lecture added foreign direct investment updated

8/6/2019 Lecture Added Foreign Direct Investment Updated

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Lecture 14-a

Foreign Direct Investment and the

Emerging China Circle:A Key Engine of Development


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FDI in the Socialist Period

Closed to foreign investment after

Soviets left in 1960, walk on two legs


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Deng and FDI

1978 -- decision to stop isolation

Two motivations: Need for foreign exchange (to import new technology)

Fear of falling further behind East Asian neighbors

1979-80: establish Special Economic Zones(SEZs)

Cautious Incremental

Geographically isolated


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Geography, Revisted:

In the beginning First Special EconomicZones in the South areas isolated from the rest

of China


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Xiamen

Shantou

Shenzhen

Hong Kong

Taiwan

South East Asia

Zhuhai

Macau

Geography of first 4 SEZs not an accident

Tapping the Overseas Chinese connections!


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Shenzhen: thesymbol of Chinasmiracle growth

From 1980

until 2000

But it did nothappen over night!


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Fi r - : T t l For i I st t

5

5

5

3

35

5

5

-

3 5 3

BillionUS

Dolla

rs

oans

ir ct For i n

Invest ent

S all b t a lot ore thanbefore!!! And, bi i pact


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The Early SEZs

Law of Joint Ventures Foreign Equity: 2 % or more / no maximum limit CEO had to be Chinese national (until 1990) Lower tax rates Simple administrative procedures

But lots of flexibility local experimentation since they were in thesouth: when the Emperor is far away, there is little to hold one back

First JV (make airline meals for Air China) Oil exploration

Mining (especially coal)

But also other trend: Early Hong Kong processing operations Much like EPZs of rest of Asia


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Export Processi g Zones: Why Chinese EZs re imil r

Chinas special economic zones are a particular type of export processing zone. Thefirst export processing zone in Asia was established at Kaohsiung in Taiwan in 1965. In the early1970s, Japan relaxed its restrictions on investment abroad and began to invest in Asia to movelabor-intensive manufacturing to lower cost environments. In 1972, Korea established the Masan

Free Export Zone and the Philippines set up the Bataan Export Processing Zone to attract theseinvestments. By the 1980s, there were 35 EPZs in Asia, and most countries had them.

All Asian EPZs offer an essentially similar set of incentives for investors. First,components and raw materials can be imported duty-free and without administrative formalities;exports leave the zone without export or sales taxes. Thus, the zones are outside the country inwhich they are located, insofar as normal customs procedures are concerned. Second, companyincomes tax holidays are typically granted for a period of 3 to ten years. Third, the administrativeprocedures are streamlined, often through a one-stop shop coordination of permits, and usuallythrough exemption of restrictions on foreign ownership and employment of foreign nationals thatmight apply in the rest of the economy. Fourth, the zone itself often operates as a commercialentity, building infrastructure and utilitiesoften at a subsidized rateto the foreign firms.

Asian EPZs offered a way to move toward export promotion without fundamentallyoverturning the structure of protection in place for domestic manufacturers. EPZs producedbenefits in terms of employment created and foreign exchange earned, but at a cost of giving upsignificant tax revenues, and foregoing potential linkages to the remainder of the domesticeconomy. Most EPZs started slow and ended up costing far more than initially envisaged; but thepolicies have typically been seen as ultimately successful in most of the countries which triedthem. EPZs primarily attracted footloose investors in such sectors as garments and electronicsassembly because of low wages and easy conditions for moving goods in and out. Turnover hasbeen substantial, but some zones have clearly contributed to the ultimate establishment ofsuccessful industries in their countries. One example has been the Penang Free Trade Zone inMalaysia which initiated the development of Malaysias now substantial electronics industry.

Chinese SEZs share all these fundamental characteristics with other Asian EPZs.


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Export Processing Zones: Why Chinese EZs re ifferent

From the beginning, Chinese SEZs were inevitably bound to be more special than other Asian EPZs. This f

ollows from the fact that the other Asian EPZs were established in economies that were basically market economies, albeit

ones that were sheltered from world markets and competition. However, because of the very early stage in the economicreform process in which Chinas SEZs were created, the difference between the rules of the game in the domestic economy

and that in the open and relatively uncontrolled economy in the SEZs was bound to be large. Moreover, Chinas SEZ are

much bigger than other Asian EPZs. As Table 17-1 shows, the typical Chinese SEZ was many times the size of an Asian EPZ.

