Economic Development in Asia 198Vincent F. Yip

Index 217

viii Contents

List of Tables

A2.1 Choice of entry mode 36A2.2 Spillovers from FDI 39

3.1 Roles of foreign firms in China’s economy, 1991–2000 473.2 Sectoral shares of contracted FDI, 1985–2000 533.3 Shares of realized FDI, leading provinces and municipalities,

1979–2000 544.1 China’s annual GDP growth, 1991–2000 654.2 Chinese FDI inflow by country of origin, 1992–2001 674.3 Sectoral share of total FDI through agreements and contracts,

1995–2001 684.4 Summary of FDI determinants highlighted in the literature 724.5 Assessment of China’s FDI regime 88

4.A2.1 The MAI Agreement 904.A3.1 WTO investment rules 934.A4.1 Extract from corporate tax rate survey, January 2002 964.A5.1 Comparison of administrative efficiency selected countries 97

5.1 China’s total FDI, 1979–97 1045.2 Top regions/territories investing in China,

January–September 2002 1065.3 China’s FDI, 2002, by types of FIE 1065.4 China’s FDI, 2000, by selected large sectors 1075.5 China’s FDI, average for 1985–97 1086.1 Profitability of Japanese affiliates, 1996–2001 1226.2 Profitability of Japanese affiliates, by affiliate type,

1998–2001 1236.3 Japanese affiliates, reasons for underperformance,

1999 and 2001 1236.4 Japanese affiliates, managerial problems 1246.5 Japanese affiliates, obstacles to gaining market

share in China, 1997–2001 1256.6 Japanese affiliates, methods of payment, 1999–2001 1266.7 Japanese affiliates, distribution channels, 1997–2001 1276.8 Japanese affiliates, relative frequency of payment method 1276.9 Japanese affiliates, cost reduction measures 129

6.10 Japanese affiliates, production costs 1296.11 Japanese affiliates, personnel problems 1296.12 Japanese affiliates, complaints about FDI policy

changes, 1997 and 1999 130

ix

6.13 Japanese affiliates, problems with government policy, 1999 and 2001 131

6.14 Expected changes in China’s FDI policy 1337.1 Average number of Japanese, US and domestic firms in

Indian manufacturing industries, 1995–6 to 1999–2000 1447.2 Average proportion of Japanese and US equity invested

in manufacturing industry, 1995–6 to 1999–2000 1457.3 Ownership structure of Japanese and US firms in four

manufacturing industries 1457.4 Univariate analysis of technology upgrading strategies

and technology acquisition index in Japanese and US firms 1467.5 Least squares regressions 1487.6 Technology adoption in Japanese and US firms 149

7.A.1 Average share of technology upgrading strategies and technology acquisition index in Japanese and US firms 151

7.A.2 Factor score coefficient matrix 1517.A.3 Correlation matrix 151

9.1 Trends of FDI flows, selected host regions, 1989–2001 1739.2 Trends and pattern of FDI, by category, 1990–2002 1749.3 Trends of FDI flows and balance of payment indicators,

1990–1 to 2001–2 1759.4 The Granger-causality test results: FDI and Index of

industrial production 1769.5 Dickey–Fuller test results 176

10.1 FDI inflows, 1985–2001 18510.2 FDI net inflows, 1991–2001 18610.3 Inward FDI flows to capital formation, 1985–2000 18710.4 FDI performance index of emerging economies of Asia,

1994–2001 18810.5 FDI potential index of emerging economies of Asia,

1991–2001 18910.6 Linear regression results of FDI with various determinants

for the emerging economies of Asia 19310.7 Log linear regression results of FDI with various determinants

for the emerging economies of Asia 19410.8 Multiple log linear regression results of FDI with various

determinants for the emerging economies of Asia 19511.1 Correlation between FDI and foreign student enrolment

in the USA, 2001 20411.2 Low-FDI Asian countries, Student numbers, 2001 20511.3 China and India: selected FDI indicators, 1999–2001 212

x List of Tables

List of Figures

4.1 Realized capital and actual FDI inflows, 1984–2000 664.2 Distribution of actual FDI, by region 695.1 Sales of personal computers in China, 1990–2000 113

xi

Preface and Acknowledgements

It all started in the early 1990s. The first step to producing a book on foreigninvestment was made when I was offered a contract to edit a book on ForeignInvestment in Developing Countries (Palgrave, 2004). I am most grateful toMr T.M. Farmiloe for his encouragement and for sowing the seeds. The chap-ters were assembled from top professionals, academics and practitionersfrom all over the world specializing in the field of foreign investment. Forreasons beyond my control, the book could not be published at that time,but persistence pays, and has its own rewards. In 2003, I was given a freshcontract by Ms Amanda Watkins, Senior Commissioning Editor. She deservesand receives my highest appreciation and regard for her encouragement andgoodwill. Ms Kerry Coutts, Editorial Assistant, Economics, Business andManagement, ably supported my endeavours throughout.

A fresh call for chapters was issued in the summer of 2003, and theresponse from contributors was overwhelming. Proposals for chapters werereceived from top scholars, professionals and academics from all over theworld and were included in the book Foreign Investment in DevelopingCountries and in the present volume, to which authors from various back-grounds and with first-hand knowledge of the theory and practice of foreigninvestment in China and India have contributed.

I wish to thank all the contributors for their excellent contributions. A spe-cial vote of thanks is also due to Professor Earl A. Thompson for acceptingour invitation and making a highly valuable contribution within very tightdelivery schedules. All of the contributors also served as reviewers for otherchapters, and assisted the Editor in producing a wonderful product. Thechapters went through a double-blind review process. Irrespective of havingtheir own congested schedules, the reviewers responded promptly and enthu-siastically to all my requests. However, some individuals need a specialmention, as their help set the benchmark. These include: Professor VincentF. Yip, University of San Francisco; Professor Takeshi Otsu, Seijo Universityof Tokyo; Dr Mark Wade, University of Tennessee; Dr Andrew Sumner,University of East London; Dr S.K. Singh, XLRI, Jamshedpur; EmeritusProfessor Akira Ishikawa, Aoyama Gakuin University; Dr Naoko Shinkai,Economist, Development Studies, Japan Bank for International CooperationInstitute, Tokyo; and Dr Richard Dawson, University of Waikato, amongothers.

A special vote of thanks is also owed to those who provided us access totheir networks, introducing us to potential authors and contributors andencouraging us to persist with the project to its successful completion. Theyare too numerous to mention by name.

xii

Preface and Acknowledgements xiii

In addition to the contributors and reviewers, the production of a bookneeds immense technical and organizational help. Here a special mentionmust be made of Harender Haresh Samtani for his technical help in the edit-ing process and also for his very valuable contribution through his comput-ing and linguistic skills. His presence, perseverance and contribution to thedevelopment of this book have significantly raised its quality. The countlesshours he spent have been rewarded by the excellence of the contributionsreceived. His personal contribution in organizing the huge amount of infor-mation was instrumental in keeping order among the deluge of papers andinformation. He was also of great help in the review process by ensuring thatthe schedule was adhered to and following up various loose ends. His orga-nizational skills deserve a special mention and should be highlighted. Hisconstant presence and persistence encouraged and strengthened my resolveto see this project through.

