Bachelor Thesis

Economics and Business Administration with International Management, 2013

The determinants of FDI

The case of Wal-Mart China Inc.

Samuel Osei Adjabeng (401556)

Supervisor: Jakob Arnoldi

School of Business and Social Sciences, Aarhus University

Characters (no spaces): 73,889

Words: 13,063

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Abstract

This thesis takes its point of departure in the conventionally held views about what constitutes the

determinants of Foreign Direct Investment (FDI) and seeks to test identified determinants on the

real world case of Wal-Mart’s FDI in China. The most essential of the goals of this paper is to

ascertain the extent to which ‘FDI type or form’ (e.g. Equity Joint Venture and contractual joint

ventures) and ‘company interest’ determines the effect of conventionally and (or) empirically

identified FDI determinants. The most crucial finding of this work is the interactive effects

between the identified FDI determinants themselves – as shown in Wal-Mart China’s undertakings.

The Market determinant was found as the most influential because of Wal-Mart’s overriding

market seeking interest. This determinant was found to be playing a neutralizing role with respect

to the effects of other determinants i.e. labor cost and tax. Infrastructure, as a determinant of FDI,

on the other hand was found to be foundational to the effectiveness of the market determinant of

Wal-Mart China considering the fact that infrastructure developments such as road constructions

makes attainable the proximity between distribution centers and retail stores.

Keywords: Determinants, Foreign Direct Investment, Wal-Mart China

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Table of Contents

Abstract ...........................................................................................................................2

Acknowledgements ......................................................... Error! Bookmark not defined.

List of Tables ...................................................................................................................5

List of figures ..................................................................................................................6

CHAPTER 1 - Introduction .............................................................................................7

1.1 Problem Statement and Motivation ...................................................................7

1.1.1 Motivation ......................................................................................................8

1.2 Delimitation .....................................................................................................9

1.3 Thesis Structure ............................................................................................. 10

CHAPTER 2 - Literature Review .................................................................................. 11

2.1 Introduction.................................................................................................... 11

2.2 A review of Empirical Studies on the determinants of FDI ............................. 13

2.2.1 Labor costs ................................................................................................. 13

2.2.2 Tax ............................................................................................................. 15

2.2.3 Exchange rate ............................................................................................. 18

2.2.4 Market ........................................................................................................ 19

2.2.5 Infrastructure .............................................................................................. 20

2.3 Conclusion ..................................................................................................... 20

CHAPTER 3 - Foreign Direct Investment in China (Inflow) .......................................... 21

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3.1 Forms of FDI in China ................................................................................... 23

3.1.2 Equity Joint Venture (EJV) ......................................................................... 23

3.1.3 Contractual Joint Venture (CJV) ................................................................. 23

3.1.4 Wholly Foreign-Owned Enterprise (WFOE) ............................................... 24

3.1.5 Joint Exploration (JE) ................................................................................. 24

3.1.6 Foreign-Funded Share-Holding Enterprises ................................................ 24

3.2 FDI Regulations and Policy Drifts in China .................................................... 26

CHAPTER 4 - The case of Wal-Mart ........................................................................ 30

4.1 About Wal-Mart Stores Inc. ............................................................................ 30

4.1.1 Wal-Mart China .......................................................................................... 32

4.1.2 Determinants of Wal-Mart’s Foreign Direct Investment in China ............ 33

CHAPTER 5 - Conclusion ............................................................................................. 41

References ..................................................................................................................... 43

Appendix 1 .................................................................................................................... 49

Appendix 2 .................................................................................................................... 50

Appendix 3 .................................................................................................................... 51

Appendix 4 .................................................................................................................... 52

Appendix 5 .................................................................................................................... 53

Appendix 6 .................................................................................................................... 54

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List of Tables

Table 1- Reasons for FDI insensitivity to tax differentials. ........................................................ 15

Table 3 Advantages and disadvantages of different forms of FDI .............................................. 26

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List of figures

Figure 1 – Global FDI Inflows, 2000-2012 ................................................................................ 21

Figure 2 - Contributions of Foreign-Invested Enterpises (FIEs) to total actual FDI ................... 25

Figure 3 - Performance Chart for Wal-Mart Inc., (2008-2012) .................................................. 31

Figure 4 - Milestones of Walmart China ................................................................................... 33

Figure 5 - China Retail Investment Volume 2006-2011 ............................................................. 36

Figure 6 - Proportion of Retail Investment Reached New High ................................................. 36

Figure 7 - Distribution of Investment in 2011 by Pdt. Type ....................................................... 36

Figure 8 - ...Supported by Healthy Disposable Income Growth ................................................. 36

Figure 9 - Retail Sales Performance Holding Up....................................................................... 36

Figure 10 - China's GDP growth and GDP per capita growth (1967-2011) (annual %) .............. 38

Figure 11 - Global FDI inflows, top 20 host economies, 2008–2009 (Billions of dollars)........... 49

Figure 12 - Non-Financial Foreign Direct Investment (FDI) Inflows, 2001-11 ........................... 50

Figure 13 - Overview of Wal-Mart's 50 years of Performance.................................................... 51

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CHAPTER 1 - Introduction

The ‘OECD1 Benchmark Definition of Foreign Direct Investment’ states that “Direct Investment

occurs when a business located in one country (the direct investor) invests in a business located in

another country (the direct investment enterprise) with the objective of creating a strategic and a

lasting relationship” (OECD, 2008). This thesis takes a cue from the above definition as a

departure point with a focus on China as a host country and a specific focus on Wal-Mart China

Inc. as a Foreign Direct Investment Enterprise.

1.1 Problem Statement and Motivation

Foreign Direct Investment (FDI) impacts trade of both home and host countries. There are varied

costs and benefits for either side, which must be considered in formulating a country’s overall

attitude towards FDI inflows and outflows. However, the purview of this thesis is the private

investor company Wal-Mart China. The research questions under inquisition are thus bothered on

the considerations of Multinational Enterprises (MNEs) like Wal-Mart, i.e. in their choice of

location and project value of foreign investments as well as their decisions of ‘why’ and ‘how’ to

vary or halt investments. The research questions can therefore be stated as follows:

1. What are the determinants of Foreign Direct Investment?

2. Which of the determinants of Foreign Direct Investment can be classified as some

of the most crucial for the case of Wal-Mart China Inc. and how have they changed

over time?

It is seemingly obvious that ceteris paribus, an increase or decrease in FDI for China, is dependent

on the merits or demerits respectively that an investment brings to bare on investor-company-

bottom-line. However, it is also practically supposable that (depending on the ‘FDI

type’ and (or) ‘company interest’2) an investor-company that envisages long term profits may

ignore these demerits or even increase its investments in wait of future gains. Therefore, the

discussion of the determinants of FDI cannot be done in isolation off of investing companies.

1 Organization for Economic Co-operation and Development. 2 The interests of companies is divisible into – ‘market seeking’ and ‘resource seeking’ (see chapter 2.2.4)

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Similarly, the fluctuation of investment values as well as the interest-fueled choices of investment

locations signal that the factors determining these investment values are ‘time-bound’ (e.g. if state

offered incentives have expiry periods, or even for the mere fact that such incentives are subject

to periodical policy changes) and ‘place-bound’ (e.g. if state incentives are place-dependent)

among others. It is not out of place therefore that this thesis analyses investor-company

maneuverings over time while identifying obsolete as well as new FDI determinants.

The inquisition as spelt out in ‘Research Question 1’ can therefore in a nut shell be seen as a

search for FDI location as well as expansion or contraction determinants. ‘Research Question 2’

asks the same question about Wal-Mart China in order to ascertain the extent to which ‘FDI type

or form’ and ‘company interest’ determines the effect of conventionally and (or) empirically

identified FDI determinants.

1.1.1 Motivation

The importance of FDI cannot be overstressed. The World Trade Organization (WTO) issued a

press release specifically to respond to the growing importance of FDI (World Trade Organization,

1996). The interest in FDI is but an off-shoot of the broader interest in the forces propelling

globalization, as the WTO consents to. Thus, in many instances, foreign-owned production and

distribution facilities are cited as tangible evidence of globalization.

This paper is important insofar as FDI has gained prominence and with it China. My choice of

China and for that matter Wal-Mart China is not surprising considering the fact that the former is

the number one location for FDI among developing countries (Chen C. , 2011) and the latter, a

subsidiary of Wal-Mart Stores Inc. which is the world’s largest private employer and Retail

Company.

It has become more important for most developing countries to strategically position themselves

to attract more FDI in order to make up for the expected continued decline in development

assistance. In the words of the WTO (World Trade Organization, 1996), the world’s poorest

countries are in for the crucially needed capital, new technology, organizational skills etc. that will

foster job creation and economic growth.

