the determinants of foreign direct investment choice in

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UPPSALA UNIVERSITY

Department of Business Studies

Master Thesis

Spring Semester 2012

The Determinants of Foreign Direct Investment

Choice in Chinese Automotive Industry

-How Swedish firms invest in Chinese market?

Authors: Cai Xingyu & Li Yongliang

Supervisor: Olivia Kang

Date of submission: 2012-05-23

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Abstract

Since China entered WTO, the multinational corporations (MNC) increased the

foreign direct investment (FDI) in Chinese market because China is famous for its

huge market volume and low labor cost. However, the knowledge of Chinese market

is still limited. This paper analyses the determinants of automotive MNC's FDI choice

made in Chinese market based on the study of Chinese FDI environment and the

investment behavior of Swedish firms. The determinants are tested through three

variables: industry development, cultural distance and the government policy. In this

thesis, data related to FDI in automotive industry is collected mainly from 13

provinces or municipalities. The results show that: (1) The regions with larger market

size will attract more FDI; (2) The larger cultural distance will create more obstacles

when MNCs invest, thus has the negative impacts on FDI choices; (3) MNCs will

give priority to those areas with lower tax burden. Besides, this thesis also describes

the detailed cultural distance at firm level between China and Sweden based on the

interview with a Swedish firm. The results suggest Swedish firms need to focus more

on the partner selection and management adaption when investing in Chinese market.

Key Words: FDI; industry development; cultural distance; government policy

Cai Xingyu & Li Yongliang

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Table of contents

1. Introduction and research proposal .......................................................................................... 1

1.1 Introduction ......................................................................................................................... 1

1.1.1 Overview of MNC and FDI ..................................................................................... 1

1.1.2 Emerging Market Introduction ................................................................................. 2

1.1.3 FDI situation in China .............................................................................................. 3

1.2 Research proposal ............................................................................................................... 4

2. Literature review ......................................................................................................................... 6

2.1 Development status in China and Sweden .......................................................................... 6

2.2 Internationalization process and FDI .................................................................................. 7

2.2.1 Internationalization process and relevant theory ...................................................... 7

2.2.2 FDI effects on MNCs and local market .................................................................... 9

2.3 Industry development .......................................................................................................... 9

2.3.1 Industry development in International Process ...................................................... 10

2.4 Cultural distance and psychic distance .............................................................................. 11

2.5 Government policy towards FDI ....................................................................................... 13

3. Research Methodology.............................................................................................................. 16

3.1 Research Approach ........................................................................................................... 16

3.2 Research Method and Model ............................................................................................ 17

3.2.1 Research data selection .......................................................................................... 17

3.2.2 Variables and methods selection............................................................................. 19

4. Empirical data ........................................................................................................................... 22

4.1 World FDI development .................................................................................................... 22

4.2 Current situation of Chinese automotive industry ............................................................. 23

4.3 Industry development test ................................................................................................. 25

4.3.1 Regional automotive industry status ...................................................................... 25

4.3.2 Industry agglomeration and its impacts on FDI ..................................................... 26

4.4 Cultural distance test ......................................................................................................... 29

4.4.1 General cultural distance with China ..................................................................... 29

4.4.2 Cultural distance and its impacts on Swedish automotive firms ............................ 31

4.5 Government tax policy test ............................................................................................... 32

4.5.1 Chinese tax incentives policies .............................................................................. 32

4.5.2 Tax bearing rate and business scale test ................................................................. 33

5. Analysis ...................................................................................................................................... 35

5.1 The connection between industry development and FDI .................................................. 35

5.2 Cultural distance and impacts on FDI ............................................................................... 36

5.2.1 Cultural distance and FDI at the national level ...................................................... 36

5.2.2 Cultural distance and FDI at Swedish firm level ................................................... 37

5.3 Government policy and its impacts ................................................................................... 38

6. Conclusions ................................................................................................................................ 39

6.1 Conclusions and implications ........................................................................................... 39

6.2 Limitations and Recommendations ................................................................................... 40

Reference: ...................................................................................................................................... 41

Appendix ........................................................................................................................................ 45


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1. Introduction and research proposal

1.1 Introduction

1.1.1 Overview of MNC and FDI

Multinational Corporation (MNC), also known as multinational enterprise (MNE),

means a corporation or enterprise that market production or delivers services in

several different countries (Pitelis, 2000). The International Labor Organization (ILO)

has defined an MNC as "a corporation that has its management headquarters in one

country, known as the home country, and operates in several other countries, known

as host countries."

One of the most important influences of MNC is creating the economic development

which usually involves structural and institutional changes. It can also increase the

employment and improve social welfare (Liang, 2003).

It is complicated and not always logical to determine the position (in favor or against)

of countries towards MNC. In general, most developed countries can make more

profit with lower labor cost from other countries with the help from MNC. It is not

very clear about developing nations’ position. Some of them will favor MNC because

it can boost the economy and infrastructure. Therefore, delegates must contemplate a

lot of economic factors that would help explain why they support or oppose MNC,

and have to establish sales agencies in order to figure out whether that particular

developing country has competitions or not. (Jagdish, 2004)

Bruce has defined that “there is increasing recognition that understanding the forces

of economic globalization requires looking first at foreign direct investment (FDI) by

multinational corporations (MNCs)”. (Bruce, 2006)


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Foreign direct investment (FDI) is direct investment by a company in distribution

located in another country either by sharing a company in the country or by expanding

operations of an existing business in the country (Borensztein, 1998, p116). FDI has

been one of the most discussed topics in the development for economic globalization.

MNCs consider FDI as an important means to reorganize their production activities

across borders, in accordance with their corporate strategies and the competitive

advantages of host countries. Host countries regard inflow of FDI as a significant

opportunity for integrating their economies into the global market and promoting their

economic development. To maximize FDI’s benefits in economic development, host

country governments employ a variety of policies and measures (Chuang, 1999).

1.1.2 Emerging Market Introduction

Most MNCs search for ways to gain and sustain competitive advantages in growing

global business surroundings, focus more and more on the new emerging markets.

In driving global economic recovery and growth, the emerging economies begin to

play an important role. Moreover, instead of the developed countries like UK, some of

the fastest growing countries in the world are represented by Brazil, Russia, India and

China.

“Emerging Markets” were created in 1981 by Antoine W. ban Agtumael, the deputy

director of the capital markets department of the World Bank’s International Finance

Corporation (Wharton, 2008). According to the Business Dictionary, emerging market

means a new market structures arising from digitalization, deregulation, globalization,

and open-standards, which are shifting the balance of economic power from the

sellers to the buyers. Investments in these markets are usually characterized by a high

level of risk and possibility of a high return (Sigrun, 2009).

Compared to developed economies, emerging economies have many unique


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advantages, such as high GDP potentials, young working populations, growing

middle classes and relatively lower-debt economies.

Generally speaking, the emerging market economies have young, expanding working

populations. For example, the average age in Japan, Germany and Italy is 43 while in

the UK around 40. Compared to the developed countries, the average age of China is

34, 29 in Brazil and 25 in India. (Nigel, May 2010.)

After 1978, China’s government put all their efforts into changing the economy to a

market-oriented one, and output had quadrupled in 2007. This is a country that has

natural resources such as coal, iron ore, petroleum, natural gas and hydropower

potential. Since 2008, China has become the second-largest economy in the world

behind the US with GDP of $ 7.5 trillion (NBSC, 2011).

1.1.3 FDI situation in China

China has become the largest recipient of FDI among developing countries. More and

more MNCs enter Chinese market through FDI for the purposes of cost saving,

market share possessing and sales expansion (Huang, 2008). According to China's

Ministry of Commerce, FDI distribution in China is quite unbalanced and the majority

of FDI are invested in the coastal area which is the most developed region in China

(China Statistical Yearbook, 2011). However, the government is trying to encourage

MNCs to invest in those areas with worse investment environment through carrying

out some incentive policies. But the growth rate of FDI in coastal area is still higher

than other areas (China Statistical Yearbook, 2011). According to China's Ministry of

Commerce, the main reason is that many MNCs believe that the cultural distance will

greatly increase the institutional cost and managerial difficulties and a developed

infrastructure can help minimize this negative impact (Huang, 2008). As a result,

industry development, cultural distance and government policy are convinced to be

the three main factors to help MNCs formulate the FDI plan in Chinese market.