This larger size reflects their multiple roles and greater importance to the domestic economy. Chinas SEZs were seen

alternatively as transmission points for world advanced technology; windows on the world for political and economic

purposes, and laboratories for economic experimentation. In concrete terms, some of the key distinctive characteristics of

the Chinese zones include:

---Chinese domestic enterprises have also had a substantial incentive to invest in the SEZs. By setting up theirown subsidiarieseven if they are not joint ventures with foreign businessesChinese domestic enterprises enjoy greater

administrative flexibility, lower tax rates (15% income tax rather than 30%), and less complicated access to the outside world.

Aside from taxes, these are largely reflections of the continued restrictions imposed on firms by the remnants of Chinas

bureaucratic economy.

---The SEZs sometimes serve as laboratories for experiments with economic reforms. For example, Shenzhen

SEZ was an early pioneer of both flexible wage systems (no limits to incentive payments) and tender bidding for construction

projects. Experiments with development of land markets through leasehold, and equity markets have also been significant.

---Shenzhen in particular has been developed as a comprehensive site, including tourism, housing, and otherservices for Hong Kong people.

---Initially, the SEZs were allowed to retain all tax and customs revenues; and all foreign exchange earned for

their own use. This reflected the large task of infrastructure construction in these relatively un-developed sites (check this).

Before 1988, they were allowed to keep 50% of tariffs. Before 1992, they also kept foreign exchange. In 1994, integrate into

national fiscal system. In 1996, pay full tariffs on commodities imported into the zones themselves, as opposed to 50%

previously (?). Thus, the SEZs were governmental bodies with unusually high levels of autonomy, compared to EPZs.

During the 1990s, the SEZs have tended to become less special as other parts of the Chinese economy have

been opened, and some special provisions have been scaled back.---


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Tabe 17-1: Szeo na'sSE s and As an E s (k 2)

Ini ial i e Si e in 1990

Shenzhen 3 .5 3 .5

huhai . 121.0

Shantou 1. 52.Xiamen 2.5 131.1

Kaohsiung, Tai an 0.

enang, Malaysia 1.2Batam Island, Indonesia 3 .

Bataan, Phili ines 3.


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If a little SEZ action is good,

then a bit more is better! In 1984-87: 14 Open Coastal Cities(OCCs)

All were open before, but now got to offerthe same special preferential treatment asthe SEZs

Also: opened up other isolated previously

unplanned areas, surrounding rural areas(in Pearl River DeltaGuangdongandLower Yangtze DeltaJiangsu)


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14 Open Coastal Cities

Northernmost:Dalian

Southernost:Beihai


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Stop and Start policies

Boom of investment and new contracts But, also allowed to import with little restrictions

(and easy access to foreign exchange) Invest or import? All foreign firms / domestic firms face

this choice (though often constrained, e g , severe import

constraints) When loosen import controls, booming imports!!

slowed FDI Govt responds, restrict all imports also affects

imports (cant import equipment or raw material for

processing firms) slowed FDI more So finally regularized policies: gave access to foreign

exchange; more legal changes; more tax reductions;power to approve small/medium investments withoutupper level approval finally began to rise again

Surge in investment from the US: Beijing Jeep


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Figure17-1: Total Foreign Invest ent

0

5

10

15

20

2530

35

0

45

50

1979

-

1

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

BillionUS

Dolla

rs

Loans

irect Foreign

Invest ent

Continue thegradual rise

14 OCCs


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Tiananmen Incident (June 4, 1989)

Cooled enthusiasm for many to invest

But Taiwanese took advantage of newround of incentives

Korea began to enter in NE


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The Explosion (third wave)

Dengs visit to the south

Shanghais Pudong (this is going to be the biggest SEZyet) and draw more FDI than anywhere else largerthan Shenzhen already a population of 1 1 million

Open up most of the country SEZs, become lessS(pecial)

Open up new sectors: Urban real estate; open housingand building; open retail and some of service sector

Gave local govts more control Competition among SEZs/regions intensified

Bonded areas established (this will be important for tradenext time)


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0

5

10

15

20

2530

35

40

45

50

1979

-81

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

BillionUS

Dolla

rs

Loans

irect Foreign

Invest ent

engssoutherntrip

uring Asian Crisis,anunprecedented

a ount ofFDIflowed into China a safe haven!