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It goes to say therefore that, the inquisition for what determines FDI is not only important for

investing firms who are keen on juxtaposing host-country SWOT3 to their company-specific

SWOT, but also nation states who are keen on attracting more FDI. Particularly, information on

the changes in FDI values will bring to the fore reasons for FDI decline or increase – a crucial

ingredient in influencing FDI location determinants.

1.2 Delimitation

This thesis approaches the issue of determinants of FDI from the perspective of ‘what attracts

MNEs to host countries’ like tax incentives and market size rather than ‘what pushes them from

home countries’ like intense competition. In effect, all efforts have been put on China instead of

the US. Also, even though the determinants of FDI may include internal factors such as managerial

skills and production and service efficiency, this paper only concentrates on external factors’

effects on FDI such as tax rates and exchange rates. The paper is further delimited by way of the

choice of industry for analysis i.e. the Retail Industry. Specifically therefore, Wal-Mart China Inc.

a subsidiary of Wal-Mart Stores Inc. has been selected for the analysis. The paper has the

limitation of the ability to independently test and verify particular claims and findings. For reasons

of scope and the possibility of exceeding institutional requirements, this thesis avoids very specific

and overly detailed peculiarities of Wal-Mart’s FDI activities in China. Instead, a more general

overview which may be applicable to like-MNEs is taken. The thesis does not delve in any

substantive depth in any other comparable trends in other countries or other forms of FDI nor does

it discuss other FDI-determinant-neutralizing-factors such as the socio-political environment.

Instead, it focuses solely on the identified determinants and their interactive neutralizing effects.

The thesis thus also restricts itself to FDI inflows into China ignoring any issues of outflows since

the specific case of Wal-Mart China is an inflow into China. In the same vein the Exchange Rate

determinant is omitted in the analysis because it necessarily brings the home country into the

discussion. The thesis is however not affected by this omission as it assumes that Wal-Mart China

would not necessarily need to repatriate profits to its parent company for those profits to be subject

to exchange rate fluctuations. Also, even though an analysis of Wal-Mart China’s supply chain is

3 SWOT – *Strengths *Weaknesses *Opportunities and *Threats

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not done, it is assumed that the company sources most of the goods on sale from China and may

thus not be substantively influenced by exchange rates.

1.3 Thesis Structure

The paper is organized as follows: It begins with a literature review of the dialectic, characteristics

and external determinants of FDI in chapter 2. This is followed in chapter 3 by an analysis of FDI

inflows to China in general since the specific case of Wal-Mart China is an inflow. Subsequent to

that, in chapter 4 is an introduction to Wal-Mart Stores Inc., which is the parent company to Wal-

Mart China – allowing for a further breakdown of analysis into the activities of Wal-Mart China

in chapter 4.1.1 and then into the central analysis of this thesis i.e. concerning the determinants of

Wal-Mart’s FDI in China, chapter 4.1.1.2. Finally, an overview of the general findings answering

the research questions is delivered in chapter 5.

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CHAPTER 2 - Literature Review

2.1 Introduction

FDI, as a form of international capital flows, facilitates economic globalization or the

interconnectedness of economies. With the dramatic overall growth of FDI annual global flow

propelled by the multiplicity of MNEs and economic globalization, studies on FDI have made

very useful contributions to finance and management as well as to economic literature. The WTO

reports of an annual global FDI flow increase between 1985 and 1995, from about $ 60 billion to

an estimated $ 315 billion (World Trade Organization, 1996). In recent years, by the preliminary

estimates of the OECD, “global foreign direct investment (FDI) flows continued declining in the

third quarter of 2012 to USD 274 billion recording a decrease of -12% from the previous quarter

(-33 % from a year earlier). The stock of global FDI at end-2011 was estimated at USD 21.1

trillion, which represents 5% increase from 2010 and 27% increase from 2007” (OECD, 2013).

Obviously, the shock from the 2008 Global Financial Crisis and the European Sovereign Debt

Crisis is yet to be extinguished. Nonetheless, we can confidently assert that the prominence FDI

continues to get, both in real terms and in academia, is overwhelming and on course.

This chapter reviews recent literature on FDI in general but more critically on the determinants of

FDI. The crust of the issue of FDI determinants is the fundamental question of what motivates

MNEs to invest overseas. The macro-level theory of FDI suggests that, industries in capital-

intensive countries will invest in capital-poor, but labor-intensive countries in order to maximize

profits. The classical macro-level theory hypothesizes that the rate of profit has a tendency to fall

in industrialized countries, often due to domestic competition, which creates the propensity for

firms to engage in FDI in underdeveloped countries. Neo-classicalists argue that, “…

economically advanced countries, owing to their relative abundance of capital but scarcity of labor,

have low rates of profit or interest but high wage rates prior to international transactions.”

(Cantwell, 2000). H. Hymer criticized this theory for being too general, as it does not consider all

the peculiar anomalies in ascertaining the catalytic elements involved in overseas investments

(Yamin, 2000). His alternative; a micro-level theory. Hymer’s option was firm-specific away from

the country-specific view. He argued that, the fundamental reason for MNEs investing overseas is

the imperfect market. To him, the driver for the MNE lay with the individual firms, rather than the

country’s capital availability. Hymer argued that MNEs can only exist in an imperfect market,

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where firms have non-financial ownership advantages vis-à-vis the “oligopolistic”

interdependencies they share with other firms. To Hymer, only the largest firms like those in

oligopoly could conveniently offset the costs of being foreign. He assumes that all assets are

tradable by focusing heavily on firm to firm interaction. Dunning & Rugman (1985) criticizes

Hymer for focusing too much on the market-power approach while ignoring Coase’s transaction

costs theory. To him, cost-minimizing, transaction-specific assets could not be overlooked.

Expounding on the critic to Hymer, Yamin (Yamin, 2000) argues that, firms are in fact, proactive

in their use of advantages, contrary to Hymer’s assumption that firms merely react to structural

market failures. According to Yamin, oligopolies succeed through their size rather than possessing

an ownership advantage since assets increase competitiveness and encourage innovation. Yamin

claimed that in as much as Hymer’s theory holds that ownership advantages was to reduce

competition via the creation of oligopolies, it is incorrect. The fact that both the macro and micro-

level theories have elements of usefulness in ascertaining the determinants of FDI becomes lucid

as both emphasize capital and expansion. With internal factors’ effects on FDI as technologies,

ownership etc., and external factors such as exchange rates and tax both at play, Dunning’s eclectic

paradigm or the OLI (ownership – location – internationalization) paradigm attempts to

encompass elements of both macro- and microeconomic theories (Dunning J. , 1977). Dunning’s

proposition in the 'eclectic paradigm' was that, there are three factors of FDI activity determinants;

Ownership Advantages (O), Location Advantages (L) and Internalization Advantages (I).

Contrary to Hymer’s assumption that all assets are tradable, Dunning establishes that, the

combination of ‘the possession of assets (Oa) (which include tangible and intangible assets, such

as technologies and skill sets), and transaction-cost-minimizing advantages (Ot)4 (which include

factors which are generally intangible, such as the ability to have effective internal and external

communications) makes many ownership advantages untradeable. Embedded in the ‘Ot’ in this

instance is the culture of the firm, which renders holistic inter-firm transferability well-nigh

impossible. Perhaps the most crucial consideration Dunning made was the observation that

ownership advantages are not static, and that firms invest abroad to improve upon them – vis-à-

vis his 1995 reappraisal (Dunning J. H., 1995). He emphasized the need for a better recognition

of the role of innovation in sustaining and upgrading the competitive advantages of firms and

countries. He also advocated the inclusion of dynamic efficiency (e.g., market positioning) into

4 Abbreviations, Oa and Ot, from Dunning (1993), pp. 80

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theories of inter-firm cooperation or collective competition. According to Dunning “, the eclectic

paradigm needs to acknowledge that the traditional assumption that the capabilities of the

individual firm are limited to its ownership boundaries (and that, outside these boundaries, factors

influencing the firms competitiveness are exogenous to it) is no longer acceptable whenever the

quality of a firm's efficiency-related decisions is significantly influenced by the collaborative

agreements they have with other firms” (Ibid). On the other hand, the attraction of a foreign

location for production is equally significant in the eclectic paradigm of international production.

On the issue of internalization, Dunning stresses that ownership advantages need to be protected

and developed within a firm, rather than sold like Hymer suggests. Internalizing value-adding

activities by the transfer of ownership-specific advantages (Oa and Ot) across nations within a

firms corporations allows for swift international acclimatization and profiteering. Having a net ‘I’

advantages therefore would represent extra capacity to organize ‘O’ and ‘L’ assets profitably.