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1.2 Research proposal

When considering of the Swedish MNCs international business relationship with

China, current research shows that Swedish firms' mainstream of business relationship

with Chinese market still stays at the level of import and licensing (Bruce, 2006).

When considering of the Chinese automotive market situations, the current research

shows that the automotive industry development varies in different areas in China and

so far the FDI approach in this industry is still restricted to joint venture (Zhang

Xiujuan, 2007). The Chinese market has abundant qualified labor force and the

government is encouraging local firms to improve the competitiveness through

international cooperation (Chen Fang et al., 2007 ). As a consequence, it is feasible

and attractive for Swedish firms to think about investing more in Chinese market

because the complementary of the two parts is obvious and both sides have the

possibility to make an improvement through the FDI behavior. In this thesis, industry

development, cultural distance and government policy are considered to be the three

determinants to affect MNC's FDI choice in Chinese market.

Our research question is: How can the determinants of Industry development, Cultural

distance and Government policy affect the Swedish automotive MNC's FDI in Chinese

market?

The aim of the thesis is to analyze and try to figure out how these three factors

mentioned above affect Swedish automotive MNC's FDI choice in Chinese market.

The testing part will base on three hypotheses raised out in the literature review part.

The conclusion will be given based on the testing results of the three hypotheses to

figure out the suitable way for Swedish firms in automotive industry to engage FDI in

Chinese market and offer a basic guideline from aspects of Chinese automotive

industry, main cultural difference and the government policy towards FDI.


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Figure 1: The outline of the thesis

Research problem: Swedish FDI

determinants in Chinese market

Sub factor 2: cultural

distance

Sub factor 3: Chinese FDI

environment and policy

Sub factor 1: automotive

industry development

Theoretical Framework:

Emerging market Features

Cultural distance

Industrial agglomeration

Government policy

Empirical test:

Location quotient

Government policy

analyze

Conclusions


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2. Literature review

Because of the increasing importance of Chinese market, many MNCs are considering

about entering Chinese market in order to gain more profit. Many Swedish firms are

considering it as well. Therefore, how to choose different approaches of foreign

market development and establishments becomes a crucial topic. The location, control,

and internationalization process has become MNCs' core research topic of the

business research (Eden & Lenway, 2001). In order to perform our research, it is

necessary to understand what research related to this study has been done. In this

chapter, research on different determinants which affect MNCs' foreign investment

style will be introduced in the following parts.

2.1 Development status in China and Sweden

From the aspect of China, China's manufacturing industry has been integrated into the

global value chain and truly becomes a "world Factory" because of the

huge manufacturing industry (Jia Sun, 2011). However, China's manufacturing

industry is at the low-end link of global value chain and there are problems of R&D

capabilities, lack of self-marketing brand and scarcity of highly-skilled human

resource. Even though the labor cost is getting higher in China, most parts in coastal

area, middle area and western area still have a wide range of space to develop from

Economic structural adjustment. Moreover, many investments choice should not only

focus on the cost but also the integrity of the related industries and supporting services.

For example, many small countries cannot offer a entire service of the product

manufacturing while China can do. Meanwhile, China has a large inner market which

forms the economies of scale. However it's not possible and proper to only rely on

export to enlarge the business scale in China. If Chinese firms can work with foreign

companies, the business scale may have a better development. (Jinping Zhao, 2010).

From the aspect of Sweden, based on recent study, the main business partners of


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Swedish firms are USA, UK, Germany and France. They are the countries which over

a long period have dominated both quantitatively and qualitatively in the Swedish

global production (Bjarne, 2008). Although Chinese market is growing fast, the main

approach of trade is through import and export. Hofstede (1983) coined four

dimensions to describe the cultural distance between different markets. Sweden has

the characteristic of low power distance and high uncertainty avoidance, which

explains why Swedish firms prefer entry mode with less commitment. As the

development of international business environment, the market in that 4 countries

nearly saturated and the BRIC countries become the market with most potential

(Bjarne, 2008). Therefore, establishing business network in this market becomes

increasingly crucial.

2.2 Internationalization process and FDI

The increase in international co-operation and business relationship lead to rapid

changes in competitive environments in the global market (Beamish and Delios,

1997). So, more and more firms are thinking about investing in foreign markets

through FDI.

2.2.1 Internationalization process and relevant theory

The motivation of internationalization has been studied by many scholars. Hymer

(1976) first raised the concept of market imperfection and explain the

internationalization as behavior to pursue the monopolistic advantage in the target

market. As a result, MNCs can get above-normal profit by their firm-specific

advantage. Peter J. Buckley & Mark Casson (1976) explained the internationalization

behavior as a way of decrease the transaction cost. They argue that the interaction

among different counterparts will create the risks and uncertainties for MNCs, which

will influence the institutional efficiency and profitability. So MNCs choose to invest

in the foreign market in order to minimize these negative factors through turning the

external business relationship into the internal cooperation. By doing that, MNCs can


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reduce the uncertainty and risk during the production process and keep high level of

profitability. Johanson and Vahlne (1979) studied the internationalization process

while researching Swedish firms' internationalization behavior. Johanson collected the

data from Swedish-owned subsidiaries in the foreign market and applied

"establishment chain" to describe the different steps of investment. Figure 2 illustrates

the internationalization mechanism -- as compiled by Johanson and Vahlne:

Figure 2: The basic mechanism of internationalization: state and change aspects (Johanson &

Vahlne, 1977: 26).

Johanson and Vahlne explained that the reasons MNCs change the way of investment

in the foreign market are due to the market knowledge accumulation and commitment

making. Moreover, Johanson (1994) combined his updated theory with the business

network approach. The theory considered foreign market as a network,

internationalization process can be judged as a behavior that the firm commits and

obtains a position in this network which will have impacts both on the firm and its

partners. Based on the business network theory, Johanson and Vahlne (2009) revisited

the Uppsala Model and made an extension. He used incorporating learning, trust

building and opportunity creation as the variables to analyze the commitment to the

foreign markets.

State Change

Market

Knowledge

Market

Commitment

Commitment

Decision

Current

Activity


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2.2.2 FDI effects on MNCs and local market

FDI has become one of the main strategies for MNCs to enter a foreign market and,

therefore, it has been widely studied by many scholars. Dunning (1980) developed

Buckley and Casson's theory. He added three factors to explain the incentives of MNC:

ownership advantage, location advantage and internalization advantage. Then he

compared different entry modes and concluded that FDI can help MNCs acquire all

these three advantages. Haddad and Harrison (1993), Chuang and Lin (1999) and

Branstetter (2005) all studied effect of FDI through empirical analyses. They found

out that FDI can not only help MNCs to establish firm-specific advantage in the

foreign market, but also create positive effect on the domestic-owned firms through

technology spillover. Also some scholars found the negative effect on the local firms.

Aitken and Harrigan (1999) found out the consequence through the study of

Venezuela that FDI will have the "Crowding out Effect" for the local firms if the

technique gap is too large between MNCs and domestic firms. Borensztein, Gregorio

and Lee (1998) used the data from 69 developing countries to analyze the FDI effect

on the host countries. They concluded that only when human recourse capital of the

country reach a critical level can FDI create the positive effect on the local industry.

Besides, many Chinese scholars also study FDI effect on both the market and

local-firm development. Chen Taotao (2003) analyzed the FDI and its effect in

different areas in China and concluded that FDI effect on local industry depends on

three variables: the gap of firm size, capital intensity and technology level. Zhang

Guoqiang (2008) studied the effect of FDI based on the Nash-counot Model and

found the consequence that the technology gap between MNC and local level had a

break-even point. If the gap is getting bigger, the positive effect of FDI will decrease.