Stories: invest ent funds andthe search for deals


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XVII-2: ina: Forei n Direct Invest ent as S are of GD

0%

1%

2%

3%

4%

5%

6%

7%

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001-half

Never more than2% in Japan; Koreaor Taiwan


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0

5

10

15

20

2530

35

40

45

50

1979

-81

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

BillionUS

Dolla

rs

Loans

Direct Foreign

Invest ent

Surging in past 8years

WTO andFDI:autos andautoparts

and ore in recent years


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And on and on and on

Todaythe good: Fairly liberal investment climate

Low taxes

Most sectors are open More opening with WTO

Currency conversions fairly easy to deal with

The awkward:

Lots of approval Still poor legal framework

Guidelines are not transparent


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Areas of Investment

Most in manufacturing

Investment in businessservices and finance is

small

Distribution is biggestbottleneck

New WTO rulessupposed to open upfinance, services anddistribution and logistics

Ot er, 4Commercial

, 10

Infra-

structure, 8

Real state,

18

Manu-

facturing,

60

Story of Syngenta

and distribution


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Main Industries

Electronics

Textiles

Food products Transport (autos)

Electric

Building materials Chemicals

A lot of this istied to Chinastrade policy atleast in the1980s, did NOTallow for imports


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Fi ure 17-3: FDI in ina: Sources

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

$50,000

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

MillionUS

Dollars

HongKong

Tai an

Japan

U.S.

EU-15

ther

US, EUJapan,Tai an:all about

8-10%

HK is byfar thelargest butrelativesharehas

fallen

In1992, HKand Tai anaccounted fornearly 80%

of FDI

Stories: Sony


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Geography, NOW

Thru 1997: 0% of FDI intoGuangdong (more than$US 100 billion)

4 southern coastalprovince: 4 %

Lower YangtzDelta thru1997:accounts for2 %

Bohai Gulf,includingBeijing, thru1997:

accounts for18%

Coastal: 4 +2 +18 = 88%


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Fi ure 17-4: Modes of FDI in ina

0%

10%

20%

30%

40%

50%

60%

70%

1979

-82

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

ercenta

eofRealied

Invest

ent

Equity Joint enture

Joint Develop ent Project

hollyForeign ned

Contractual J

Stories: Mars

This ishere

Mr.Chinaresigned..


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Impact

Quantity of investment?

Not real effect! Only a small percentage oftotal investment rest by domestic firms andindividuals

Ideas:

Technology

Management Spread through economy

How does this showup on graphs?

Shifting out of PPF!


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New Trends, Powerful Forces:The China Circle

China

Hong Kong

Taiwan

Emergencecame in response to 3 changes in theeconomicenvironment:

1. Success of East Asias Miracle Export-led Industrialization

2. Reduction in Transaction costs that made it possible to relocate productionto low wage sites (outsourcing)

. Collapse in resource prices (1980s) that made natural resource-development strategy unattractive

(4) Chinas reform but this may have been consequence not causal factor


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Basis for China Circle

Success of Taiwan/Hong Kong indeveloping labor-intensive manufacturedexports during 1960s/1970s (directed at the

US market) Success had two effects:

Demonstration effect (China copied T and HK)

Restructuring effect (Export surplus, currencyappreciation (in T and K); increasing costsboth wages and environmental need torelocate production to low-wage locations


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Attractiveness of China in mid-1980s

China: low wage; land available; operating costslow (little or no environmental protection or laborregulation); depreciating currency

China became especially attractive tobusinessmen in T and HK language andcustoms the same

China welcomed them for Capital andTechnology and Learning

[nothing new South East Asia was also feelingthe boom through the same dynamics Japan was playing a bigger role there]

Taiwan town in suburbs of Shanghai


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Specializations around the Circle

China: low-wage production Taiwan / Hong Kong: high value services and

technology-intensive production

Created a new economy style (also elsewhere in theworld) of infra-industry trade AND intra-firm trade Organization and financing in T and HK Key components manufacturing/technology creation in T and HK Ship to China for production

Export and marketing by T and HK Electronics, first then textiles other consumer goods Much like semi-conductor industry in SEA Silicon Valley and

Malaysia]

Ai ed / sp rredon y reakthro ghs in

transport/comm nications


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The end?

1 China; systems?

1 China, deteriorating HK, uncooperative

Taiwan 1 China, No Taiwan

More mutual dependence, the more likelya happy outcome

This may be FDIs greatest contribution

lecture added foreign direct investment updated

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