The discussions thus far, is purposed to give clarity to the dialectic revolving around the theoretical

foundations on the issues of what necessitates or motivates FDI by MNEs, and what is seen albeit

amidst conflicting views, in our current dispensation as constituting some of the most important

and prevalent factors of FDI activity determinants. Under the umbrella of these factors therefore,

what follows is a review of empirical evidences of specific elements that may affect FDI activity.

2.2 A review of Empirical Studies on the determinants of FDI

Although the specific factors likely to affect FDI behavior include internal factors such as firm-

specific characteristics (e.g. managerial skills and production or service efficiency), this paper

focuses on external factors. Tax, exchange rate, market size or market potential, human capital

especially labor cost and labor quality, international trade, and the development of infrastructure

have been overwhelmingly cited by researchers as part of the external factors determining the flow

of FDI. This chapter reviews previous findings of five of these external factors’ effects as per the

empirical analysis of numerous researchers.

2.2.1 Labor costs

In the wake of stiff global competition of FDI, developing countries such as China and India have

been the target for their relatively low labor costs. There is a lot of studies that explore the

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relationship between labor costs and FDI inflows. Most of these studies provide empirical

evidence of a positive link between labor and FDI levels.

Ping Zheng employed a two panel data set and two statistical models to identify the determinants

of FDI inflows from home countries worldwide to two host countries: China and India, by

considering both home and host-country characteristics (Zheng, 2009). His empirical results

suggested that, “economic growth, exports, labor costs, and country and political risk/policy

liberalization all exercise an important influence upon inward FDI of both countries”. But should

the effect of labor be taken for granted across country and varied forms of FDI?

An empirical analysis of the potential determinants of FDI inflows across the four regions of China

for the period 2001-2009 using a multiple regression model for each region, indicate that, FDI

determinants vary in effectiveness per region, and thus different governmental strategies are

needed to attract regional FDI inflows (Liu, 2012). Noteworthy is the papers resolution that, high

labor cost reduces the attractiveness of a region - nonetheless. Also indicated are varied region-

specific location determinants of FDI inflows, e.g. the physical infrastructure in the central region.

This clearly implies that specific regions are set to attract particular MNEs. It also implies that

governments can tweak region-specific FDI advantages through the provision of infrastructure

and incentives as well as the upgrading of the human capital, in order to help less developed inland

regions to attract FDI.

The rise of China as one of the world’s most sought after location for FDI has resulted in many

writers enumerating several reasons. Chief among these is the presence of abundant and relatively

cheap labor cost. However, in a recent article, Chen et al hinted that “the end of an era of low-cost

labor and the beginning of a more challenging labor environment for foreign-invested enterprises

(FIEs) and other employers in China” might indeed be the brain-child of the 2010 series of labor

conflicts against foreign-invested factories (Chen & Estreicher, 2011). They emphasized the

Chinese government’s renewed interest in labor market regulation, noting the employee statutory

rights law – the 2007 Labor Contract Law - and the minimum wage law issued in 2004 as evidence

that governmental focus has begun to shift from economic growth (as was the case with the then

PRC government in the early decades of the reform era) to include social harmony, political

stability, and better income distribution.

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2.2.2 Tax

In open economies such as the United States, the liberalization of capital flows implies that, firms

engaging in FDI enjoy the freedom of location-choice on taxation grounds. What comes to the

fore then is FDI-elasticity or FDI-reaction with regards to corporate profit taxation.

In his empirical research work, Joosung Jun (Jun, 1994), using data on investment in the United States

by ten other countries between the period 1980 and 1989, estimated the degree to which the tax

systems of both home and host countries affect FDI. He presented evidence that home-country

statutory tax rate significantly hurts FDI when the country subjects foreign-source income to home-

country taxation. According to Jun, weak performance of the host-country tax variable in the estimated

equations highlights the fact that host-country tax does not affect FDI location decisions as is

conventionally perceived.

In a document by Bénassy-Quéré et al however, it was resolved that, tax differentials rather than

tax levels should be the variable of decision since investors arbitrate not only among foreign

locations but also between each foreign location and domestic investment (Bénassy-Quéré,

Fontagné, & Lahrèche-Révil, 2004). Nonetheless, there are numerous reasons why FDI might be

insensitive to tax differentials among countries – as indicated by Joosung Jun. A sampled few are

as follows:

Table 1- Reasons for FDI insensitivity to tax differentials.

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“First, the use of transfer pricing and intra-firm debt contracting allows firms to shift

profits where taxation is the lowest, therefore disconnecting the location of profit and

production”

“…location decisions depend on the combination of taxation and public goods provision

available in host countries (Tiebout, 1956), which can soften the link between the tax level and

the amount of FDI located in a country. Along the same line, the impact of tax differentials on

FDI location decisions may not compare to that of structural determinants like the proximity to

final markets, the characteristics of competition on the labor and goods markets, and so on

(Markusen, 1995).”

“…Tax differentials can be an equilibrium outcome in an imperfect competition setting

combining economies of scale with trade costs and/or agglomeration forces (Haufler and

Wooton, 1999, Andersson and Forslid, 1999, Baldwin and Krugman, 2004, Ludema and

Wooton, 2000).”

Source: (Bénassy-Quéré, Fontagné, & Lahrèche-Révil, 2004)

To the contrary, using a panel of bilateral FDI flows across 11 OECD countries over the period of

1984-2000, Bénassy-Quéré et al finally established that although the impact of market potential

and the availability of public goods is undisputed, tax differentials also play a significant role in

driving FDI flows.

These findings bring to the fore the question of the nature of effects that tax differentials have on FDI

flows - the relative importance of quality and quantity effects of corporate taxation on FDI.

In a recent article sourced from the European Economic Review (Becker, Fuest, & Riedel, 2012), it

was held that the quantity of FDI is affected if corporate taxes reduce the equilibrium stock of foreign

capital in a given country, while quality effects arise if taxes decrease the extent to which investment

contributes to the corporate tax base and the capital intensity of production. The article, using detailed

data on European multinational firms claimed that, investment quantity variations is not the only

component in the measurement of investment distortions. There is also the efficiency cost of taxation

referring to the profitability of the incoming projects as well as labor income.

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In another article, while investigating whether the creation of special tax incentive zones is an effective

tax policy for China to induce new foreign direct investment (FDI) into specific regions, and whether

changes in the tax rules influence the particular form of foreign direct investment selected, i.e. equity

joint ventures, contractual joint ventures, and wholly foreign-owned enterprises; the result was in the

affirmative (Tung & Cho, 2000). Although Tung and Cho acknowledged that their research could not

adequately control for the correlated-omitted-variable, i.e. other governmental policies and socio-

economic changes that occurred simultaneously to concessionary tax rates, they still had the conviction

that changes in tax laws affect investment decisions. They showed that prior to 1991 in China, the total

project value of equity joint ventures increased faster than other forms of FDI like ‘contractual joint

ventures’ and ‘wholly foreign-owned enterprises’. This, according to their findings was due to the fact

that the tax laws prior to 1991 were more favorable to equity joint ventures. The story was different in

the aftermath of 1991, when tax incentives were granted equally to all forms of FDI – All FDI forms

showed similar growth patterns as expected.

In the words of the Jacques Morisset, “the effectiveness of tax incentives is likely to vary depending

on a firm’s activity and its motivations for investing abroad” (Morisset, 2003). According to Morisset,

tax rates generally have greater effect on the investment decisions of export-oriented companies than

on companies seeking the domestic market or location-specific advantages since they are not only

mobile but also operate in competitive markets with very slim margins. He also noted that tax

incentives may not necessarily be universally beneficial to for instance the state if it is indeed the case

that a particular company would have still invested – tax incentive bait notwithstanding. In which case

“free-rider” investors probably attracted by, and benefitting from the provision of public goods and

other resources are occasioned into a double meritorious situation, whiles the host-country treasury

loses, and its economy reaps no net gains. Some governments like that of Ireland and Singapore have

resorted to “targeted tax incentives” and have had marked successes, but as Morisset explains, this

strategy has proven to be challenging for many other governments seeking to attract FDI.

From the above discussions and indeed from the works of most experts, it is difficult to find any reason

why a lower tax, be it in rates or embedded in tax laws would not inure to the benefit of MNEs. It

therefore seems logical that higher taxes would as it were, be a deduction on the balance sheets of

corporations and thus add zero benefits to company profits – to say the least. But aside this fact is the

reality that MNEs don’t act solely tax impulse. As Morisset argued, some MNEs may choose an

investment location – tax rate or rules notwithstanding. The bone of contention has thus been the

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sensitivity of FDI inflows and variations in the project value as a result of tax differentials, rates or

incentives. It can conveniently be inferred that, it depends on what specific MNEs consider as most

crucial for their bottom line – after a holistic self-assessment and inspection of the business

environment. For instance, an export-oriented company may see taxes as highly influential in their

investment decisions while a retail company seeking specific advantages from the domestic market

may notice other more influential factors than tax.