I also wish to acknowledge the unselfish help and technical support providedby Varinder P. Singh and Dr Kiranjit Sohi during the final days of the project.

The journey on this path over eight years has been very arduous, I takethis opportunity to express my sincere thanks and gratitude to my family,who have been supportive and patient throughout this venture, withoutwhich this project could not have been completed successfully. I am highlygrateful to my wife Harbans Kehal, my children and other members of thefamily for great moral support that bolstered me throughout the long gesta-tion period of this project. Without their forbearance, understanding andenthusiasm, I could not have brought it to fruition.

A collaborative project like this cannot exist in a vacuum, and cannot bekept running without enormous support and help of many kinds. It is appro-priate to acknowledge all of those people who I know have directly or indi-rectly shaped this work by contributing to its successful production. Manyfriends in Sydney and other countries have provided the inspiration andsupport by reading and commenting on drafts. Mr J.S. Sawhney deservesspecial mention and also Professor Tejpal Singh and Dr G.S. Sidhu for pro-viding valuable and constructive comments. Thanks also to the many oth-ers too numerous to mention by name who spared their valuable time.

This book is a culmination of hard labour over fifty years of learning,teaching, researching, sharing and imparting knowledge of economics andrelated subjects in developing countries and also in Australia, Japan andother developed countries. Particular mention must be made of the intel-lectual enrichment received from discussions with colleagues from Japan:Professor Minoru Harada, Kyushu University; Professor Saburo Saito,Fukuoka University; Professor Ken-Ichi Tanaka, President, KitakyushuUniversity; and many others who shared their ideas, insights and technicalknowledge with me during my frequent sojourns in Japan.

Interactions with professionals, academics and researchers at professionalmeetings and gatherings including the Western Economic Association

International, Business and Economics Society International, InternationalFood and Agribusiness Management Association, Indian Ocean ResearchNetwork, the Economic Society of Australia, the Australian Institute ofInternational Affairs and many other professional organizations. My stu-dents spread all over the world always come handy for sharpening my argu-ments. Discussions with Dr P. Dass, University of Manitoba, on variousaspects of FDI strategy have clarified many issues. A special environment atthe University of Western Sydney also facilitated my work on this project.The cooperative attitude of all my colleagues has had a direct impact on thesuccessful completion of this task.

Special thanks go to the publishing team at Palgrave Macmillan who viatheir timely emails prompted me to always meet my deadlines and keep theproject on schedule. I hereby acknowledge their help for their unstintingsupport to this project.

H.S. KEHAL

xiv Preface and Acknowledgements

Notes on the Contributors

Madhu Bala is an Associate Professor of Economics at Indira GandhiNational Open University (IGNOU), New Delhi, India. Dr Bala is a goldmedallist in MA Economics and received her Doctorate from JawaharlalNehru University, New Delhi. Her areas of interest include development eco-nomics, India–Australian studies and research methods. She has authoredmany publications in national and international books and journals. Hermost recent book is the Cement Industry in India: Policy, Perspective andPerformance (2003). She is currently coordinator of two international collab-orations (IGNOU and the World Bank and IGNOU and ManchesterMetropolitan University).

Rashmi Banga is an Associate Professor in Department of Economics of Jesusand Mary College, Delhi University and is also associated with Indian Councilfor Research on International Economic Relations (ICRIER). She has submittedher doctorate thesis to Delhi University and holds Mphil and Masters degreesin Economics from the Delhi School of Economics. Her areas of interest includeinternational economics, with emphasis on trade and FDI; WTO issues; pro-ductivity analysis; labour market issues; and corporate governance. She haspresented papers in many International Conferences and she is a board mem-ber of the Academy of International Business (AIB Chapter on India). Her pub-lications have appeared in journals such as World Development, the Journal ofInternational Economic Studies, Economic and Political Weekly, etc. she has alsocontributed to an edited volume for Palgrave Macmillan.

Santosh Bhandari is a Senior Lecturer of Commerce at Bhupal Nobles’ PGCollege, Udaipur, Rajasthan, India. She specializes in marketing and humanbehaviour and has 10 years’ teaching experience in undergraduate and post-graduate classes. She has published four articles and is a life member of theAll India Commerce Association, and the All India Accounting Association.She is currently working on a University Grants Commission-sponsoredProject on ‘Marketing of Hotel Services’.

K. Sham Bhat received his MA degree in Economics from Calicut Universityin 1981 and his PhD degree in Economics from Cochin University of Scienceand Technology in 1986. He has more than 20 years of teaching and researchexperience and has published more than 60 articles in national and interna-tional journals and two books. He is currently a Member of the PlanningCommission, Government of Pondicherry, Heading the Department ofEconomics, Pondicherry University and also Chief Editor of the Asian-AfricanJournal of Economics and Econometrics.

xv

Sumon Kumar Bhaumik is a Lecturer of Economics at Queen’s UniversityBelfast. He is also a Fellow of the Centre for New and Emerging Markets atLondon Business School, and a Research Fellow of William Davidson Institute,Ann Arbor, Michigan. He is on the editorial boards of Emerging Markets Financeand Trade and The Eurasian Review of Economics and Finance. His areas ofresearch are corporate governance, financial markets and firm-level strategies.

Leonard K. Cheng is Professor and Head of Economics in the School ofBusiness and Management at the Hong Kong University of Science andTechnology. He received his BSoSc from the Chinese University of HongKong, and his MA and PhD from the University of California at Berkeley. Hisresearch interests are in international trade and investment, currency crisis,applied game theory, industrial organization and high-tech industries. Hehas served as Associate Editor for the Journal of International Economics andthe Pacific Economic Review, and as Guest Editor for the Review of IndustrialOrganization. He has published articles in leading international academicjournals, book chapters and two books on Hong Kong’s economy. In addi-tion, he has co-edited a book on global production and trade in East Asiaand another on the management and performance of China’s domesticprivate firms.

Ramin Cooper Maysami is an Associate Professor at the School of Businessat the University of North Carolina at Pembroke, USA. His previous teachingexperience includes an Associate Professorship at Nanyang Business Schooland an Assistant Professorship at the University of Illinois at Springfield,USA. His research experience is multi-disciplinary and crosses geographicborders. His main area of research is regulation of financial institutions andmarkets, with secondary interests in entrepreneurship and economic educa-tion. He has published on issues related to and concerning Singapore,Malaysia, Thailand, South Korea, China (and Hong Kong), the Middle East,Mexico and the USA, in total, more than 50 articles in academic refereedjournals and professional/trade publications.

Harbhajan S. Kehal is a Senior Lecturer in Economics at the University ofWestern Sydney, New South Wales, Australia; previously he completed hisPhD at the University of Western Australia, Perth. His research interests cen-tre around the digital economy, foreign investment in developing countriesand the economic relationships of Australia with Japan and other countries.Chapters based on his research have appeared in books published inAustralia and other countries. He is Associate Editor of the World Review ofScience, Technology and Sustainable Development. He has co-edited a book onDigital Economy: Imputs, Influences and Challenges.