2.3 Industry development

The eclectic paradigm theory developed by Dunning (1993) provides an explanation

that how MNC's internationalization plans are processed. MNC will first think about

the location with higher level of development in order to establish value chain with


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less risk and communicating costs. Kostova and Zaheer (1999) argue that MNCs will

think about investing firms at the location with high economic efficiency because this

efficiency can help MNCs successfully minimize the transaction cost. Many scholars

use industry agglomeration to measure the industry development. Crozet (2004)

studied the location determinants of FDI in France and found out that the investors of

the same nationality will give priority to "co-locate". That is to say, the followers of

FDI will give more priority to the place that the first-mover invested. Besides, Head's

(1995) studied about the Japanese investment in the US market and also made similar

conclusions. Wheeler and Mody (1992) studied the location strategy of US companies

and tried to find out the most important determinants. They conclude that industry

development, market size and transportation become critical factors of MNCs'

decision-making. Lu Minghong (1997) used the FDI data from 29 Chinese provinces

and regions to analyze the key factors that influence MNC's investment strategy. He

concludes that industry development, export dependence and the specialization of

labor force all have the positive effect in encouraging MNCs to invest in those areas.

Liang Qi (2003) analyzed the FDI intensity in the coastal areas in China. She studied

the MNCs' investment motivations through interviews in provinces of Jiangsu,

Guangdong, Zhejiang, Shandong and Fujian. She concludes that the development of

industry has replaced the government policy and has become the most important

factor for MNCs when thinking about investing in China.

2.3.1 Industry development in International Process

The concept of industry development is essential to IP model and it is important that the

multinational firms learn from different business partners in order to create valuable

business networks and sustainable operations abroad (Johansson and Vahlne, 2003; 2009 ).

Industry development in target market will offer different aspects of knowledge which are

critical to MNCs.

Industry development includes information about firm number, firm size and number of


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upstream and downstream enterprises etc. This information is seen as the most important

part of relevant knowledge for MNCs according to the IP model. Higher level of industry

development always related with more active market activities. This makes firms easier to

learn from each other and they will find opportunities by which they both can improve

their business operations (Johansson and Vahlne, 2009). Besides Learning from each other,

new knowledge can also be created through the interactions within a network.

However, higher level of industry development also relates to more fierce competitions

and less privilege which will create higher entry cost (Williamson, 1979). High level of

competition will create obstacles when MNCs are considering about FDI. Besides, Chetty

and Agnal (2007) argued that high level of industry development leads to the

"over-embedded network" which will create barriers for MNCs to share knowledge with

external environment. So industry development also possibly has negative impact on FDI.

Hypothesis 1: The high level of industry development in a region will make it

easier to attract FDI from MNCs.

2.4 Cultural distance and psychic distance

Hofstede (1983) first raise the concept of cultural distance and give the valuables to

measure it. He argues that national cultural difference is the key issue for management

and organization science. He emphasizes on the importance of nationality based on

three reasons: (1) Political reason: this reason create the institutional differences

between two countries; (2) Sociological reason: nationality is the identity of people,

so different nationalities result in the different social environments; (3) Psychological

reason: different level of psychological ability will lead to the different learning skills

and the different ways of doing things. Hofstede uses the gaps of different

nationalities to measure the cultural distance between different countries. He uses four

dimensions to describe the national cultures: (1) "Individualism versus collectivism".

People with the character of "individualism" tend to be more independent and


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self-centered. They are willing to do things on their own and prefer taking risks and

trying new things. On the contrary, "collectivists" prefer working in-groups and tend

to think about the members in the groups and sometimes will give first priority to the

mutual benefit of the group. (2) "Power distance". This dimension is mainly used to

describe people's attitude towards inequality. The big power distance always leads to

the high level of centralization. People in this environment will be more accustomed

to the hierarchical management and automatic leadership. (3) "Uncertainty avoidance".

This dimension is mainly used to describe people's view towards change. It is quite

difficult for people labeled with "strong uncertainty avoidance" to accept changes.

These people feel anxious about unknown factors and prefer preserving the status quo.

So they always create specific regulations in order to minimize the risks. While

people in "weak uncertainty avoidance" always feel excited about new things and are

willing to make changes regardless of its potential risks. (4) "Masculinity versus

Femininity." Hofstede argues that in different nationalities people will have different

attitudes to the job division related to sex. In masculine society, people always have

the mutual sense about what kind of job should be done by males and what should be

done by females. While in feminine society, actually there is no clear boundary.

Hofstede took 50 countries as research samples and tested their cultural distance in 4

dimensions above and finds out that those dimensions have much higher impact on

the management focus and organization structures. So firms from countries with large

cultural distance will have quite different management styles.

According to the Uppsala Internationalization Process Model (I-P model), Johanson

(1997, 2009) also explained the MNC's internationalization behaviour. He presented

his view in the I-P model that an internationally inexperienced firm or a firm has

really limited knowledge to one foreign market will choose a low commitment entry

mode in order to minimize the uncertainties and risks. Based on the transaction

behavior in target market, MNCs will increase their commitment and thus gain more

information and knowledge from new market. As a result, MNCs are able to shorten

the psychic distance with target market and probably give more investment and


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change the business modes from low-commitment (export, licensing) to the

high-commitment (JV or WOS) once they accumulating enough information.

Besides, Eriksson (1997) developed the concept of "experiential knowledge" into

three types: internationalization knowledge, business knowledge and institutional

knowledge. Internationalization knowledge is gained from the firm's previous

international behaviour while business knowledge and institutional knowledge are

gained from the experience from particular market and only useful to this market. The

internationalization knowledge enables MNCs to expand business into foreign

markets with larger cultural distance. The business knowledge and institutional

knowledge will help firms accumulate commitment in particular market and shorten

the psychic distance.

Hypothesis 2: The cultural distance between China and Sweden will make it

more difficult to invest in Chinese market with the approach of joint venture.

2.5 Government policy towards FDI

From 1980s, the government policy towards foreign investment has changed a lot

from the restrictive policies to the open policies (Zhang, 2007). According to the

report from United Nations Conference on Trade and Development (UNCTAD), from

1990s, the policy changes have been increasingly taking place in many countries.

Based on the proportion of two kinds of policy--- incentive policy and restrictive

policy, incentive policy has become absolutely the mainstream. The Chinese

government has been increasingly concerned about how to attract and acquire more

investment from foreign countries and sometimes even create the competition with

neighbor countries (Zhang, 2007).


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Year

Country with

policy change

Number of

policy change

Incentive

policy

Restrictive

policy

1991 35 82 80 2

1992 43 79 79 0

1993 57 102 101 1

1994 49 110 108 2

1995 64 113 106 7

1996 65 114 98 16

1997 76 151 135 16

1998 60 145 136 9

1999 63 140 131 9

2000 69 150 147 3

2001 71 208 194 14

2002 70 248 236 12

Figure 3: Global policy changes to FDI (World Investment Report, UNCTAD, 2005)

UNCTAD also introduces the main policies that government frequently employs to

attract FDI. There are two categories: tax incentive and non-tax incentive. The former

one mainly attracts FDI through tax reduction. It includes import and export tariff

privilege, profit tax privilege, capital tax privilege, sales tax privilege and value-added

tax privilege. The latter one includes subsidy, equity participation and currency

insurance.

Many scholars present their point of view about whether these policies can

successfully attract FDI. Bond and Samuelson (1986) argue that in some countries

with high level of information asymmetry, the tax privilege policy in developing

countries can be judged as a signal from government to show the sincerity and eager

to invite FDI. These policies are used to strengthen investors' confidence. Spar (1998)

studied the tax incentive policies in Costa Rica and concludes that those policies can

reduce the investment risks and provide a sense of safety to those investors. Coyne

(1994) compared firms' responses to the incentive policies and their investment scales.

Coyne concludes that firms with less HR recourse and capital need to benefit from

those policies to minimize their costs while some large investors always reach

agreements with host country before entering. As a result, small-scale investors will


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be more sensitive to the incentive policies.

However, some scholars also have the opinions that the government tax incentive

policies have little influence on the foreign investors. Ahmed (1978) interviewed 52

MNCs about most important factors they have to consider in the process of

investment. Based on the survey, the tax incentive policy is only in the 7th

place in

developing countries and 8th

in developed countries. Some other scholars with similar

opinion think that market and the political environment are the most important factors

while tax privilege is just a method to reduce some disadvantages for the foreign

investors.