2.2.3 Exchange rate

It is widely believed among scholars that future exchange rates has an effect on a firm’s cash flow

and thus its FDI decisions. Empirical studies however, provide mixed support for the correlation

between exchange rates and FDI.

Although a firm may face a certain price in a host country, given it was selling its produce there,

its returns in its home currency fluctuate if the bilateral exchange rate (between host and home

countries) fluctuates. This suggests that such a firm’s returns are subject to uncertainties. If the

exchange rate is defined as units of home currency per host currency, then a higher exchange rate

increases the home currency profits. So the volatility of exchange rate determines home-currency-

return volatility, ceteris paribus (Alba, Wang, & Park, 2010). Alba et al built on the works of

“Dixit (1989)”, who as they express, showed that “…greater price volatility leads to a wider range

of prices in which inactive firms do not enter and active firms do not exit. That is, uncertainty

expands the gap between the entry-triggering price and exit-triggering price, thereby deterring

both entry and exit”. They also most importantly built on the works of “Campa (1993)” whose

empirical evidence unlike “Tomlin (2000)” strongly support a significant effect of the real

exchange rate on the probability of FDI entry in US wholesale trade industries. In the context of a

model that allows for the interdependence of FDI overtime (with industry-environment

favorability), Alba et al employed an unbalanced industry-level panel data from the US wholesale

trade to conclude with two main findings. First, that FDI is indeed interdependent over time, and

second, that under a favorable FDI environment, the exchange rate has appositive and significant

effect on the average rate of FDI inflows. They indicate that, the insignificance of the value of

their measure of exchange rate uncertainty shows a sway from Dixit’s claim that exchange rate

uncertainty can deter FDI. They assert that sunk costs rather than exchange rate uncertainty deter

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the exit of FDI in their specific tests. Alba et al went as far as to suggest that, drawing from their

US wholesale sector empirical analysis, sunk cost for emerging economies (which could include

administrative costs due to governmental bureaucracy or red tape in undertaking FDI) could also

be the FDI discouraging factor in the wholesale sectors of these countries.

Even though there are no universally held exactitudes with regards to the level of effect that

exchange rates have on FDI, it is clear as the discussions suggest, that exchange rate is most

definitely an item on the watch lists of MNEs both in real time and in prospect – especially when

they seek to repatriate their profits to home countries.

2.2.4 Market

Markusen and Maskus suggested that the motivations for FDI can be divided into two types:

Market Seeking FDI (also called horizontal FDI) and Resource Seeking FDI (also called vertical

FDI) (Markusen & Maskus, 2002). According to them, vertical MNEs set out to locate skilled-

labor-intensive activities in skilled-labor-abundant countries and to basically exploit resource

advantages in the host countries while horizontal MNEs seek market in the host country and avoid

trade frictions. Their findings favor market seeking MNEs (what they refer to as the HOR model)

over resource seeking MNEs (i.e. VER model); identifying the former as considerably more

descriptive of world multinational activity than the latter.

For most market seeking MNEs, the market or growth rate of the market size is a very crucial

determinant for FDI. Recent empirical results from the work of Ranjan and Agrawal showed that

market size, trade openness and growth prospects among other factors are potential determinants

of FDI inflow in BRIC5 countries (Ranjan & Agrawal, 2011). The study employed a random effect

model on a panel data set consisting of annual frequency data of 35 years ranging from 1975 to

2009 to identify the FDI inflow determinants in BRIC countries. “Market size is generally

measured by Gross Domestic Product (GDP), GDP per capita income and size of the middle class

population.” (Ibid).

5 BRIC - * Brazil, * Russia, * India and * China

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2.2.5 Infrastructure

Infrastructure is one of the factors believed to have a notable effect on FDI location decisions. A

lot of previous studies have found significant correlations between measures of infrastructure and

FDI inflows. Havrylchyk and Poncet show their resonance with the views of “Berthélemy and

Démurger, 2000; Cheng and Kwan, 2000; Sun et al., 2002; and Zhang, 2001” on the fact that

infrastructure development is an FDI-attracting factor (Havrylchyk & Poncet, 2007). In the words

of Ranjan and Agrawal, “An established and advanced infrastructure facility of the host country

provides great platform for investment and leads to greater FDI inflow” (Ranjan & Agrawal, 2011).

2.3 Conclusion

Even though this paper shares the view of neo-classical macro-level theorists that economically

advanced countries have relative abundance with respect to capital and high wage rates, it is

opposed to their assertion that such advanced countries have scarcity of labor and low rates of

profit relative to economically poorer countries. The neo-classicalist view does not hold for all

economically advanced countries. China has been the second largest economy of the world since

2010 (World Bank, 2010). As a matter of fact, China’s economy grew from USD 5.9 trillion to

USD 7.3 trillion just from 2010 – 2011 (CNNMoney, 2011). However, China is still considered as

the foremost country with respect to ‘size of labor force’ and “by the end of 2012 China's

population at working age (15-64 years) was 1.0040 billion” (Central Intelligence Agency, 2013).

Furthermore, given the fact that rate of profits is subject to a lot of firm-specific variables, this

paper sides with Hymer. It is important to note however that ownership advantages of MNEs be it

vis-à-vis inter-firm oligopolistic interdependencies as expressed by Hymer or through Dunning

and Rugman’s cost-minimizing, transaction-specific assets have been projected in this paper only

to the extent to which these (firm-specific) ownership advantages neutralize the effects of

conventionally and empirically identified determinants of FDI. To this end therefore, this paper

identifies with Dunning’s 3-factor FDI activity determinants (in his eclectic paradigm), which

adds two more factors; ‘location’ and ‘Internalization’ advantages apart from ownership

advantages. These three factors come to play in the specific case of Wal-Mart Stores Inc. like

some other MNEs who have both ‘Oa’ and ‘Ot’; have responded invariably to ‘L’ advantages; and

have endeavored to replicate their vision and business modules across international subsidiaries.

P a g e | 21

CHAPTER 3 - Foreign Direct Investment in China (Inflow)

This section deals with FDI Inflows to China. It is intended to bring into perspective the FDI

environment that awaits MNEs. According to the United Nations Conference on Trade and

Development (UNCTAD), developing economies in 2012 absorbed an unprecedented US$130

billion more (of FDI Inflows) than developed countries, recording the second highest level ever

of US$680 billion (see figure 1).

Source: (UNCTAD, 2013)

As the world’s largest developing country and one of its fastest growing economies, with an

average real growth rate of gross domestic product (GDP) around 10 percent for the past three

decades; China continues to absorb the lion’s share of FDI among developing countries and to

cement an enviable position in the worldwide list of FDI recipients (Chen C. , 2011).

China’s FDI prows is largely owed to its economic and policy reforms since 1979, and the ensuing

integration with the world economy (Fung, Lizaka, & Tong, 2002). Fung et al divide foreign

capital inflow into three main forms, namely: foreign loans, foreign direct investment (FDI) and

other foreign investment. “In China, foreign equity capital inflows are classified as FDI only if

Figure 1 – Global FDI Inflows, 2000-2012

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they lead to a foreign equity stake at or above 25 percent” (Huang, 2003). Among the forms of

foreign capital inflows, FDI continues to gain prominence as it continues to outgrow other forms

of inflows. China’s FDI inflows constituted more than two thirds of total foreign capital between

the period of 1979 and 2000 (Fung, Lizaka, & Tong, 2002).

FDI trend in China can be delimited according to changes in policy directions, the first step

between 1979 and 1983, the second one between 1984 and 1991, and the third one between 1992

and today.

Although FDI inflows in China have had incremental growth in general since the late 1970s, many

scholars have sought to examine the periodical characteristics regarding the rate of growth – in

order to ascertain the causes of growth variations. Fung et al enumerate some reasons why China

recorded a relatively low FDI inflow of 12 percent of total actual foreign capital utilization - in

the ‘first step’ (1979-1983). These reasons included uncertainty in property rights, fear of policy

reversal and the lengthy process of bureaucratic approval. The investment climate in China has

since improved overall, leading to increased FDI growth pace. However, incidences such as the

political turbulence in 1989, fund shortage problems due to the government’s tight credit squeeze

and tax-incentive-instigated establishments of phony joint ventures contributed to a decline in the

FDI utilization percentage in the ‘second step’ (1984 and 1991) even though contractual FDI

surged to a record high (Ibid). It is not dismaying therefore that Chunlai Chen, largely in

agreement with Fung et al, describes the entire period from 1979 to 1991 as “the experimental

phase”6. The consensus is that, China’s FDI boom gained significant pace after 1992 “ … after the

then Chinese leader Deng Xiaoping launched a new wave of economic reforms…” (Wang, Wei,

& Liu, 2007).