Wayne Lim is a Master of Business (by research) candidate on a full acad-emic scholarship at Nanyang Technological University, Singapore. He

xvi Notes on the Contributors

Notes on the Contributors xvii

graduated with a Bachelor of Business from Nanyang TechnologicalUniversity in 2000. Prior to the commencement of his graduate studies, hewas a credit analyst with Skandinaviska Enskilda Banken AB, SingaporeBranch, and took charge of a portfolio of corporate clients in Asia. Hisresearch interests include monetary, developmental and international eco-nomics, with a special focus on East Asian economies. Currently, he is con-ducting a comprehensive analysis of the impact of deposit insurance onbank stability in developed countries and countries with well-liberalizedfinancial systems.

Rekha Mehta is an Assistant Professor of Economics at J.N.V. University,Jodhpur, India. She did her postgraduate work at Rajasthan University andholds an MPhil and a PhD from the J.N.V. University. She has taught under-graduate and postgraduate subjects at Bangur College Pali from 1992and since 1996 at J.N.V. University. She is a life member of the RajasthanEconomic Association and the Indian Economic Association. Her mainresearch interests are macroeconomics and international economics and eco-nomic growth and development. She is also the author of Saving Behaviourin India and has participated in national and international conferences.

Takeshi Otsu studied economics at Keio University, Tokyo, Japan, where hereceived his BA in 1990 and his MA in 1992. In 1999, after gaining a PhD inInternational Economics and Finance from Brandeis University, USA, hebecame an Assistant Professor at Keio Economic Observatory, Keio University,Tokyo, where he participated in projects studying economic growth andenvironmental problems in Asian regions and China. He was also an assis-tant researcher at a private policy institute, the 21st Century Policy Institute,Tokyo. In 2000, he took up a lectureship at Hitotsubashi University, Tokyoteaching undergraduate courses in econometrics and graduate courses inapplied econometrics. In 2003, he became Associate Professor at SeijoUniversity, Tokyo, teaching undergraduate courses in macroeconomics.

K. Durai Raj completed his MS degree in Applied Economics and is currentlypursuing his MPhil degree at Pondicherry University, working in research inthe area of international economics.

Jurgis Samulevicius works as a Lecturer of Micro- and Macro-economics atthe Department of Social Economics and Management in Vilnius GediminasTechnical University of Lithuania. He graduated from the Vilnius Universityand postgraduated in the Kiev Institute of Trade. After graduating in MasterStudies in Vilnius University, he worked in the Institute of Economics of theLithuanian Academy of Sciences as a senior researcher. The results of hismultiple researches have been presented in more than 80 publications. Hismost recent publications in English are: Introduction to Macroeconomics(Vilnius 2001) and Introduction to Modern Economics: Macroeconomics (Vilnius,

2003). His research interests include foreign investment in developingcountries, environmental economics and management, the economics ofEuropean integration and the digital economy.

Harender H. Samtani has three masters’ degrees in the fields of manage-ment, finance and accounting. His interests lie in the fields of internationalfinance and trade. He has had a rich and varied professional experiencederived from various roles in a multinational bank before moving to the aca-demic fraternity, where he has held a research position. Well versed in thebusiness scenario in India, he is currently focusing his research towardsrecent economic developments. He has been actively involved in the editingof this book and played a key role in its development.

Jagjit S. Sawhney retired from the Indian Economic Service after a highlysuccessful career. He was an Additional Economic Adviser to the Ministry ofCommerce, Government of India and also held many other responsible posi-tions in the Indian public service. He maintains a deep interest in economicresearch and has published a number of articles and research papers. Heactively joined with the editor of this book in reviewing the contributions.

C.U. Tripura Sundari completed her BSc in Computer Science at theWomen’s Christian College affiliated to Madras University. She received herMSc Degree in Economics in 2000 at the Madras School of Economics, affil-iated to Anna University Chennai. She is now a full-time PhD scholar atPondicherry University, engaged in research work in the area of interna-tional economics and regional economics. She is actively involved in thepreparation of the ‘Pondicherry Vision 2020’ document and has publishedseveral articles in national and international journals.

Earl A. Thompson received his Bachelors degree at UCLA in 1959 and hiseconomics MA and PhD from Harvard in 1961. His next three years werespent as Assistant Professor of Economics at Stanford University, where hisformative ideas were developed. Perhaps the one for which he is best knownis his 1966 paper establishing the first demand-revealing mechanism for col-lective goods. A second was a 1968 paper describing various inefficienciesresulting from the perfectly competitive production of collective goods.A third, from which Chapter 1 of this volume springs, was a pair of JPEpapers (1974 and 1979) establishing an efficiency rationale for a country’sevolved tax system. These papers, and many others, can be downloadedfrom http://www.econ. ucla.edu/thompson/. He has been a UCLA Professorsince 1965.

Tong Xiaoshuang is a final-year student for his bachelor degree at theVilnius Gediminas Technical University of Lithuania. His study programmeis business management, and his specialization is marketing management.He has been involved in studying international business strategies in the

xviii Notes on the Contributors

Notes on the Contributors xix

developing countries. His bachelor thesis will focus on the development ofChina’s economy from the overview of FDI, China’s accession to WTO, theIT and digital revolution and the vision of China’s economy in long-runperspective.

Vincent F. Yip is an international lecturer and consultant with wide globalexperience. He received his PhD in Materials Science (USC, 1973) and hisMBA (USD, 1976). He was Chief Scientist and Administrator of the SingaporeScience Park during 1980–9, and served as Singapore’s Deputy Ambassador tothe EC in 1989–91. He has consulted in China, the USA, Europe, Mexico andEgypt for clients such as the World Bank, the Asian Development Bank andUNDP. He was awarded the French Government decoration PalmesAcademiques in 1989 for his international contribution to France’s scientific/technology fields. His teaching and research fields include technologypolicy, cross-cultural management, international talent flow, product man-agement and project management. His latest research project on the Socio-Cultural Aspects of e-Business in China is being done in cooperation withProfessor Alev Efendioglu of USF’s SOBAM.

List of Abbreviations and Acronyms

802.11 technology Wireless LAN technologyADVT Advertisement intensityAPEC Asia-Pacific Economic CooperationASEAN Association of Southeast Asian NationsASI Annual Survey of Industries (India)AT&T American Telephone and Telegraph CompanyB2B Business-to-business networkBCC Beijing Conciliation CentreBEEM Bureau of Entry–Exit Permit Management (China)BOI Board of Investment (Sri Lanka)CAGR Compound annual growth rateCCOIC China Chamber of International CommerceCCP Central Communist Party (China)CCPIT China Council for the Promotion of International

TradeCEE Central and Eastern European (countries)CEO Chief executive officerCFETC China Foreign Exchange Trading CentreCIETAC China International Economic and Trade Arbitration

CommissionCIFIT China International Fair for Investment and TradeCJV Contractual joint ventureCMAC China Maritime Arbitration CommissionCMC Computer Maintenance CorporationCNNIC China Internet Network Information CentreCPE Centrally planned economyDoT Department of Telecommunications (India)DSU Dispute Settlement Understanding (WTO)EDTZ Economic and technological development zone