As China is aiming for the international standards, foreign policy has been unable to

adapt to the changing international situation. In the process of the development of

China’s market economy, multinational corporations constantly enlarge their scale of

investment and they are having a big impact on Chinese foreign policy based on their

firm-specific advantages. The impact that the multinational corporations have

includes 5 main points, which are proposing policy issues, agenda setting,

policy-making, policy implementation and policy evaluation (Chang Liu, 2011). Xia

Wang mentioned that, the effectiveness that the adjustments of foreign policy showed

includes four main points. (1) It won’t make a big effect on the scale of foreign

investment. (2) It is good to meet the foreign company's requests in order to attract

foreign capital (3) It’s good to improve the efficiency of using foreign investment. (4)

It is good to optimize the industrial structure and regional economic structure (Xia

Wang & Liuqin Chen, 2008). Li Zonghui and Lu Minghong (2004) use the Panel Data

Model to test the effectiveness of government tax incentive policies to attract FDI.

The analysis shows that the tax incentive policy is one of the main factors to attract

FDI in Chinese market.

Hypothesis 3: The Chinese government tax incentive policy will have a positive

impact on firm's FDI in automotive industry.


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3. Research Methodology

3.1 Research Approach

In this thesis, both qualitative and quantitative approaches are used to analyze the

investment environment of Chinese market. The aim of the research is to find out if it

is feasible for Swedish firms to enter Chinese market through investment approach of

joint venture. Theories show that the industry development, cultural distance and

government policies are quite important for MNCs when planning to enter foreign

market in the world. How these determinants will affect MNC's choice in Chinese

market still needs to be analyzed. For the determinants of industry development and

government policy, we need to collect data from National Bureau of Statistics which

can describe the industry development and incentive policy intensity and then try to

use data to find out the connection with FDI intensity. As a result, a correlation testis

best suited for the test of industry development. Besides, a quantitative regression

analysis is suited best for the test of government policy. Cultural distance is treated as

a determinant which will create obstacles during FDI activities. This factor is based

on social studies so that it is impossible to be represented by numbers or formulas.

Based on this reason, a qualitative research is suited for this purpose. In this paper, the

data for the qualitative research is gathered from website and through our interview.

Qualitative analysis based on interview will help analyze Swedish firm-specific

advantage and automotive industry current situation to identify the motivation of

Swedish firms to enter Chinese market. Besides, qualitative analysis based on the data

from website is also used to help describe the general situation of automotive FDI

distribution and government policy support in main provinces in China. Moreover,

quantitative analysis of cultural distance based on Hofstede's Cultural Distance Model

is used to describe the cultural distances between China and some other important

countries in the world. This mainly strives to provide a clear picture on how large the

differences between China and Sweden are compared with other countries.


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To analyze international FDI flows and intensity, there are two essential statistical

sources namely the OECD and UNCTAD. The former publishes some flow data while

the later publishes world FDI flows annually in early autumn covering the previous

year in the World Investment Report. It contains not only data but also commentary

and the information is collected from a wide range of countries. Both sources base

their figures on national statistical sources.

3.2 Research Method and Model

3.2.1 Research data selection

In this thesis, the MNC's FDI strategies are convinced to be influenced by three

determinants: industry development, cultural distance and government policy. In order

to analyze how these three determinants affect the FDI strategies, both primary data

and secondary data are used in this thesis. To find the relationship between industry

development and FDI, the data about FDI intensity in automotive industry and the

total output in each area in China are necessary. In consequence, the secondary data

are mainly gathered from National Bureau of Statistics. Besides, the tax burden in

each area is needed to analyze the relationship between FDI and government policy.

So the secondary data are also gathered from National Bureau of Statistics. The aim of

the research is to study the Swedish automotive firm's FDI strategy in Chinese market.

And the cultural distance is the main determinant to show the obstacles to create joint

venture between Sweden and China. As a result, primary data are collected through

interview with Swedish automotive firm. In this thesis, Scania is chosen as our

research sample and database to evaluate the cultural distance between Sweden and

China. Scania is one of the world's leading automotive manufacturers and has

established business relationship with China. However, the approach is still stagnated

at the level of import. Even though Chinese market is of great potential, Scania only

established sales agencies in China and the only business interaction with China is the

relationship with Chinese dealers to offer its after-sales service (Scania annual report,

2010). At the same time, Scania is also looking for partners to establish a joint venture


18

in China. As a result, the study can effectively figure out the main factors for Swedish

firms to think about when entering Chinese market and the main barriers in building

up business relationships.

Credentials of the Interviewee: Peter Sjöblom is the CEO of Scania Chinese Sales

& Service Company since October, 2010. Before 2010, he was in charge of sales

business in South East Asia. Peter Sjöblom joined Scania in 1982 and has abundant

knowledge about Scania and sufficient experience in Asian market.

Operationalization: As the main purpose of the interview is to find out the main

cultural difference between Swedish firms and Chinese firms in automotive industry.

The questions are designed to help authors research on the core values of Scania in

selecting Chinese partners and the main obstacles they think would emerge during the

creation of joint venture. First of all, we need to have a clear image about Scania's

business and its activities in China. So questions 1-3 as Appendix 1 shows are mainly

focused on the current situation of Scania. Through these three questions, we can have

a better understanding of both Scania and Chinese market environment. After that, the

following questions focus on the different steps during FDI process. Question 4

focuses on the main standards of Scania to select partners. This question aims to

research different values between Swedish and Chinese firms when thinking about

co-operation. Question 5 strives to examine Scania's attitude to the ownership

structure in joint venture. This question is quite practical especially in China. It aims

to investigate the attitude about the importance of control and final saying. Questions

6-9 mainly focus on the cultural gap in human recourse management in order to find

out the obstacles in leadership part. These questions mainly focus on the attitude

about cultural adaptation. Last two questions mainly ask Scania's future expectation in

the future.


19

3.2.2 Variables and methods selection

In this thesis, three hypotheses will be tested in the empirical part to evaluate the

investment environment in Chinese market at the province (or regional) level.

Quantitative analysis will be involved in testing the hypothesis 1 and 3. The following

section will explain the variable selection and the mechanism. Hypothesis 2 will be

tested both quantitatively and qualitatively. First, quantitative analysis will be used to

test the relationship between FDI and cultural distance at the global level. Afterwards,

a qualitative analysis based on the interview to the Swedish automotive firm will be

used to understand the main cultural difference between Sweden and China.

3.2.2.1 Test on the relationship between industry development and FDI

In this thesis, industry agglomeration is used to describe the industrial development.

Industry agglomeration reflects the level of geographical concentration. These

variables can also describe the development of relevant industries and the

specification of labor force. In this thesis, model of location quotient is used to test the

industry agglomeration in main automotive manufacturing areas in China.

Location quotient (LQ) is a index to quantify that how concentrated a certain industry;

cluster or demographic group is in a region as it is compared with the national average

level. The formula of LQ is as follows:

1

1 1 1

/

/

m

ij ij

j

ij n n m

ij ij

i i j

e e

LQ

e e

In this formula, i means the particular region i (i=1,2,3...n), j means the particular

industry j (j=1,2,3...n) and eij means the total output of industry j in the region i. LQij

here means the location quotient of industry j in the region i. If the LQij is larger than

1, it means that the agglomeration of industry j in region i is higher than the national

level. Besides, larger LQ value means higher level of industry agglomeration. Then

the LQ value will be compared with the FDI growth rate to test out how LQ will have


20

the impact on FDI inflows. As a result, the correlation test will be used. The formula

is as follows:

)1/()()1/()(

)1/())((

22 nyynxx

nyyxxr

Here x means the first variable (LQ change in this thesis). x refers to the average

value of x . y refers to the second variable (FDI growth in this thesis). The value of

r is from -1 to 1. The positive value of r means that the two variables have positive

correlation while the negative of r means the negative correlation. Besides, if r

closes to 1 means that these two variables are closely related.