In recent years, in the light of world economic turmoil, China’s surge in FDI utilization has been

on a downward spiral even though the Asian giant still enjoys favorable FDI-location-choice

rankings. According to UNCTAD, countries in the developed world suffered a much graver

decline in FDI flows with EU countries having a fall of US$150 billion while United States’ fell

by US$80 billion. China however, in the wake of strong downward pressure on FDI in

6 Chen C. broadly divides the growth of China’s FDI Inflows from 1979-2009 into three phases : the

experimental (1979-1991), boom (1992-2001), and post-WTO (2002-2009) - (Chen C. , 2011)

P a g e | 23

manufacturing caused by rising production costs and weakening export markets, still managed to

decline by only 3.4 percent, largely because of the country’s ability to sustain investor confidence

through a 7.8 percent economic growth in 2012 (UNCTAD, 2013). As a matter of fact China,

according to the OECD, attracted the lions share with “USD 170 billion followed by the United

States (USD 104 billion), Brazil (USD 48 billion), the United Kingdom (USD 47 billion), and

France (USD 46 billion). These five host economies received 45% of global inflows during first

nine months of 2012 (as opposed to 37% in the first three quarters of 2011)” (OECD, 2013). A

discussion of the forms of the FDI that flow into China is thus important considering the fact that

China has used policies to attract specific FDI forms

3.1 Forms of FDI in China

There are essentially five forms of FDI in China namely; equity joint ventures (EJVs), contractual

joint ventures (CJVs), wholly foreign-owned enterprises (WFOEs), joint exploitations, and

foreign-funded share-holding enterprises.

3.1.2 Equity Joint Venture (EJV)

An EJV also known as shareholding corporations refers to limited liability companies with a

shared equity and management between both Chinese and foreign partners. Risks, losses and

profits are thus shared between partners on a pro-rata base with foreign partner’s contribution

expected to be no less than 25 percent of the total investment (Meng, 2010) (Dang, 2008) . EJV

is the earliest form of FDI in China necessitating the adoption of a guiding regulatory law – the

first Chinese foreign trade law, “The law of the People’s Republic of China on Chinese-Foreign

Equity Joint Ventures” of 1979 (Ibid). EJVs accounted for about 8.4 percent of total FDI Inflow

in China from 1979-1982. The figure rose rapidly to about 60 percent in the late 1980s “as the

share of Contractual Joint Ventures dropped” and started to plummet in 1990 as WFOEs started

surging (see figure 2).

3.1.3 Contractual Joint Venture (CJV)

CJVs, also called Cooperative Operation Enterprise like EJVs are established jointly by both

Chinese partners and foreign investors but this time with preset operating terms and conditions in

P a g e | 24

venture contracts. Also, unlike EJVs, CJV profits and losses are not shared in accordance with the

proportions of capital shares but as per preset venture agreement (Meng, 2010). The importance

of CJVs in the early years of China’s Reform have been suggested to be due to the inherent low-

risk and flexible form of cooperation especially for foreign partners (Ibid). Notice the ‘about 45

percent share of total FDI’ that CJVs wielded between 1979 and 1982, and the subsequent

dwindling of CJV importance from (figure 2)

3.1.4 Wholly Foreign-Owned Enterprise (WFOE)

As indicated in the name, a WFOE “is limited liability company established on the territory of

China with foreign investment only” (Dang, 2008) (Meng, 2010). Therefore the foreign investor

enjoys complete control over the business – implying also that risks, gains and losses are fully

absorbed by him. WFOEs operated under Chinese law in what is classifiable in the early stages of

the reform as largely a planned economy. “The law on Enterprises Operated Exclusively with

Foreign Capital (1986) and its Enforcement Regulations (1988)” governed WFOE activities (Dang,

2008). It was not until the 1990s when FDI restraint-knobs were loosened to garner high-tech and

export-oriented FDI projects that WFOE growth picked up to about 50 percent in 1999 (see figure

2). Notice also the catapulted WFOE growth rate after China’s abolishment of WFOE requisite

‘high-tech specifications’ in consonance with WTO entry demands in 2001.

3.1.5 Joint Exploration (JE)

JE is the abbreviation of “maritime and overland oil joint exploitation”. It is a form of cooperative

investment widely adopted in the international natural resources industry characterized by high

risk, investment and reward (Zhang, 2011) (Meng, 2010). Similar to CJVs, JE risks and rewards

are distributed according to agreed shares. JE’s share of total FDI as shown in figure 2 – shows

dwindling importance from a high in the early years of China’s opening up of above 40 percent.

3.1.6 Foreign-Funded Share-Holding Enterprises

This form of FDI is formed by foreign investors and Chinese enterprises and is similar to EJVs in

the sense that responsibilities are proportionate to share-holdings. However, it is different from

P a g e | 25

EJVs because of the requirement that foreign investor share-holdings should be at least 20 percent

of company registered total capital (Meng, 2010).

Source: (Meng, 2010)

To some extent, the determinants of firm-specific FDI can be traced to the firm’s FDI type or form,

as the varied forms have different advantages and disadvantages. It is also possible to infer that

the forms of FDI that represent the main means adopted by the Chinese government to attract

foreign investment would be more favored vis-à-vis tax incentives and business environmental

enhancements. Zhang shows the main advantages and disadvantages for three forms of FDI he

considers are most interesting to the Chinese government (Table 3).

Figure 2 - Contributions of Foreign-Invested Enterpises (FIEs) to total actual FDI

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Source: (Zhang, 2011)

3.2 FDI Regulations and Policy Drifts in China

With the gradual opening up of China’s economy came changes, amendments and enactment of

policies and regulations. Policy and regulatory manipulations have been a weapon in the Chinese

government’s arsenal with which it determined which FDI form or type to favor most. Therefore,

given that the goal of this essay is to ascertain what determines FDI in China, it is important to

highlight the attractiveness and deterrence that these legislations have proffered on foreign

investors thus far. To increase export level’s for instance, China implemented compulsory, neutral,

Table 2 Advantages and disadvantages of different forms of FDI

P a g e | 27

and voluntary FDI policies. The policies with compulsion required that “FDI shall be able to keep

a balance of exchanges, or make sure the proportion of their domestically made products in the

total number of products reaches a certain benchmark, or a certain percentage of their products

must be exported.”7 (Long, 2005). Left on the surface, this strategy would pass for what the OECD

refers to as FDI hampering restrictions (OECD.org). However, China’s entry into the WTO in

December 11, 2001 brought a degree of openness under which the country started establishing

more rapidly, a legal infrastructure conducive to market development (Chen A. , 2006). In

compliance with the “TRIMs”8 agreement of the WTO most compulsory requirements were thus

eliminated by the China legislative apparatus. China has as a result “…implemented neutral (such

as refunding of VAT for export) and voluntary policies (such as tax preference and trade

facilitation) to promote exports” thereby revising the “Guiding Directory”9 (Long, 2005). Post

WTO amended laws regarding foreign investment, intellectual property and foreign trade

included; “Enterprise Law on China-Foreign Cooperative Management, Enterprise Law on

China-Foreign Joint Investment, Foreign Enterprise Law, Patent Law, Trade Mark Law, Copy

Right Law, and the Export and Import Commodity Inspection law” (Chen A. , 2006). Long

demonstrates that Foreign Invested Enterprises in China are entitled to policy-driven differential

treatments depending on the region and industry. He highlighted two Chinese policies to make his

point – i.e. “…Develop China’s West at Full Blast” and “Strategy of Reviving Rusty Industrial

Bases” aimed at encouraging FDI into the western and northeast regions of China. The OECD

however has hinted as per available evidence that, tax incentives such as described above are more

likely to attract small and medium-sized enterprises and short-term investment projects than large

multinationals. For further analysis in subsequent chapters, a list of some landmark laws and

regulations as well as the amendments of same from China’s Reform era till date follows – sourced

from (OECD, 2008) and (Zhang, 2011).

First Stage – 1970s to late 1980s

7 Law on Foreign-Invested Enterprises, PRC. 8 Agreement On Trade-Related Investment Measures : “Desiring to promote the expansion and progressive

liberalisation of world trade and to facilitate investment across international frontiers so as to increase the economic

growth of all trading partners, particularly developing country Members, while ensuring free competition” (www.wto.org).

9 A legal document which contained different preferential treatments accorded to enterprises in various

industries. This document according to Long, 2005 divides FDI-involved projects into four categories, namely;

encouraged, allowed, restricted, and prohibited projects.

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1979 – Introduction of the Law of People’s Republic of China on Joint Ventures Using Chinese

and Foreign Investment: purposed to incentivize joint ventures and provide legal clearance

for foreign investments.

1980 – Introduction of the Law of the People’s Republic of China on the Income Tax of the China-

Foreign Joint Ventures.