(China)EJV Equity joint ventureEPZ Export processing zone (India)ERP Effective rate of protectionEU European UnionFDI Foreign direct investmentFIE Foreign-investment enterpriseFIPB Foreign Investment Promotion Board (India)

xx

List of Abbreviations and Acronyms xxi

FSU Former Soviet UnionFYA First-year allowanceGATS General Agreement on Trade in services (WTO)GATT General Agreement on Tariffs and TradeGDP Gross domestic productGMAT Graduate management aptitude testGNI Gross national incomeGRE Graduate record examinationH1B Temporary professional work visa (USA)HKD Hong Kong dollarHR Human resourcesHRST Human resources of science and technologyHSIP Hsinchu Science-Based Industrial Park (Taiwan)ICSID International Convention for the Settlement of

International DisputesIIE Institute of International Education (New York)ILO International Labour OrganizationIMF International Monetary FundINMARSAT International Mobile Satellite OrganizationINR Indian rupeeIPR Intellectual property rightsIS Information servicesISCO International Standard Classification of OccupationsISDN Integrated service digital networkISP Internet service providerIT Information technologyITA Indian Telegraph ActJCIPO Japan–China Investment Promotion OrganizationJE Joint explorationJPY Japanese yenJV Joint ventureLDC Less-developed countryM&A Merger and acquisitionMAI Multilateral Agreement on Investment (OECD)MDG Millennium development goalMFN Most favoured nationMIGA Multilateral Investment Guarantee AgencyMNC Multinational corporationMNE Multinational enterpriseMOFTEC Ministry of Foreign Trade and Economic Cooperation

(China)MoU Memorandum of understandingMPS Ministry of Public security (China)MTNL Mahanagar Telephone Nigam Ltd

NASSCOM National Association of Software and Service CompaniesNIE Newly industrialized economyNIIT National Institute of Information TechnologyNOC No objection certificate (Pakistan)NRI Non-resident IndiansNSF National Science Foundation (USA)NTD New Taiwan dollarNTP National Telecom Policy (India)OECD Organization for Economic Cooperation and DevelopmentPC Personal computerPCA Principal component analysisPII Pollution-intensive industriesPPIC Public Policy Institute (California)PRC People’s Republic of ChinaR&D Research and developmentRBI Reserve Bank of IndiaRIA Regional integration arrangementRMB Renminbi (China)S&T Science and technologySAARC South Asian Association for Regional CooperationSAFE State Administration of Foreign ExchangeSAPTA South Asian Preferential Trade AgreementSAT Scholastic aptitude textSESTAT Scientists and Engineers’ Statistical Data SystemSETC State Economic and Trade Commission (China)SEZ Special economic zone (China)SFCV Sino-foreign cooperative ventureSFJV Sino-foreign joint ventureSIA Secretariat for Industrial Approval (India)SIA Secretariat of Industrial Assistance (India)SME Small and medium-sized enterpriseSOE State owned enterpriseSSB State Statistical Bureau (China)TIE The Indus EntrepreneurTNC Transnational corporationTOEFL Test of English as a foreign languageTRIMS Agreement on Trade-Related Investment Measures (WTO)TRIPS Agreement on Trade-Related Aspects of Intellectual Property

Rights (WTO)TSMC Taiwan Semiconductor Manufacturing CompanyUC University of CaliforniaUNCTAD United Nations Conference on Trade and DevelopmentUSA/US United StatesUSD US dollar

xxii List of Abbreviations and Acronyms

List of Abbreviations and Acronyms xxiii

USSR Union of Soviet Socialist RepublicsVPN Virtual private networkVSNL Videsh Sanchar Nigam LtdVW Volkswagen Co.WEF World Economic ForumWFOE Wholly foreign owned enterpriseWFOV Wholly foreign owned ventureWIPO World Intellectual Property OrganizationWOS Wholly owned subsidiaryWTO World Trade Organization

xxiv

IntroductionHarbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney

There are eleven chapters in this book. Chapter 1 (Earl A. Thompson)presents an excellent analysis of the phenomenon of foreign direct invest-ment (FDI) as an important instrument of economic development in theframework of the conventional model of cross-border FDI flows. The remark-able recovery of Germany and Japan during the post-Second World Warperiod has hardly any similarities with development taking place in thedeveloping counties such as the People’s Republic of China, India and otherAsian countries. While Germany and Japan were at the forefront of techno-logical development and economic growth even before the Second WorldWar, the so-called ‘underdeveloped countries’ have had to start from ascratch. Even with high rate of saving and investment, these countries wouldhave found it hard to progress without technological back-up from the devel-oped countries. Herein lies the relevance of FDI more than making investablefunds available to these countries. In addition to investment and technol-ogy, what is essential is human and natural resources, infrastructure, legaland financial institutions and above all a development culture that providesthe right atmosphere for growth to proceed. This general environment hasperhaps only now reached a critical mass for FDI to come and play its role.

Several paradoxes arise in an empirical study of ‘growth miracles’. Theseprolonged, exceptionally high-growth experiences were all preceded andaccompanied by significantly increased outflows, not inflows, of foreigninvestment. This, however, is paradoxical only within a Keynesian frame-work. A more traditional economic framework tells us that, unlike largeforeign-investment outflows, large foreign-investment inflows inducediminishing returns and crowding-out that prevent the capital movementfrom creating a prolonged growth experience. However, ‘growth miracles’present more serious paradoxes, puzzles that no conventional theory canexplain. Nevertheless, the only thing unconventional about our paradox-resolving model, besides our assumption of the economic rationality of thepolicy makers of less-developed countries (LDCs), is our recognition of anexternal diseconomy that arises from the private accumulation of capital

Harbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney xxv

coveted by a government’s military adversaries. Such accumulations imposelosses on those who bear the costs of defending the government. The exter-nality applies in particular to imports of consumer durables and justifies sub-stantial tariffs on these imports.

Hence, when dominant countries demand that a dependent country lowerits tariffs, the accommodating dependent country would suffer growingdefence problems if it did not ameliorate the effects of its lower tariffs. Anoptimal response for the dependent country is to overvalue the currency,thereby inducing import exchange controls that emulate a tariff system.Most dependent countries have adopted this response. But import exchangecontrols were denied to the post-war Japan and Western Germany. The onlyway for these countries to restrict imports was to undervalue their curren-cies, which required them to devise methods of artificially stimulating theiroutflows of foreign investment in order to increase the domestic pricesof foreign currencies and, quite incidentally, create export booms. Similarly,after an aggressive China exploded a nuclear bomb in the late 1950s, theUSA denied it the right to employ import exchange controls to suddenly-more-dependent Korea, Singapore, Taiwan and Hong Kong, who then imme-diately switched to the same currency-undervaluing policy that had createdthe Japanese and West German ‘growth miracles’. More recently, the demiseof the USSR made India and China more economically dependent on theUSA, who induced these countries to so substantially weaken their importexchange controls that they similarly created large net foreign-investmentoutflows and correspondingly undervalued exchange rates. Quite pre-dictably, these countries have become the latest ‘growth miracles’.

Many countries where large concentrations of private wealth aredissipated through various forms of rent-seeking do not have the capacityfor such growth. There, ruling elites will rationally refuse to subsidize thelarge increases in foreign investment required of ‘economic miracles’. Suchrational refusals, although not without costs, are what account for the bustof the fledgling Southeast Asian ‘growth miracles’.