3.2.2.2 Test on the cultural distance

In this section, the study will analyze the cultural distance index between China and

Sweden and some other countries or areas. Then the comparison of FDI and the FDI

modes will be applied to test the importance of cultural distance factor to the MNC's

FDI strategy. Cultural distance index is to test the cultural distance in quantitative way

based on the 4 dimensions of Hofstede's cultural distance model. The formula of

cultural distance index is as following:

4

1i iu

iuij

jI

IICD

Here CDj represents the cultural distance between country j and home country. Iij

represents the index of CD dimensions i in country j and Iiu represents the index of CD

dimension i in home country.

Besides, the detailed information on cultural distance will be gathered from the

interview to Scania about the cultural barriers which will institutionally affect the

investment strategy making in Scania. We contacted Peter Sjöblom. Due to his limited

availability and occupied schedule, we finally conducted a telephone interview to ask

him about the details in communication, negotiation and business relationship

building in China.


21

3.2.2.3 Test on the effect of government incentive policy

As an emerging market, China’s economy is growing at a double-digit growth rate.

So the capital shortage is a common phenomenon to almost every industry (Xu & Tan,

2003). So far, the FDI incentive policy offered by Chinese government mainly has

been focused on the tax privileges (Zhu & Fu, 2008). In this thesis, the hypothesis 3

suggests that the FDI will be influenced by both government tax incentive policy and

the regional business scales. So the following model is used:

),( SVPVfFDI

PV represents the variable of tax privilege because there are many different types of

tax privilege in China and it isn’t shown on the National Bureau of Statistics. So

"tax bearing rate (TBR)" is used to measure this variable.

TBR = TAXf / Output

TAXf represents the income tax from foreign-funded enterprises. This value reflects

the tax cost for foreign-funded enterprises in different areas. Low value in TBR means

high level of policy privilege.

SV represents the size of the market. In this thesis, the total output is used to measure

the market size because larger market size always relates to more opportunity and

ability to acquire FDI.


22

4. Empirical data

4.1 World FDI development

From the UNCTAD data published in July 2011, one may conclude the following: In

general, the overall world inflows of FDI increased, among which FDI flows into

developing countries increased the most. Moreover, total FDI flows into developed

countries in 2010 fell and it indicates that MNCs are transferring investment focus

from developed countries to developing countries.

Figure 4 illustrates FDI inflows to developed and developing major world economies

since 1970, as well as inward stocks in 2010. In 2010, the highest level of inflows

belong to US ($228 billion), followed by China ($105 billion) and Hong Kong ($68

billion). The same as the stocks of inward FDI, US has the highest level of stocks at

($3.5 trillion), followed by Hong Kong ($1.1 trillion).

Compared with 2010, the global FDI inflows increased by 17%. In the recipient of

FDI, US was again the largest, receiving $77 billion, but China just $11 billion.

($ millions) Flows Stocks

1970 1980 1990 2000 2009 2010 2010

Developed

economies

9,491 46,576 172,526 1,138,032 602,835 601,906 12,501,569

(EU) total 5,158 21,279 97,309 698,279 346,531 304,689 6,890,387

United States 1,260 16,918 48,422 313,997 152,892 228,249 3,451,405

Developing

economies

3.854 7,479 34,853 257,625 510,578 573,568 5,951,203

China N/A 57 3,487 40,715 95,000 105,735 578,818

Hong Kong,

China

50 710 3,275 61,938 52,394 68,904 1,097,620

World 13,346 54,078 207,455 1,402,680 1,185,030 1,243,671 19,140,603

Figure 4: World inward FDI 1970-2010, (World Investment Report,UNCTAD, 2011 )

Figure 5 mainly illustrates the outward flows and the stock of outward FDI in the past


23

40 years. In 2010, 70% of world FDI outflows were made up by developed countries

while 25% was contributed by developing countries. Among all the outflows, the EU

member states made up 31% of outflows. The US was the largest investor ($329

billion) in the world, compared with the entire EU ($407 billion) and China ($68

billion). The US also holds the highest outward stocks of FDI in terms of stocks at

$4.8 trillion.

($ Millions) FDI Flows Stocks

1970 1980 1990 2000 2009 2010 2010

Developed

economies

14,100 48,397 229,584 1,094,728 850,975 935,190 16803536

(EU) total 5,063 21,902 130,572 813,119 370,016 407,251 8,933,485

United States 7,590 19,230 30,982 142,626 282,686 328,905 4,843,325

Developing

economies

51 3,192 11,914 134,194 270,750 327,564 3,131,845

China N/A N/A 830 916 56,530 68,000 297,600

World 14,151 51,590 241,498 1,232,117 1,170,527 1,323,337 1,323,337

Figure 5: Outward world FDI 1970-2010, (World Investment Report, UNCTAD, 2011)

In considering FDI flows, the developed countries made an important role, which is

illustrated by the data relating to outflows and stocks. The situation that FDI flows

mainly occur between developed countries still remains. However, in recent years the

flows to developing countries have been growing and are expected to continue to

grow in the future.

4.2 Current situation of Chinese automotive industry

Chinese automotive industry has been developing during recent years even when

financial crisis happened in the year 2008. In Figure 6 it illustrates that the total

output of Chinese automotive industry increased from 1571.49 billion CNY in year

2005 to 4173.03 billion CNY in year 2009. The annual growth rate is kept above 20%,

which is quite attractive to MNCs from other countries. The increase of import and

export volume as well as the FDI intensity described below will also show the same

situation that Chinese market is becoming a hot spot of FDI in automotive industry.


24

Figure 6: The Chinese Automotive industry output in year 2005-2009 (Source: China Statistical

Yearbook, 2010)

According to Figure 7, both import and export of automotive in China have been

increasing (except the export volume in the year 2009 decreases because of the

financial crisis). From year 2001 to 2008, the import volume increases from 71.90

billion CNY to 407.5 billion CNY and the export volume increases from 24.50 billion

CNY to 641.1 billion CNY. Based on the time flow, the export growth is faster than

the import growth.

Figure 7: The import and export of Chinese automotive in the year 2001-2009 (Source: China's

Automotive Industry Development Research, 2010)

One of the main reasons why China's export increases so rapidly is because many

MNCs invest in Chinese market to establish the business relationships mainly through

the way of joint venture ("Chinese Automotive Industry Research", 2010). Based on

the data from China National Bureau of Statistics, there are 19,441 firms in Chinese

automotive industry in year 2009 and 3,637 of them are foreign-funded enterprises.


25

The total capital of foreign-funded enterprises is 1478.52 billion CNY while the total

capital of automotive industry is 3809.57 billion CNY. The foreign-funded enterprises'

capital has reached the proportion of 38.81%. Besides, the total industry output is

4173.03 billion CNY and the foreign-funded enterprises create the output of 1853.32

trillion, up to 44.41% of the total output.

4.3 Industry development test

4.3.1 Regional automotive industry status

China has vast territory and there are many provinces and municipalities which has

different features. These areas are categorized as three main areas based on the

geographical conditions: Coastal area, Middle part and Western area. The industry

development in each area is quite different from each other. According to the China

Statistical Yearbook (2010), the total output of automotive industry in China reached

4173.03 billion CNY. The Figure 8 shows the output of automotive industry in top 13

provinces/municipalities in year 2009 and their locational distribution. Jiangsu

Province ranks the first by having the 452.36 billion CNY in total, reaching 10.84% of

the total output. Shanghai and Jilin Province follow and rank at 2nd

and 3rd

place with

output of 324.62 (7.78%) and 311.12 (7.46%) respectively. Other places also have

good output performance such as Zhejiang (6.90%), Hubei (6.25%), Chongqing

(5.57%), Tianjin (3.51%). The top 5 provinces' output reaches 1637.13 billion CNY

which is 39.23% of the total output in Chinese automotive industry.