1981 - Promulgation of the Law of Foreign Enterprise Income Tax: which apply also to

contractual joint ventures apart from foreign enterprises.

1983 – Promulgation of the Act on the Implementation of the Law on Joint Ventures: purposed to

guide and enhance FDI-attracting incentive policies.

1986 – Introduction of the Law on Enterprises Operated Exclusively with Foreign Capital:

purposed to allow the entrance of WFOEs into the Chinese market.

Second Stage – 1990s to 2001

1991 – Introduction to a new Corporate Income Tax Law for Enterprises with Foreign Investment

and Foreign Enterprise: Intended to replace the 1980 and 1981 stated above, and purposed

to provide a more extensive range of ‘business sector’ and ‘location dependent’ incentives

for FDI.

1995 - Issuance of the Provisional Guidelines for Foreign Investment Projects: purposed to attract

foreign investment into more sectors of the Chinese economy (i.e. transportation, high-

tech. etc.).

Third Stage – 2001 till date

2002 - Revision of the Guidelines for Foreign Investment Projects following China’s accession

to the WTO in December 2001. This version contained amendments that appropriately

reflected the new wave of liberalization of China’s investment regime. “The number of

encouraged industries were increased from 186 to 262, while the number of restricted

industries was cut from 112 to 75”.

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2006 - Introduction of new set of regulations on the Acquisition of Domestic Enterprises by

Foreign Investors by the Ministry of Commerce (MOFCOM), China: purposed to prevent

the foreign acquisition of leading Chinese firms in critical sectors.

2007 - Promulgation of Enterprise Income Tax Law applicable for the first time to all enterprises

established in China and replacing the ‘Foreign-Invested Enterprise Income Tax Law’ and

the ‘Interim Enterprise Income Tax Regulations’ that applied to domestic enterprises. This

law establishes a level playing ground by setting a single 25 percent tax rate for all resident

enterprises regardless of ownership – thereby replacing the ‘15% against 10%’ enterprise

income tax rates for Foreign-Invested and domestic enterprises respective. This essentially

becomes a check against “round-tripping”10 but the possibility of discouraging formerly

incentivized foreign investment is also present.

It is worth noting however that concerns about the related issues after the cancellation of

several Previous Tax Preferential Policies on Foreign-Invested Enterprises and Foreign

Enterprises, did lead the State Administration of Taxation (SAT) to issue a circular. The

circular gave the foreign-invested enterprises (given that investments were completed

before the end of 2007 and were not made with profit earmarked for distribution) the

opportunity to apply for tax refund on direct re-investment of post-tax profit utilized to

increase registered capital or set up another foreign-invested enterprise. For the same

deadline of 2007, incomes obtained by foreign enterprises from the transfer of know-how

or allowance of credit to China were exempted from tax. Finally, the circular specifies that

a change in the ability of a foreign-invested enterprise to meet the original legal conditions

for preferential treatment after 2008 (due to changes in the nature of production or duration

of business operations) will render previous tax reductions or exemptions refundable.

2007 - The promulgation of the Property Rights Law of the People’s Republic of China: purposed

to establish a firm basis for the protection of both local and foreign investors by the

inclusion of the protection of private property (resulting thus in a landmark change to

China’s state constitution in 2004). “The law states that the State shall develop the public

10 Used here to refer to the actions of Chinese companies who seek to unduly benefit from incentives

offered to foreign investors by disguising in-country capital as FDI.

P a g e | 30

sector while at the same time encouraging, supporting and guiding

the development of non-public sectors of the economy”. It also

explicitly states that “the property rights of the State, collectives,

individuals and others are protected by laws and may not be infringed

(Article 4)”.

2007 - The adoption of the Anti-Monopoly Law of the People’s Republic of China being the first

full competition law. This is applicable to all relevant domestic and foreign-owned

enterprises and is prohibitive of “monopoly agreements” (such as commodity price fixing

and changing), “abuse of market dominance” (such as constraints on counter-parties to

enter into exclusive transactions without a justification), “concentration of business

operators” and the “abuse of administrative powers to eliminate or restrict competition”

( such as the imposition of discriminatory fees, product prices, standards and technical

requirements).

2007 - Revision of the Catalogue for the Guidance of Foreign Investment Projects with mainly

additions of new sectors to all the areas of the catalogue (i.e. encouraged, prohibited,

restricted and permitted categories). Chief among these – the additions to the encouraged

list of projects. Notable are projects interested in the technology to help address safety

concerns such as “food quality inspection and monitoring equipment; anti-bacterial

equipment for food powder; bacteria-free solid and semi-solid food packaging facilities;

and bacteria-free packaging materials.”

In the wake of numerous fulfilled investment targets such as the share FIEs in China’s

merchandise exports of 57.5 percent in 2008 and a relatively comprehensive industrial base, the

Chinese government is no longer encouraging a boost in exports and is instead encouraging

foreign investment targeting the domestic market (OECD, 2008).

CHAPTER 4 - The case of Wal-Mart

4.1 About Wal-Mart Stores Inc.

Walmart Stores Inc. is the world’s largest private employer and retail company founded by Mr.

Sam Walton in Arkansas in 1962 (Wal-Mart, 2013). “Wal-Mart operates retail stores in various

formats worldwide - discount stores, supercenters, neighborhood markets and club stores in

P a g e | 31

countries like the US, Argentina, Brazil, Canada, Central America, Chile, China, Japan, Mexico,

Puerto Rico, and the UK” (GlobalData, 2012). Walmart offers branded as well as private label

products of various categories. The company boasts of more than 200 million customer and

member visits to their more than 10,700 stores under 69 different banners across 27 countries. It

has e-commerce websites in 10 countries and operates its business through three reportable

segments, namely Wal-Mart US., Wal-Mart International and Sam’s Club. Walmart has enjoyed

continuous growth in revenue over the period 2008-2012 recording a 5.95 percent increase in

revenue and a 3.98 percent increase in operating profit in 2012 over 2011 (GlobalData, 2012) (see

figure 3). However, Wal-Mart recorded a decrease of 4.21 percent in the net profit the same period

signaling an increase in deductibles.

Wal-Mart’s 2013 revenue followed the trajectory of increased revenues in past years recording

approximately $466 billion (Wal-Mart, 2013). Wal-Mart employs more than two million

associates worldwide to fulfil its core mission, which is to “save people money, so they can live

better, and continue to make a difference in the lives of our customers, members and associates”

(Ibid).

Figure 3 - Performance Chart for Wal-Mart Inc., (2008-2012)

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4.1.1 Wal-Mart China

Wal-Mart started its operations in China in 1996 with the opening of a supercenter and Sam’s

Club in Shenzhen. Through joint ventures in China, the company has total retail units till date of

393; constituting Walmart Supercenters of 349, Sam’s Club of 8, Neighborhood Market of 2,

Discount Compact Hypermarket of 5 and Trust-Mart Hypermarket of 29 (Wal-Mart, 2013). The

supercenters have an average store size of 170,000 square feet and combine a complete

supermarket and general merchandize for a one-stop shopping experience (Ibid). Sam’s Club have

an average size of 232,000 square feet and is a membership club that sells products to both

business customers on wholesale, and to private end consumers on retail. Neighborhood Markets

are relatively small with an average store size of 47,000 square feet selling limited general

merchandise, fresh produce, groceries among other things. Even smaller in size are Discount

Compact Hypermarket with 45,000 square feet carrying full assortments of products in a smaller

setting than supercenters. Trust-Mart Hypermarkets are quite sizeable stores with an average of

157,000 square feet that combine a complete supermarket and general merchandise store like

‘Walmart Supercenters’ to provide a one-stop shopping experience. Wal-Mart is not without

competition in China. It has fierce competition from Carrefour (France), Metro (Germany) and

other giants in the Chinese retail sector. Wal-Mart is no. 2 in the Chinese market share, behind

China-based Sun Art Retail Group Ltd., a joint venture between Taiwanese conglomerate Ruentex

Industries Ltd. and France's Groupe Auchan SA (Burkitt, 2013).

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Source: (Wal-Mart, 2013)

4.1.2 Determinants of Wal-Mart’s Foreign Direct Investment in China

Even though Wal-Mart met China in 1996, their love affair certainly started much earlier when

China embraced the world through its 1979 reforms. The baits, in the form of legal regimes etc.,

China put in place to attract the already successfully-engaged US-founded Wal-Mart, are here

discussed as necessary catalysts. In the purview of all the generally held views about what

constitutes the determinants of FDI, this section sets out to present an overview and suggests what

could be counted as motivating factors of Wal-Mart’s FDI in China.

The story of China’s FDI as espoused thus far exemplifies periods conducive and otherwise to

companies running varied forms of FDI. It can however be argued largely in consonance with

Yamin’s postulation that when it comes to the intensity of the effects of FDI-affecting factors, size

does matter. This is considering the fact that host-country negative effects on company

Figure 4 - Milestones of Walmart China

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productivity could easily be withered away by retail giants like Wal-Mart in anticipation of

projected future gains.