More generally, the extended terms-of-trade losses resulting from pro-longed foreign-investment subsidies are not justified by welfare economics,which complements the message of the dependent-country politicians bytelling us that such policies unambiguously decrease domestic welfare.‘Growth-miracle’ countries continually and substantially sacrifice for theirtrading partners. Microeconomics does not approve of the ‘growth-miracle’-seeking policies of macroeconomists: countries, like people, must be carefulwhat they ask for.

Chapter 2 (Sumon Kumar Bhaumik) also relies primarily on traditionaleconomic analysis, but concentrates on micro issues, particularly thoseconcerning the motivation of the multinational corporations’ (MNCs) deci-sion to invest in a foreign land. Obviously maximization of profit can be theonly principal objective driving the decision for cross-border investment.

Any country offering the best opportunities for profit making will acquirepriority in its favour. An MNC would like to maximize its hold on its tech-nology and would be least interested in parting with it. The opportunitiesoffered to it in terms of making money without losing an undue hold on itstechnology will be the prime determining factor in its decision to invest. Onthe contrary, the objective of the host country will be to secure technologi-cal spillover with as little loss of economic welfare for its people as possible.Between these two objectives, the right atmosphere for investment will haveto emerge.

FDI by itself is sufficient neither for economic development nor for wel-fare maximization of the host country. It is the development dynamics of thehost nation that will in the ultimate analysis decide the outcome of the entiredevelopment activity both domestic and from abroad.

Much of the economics literature examines the determinants of the quan-tum of FDI, and hence focuses largely on appropriate government policy anddevelopment of institutions such as protection of intellectual property rights(IPR). As a consequence, little reference is made in debates and discussionsto the significant industrial organization, strategy and international businessliterature that have explored the decision making process of MNCs, andtherefore shed light on what these firms look for in countries in which theycan potentially invest. The aim of this survey chapter is to bring to the forethe discussion about these micro-issues. Specifically, this chapter discussesthe motives, objectives and behaviour of MNCs that are the unit of decisionmaking in the context of FDI. Section 1 provides an overview of the debateabout FDI, which is largely macroeconomic in nature. It argues that thisdebate does not provide an insight about the process of FDI, and that inorder to better understand the drivers of FDI one has to explore the motivesand strategic decision making process of MNCs in the context of entry intooverseas markets and/or production locations.

Section 2, discusses the rationale for FDI, from the point of view of theMNC, essentially reviewing the OLI paradigm and its implications. Section 3focuses on the choice of the mode of entry of MNCs into the host countries,an important determinant of the nature and extent of spillovers. The litera-ture argues that this decision depends on the balance between the two typesof costs associated with doing business in the potential host country – theagency costs associated with the interaction of the MNC and a potential localpartner, and the transaction costs associated with procuring resources andselling the product to potential customers.

Section 4 examines the life-cycle of joint ventures ( JVs) which is the pre-ferred mode of entry of many developing country governments, because ofthe perceived link between JVs and technological spillovers. Examination ofthe largely theoretical literature suggests that the presence of informationalasymmetry and agency problems involving a MNC and its local JV partnerusually results in the dissolution of a JV (with or without the dissolution of

xxvi Introduction

Harbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney xxvii

the firm itself) once the MNC has acquired a significant amount of knowl-edge about the local business environment. Section 5 highlights the caveatsassociated with technology transfers and spillovers from FDI. The literaturesuggests that the evidence regarding the spillover effects of FDI is mixed:while some industries in some countries have unambiguously benefitedfrom the presence of MNCs, such experience has not been replicated inmany other contexts. Section 6 concludes the chapter, and the appendicesprovide a summary of the key empirical papers examining the determinantsof the choice of mode of entry by MNCs as they enter new markets, and thedeterminants of the extent of FDI-related spillovers. According to the WorldInvestment Report 2002, as of 2001 there were 65,000 MNCs in the world,with about 850,000 affiliates around the globe. They accounted for 54 mil-lion employees and USD 19 trillion in sales. It is, therefore, not surprisingthat economists have explored in detail the phenomenon of FDI.

Chapter 3 (Leonard K. Cheng) emphasises the role of FDI in bringingabout global divisions of labour not only in production of different goodsand services but also in the process involved in a single product. It alsodetails the historical development of China’s policies regarding foreigninvestment and the actual achievement of China in becoming the singlelargest recipient of FDI. The chapter points out that FDI is not merely anadditional source of funds for investment but, more importantly, providesbetter technology, superior managerial skills and linkages to internationalmarketing networks.

China took a very pragmatic view of encouraging FDI particularly inlabour-intensive, low-technology consumer goods. This policy helped gen-erate widespread employment and also rapid development in the designatedareas besides building up export surpluses and phenomenal export growth.Chapter 3 analyses China’s experience in attracting FDI over the period of1979–2000, draws some lessons for developing economies from this experi-ence and compares the case of China with those of ASEAN and India.

The chapter begins by reviewing the evolution of China’s FDI policy andperformance in four successive phases. The initial phase (1979–85) was oneof experimentation. The second phase (1986–91) was characterized by theintroduction of measures to address the difficulties faced by foreign investorsand to improve the general business environment. In the third phase(1992–7), China reaffirmed its ‘open door policy’ and adopted broader andbolder measures of liberalization. In the fourth phase (1998–2000) it dealtwith the challenges of the Asian Financial Crisis. Three important analyticaland empirical issues are addressed:

(1) Did foreign firms transfer only low and old technology to China?(2) Was there a serious threat of monopolization and control of the Chinese

market by foreign firms?(3) What was the relationship between FDI and economic growth?

Answers to these questions have obvious policy implications. There wasevidence that the relatively superior technology possessed by leading MNCswas indeed transferred to China, that FDI contributed to an upgrade ofChinese industries and exports and that foreign firms contributed to theemergence of efficient Chinese firms. Despite this, the control of China’s mar-ket by foreign firms, as measured by their shares of revenues, value-added, andassets, was relatively small. Statistical analysis of data on FDI and economicgrowth at the provincial level shows that there was a positive two-way rela-tionship between FDI and economic growth, and that FDI was a significantfactor in explaining the differential growth rates of Chinese regions and cities.

Promotion of export-oriented FDI was a common strategy of economicdevelopment adopted by both China and ASEAN, and their effort resultedin rapid economic growth. Nevertheless, they differed in terms of the majorsources of FDI and their restriction on foreign ownership (i.e. China had amore liberal attitude toward wholly foreign owned firms). In contrast toboth China and ASEAN, India’s foreign investors were primarily attracted byits domestic market. Much FDI in India took the form of merger and acqui-sition (M&A), but in China FDI was predominantly greenfield investment.India’s experience with FDI was less positive than that of China and ASEAN,perhaps because of the foreign investors’ failure to exploit India’s abundantlabour supply for export.