(Billion in CNY)

Output (2009) Percentage Location

Jiangsu 452.36 10.84% Coastal area

Shanghai 324.62 7.78% Coastal area

Jilin 311.12 7.46% Middle part

Zhejiang 288.09 6.90% Coastal area

Hubei 260.95 6.25% Middle part

Chongqing 232.31 5.57% Western area

Tianjin 146.58 3.51% Coastal area

Anhui 122.85 2.94% Middle part


26

Guangdong 109.91 2.63% Coastal area

Sichuan 99.06 2.37% Western area

Shandong 98.68 2.36% Coastal area

Hebei 79.28 1.90% Coastal area

Fujian 50.31 1.21% Coastal area

China in total 4173.03

Figure 8: Top 13 provinces or municipalities in output of automotive industry and their locations

(Source: China Statistical Yearbook, 2010)

From the locational distribution, the majority of top ranking provinces/municipalities

in China are at coastal area. As Figure 8 outlines, only Jilin, Hubei and Anhui are

from middle part and Chongqing, Sichuan from western area. Other provinces/

municipalities outlined in Figure 8 are from coastal areas. The total output of coastal

area in Figure 8 reaches 37.13% of total output while middle area and western area

are much smaller (16.65% and 7.94%).

4.3.2 Industry agglomeration and its impacts on FDI

In this part the location quotient index (LQ) will be used to analyze the automotive

industry development. Due to the different statistic standards in each province in

China, bureau of statistics in some provinces/municipalities does not publish the data

of the industrial output of foreign-funded enterprises in automotive industry. As a

result, 12 provinces / municipalities are chosen as the test sample (Shanghai bureau of

statistics only publish the data of manufacturing industry, not specific in automotive

industry). As Figure 9 illustrates, only 7 provinces/municipalities have the

above-average index of location quotient (LQ > 1). Based on the data of 2009, Tianjin

has the highest index of LQ (4.53), which means the automotive industry

development in Tianjin is quite centralized and the relevant service is

well-constructed. Chongqing follows Tianjin, occupying the 2nd

place. Jilin, the

province which focuses on the automotive production since the establishment of

People's Republic of China, ranks the 3rd

. Hubei as an emerging market for

automotive industry has strengthened the capital input since 2000s and its LQ index

ranks 4th

place. The LQ of other provinces are all around 1, most of which are large


27

manufacturing provinces. There are many foreign companies invested in different

industries which lead to the decentralization of the automotive industry development.

Region 2003 2004 2005 2006 2007 2008 2009

Jiangsu LQ 0.58 0.6 0.61 0.66 0.69 0.81 0.68

LQ

change 0.02 0.01 0.05 0.03 0.12 -0.13

FDI

growth 18.72% 22.13% 25.40% 15.34% 11.47% -2.03%

Zhejiang LQ 0.74 0.73 0.76 0.88 0.92 0.89 0.83

LQ

change -0.01 0.03 0.12 0.04 -0.03 -0.06

FDI

growth 2.78% 3.03% 6.87% -4.79% -8.00% -2.31%

Hubei LQ 2.05 2.08 2.18 2.33 2.37 2.58 2.77

LQ

change 0.03 0.1 0.15 0.04 0.21 0.19

FDI

growth 5.75% 1.18% 14.06% 2.14% 17.43% 9.12%

Chongqi

ng

LQ 4.01 4.15 4.78 4.21 4.54 4.24 5.41

LQ

change 0.14 0.63 -0.57 0.33 -0.3 1.17

FDI

growth 45.13% 99.71% 7.72%

162.58

% 65.00% 31.15%

Tianjin LQ 3.83 3.93 4.05 5.31 5.3 4.72 5.03

LQ

change 0.1 0.12 1.26 -0.01 -0.58 0.31

FDI

growth 14.14% 19.24% 12.14% -20.91% 50.98% 21.18%

Anhui LQ 0.97 1.01 1.04 1.08 1.17 0.97 1.21

LQ

change 0.04 0.03 0.04 0.09 -0.2 0.24

FDI

growth 79.21%

169.72

%

133.81

% 10.30% 25.36% 17.31%

Guangd

ong

LQ 0.71 0.68 0.67 0.73 0.67 0.56 0.65

LQ

change -0.03 -0.01 0.06 -0.06 -0.11 0.09

FDI

growth 8.83% 10.65% 0.52% 8.91% -2.48% 7.17%

Shandon

g

LQ 1.18 1.24 1.43 1.82 1.37 1.11 1.13

LQ 0.06 0.06 0.19 0.39 -0.45 -0.26 0.02


28

change

FDI

growth 3.84% 5.67% 6.50% -41.86% -2.12% 0.18%

Fujian LQ 0.7 0.71 0.7 0.96 0.98 0.94 1.42

LQ

change 0.01 -0.01 0.26 0.02 -0.04 0.48

FDI

growth 16.41% 15.18% 41.12% 5.27% 4.05% 22.12%

Figure 9: Location quotient change and FDI growth rate of top 9 provinces or municipalities in

output of automotive industry.①

In order to test the correlation between FDI inflows and the LQ index, the FDI growth

and LQ change are chosen as the variables. Figure 9 illustrates the FDI growth rate

and the LQ change from year 2004 to 2009. Correlation test is chosen as the

quantitative method here to test the correlation between these two variables. The

formula is as following:

)1/()()1/()(

)1/())((

22 nyynxx

nyyxxr

This test is processed in 9 provinces mentioned above respectively in order to figure

out the correlation in different regions. The outcome of correlation test is as

following:

Region r value

Jiangsu 0.61

Zhejiang 0.63

Hubei 0.78

Chongqing 0.22

Tianjin -0.33

Anhui -0.08

Guangdong 0.19

Shandong 0.82

Fujian 0.63

Figure 10: Correlation test of LQ change and FDI growth

One can figure out that there are two regions (Tianjin and Anhui) that have the

negative r value and other regions have the positive r value. The absolute values

① The data of FDI in automotive industry in Shanghai, Jilin and Sichuan is not available.


29

in four regions (Chongqing, Tianjin, Anhui and Guangdong) are close to 0 while

others are close to 1.

From the result we can get the conclusion that from national wide, the LQ and FDI

may have positive correlation, although we cannot determine whether the correlation

is linear or not. Two of the r values are negative but the negative relation is very weak

(r value close to zero) and we also get some result strongly support the position that

the relationship is significant(r value close to 1). For the regions with large FDI

adoption and good industrial basis, the relationship is strong. For less develop areas,

the FDI base is very low, the variance shall be much higher than average, thus appear

to be different from normal.

4.4 Cultural distance test

The cultural distance and its effects on FDI strategies of Swedish MNCs will be tested

in this section. The first sub-section deals with the general cultural distance test to

figure out the main difference between Chinese and Swedish. The second sub-section

aims to find out which factors Swedish automotive firms care when thinking about

investing in China through the data collection from the interview with the CEO of

Chinese service company of Scania.

4.4.1 General cultural distance with China

In this part, Hofstede's cultural distance model will be used to evaluate the cultural

distance based on four dimensions: power distance (PDI), individualism (IDV),

uncertainty avoidance (UAI) and masculinity/femininity (MAS). In order to find some

connections between cultural distance and FDI intensity, this study aims to analyze

not only the cultural distance between China and Sweden but also other countries /

areas which have close business connections with China.


30

(Unit: million $) FDI flows Percentage FDI intensity②

Hong Kong 38505.21 36.42% 42.30%

Australia 1701.7 1.61% 0.63%

United States 1308.29 1.24% 0.61%

Canada 1142.29 1.08% 0.50%

Singapore 1118.5 1.06% 7.31%

Germany 412.35 0.39% 0.72%

Sweden 161.05 0.15% 0.37%

Total FDI in China 105735.1 100.00%

Figure 11: FDI flows and intensity in China, (China Statistical Yearbook, 2010;

World Investment Report, UNCTAD, 2010)

Based on the FDI volume ranking from National Bureau of Statistics and the

availability of information access on Hofstede's model website, Sweden, Hong Kong,

United States, Singapore, Germany, Canada and Australia are chosen as the test

samples. The Hofstede's website gave the values of the countries above based on the

Hofstede's Cultural Distance Theory. See, Figure 12:

PDI IDV MAS UAI

Hong Kong 68 25 57 29

Australia 36 90 61 51

United States 40 91 62 46

Canada 39 80 52 48

Singapore 74 20 48 8

Germany 35 67 66 65

Sweden 31 71 5 29

China 80 20 66 30

Figure 12: Values of four dimensions in Hofstede's cultural distance model. (Source:

http://geert-hofstede.com)

Hong Kong 0.57 Canada 4.32 Germany 4.08

Australia 4.83 Singapore 1.08 Sweden 4.12

United States 4.64

Figure 13: Cultural distance index of some main invest countries

From Figure 13 it emerges that Hong Kong has the smallest cultural distance with

China. Singapore also has quite small cultural distance with China because the

② The FDI intensity data equals FDI into a certain country divided by the whole FDI of home country. This data

measures how important that host country to the home country.