Even though Wal-Mart US operates more than 4000 stores out of the overall over 10,700, the

company’s faster growing international division, seen as exclusively among the three largest

retailers in the world with $125 billion in sales, remains the company’s primary growth engine

(Wal-Mart Stores, Inc., 2012). The key Ratios and Statistics indicating the company’s overall

financial strength, profitability etc. show that Wal-Mart’s motivations and actualizations have

been generally fruitful. From 2011-2013, the company recorded a faster rate of increase in

‘Income before Tax’ than that of the ‘Income Tax’ itself (Appendix 5). This is a hint that not every

increase in deductibles is adverse to company progress. Nonetheless, the key issue for this thesis

is the fact that Wal-Mart continues to pursue international expansion – specifically in China. The

question of what determines Wal-Mart’s continued Investments and expansion is here going to be

analyzed primarily vis-à-vis the identified ‘FDI determinants’ discussed in the literature review

chapter. This is to attempt a gauge of their correlation to FDI flows, using Wal-Mart only as a

guide in order to garner a moderated level of specificity. Most of the analysis will thus not be

exclusive to Wal-Mart, as the company is analyzed largely on the basis of its nature, goals and the

FDI form it undertakes in China (i.e. Equity Joint Venture). A look at Wal-Mart’s financials over

the past 50 years shows a company on the right path, i.e. on the right side of overall earnings

(Appendix 3). However, instances such as the shutdown of four and three stores in 2012 and 2013

respectively suggest that Wal-Mart’s Chinese investment is equally subject to FDI-determinant

factors as is Media Markt, which is reported to be leaving China by March 2013 (CAIXIN MEDIA

(China), REUTERS, 2013). Even if Wal-Mart’s moves are strategy-propelled, say for relocation

purposes, it still hints that they are being driven by regional location-specific advantages or

disadvantages.

This chapter adopts the resolve of the “Experts’ Meeting on Foreign Direct Investment in

Developing Asia – November 2003” that there essentially are two broad factors that affect FDI:

first, ‘Non-Policy Factors’ including the effects of gravity (e.g. market size and distance) and

Factor Proportions i.e. relative endowments of different inputs), and second, ‘Policy factors’

(Nicoletti, Golub, & Hajkova, 2003). In line with Markusen and Maskus’s suggestion that the

motivations for FDI can be divided into two types; i.e. market seeking FDI (or horizontal FDI)

P a g e | 35

and resource seeking FDI (or vertical FDI), it was also resolved that the influence of FDI-affecting

factors is dependent on whether the FDI in question is horizontal or vertical . Having identified

the general guide for the chapter analysis, a discussion of what may constitute Wal-Mart’s

motivations for FDI in China, taking a cue from the identified FDI determinants in chapter 2

ensues.

4.1.2.1 Market

Chief among the determinants of Wal-Mart’s FDI in China is its interest in the increasing retail

market size vis-à-vis China’s growing population. The increasingly affluent middle class coupled

with the fact that China remains a price-conscious market, has worked in favor of Wal-Mart’s

EDLP11 and EDLC12 strategies (Datamonitor Plc., 2005). Wal-Mart has thence affirmed their

pursuance of middle-income customers in high-growth markets such as “Brazil, China and Mexico”

and announce intentions to further add between 30 and 33 million square feet of retail space to

their international segment in the financial year 2013 (Wal-Mart Stores, Inc., 2012). In fact, the

company has entered into e-commerce; buying a “51% stake in Chinese e-commerce company

Yihaodian” in 2012 in order to further exploit the “explosive growth of online retailing in

emerging markets” (Burkitt, 2013) (Wal-Mart Stores, Inc., 2012), which is in consonance with

Dunning’s view to the extent that it is an innovation aimed at sustaining and upgrading the Wal-

Mart’s competitive advantage. As identified in the empirical studies of Rajan and Agrawal

(chapter 2.2.4), for market seeking MNEs like Walmart, the market size and growth prospects are

among the factors that determine FDI. It is presumed therefore that prior to Wal-Mart’s entry into

China in 1996, location advantages like market size and growth served as major attractions and

that the company surmounted entry barriers largely because of its size and ownership advantages,

e.g. Company abilities and expertise with regards the replication of the Walmart model – in

conformity with Dunning’s Eclectic Paradigm (OLI). The company is also seen as benefiting from

successful Internalization for its adaptability and ability to effectively deploy the EDLP and EDLC

strategies in China.

11 EveryDay Low Prices – for customers. 12 EveryDay Low Cost – with the aim being low-cost market leaders

P a g e | 36

A look at the growth trajectory of China’s retail market in order to gauge the effects it must have

had on Wal-Mart’s FDI activities is therefore not out of place. In a recent publication by Jones

Lang LaSalle on the Chinese retail investments the fundamentally sound growth trajectory and

remarkable prospects of China’s retail sector was highlighted (Jones Lang LaSalle, 2012).

Source: (Jones Lang LaSalle, 2012)

Figure 5 - China Retail Investment Volume 2006-2011

Figure 6 - Proportion of Retail Investment Reached New High Figure 7 - Distribution of Investment in 2011 by Pdt. Type

Figure 9 - Retail Sales Performance Holding Up... Figure 8 - ...Supported by Healthy Disposable Income Growth

P a g e | 37

Figures 5-7 clearly indicate a lucrative business environment of which Walmart is very much part.

The three figures show the competitive nature and trend Retail Investments have taken from 2006-

2011. Figures 5 and 7 highlight the effects of the 2008 Economic Downturn but the fast bounce-

back after 2009 shows how intense the attraction to the Chinese retail market is to companies like

Wal-Mart. It can therefore be conveniently inferred that for Wal-Mart as well as like companies,

the attractiveness of Chinese market potential dwindled when other factors like overall economic

situation, apparently because these are MNEs and take a hit when the global economy suffers. In

figure 4, the response mechanism of Wal-Mart shows an attempt to not necessarily cut back on

investment but to diversify and innovate as soon as 2010. Wal-Mart tuned its attention to what it

envisaged would help the company offset the cost of being foreign – online shopping. The fact

that that Wal-Mart continued to expand even in this period opening its first environmentally

friendly store in Beijing in 2008, suggests that as a market seeker, the company was in China to

stay. Presumably, Wal-Mart having stayed in China since 1996 must have had exit-hindering sunk

costs as Alba et al explain (see chapter 2.2.3). Figures 8 and 9 clearly indicate a positive correlation

between Consumer Confidence and Retail Sales that to a large extent explain Wal-Mart’s

determination to continue expansion. With the presumption that Consumer Confidence is an

offshoot of Consumer Disposable Income, it is indicative that the dips in figure 9, i.e. 4Q08 –

2Q09; 4Q09 – 2Q10; 4Q10 – 2Q11, have been exactly reflected in figure 8. It follows therefore

that healthy Chinese Disposable Income, which affects Consumer Confidence would also

invariably determine retail sales and by extension, Wal-Mart’s sales. So the possible extent to

which these market indicators, i.e. Disposable Income and Consumer Confidence affect Wal-

Mart’s investment volumes for instance could be deduced albeit without exactitude from the

performance of the associated retail sales. It is assumed therefore that a dip in sales especially

protractedly will invariably affect Wal-Mart’s FDI and potentially even cause shut-downs or

relocations (as exemplified in appendix 5). As indicated in chapter 2.2.4, “Market size is generally

measured by Gross Domestic Product (GDP), GDP per capita income and size of the middle class

population” (Ranjan & Agrawal, 2011). The indicators leading to the size of China’s economy

(with USD1.3 trillion in 2001) surpassing France (also with USD1.3 trillion in 2001), the United

Kingdom (with USD1.5 trillion in 2001), Germany (with USD1.9 trillion in 2001) and Japan (with

as high as USD4.2 trillion in 2001) indeed form the integral basis for which market seekers like

Wal-Mart have sought to invest in China (CNNMoney, 2011). As indicated earlier, China has been

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second to the US since 2010 in the worldwide ratings of ‘economy size’. High GDP growth is

expected to progressively give rise to more middle income customers for market seeking MNEs.

As Wal-Mart indicates in their 2012 Annual Report; “In high-growth markets, such as Brazil,

China and Mexico, we pursue middle-income customers who look for quality and value” (Wal-

Mart Stores, Inc., 2012). Figure 10 and appendix 6 show that against most odds China’s GDP and

GDP per capita growth were comparatively better than both the United states and Japan

(comparing from 2001-2011). Despite the global shock of the 2008 financial crisis, China unlike

the US and Japan managed to stay afloat atop the five percentage growth rate. The US and Japan

on the other hand continue to languish below that rate after all this while. This simple comparison

shows both resilience and sustainability of China’s GDP and GDP per capita growth, which is a

necessary ingredient in attracting and maintaining MNEs like Wal-Mart.