Chapter 4 (Ramin Cooper Maysami and Wayne Lim) traces the history ofFDI in China following the liberalization initiated by Deng Xiaoping in1979. The wide-ranging policy shift from complete isolation from the mostof world combined with public control and means of production to an ‘opendoor’ policy for foreign investment and allowing a comparatively free handto private enterprise had a salutary effect on the rapid growth of FDI intoChina. Chapter 4, however, points to the various negative effects of FDI andthe obstacles that may slow down FDI inflow. The biggest concerns aboutdevelopment through FDI relate to accelerating regional disparities andenvironmental degradation, besides the rapid depletion of China’s naturalresources. Policies need to be evolved to guard against these ill effects whileeffort also needs to be made to meet the requirements of foreign investorsregarding protection of IPR and strengthening of neutral legal systems andbureaucracy. The archaic banking, insurance and exchange rate regimes alsoneed effective reform.

The fortunes of the Chinese economy have been on the rise since the1990s, primarily as a result of the ‘open door’ policies of Chairman DengXiaoping and his successors. The country has impressed the world as it hasjoined the list of those experiencing the ‘East Asian Miracle’. In the 1990s,for example, its year-on-year GDP growth was an astounding average ofmore than 8 per cent, and China has become a hotbed for foreign invest-ment. In September 2001, China officially became a member of the WorldTrade Organization (WTO), and this is expected to provide a further boost

xxviii Introduction

Harbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney xxix

to its economic development as well as the acceleration of its economicintegration with the global economy.

Open economic doors in most cases mean free capital flow; does it havesuch a meaning for China? There are sceptics who question whether thescene is set for free flow of capital into and out of the Chinese economy.Chapter 4 evaluates China’s FDI regime by examining whether the Chinesegovernment has pursued the constituents of a normative model that encom-passes the often-cited causal factors in a ‘successful’ FDI regime. The studyalso investigates the existence of its effective enforcement and application.

The chapter begins by stating the trends in FDI in China by country of ori-gin and the receiving sectors and regions of the Chinese economy, beforereviewing the relevant literature and international agreements leading to theidentification of the contributory factors in a successful FDI regime. The nor-mative model constructed includes selected factors based on the preponder-ance of evidence in the FDI literature and amalgamates them with relevantfeatures of several agreements from two international economic bodies – theOrganization for Economic Cooperation and Development (OECD) andthe World Trade Organization (WTO). For example, there have been twobroad categories of policies which are likely to affect the level and impact ofFDI on the host economy: economic policies that are largely under directdomestic control and those that are not controllable by the host economy(Velde 2001). The former encompasses both industrial and macroeconomicpolicies. Relevant industrial policies expected to affect inward FDI, forexample, include promotion, targeting and image-building, financial andfiscal incentives, efficient administrative procedures and rules on ownership,encouraging development in key sectors, taxation, developing export plat-forms, training of employees, encouragement of research and development(R&D), performance requirements and interaction with research institutionsand other firms. The macroeconomic policies affecting FDI inflow arelabour market policies, development of financial markets, sound macroeco-nomic performance and prospects, trade policies and export promotion,competition policies, the availability of infrastructure and privatizationopportunities.

Chapter 4 incorporates the above-mentioned point of view as well as otherviews offered in the literature to identify the following factors as thosecontributing to the success of an FDI regime:

(1) Production factors(2) Support facilities and infrastructure(3) Domestic market effects(4) Global market influences(5) Investment promotion policies(6) Laws and government policies(7) Quality of administration

(8) Political and social stability(9) Exchange rate regime.

Equipped with this framework, the chapter proceeds to evaluate China’ssuccess in attracting FDI with respect to these contributing factors.

Chapter 5 ( Jurgis Samulevicius and Tong Xiaoshuang) examines theimpact of China’s entry into the WTO. It indicates that the initial impact ofreduction in tariffs may be an influx of industrial and agricultural goodsadversely affecting China’s trade, but in due course competition will lead toimprovement in technology and the competitiveness of Chinese productsand will help the general population in the provision of better qualityproducts at lower prices. The growth of the information technology (IT)industry is particularly expected to pick up as China begins to honour itscommitments under WTO.

Since the 1990s, close attention has been paid to China’s economy, whichhas had the highest rates of growth in the world economy. China is acknowl-edged as an ‘Asian tiger’, as a country of socialist market economy on theone hand, and of totalitarian capitalism on the other. Another big economy,Russia, is ready to follow China’s lead: rumours about the planned‘Chinazation’ of the Russian economy are spreading.

The purpose of chapter 5 is to show how China has modernized the econ-omy and in a very short period of time changed its orientation from centralmanagement towards one which is market oriented. FDI has been one of themajor factors sponsoring the boom of growth in China’s economy. China isby far the largest recipient of FDI among the developing countries, and thelegal forms of FDI in China and its ‘open door’ policy since 1979 areanalysed to show not only the relationship between China’s economicdevelopment and FDI, but also to reveal its composition, structure andfuture trends.

China’s successful accession to the WTO is characterised as a cornerstonein China’s move to a market oriented economy. The benefits of the acces-sion to the WTO are examined with reference to the business environmentof Chinese firms and industries and Chinese exports and imports. Chineseeconomists predict that WTO membership will create 12 million jobs in sec-tors such as textiles, toys and footwear. It is also stressed how China’s entryinto the WTO will influence global economic development by becoming a‘new engine’ that could promote the world economy if the three major econ-omy pillars (USA, EU and Japan) found themselves in a recession.

At the end of the chapter FDI in China is described from the IT and digi-tization perspective. China’s IT industry is expected to aggregate 7 per centof its GDP. Attracted by the market potential all the global IT giants havecome to China with the aim of making the country a part of their globalstrategy. China’s high-technology strategy, internet and e-commerce policiesare then discussed in detail. The chapter also outlines some guidelines for

xxx Introduction

Harbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney xxxi

China’s economy in the long run, with respect to the fact that it threatensto become the world’s largest by the year 2020. Conclusions concerning avision of China’s economy ‘starting from local to global’ are then provided.

Chapter 6 (Takeshi Otsu) discusses the aspect of foreign investment in acountry where cultural value system and the business environment is greatlydifferent from that where the FDI originates. Japanese investors found to theirchagrin that Chinese business practices – particularly those relating to distri-bution channels, credit recovery, fund-raising from financial institutions,price and quality competitiveness, etc. – were vastly different from those theywere familiar with. Investors from Hong Kong and Taiwan, who were familiarwith Chinese practices, had a clear advantage over other investors.

What is true about Japanese investors also applies to investors with noChinese background. The lessons that can be drawn from this analysis arefor foreign investors as also for the host country. Whereas it is the responsi-bility of the host country to create the business environment common inthe investing countries, the investing firms must also try and understand theenvironment in the host country in order to be able to make best of theexisting situation.

The Chinese economic reforms successfully attracted a large amount ofFDI from all over the world in the 1990s. This FDI contributed to a rapid eco-nomic growth. A large number of Japanese companies also established theiraffiliates in Asian countries, and Japanese FDI flowed into China in the mid-1990s. Chapter 6 attempts to contribute to understanding what needs to bedone for further economic development in China by observing issues of theJapanese affiliates. The analysis here is based on the survey data (1997–2001)provided by the Japan–China Investment Promotion Organization in Japan.The survey questionnaires include questions on various market and institu-tional conditions, and provide a unique opportunity to investigate the busi-ness environment of the Japanese affiliates in China.