31

Chinese language is spoken in both countries and they have been keeping business

connection for a longtime. Other countries in Europe and North America all have the

value over 4.

4.4.2 Cultural distance and its impacts on Swedish automotive firms

In this section, several factors will be mentioned to describe the differences between

China and Sweden based on the interview with Peter Sjöblom from Scania.

4.4.2.1 Establishment in Chinese market

Scania is one of the leading companies in automotive industry in Sweden and famous

for its products of trucks and buses. Scania only established the services companies in

Beijing and work with several firms in after-sales service part so far. According to

Peter Sjöblom, Scania prefers the organic growth and the corporate culture is

important to Scania to keep its firm-specific advantage. Scania has no plan to create

the joint venture with Chinese firms because they are still looking for suitable

partners.

4.4.2.2 Partner Standards

Scania is searching and evaluating the potential partners to create a joint venture in

Chinese market. When thinking about the main features of the partner, it is important

to have the same goals since the mutual goals will help the two parts eliminate many

problems. The partner should not only focus on how much profits they can get from

the cooperation but also think about how to make the joint venture operate and

develop well.

4.4.2.3 Institutional and managerial problems

According to Peter, most of the truck and bus producers in China are state-owned.

These enterprises are of large scale and have abundant financial resources. Peter

implies that Scania perceives that the joint venture with half or similar shares are the


32

worst situation for ownership structure because this kind of structure always leads to

more conflicts on the final saying. He believes this kind of structure will only cause

more conflicts owing to the cultural difference. Peter said if Scania find a partner with

the same goal in business, it would be not so important to have the majority of the

shares. Besides, Chinese people always work together, which is quite different from

Swedish firms. So if Scania established a joint venture with a Chinese partner, the

management control will be more likely implemented in a Chinese way.

4.4.2.4 Language gaps

According to Peter, many Chinese state-owned enterprises have special department to

deal with the international business issues. However, the average English level in

China is still low and the language gap will influence the communication efficiency

when doing business with small suppliers or sales agencies which is unavoidable in

China. So if a company decides to create a joint venture in China, it is wise to

decentralize its control and give this right to the Chinese partner.

4.5 Government tax policy test

4.5.1 Chinese tax incentives policies

After year 1991, China is keeping its first place in attracting FDI in developing

countries. In order to keep the high speed of growth and solve the problem of capital

Shortage, Chinese government has promulgated many incentives policies to attract

FDI. Besides, different regions also give privileges to attract FDI in some specific

industries.

At the national level, the income tax rate for foreign-funded enterprises is 25% while

it’s 33% for normal Chinese state-owned enterprises or private-owned enterprises

according to the "Enterprise Income Tax Law of the People's Republic of China",.

Besides, there are many regional tax incentives policies. Based on the data from local

government website, the incentives policies are summarized as Figure 14 shows:


33

Region Tax rate

Special Economic Zones, Economic and

Technological Zone 15%

Shanghai Pu Dong Area 15%

Coastal Economic Development Zone 24%

Capital city in provinces of middle part 24%

Western areas 15%; "1 and 2" Policy③

Figure 14: Regional tax incentives policies in China. (Source: Foreign Economic and

Trade Office)

Moreover, many regional governments have offered the privileges to special industry

investment and infrastructure investment. Therefore, in order to have a whole view of

tax cost, the tax bearing rate will be evaluated in the next part.

4.5.2 Tax bearing rate and business scale test

In this part, the connection between tax incentives policies and the FDI inflow will be

tested. Due to different data standards, many statistic offices do not publish the

income tax of foreign-funded enterprises. Based on the available data, 9 provinces/

municipalities are evaluated. As Figure 15 shows, Guangdong has the highest tax

bearing rate (18.91%) and Jiangsu ranks the 2nd

place (18.12%). Anhui only has

3.34% of tax bearing rate and ranks at the bottom of the 9 places.

③ "1 and 2" policy is promulgated in year 2008 in order to attract FDI in western areas. "1" means no income tax

for the new foreign-funded firms for the first year. "2" means in the following 2 years, firms only need to pay for

the half of its tax.


34

Region FDI (million $) TBR Industry output (million $)

Guangdong 11097.13 18.91% 1001111.00

Jiangsu 17271.24 18.12% 1073314.22

Tianjin 3875.71 16.01% 62308.36

Chongqing 1433.24 15.62% 99317.01

Hubei 2335.83 13.29% 228255.43

Fujian 4207.88 11.99% 273921.99

Shandong 4862.53 10.86% 276360.35

Zhejiang 6282.91 10.59% 601690.47

Anhui 2565.18 3.34% 195199.41

Figure 15: FDI, TBR and industry output of 9 regions in year 2009

Based on the data in Figure 15, the test will illustrate the correlation between FDI,

TBR and industry output. First the stationary test is used to check the data. The

Industry output (I) is found out to have unit root. So the natural logarithm process is

used and then found the data is stable. Based on the Hausman test, fixed effect model

is established as following: i i i iFDI C I T u

Ii represents the industry output of region i. Ti represents the TBR of region i. Ci is

constant term and u is a disturbance. Then the regression is used to test the correlation

of two variables. As Appendix 2 shows, the absolute value of "t-statistic" of the

variables are all above 2, so the correlation is significant and can be used in analysis

part.


35

5. Analysis

5.1 The connection between industry development and FDI

According to the data of regional output in automotive industry, the coastal areas are

still manufacturing the majority of products in China. Because of the "open up" policy,

some of the coastal areas④ were first benefited and open to the world earlier than

other areas in China. So the total FDI volume in the coastal area is higher than other

regions. However, there are too many foreign-funded enterprises in almost every

industry, the industry agglomeration is not so obvious, which means the MNCs cannot

save as many transaction cost as one could imagine. Besides, they cannot enjoy a

good effect of industry cluster. That's the reason why the FDI growth rate of coastal

areas remains at a lower level. Based on the data of FDI volume, most of the FDI

inflows still take place in these regions.

Based on the correlation test, there are 5 regions (Jiangsu, Zhejiang, Hubei, Shandong

and Fujian) which have positive value and the absolute values are close to 1. This

shows that LQ change has the positive impact on FDI growth in these regions. These

regions are mostly located in the coastal areas which already have comparatively

mature market and business environment. This outcome shows that, in these areas,

MNCs will invest more when the level of industry development gets higher. However,

one can figure out that the correlation between FDI growth and LQ change in two

regions (Tianjin and Anhui) are negative and the absolute values are close to 0. That is

to say, FDI in these areas is not so influenced by industry development. There are two

other regions (Chongqing and Guangdong) where the correlation value is positive but

the absolute values are close to 0. This also shows that industry development has little

impacts on FDI growth in these regions. The main reason for Chongqing and Tianjin

is that these two regions are municipalities which have much smaller geographical

boundaries and business scales. As a result, the FDI in these two areas depend more

④ The regions include Guangdong, Fujian, Jiangsu, Shangdong, Zhejiang.


36

on government policies. However, Anhui Province has treated automotive industry as

one of the most important industries since early 2000s. Moreover, the automotive

manufacturing condition in Anhui Province is not as good as coastal areas. The main

reason for FDI growth in Anhui Province can be concluded based on Figure 15 that

Anhui has the lowest Tax burden. This means government offer many incentive

policies so the impacts of policies are much larger than industry development. In these

three areas, the impacts of industry development are much smaller than policies. As a

result, the impact of industry development is unclear. Besides, Guangdong province is

the earliest region where Chinese government implemented "open-up" policy and it

has the most FDI in China. As a result, the market is now nearly saturated and the

competition is fiercer than other regions. So the level of industry development may

not have so much impact on FDI choice. Based on the analysis, the hypothesis 1 is

partly supported.