Source: World Development Indicators

Figure 10 - China's GDP growth and GDP per capita growth (1967-2011) (annual %)

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4.1.2.2 Labor cost

Across the various forms of FDI (i.e. discussed in chapter 3.1), labor cost seems to be one of the

most applicable. As a resource, the labor force of China attracts both resource seeking MNEs

(Vertical FDI) and market seeking ones (Horizontal FDI). China is the world’s most populous

country with a population of 1,344,130,000 in 2012 (World Bank, 2013) estimated to reach

1,349,585,838 by July, 2013 (Central Intelligence Agency, 2013), and as a consequence of that it

possesses a rich source of labor with relatively lower cost. By the end of 2012, Chinese population

at working age (15-64 years) as indicated earlier was 1.0040 billion. The possible effect that the

cost of labor can have on FDI has been addressed in chapter 2.2.1; however, for the case of

Walmart and like, MNEs remain one of the crucial FDI determinants. There is a clear difference

between ‘what has been the case’ and ‘what is yet to come’. When we put the former into

consideration, then Wal-Mart’s overall performance in China (as exemplified in figure 3) coupled

with its expansion efforts seem to suggest that an in-depth analysis of FDI sensitivity to labor cost

would inevitably arrive at the obvious, i.e. that Chinese market conditions have been favorable to

the extent of containing labor costs. This then is a clear example of one FDI determinant

overshadowing another otherwise potent determinant. When we put the latter into consideration

however, a number of key assumptions can be made, as also indicated by Chen & Estreicher, 2011

(see chapter 2.2.1 - last paragraph). Wal-Mart China’s prospective sensitivity to labor cost

variations is exacerbated by the fact that it will be difficult to raise wages and salaries without

price increases. Given the fact that the company’s prices are already very low vis-à-vis its EDPL

strategy, a substantive increase in labor costs could may leave the firm option-less except for

cutting back FDI. This effect is still subject to the possible overshadowing of market effects where

possible, since favorable sales is basically able to give the company the needed option to avoid

FDI project value manipulations.

4.1.2.3 Tax

The promulgation of laws specifically in 1979, 1980 and 1983 marked periods of favorable tax

laws to Equity Joint Ventures like Wal-Mart China Inc. (see chapter 3.2). This is in harmony with

the relatively faster growth of the total project value of Equity Joint Ventures in the years

preceding the 1991 promulgation of the new Corporate Income Tax Law for Enterprises with

P a g e | 40

Foreign Investment and Foreign Enterprise (see chapter 3.2) (Tung & Cho, 2000). Under which

law incentives were granted equally across all FDI forms and WFOEs took over the pace of growth

(see figure 2). Nonetheless, tax behaves in a similar way as labor cost – acting as deductibles from

what Walmart garners from the Chinese market in terms of sales. Therefore, tax increases would

not necessarily take effect on Wal-Mart’s FDI. This determinant (i.e. tax) – be it home/host-

country differentials, absolute host-country rates or embedded in laws will only make an impact if

the paramount determinant - i.e. Market fails to intervene. Wal-Mart’s motivations for investing

in China makes credible the claim in the preceding sentence (Morisset, 2000 – elaborated upon in

chapter 2.2.2).

4.1.2.4 Infrastructure

For a market seeker like Wal-Mart, the provision of public goods in China can further soften the

link between other FDI determinants (e.g. the tax level) and the amount of FDI the company

invests in China (Bénassy-Quéré, Fontagné, & Lahrèche-Révil, 2004) (table 1). As hinted in ‘table

1’, infrastructure development plays a major role in influencing FDI location choices across the

various forms of FDI. As Bénassy-Quéré et al indicates “the impact of tax differentials on FDI

location decisions may not compare to that of structural determinants like the proximity to final

markets, the characteristics of competition on the labor and goods markets…” “Infrastructure

investment has been the engine driving the economic growth of China” (Chuan, 2008).

Infrastructure is an important FDI determinant across board also because it promotes economic

growth – given the fact that it is the ‘street’ on which every FIE operates. Judging from the fact

that even ‘the market’ for Wal-Mart China as a determinant of FDI is severely subdued in the

absence of adequate growth-fostering and market-linking infrastructure, it is not wrong to put

infrastructure development as the next on the watch list of Wal-Mart in the determination of FDI

location as well as business expansion decisions. In a recent article, Wang Wei, head of the Wal-

Mart China's general affairs department attributed lowered costs to a Chinese government-initiated

program to link farmers' products and supermarkets directly (Xinhua, 2010).

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CHAPTER 5 - Conclusion

This thesis has succeeded in collating overwhelmingly acclaimed determinants of Foreign Direct

Investment and in testing these conventionally known determinants against the undertakings of a

prominent Multinational Enterprise: Wal-Mart Stores Inc. The goal as spelt out in chapter 1.1 was

essentially to “ascertain the extent to which FDI type or form’ and ‘company interest’ determines

the effect of conventionally and (or) empirically identified FDI determinants”. Identified FDI

determinants included: Market, Labor Costs, Tax, Infrastructure and Exchange Rate. It was

determined that all these determinants fell under two broad FDI-affecting factors, i.e. Policy and

Non-Policy effects in consonance with Nicoletti et al’s view (Nicoletti, Golub, & Hajkova, 2003).

Put in other words, the identified determinants ‘shoot their FDI-affecting venom’ through Policy

(e.g. host country regulations) and Non-Policy factors (e.g. GDP growth rate). However, the

determination of the potency of these venoms lie with the type of MNE, i.e. horizontal or vertical

and to some extent, the form of FDI, i.e. equity joint ventures (EJVs), contractual joint ventures

(CJVs), wholly foreign-owned enterprises (WFOEs), joint exploitations, and foreign-funded

share-holding enterprises. The case of Wal-Mart China highlighted policy-driven FDI-affecting

factors like the 1979 Law of People’s Republic of China on Joint Ventures Using Chinese and

Foreign Investment which was purposed to incentivize joint ventures and provide legal clearance

for foreign investments. This promulgation like the 1980 and 1981 laws on income tax all sought

in one way or another to foster specific FDI forms – including, and of relevance to this paper; joint

ventures (Wal-Mart’s FDI form in China). It was ascertained in alignment with the views

expressed afore that Wal-Mart, being a horizontal MNE (Market seeking MNE) essentially

determined the potency of both policy and non-policy factors to harness its market seeking needs.

In effect, Wal-Mart decides the gravity of the effects from determinants like Labor costs and tax

rates with respects to company interests.

Within the identified determinants of FDI, four were determined to be among the most relevant to

Wal-Mart China: Market, Labor Costs, Tax, and Infrastructure. Market conditions and indicators

like consumer disposable income, consumer confidence, GDP per capita income and GDP growth

rate were seen as having the most effect on Wal-Mart’s FDI in China. Wal-Mart’s case also proved

that an MNE-interest-instigated FDI determinant like Market (even though held as paramount)

could itself be predicated on another determinant, which is Infrastructure, in the case of Wal-Mart.

P a g e | 42

Infrastructure development was found to be a bedrock, foundational and potent in the

determination of FDI location choices as well as project value variations across FDI form and

MNE type. One reason for this being the fact that Market activities will grind to a halt in the

extreme case of poor road and other transportation linkages between distribution centers and retail

stores. Also if China’s IT infrastructure is woefully inadequate, then Wal-Mart’s pursuance of e-

commerce would inevitably be to no avail. Even though labor was upheld as equally important in

harnessing Wal-Mart’s interest, labor cost as well as tax were seen as negatively affecting the

company’s FDI in China only to the extent to which market determinant fails to intervene in the

opposite direction (and vice versa).

Perhaps the most crucial and differentiating finding of this work are the interactive effects between

the identified FDI determinants, as shown in Wal-Mart China’s undertakings.

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Appendix 1

Source: UNCTAD (http://www.unctad.org/fdistatistics)

Figure 11 - Global FDI inflows, top 20 host economies, 2008–2009 (Billions of dollars)

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Appendix 2

Source: US-China Business Council. https://www.uschina.org/statistics/fdi_cumulative.html

Figure 12 - Non-Financial Foreign Direct Investment (FDI) Inflows, 2001-11

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Appendix 3

Source: www.walmart.com

Figure 13 - Overview of Wal-Mart's 50 years of Performance

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Appendix 4

(CAIXIN MEDIA (China), REUTERS, 2013)

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Appendix 5

www.walmart.com

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Appendix 6

United States’ GDP growth and GDP per capita growth (2001-2011)

Japan’s GDP growth and GDP per capita growth (2001-2011)