It is argued that Japanese affiliates should have economic and institutionalissues common to other foreign affiliates of non-Chinese origin because of thesimilarity of their FDI pattern in China. The issues identified are the under-development of the distribution, credit recovery and the market competitionchannels, the administrative transparency of the government and the fre-quent change of China’s policy and laws. The main conclusions are that:

● Firstly, the gradual liberalization of the distribution sector has given leewayfor the Japanese affiliates to deal with the credit recovery problem aswell as the underdevelopment of the distributional system. The affiliatesuse foreign-funded distributors to avoid the credit recovery problem.Otherwise, they ask for prepayment. The distribution system is coveringall regions in China. Further reforms in these two fields need to be madebecause a reliable credit system and an efficient distribution systemunderline the development of all market economies.

● Secondly, market competition is fierce in China. Although the economic lib-eralization in China expands business opportunities of the foreign affili-ates, it also implies withdrawal of preferential policy measures such aspreferential taxes. Foreign affiliates will thus face much fiercer competitionin return for expanding business activities. Because a large part of produc-tion costs is attributable to the procurement costs of intermediate goodssuch as parts and materials, it is crucial for local procurement of cheapintermediate goods and labour to be attained. Here, the main issue is qual-ity. It is difficult to find good experts and managers in China and the rela-tively high defect rates of products and low quality of intermediate goodsworsen the affiliates’ performance.

● Finally, the Chinese government’s policies and laws tend to be subject to fre-quent and sudden change in the course of the economic reforms. Such asudden change is inevitable to a certain degree, but is a burden to foreignaffiliates. To reduce confusion in the market and keep a steady economicgrowth, the Chinese government may need to notify firms of changes ofrules well in advance and make administrative procedures transparent.

Chapter 7 (Rashmi Banga) makes an interesting comparison between firmswith Japanese FDI and those with the American FDI in respect of techno-logical spillover and its adoption in the Indian economy. The conclusionsare fairly mixed, as in some respects the Japanese firms lead in technologytransfer while in some other respects the American firms take the lead. Itseems that level of technology transfer is driven by the business needs of thefirm in question, and its country of origin makes hardly any difference forthe transfer of technology it achieves.

FDI in developing countries is sought because it is expected to augmentinvestible resources – and, more importantly, it is expected to improve tech-nological standards, skills, efficiency and competitiveness of the domesticindustry. It is also expected to bring ‘relatively’ later technology into theindustry. However, the question raised in Chapter 7 is whether foreign firmsfrom different source countries differ with respect to their level of technol-ogy adoption in the same industry of the host country. Studies have foundthat the costs of intra-firm transfer of technology may differ between differ-ent types of technology transferred and between different modes of technol-ogy transfers. This gives us reason to believe that FDI that come fromdifferent sources, with different types of technology and different modes oftransferring technology, may entail different costs of transferring technology.And this may lead to differences in the extent of technology adoption in theaffiliates of foreign firms from different countries of origin in the same hostcountry. This issue is of great relevance for small and medium-sized firms(SMEs) who, in an attempt to upgrade their technology, collaborate with for-eign firms and therefore need to choose between foreign firms of differentcountries of origin. It therefore becomes important to study the technologybehaviour of foreign firms with respect to their country of origin.

xxxii Introduction

Harbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney xxxiii

The two source countries of FDI chosen for the analysis are Japan and USAand the period of analysis considered is 1994–5 to 1999–2000. The analysisis undertaken at three levels:

● Firstly, an univariate statistical criterion (i.e. Mann–Whitney U-test is usedto find whether the technology up-grading strategies differ between theJapanese and US firms

● Secondly, to compare the extent of technology adoption in the firms anindex of technology adoption is prepared using PCA

● Finally, an attempt is made to compare the factors that determine technol-ogy adoption in Japanese and US firms, using panel data estimates.

The results show that technology up-grading strategies with respect toembodied technology, disembodied technology and R&D expenditures dif-fer significantly between the Japanese and US firms operating in Indianmanufacturing. It is also found that after controlling for firm-specific andindustry-specific effects, not only the ownership of foreign firms but thedegree of foreign control in a firm also has a significant impact on its extentof technology adoption. Japanese firms are found to have higher level oftechnology adoption as compared to US firms. Japanese firms that have,on an average, higher control of the parent firm; are larger in size; morecapital-intensive and more profitable and tend to have a higher level of tech-nology adoption after controlling for industry-specific effects. On the otherhand, US firms that have higher control of the parent firm and are moreexport-intensive in nature and are found to adopt higher levels of technol-ogy. Industry-specific effects are found to be significant for US firms but theyare not significant for Japanese firms.

Chapter 8 (Madhu Bala) focuses on the impact of FDI on the informationand communications technology (ICT) sector of India. Significantly, it is thissector that has gained most from the inflow of FDI. While the impact on theother sectors has been nominal, the ICT sector was not only the major recip-ient of the FDI but was also the major beneficiary of the technology spillover.The flow of FDI helped the sector to leapfrog into the world technology fore-front and be ranked among IT powerhouse regions. Notwithstanding theseachievements, there are serious gaps in the ICT sector in India and the ‘digitaldivide’ is all too visible. Except for a few states the rest of the country is notin a position to take advantage of the digital revolution. The divide also per-vades across the sectors, where except for a few industries the rest of the econ-omy is devoid of the benefits of advancement in the ICT sector. This chapteremphasizes the need for a set of policies that could remove the difference indigitalization between sectors and states. The flow of FDI can help greatly inbridging this gap, which will in turn help uplift the use of technology in sec-tors left behind in the race for digitalization. Similarly, the lagging states needthe adoption of positive policies for the attraction of FDI so that they are ableto keep pace with the advancing states.

The IT revolution in the 1990s led to a renewed debate on the role of ICTin development and the existence of the ‘digital divide’ between developedand developing countries. The 2001 World Telecommunication DevelopmentReport (2002), while defining the present-day digital world as ‘Private, com-petitive, mobile and global’ has acknowledged the existence of a ‘digitaldivide’. Numerous measures have been suggested to tackle this, and FDI isone such measure. Various research studies have shown that FDI is presentlydetermined more by the level and extent of digitalization in the recipientcountry as compared to the traditional factors such as savings and invest-ments (in classical models), technical progress (in neoclassical models) andR&D, human capital, accumulation and externalities (in new growth theo-ries). Developing countries have now begun to acknowledge the existence ofa ‘digital divide’ and to take suitable initiatives to bridge it by adopting acombination of strategies including attracting FDI. Brazil, China and Indiaare examples of such FDI-attracting countries.

Chapter 8 deals with India as a case study. It points out that despite theIndian ICT industry recording incredible evolution and explosive growth overthe 1990s, a number of research studies argue the extent and seriousness ofthe ‘digital divide’ in India. There are lots of efforts by government and pri-vate sector at both policy and infrastructure level. However these efforts aredrops in the ocean and a lot is still required. Therefore this chapter looks intothe issue of the ‘digital divide’ at both national and international level.Despite the limitations of the data, the chapter attempts an estimation of anextended Cobb–Douglas model, and tries to prove that FDI (in ICT) assists inbridging the ‘digital divide’ by adding to human capital development and inthe process to overall economic development. The regression model estimatedin this chapter shows us that while digitalization contributes to the economicgrowth of India FDI contributes significantly to the growth of human capital.