5.2 Cultural distance and impacts on FDI

5.2.1 Cultural distance and FDI at the national level

Based on the Hofstede cultural model, Hong Kong has the lowest cultural distance

index. The main reason is because the Chinese (Cantonese) is spoken in these two

countries so the language gap is quite small. Besides, China and Hong Kong share the

border. This geographical location has enabled them to do business for a longtime.

Singapore has the less language advantage compared with Hong Kong but its society

is also rooted in Confucianism.⑤So the cultural distance between Singapore and China

is much smaller compared to European and American countries. The cultural

distances between China and those countries in Europe and North America are at the

similar level (CD>4). The main differences between China and those countries appear

in the dimension PDI and IDV. Chinese people always work together as a group

which leads to a low value in IDV index (20 in China). In order to operate a big group

and keep it work efficiently, more control in the group is required which leads to the

⑤ Source: www.geert-hofstede.com

http://www.geert-hofstede.com/


37

high vertical management structure. The PDI index is correspondingly increasing (80

in China). In contrast, people in European and North American countries tend to work

individually and they focus more on themselves when facing different situations. So

the IDV index values of these countries are almost above 70. Besides, the

management style in these countries is focused more on the individual behavior which

makes the firm structure more flat and horizontal. This leads to the average level of

PDI index lower than 40. Because of this difference, the cultural transmission and

communication mechanism will be totally different, which will cause many conflicts

when these two values stay together. According to the FDI intensity which shows the

willingness of a foreign country to invest in the target country, Hong Kong has the

smallest cultural distance and the highest FDI intensity to Chinese market. Singapore

has the second smallest index and the FDI intensity ranks the second. Other countries

with larger cultural distance with China have the FDI intensity which is much lower

than Hong Kong and Singapore. As a result, we can conclude that cultural distance

will have negative impacts on attracting FDI.

5.2.2 Cultural distance and FDI at Swedish firm level

The variables at firm level are more detailed due to the interview. In the automotive

industry, the FDI mode is restricted to joint venture with a Chinese partner according

to the government policy (China Ministry of Commerce, 2008). So the main variables

to describe the impacts of cultural distance appear during the establishment of joint

venture.

When searching for a partner, it is crucial to keep in mind that most of the potential

partners to create joint venture in Chinese automotive industry are state-owned firms

(Wang Zhile, 2010). State-owned firm can provide enough capital to establish the

joint venture and also for the future expansion. This kind of firm focuses more on

quantity of products, profitability and the control of the joint venture. While Swedish

firm (Scania as an example) prefers organic growth, they like to develop the business


38

scales with the company fame increasing at the same time. So the Swedish firms

focus more on the quality of products and the customer services.

When it comes to management, efficient communication becomes the main issue. The

language gap may cause the conflicts and misunderstandings. Besides, if Swedish

firms need to establish value chain under their own control, the language gap would

have the negative impact on the efficiency. The leadership in Swedish firms tends to

be horizontal and the human resource management is designed for individuals.

However, Chinese people prefer work in small groups and each group will have its

own features and "sub-culture". So the Swedish leadership will lose its effectiveness

when used in China.

Based on the obstacles mentioned above, the cultural distance between China and

Sweden remains large according to Hofstede's model and Peter Sjöblom. Many of the

Swedish firms still remain at the stage of export or licensing. Thus, hypothesis two is

supported.

5.3 Government policy and its impacts

Based on the general data about tax incentive policies it can be concluded that the

government policies are trying to offer a guideline for FDI. Based on the current

policy, the government hopes to help those less developed regions to acquire more

FDI through attracting FDI with low tax rate and privileges. However, the data from

Figure 14 show that the main FDI inflow regions are still those coastal areas with

high TBR. To find out the correlation of market size, tax rate and FDI inflows, the

regression is used to test it. The result shows that the formula of FDI inflows is as

follows:

uTIFDI iii 3.38880217.092.4752

This shows that the market size has the positive correlation which means region with


39

larger market size will be easier to attract FDI. The TBR has the negative correlation

with FDI flows which means the region with lower TBR will be easier to attract FDI.

That is to say, tax incentives policies are still attractive to those MNCs. Thus,

hypothesis 3 is supported.

6. Conclusions

6.1 Conclusions and implications

In this thesis, the determinants of FDI location choice in Chinese automotive industry

have been analyzed based on the data collected from 13 regions and the cultural data

of Swedish firm from interview. The results basically support the three hypotheses

raised: (1) The current mainstream of FDI inflow in automotive industry still invests

at the coastal areas but the higher FDI growth rate in the inner region shows that the

FDI choice has trend to change from regions with large FDI stock to those regions

with higher industry agglomeration extent. (2) The large cultural distance will have a

negative impact on FDI choice. In this thesis, the main difference between China and

Sweden appears in power distance and individualism which lead to the different

leadership and management. This difference may create conflicts and therefore the

cultural adaptation is needed. (3) The tax incentive policies can help foreign-funded

enterprises reduce the transaction cost in order to give investors more confidence on

FDI choices. The regression analysis in this thesis confirms this hypothesis. Results

show that the tax bearing rate will have the negative impact on FDI inflows. That is to

say, the regions with tax incentive policy can lower the tax bearing rate and attract

more investment.

According to the test results and the interview data, the thesis summarizes the


40

important variables which will influence the FDI choice of Swedish automotive firm

and give the following suggestions: (1) Investigate the industry development in

different regions and choose the ideal area; (2) Make a careful evaluation on your

potential partner. The mutual goal of two sides is the key to the success of FDI; (3)

Decentralize the control and give more adaptation to Chinese culture. (4) Learn the

government policies toward FDI both nationally and regionally in order to find out the

best region to invest.

6.2 Limitations and Recommendations

The study in this thesis has some limitations and further research would be needed. To

begin with, the thesis investigated the cultural distance and its impacts only from the

perspective of the Swedish firm. The partner selection of host country and its standard

in selecting partner is not included. It would be interesting to study the firms in host

countries which are trying to acquire FDI and their point of view towards cooperation

with foreign partners. This comparison would give a more comprehensive evaluation

of the cultural distance at the firm level.

The study has described the Chinese FDI environment in automotive industry.

Because of the government regulation in this industry, the investment mode focuses

only on the joint venture, which is not representative enough as a guideline to

Swedish investors which wish to enter Chinese market with wholly owned subsidiary

or merger and acquisition. But since China has joined into WTO, the government has

already loosened many of its restrictions. As a result, other kinds of FDI modes in

automotive industry such as merger & acquisition and wholly owned subsidiary are

probably available to the MNCs. It would be interesting to study the potential of these

entry modes as well as the obstacles.


41

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Appendix

Appendix 1: Interview guide of Scania

1. Could you make a brief introduction and your company?

2. What is Scania's current business relationship with China?

3. Does Scania invest or plan to invest to establish subsidiary in China?

-Why do you choose joint venture?

-Does the government restriction of FDI makes Scania feel uncomfortable?

4. If Scania plan to create joint venture, how to choose your partner?

-Can you select your partner?

-Are the firm size and its financial status important to Scania when selecting a

Partner?

-What is Scania's standards in selecting partner?

-Which values is the most important one?

-What kind of cooperation will be between Scania and its partner?

5. If Scania create a joint venture with a partner in China, what kind of ownership

Structure is good for Scania?

-Do you mind if Scania do not have the same or similar amount of share with your

partner?

-Does Scania need the final say when something important happened?

6. Based on the past business relation with Chinese companies, is there any conflict

Happened? What kind of conflict is the most frequent one?

7. Do you think the language gap will have a big influence on the efficiency of


46

Cooperation and communication with other counterparts in Chinese market?

8. What do you think about Chinese culture and its implication in the management of

Chinese firms?

-How to make the balance between corporate culture transfer and local culture

respect?

-What kind of leadership for the joint venture will be suitable to Swedish-Chinese

firm according to you?

9. What do you think about the Chinese way of business relationship maintaining?

-Will Scania choose other partners to establish the value chain on its own standards

or give this right to the partner side?

10.Is it important to keep good relationship with local government?

11.What do you think about the future of Chinese environment for FDI?

Appendix 2: The result of tax bearing rate regression

Formula:

i i i iFDI C I T u


47

the determinants of foreign direct investment choice in

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