Chapter 9 (K. Sham Bhat, Tripura Sundari CU and K. Durai Raj) calls forthe following policy options to enhance economic growth through FDI:There is a need for further liberalization of FDI and a Granger-Causality testwas employed to examine the causal nexus between foreign investment andeconomic growth in India. The Dickey–Fuller test was also employed toexamine the stationarity of the series. The data series were on a quarterlybasis and collected from various issues of the Reserve Bank of India Bulletin,the World Investment Report and the Centre of Monitoring the IndianEconomy for the years 1990–2002.

The analysis revealed an independent relationship between foreigninvestment and economic growth in India. The possible reasons for sucha relationship are:

(a) In India, foreign investment is only 0.9 per cent of gross domestic prod-uct (GDP) and its high transaction cost in the form of corruption andunnecessary regulatory requirements

xxxiv Introduction

Harbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney xxxv

(b) The lack of full integration of capital and financial markets(c) Higher levels of economic growth may not attract foreign investment

due to lack of stability of the Indian rupee in international markets foroutward oriented trade policies.● strengthening the regional economic integration through organiza-

tions such as ASEAN and NAFTA.● Maintenance of the stability of the Indian rupee in terms of foreign

currency.

Chapter 10 (Rekha Mehta and Santosh Bhandari) analyses the flow of FDI tovarious Asian countries over time and concludes that the trend has shiftedfrom the ASEAN-5 to emerging economies such as India and China.However, the flow to countries other than China has not increased signifi-cantly. China has dominated FDI flow and the trend is likely to continue forsome time to come unless other countries create a very favourable environ-ment for FDI to flow in. Efforts in this regard are being made by many coun-tries, especially India, but the results of these efforts have yet to be seen.

A review of evidence on resource flows to emerging countries points to arising trend. Until the 1990s, FDI flows were quite minimal, and most coun-tries in south Asia were not seen by international investors as attractiveinvestment destinations. In the 1990s, however, these countries started toattract FDI under the impact of the globalization of business. Emergingeconomies improved their share in terms of total FDI inflows to the world,developing countries and Asia over the period 1985/1990–2001. Despitethis growth, FDI as a proportion of the GDP of emerging economies remainvery low.

Both the inward FDI performance index and the inward FDI potentialindex have been studied in Asian countries, and an econometric analysis hasbeen undertaken, in the context of the emerging economies, using two deter-minants of FDI – the size of the market and the openness of the economy.The flow of FDI in Asia has shifted over time from the ASEAN-5 to the emerg-ing economies, but despite this growth FDI as a proportion of GDP of theemerging economies remains low. China has accounted for an impressiveshare of FDI inflows to the emerging economies. The FDI performance indexcalculated by UNCTAD shows that the performance of China, India,Pakistan and Sri Lanka in 1999–2001 is no better than 1994–6, but thepotential index of China and India increased from 1991–3 to 1999–2001.FDI policy in different emerging countries has also been studied. A range ofmeasures has been implemented to enhance FDI, including provision of var-ious tax duty and other incentives, removal of restrictions on repatriationsof profits, establishing current account convertibility, relaxation of owner-ship, restrictions and non-discrimination in favour of domestic investorswith fast tracking of FDI approvals. Different determinants such as a lag ofGDP, a lag of per capita income and openness were also studied. All the

variables in different countries were found to be significant but resultsshowed that per capita income was an important determinant.

Chapter 11 (Vincent F. Yip), the final chapter, makes very interestinganalyses of the trends in human resource mobility and FDI. For many yearsthe USA has been a centre of higher learning and scientific research, andthere has been a long-standing desire by students from Asian countries(India, China, Taiwan, South Korea, Singapore and Hong Kong) to seekadmission to American universities and institutions of higher learning. Mostof these students preferred to settle in the USA for better conditions of workand living. However, with the growth of FDI in their countries of origin thesetechnocrats began to return to their homelands, either as entrepreneurs oras scientific manpower. The largest number of foreign students from a sin-gle ethnic group came from China, Hong Kong and Taiwan. With theincrease in the flow of FDI in China and its emergence as one of the largestrecipients of FDI, the return flow of scientific manpower from the USA toChina became very significant. One of the major forms of technologytransfer – the return of top scientific human resources – has begun to play asignificant role, and establishing enterprises in third countries is increasinglybecoming common.

Whereas the earlier phase of human resource migration from third worldcountries to the USA was regarded as a ‘brain drain’, it has now turned intoa ‘brain circulation’ where scientific know-how in the form of humanresources is moving from one country to another in search of entrepreneur-ial opportunities. The phenomenon of large-scale FDI movement has furtherstrengthened this flow.

In discussing investment and development issues of developing countries,the proper management of human talent could potentially be more impor-tant than resource, market, financial instruments, infrastructure and eventhe political system of a country. This is especially relevant in today’s globaldigital economy where technology transfer often is highly dependent onhuman factors. While it may not be possible to determine an incontrovert-ible casual relationship between FDI and human capital in terms of a con-crete correlation of statistics and data, Chapter 11 explores the phenomenonof the migration of human resources of science and technology (HRST) andits effect on FDI and economic development of Asian countries.

The ‘Asian boom’ that started in the 1970s coincided with the largest tideof foreign students sent from Asia to the developed countries, especially theUSA. However, only in the 1990s did in-depth discussions and empiricalresearch, notably that by the OECD on understanding the relationshipbetween the mobility of these crucial HRST and FDI inflows–outflows andthe economic development of their sending and host nations in generalbegan to be produced. As physical capital and skills go hand in hand, so FDIand international transfer of HRST can be seen as complementary to eachother. Entrepreneurs in technology are accomplished migrants who create

xxxvi Introduction

Harbhajan S. Kehal, Harender H. Samtani and Jagjit S. Sawhney xxxvii

cross-border networks and channel their skills and the capital they musterbetween nations, the best examples being the highly visible and successfulethnic Chinese and Indian venture capitalists and entrepreneurs in SiliconValley. A comparison of figures for the Asian nations with the top tenFDI inflows shows there is undeniably a complementarity between theFDI inflow and the number of students the developing Asian country sendsto the USA, the largest recipient of international students.

Three case studies of how international movement of HRST can effectenormous economic and social-political changes are also examined:

● Firstly, the successful return flow of HRST to Taiwan and now mainlandChina

● Secondly, the Indian diaspora and its large impact on the Indian softwareindustry

● Finally, Singapore’s effort in mustering international and local HRST fornation-building.

In fact, in all three cases, returned HRST’s pivotal role in the home coun-try often extends beyond the economic realm into social, cultural and evenpolitical arenas. There is no doubt that in today’s world, HRST has becomea major determinant of FDI and economic development, and there is amovement away from one-way human capital loss by sending nations,(‘brain drain’) into a mutually beneficial scenario (‘brain circulation’).International mobility of HRST stimulates FDI and skill–technology transferbetween sending and host nations, creating a ‘win–win’ situation for all.Talent is now the name of the game.

References

1. Velde, World Telecommunication Development Report 2001.2. World Bank, World Investment Report 2002, Washington, DC, World Bank, 2002.3. World Telecommunication Development Report, Washington, DC, 2002.