FDI China

Economic Development in China 1
Foreign Investment, Trade, and Economic Development in China

By Danie S. Samuel
Table of Contents
Acknowledgements...................................................................................................3
Abstract...................................................................................................................4
Introduction..............................................................................................................6
Literature Review......................................................................................................9
FDI as Driver of Economic Growth...........................................................................9
FDI and Technology Transfer.............................................................................13
Drivers of FDI Flows..........................................................................................14
International Trade as an Engine of Growth.............................................................15
Conclusion..........................................................................................................19
Trade and Investment in China's Economic Development: An Analysis...........................21
Economic Policy and Growth.................................................................................21
FDI and Exports in China......................................................................................24
Policy Initiatives on FDI.........................................................................................28
Acceleration of the Market Economy.......................................................................29
Sectoral Distribution.............................................................................................33
Regional Disparities in China’s Economic Growth.....................................................34
Trade and Investment in the Regional Context: China in the Asia Pacific Region...........37
Trade Imbalance Tensions....................................................................................39
Conclusion.............................................................................................................42
References............................................................................................................44
References
List of Tables
Table 1: Growth Indicators of the Chinese Economy
Table 2: Sector Growth of Chinese Exports
Table 3: China’s Trade with the World
Table 4: Total Foreign Trade and FIE Shares
Table 5: Top 10 Origins of Non-Financial FDI
Table 6: U.S. Trade with China
List of Figures
Figure 1: GDP, FDI, and Export Trends
Figure 2: FDI Flows to China
Figure 3: Sectoral Distribution of FDI in China – 2004
Figure 4: Inequality in FDI investments in China
Figure 5: Regional Inequality of FDI investments in China – 2003

Acknowledgements
Abstract
The emergence of China as a trading nation and manufacturing center

following the adoption of liberal economic policies in 1978-79 is perhaps the
single most important development affecting the world economy in the Twenty-
first century. Estimates put the gross domestic product (GDP) for 2006 at
20,940.7 billion Yuan, up 10.7 percent and a rate of growth 0.3 percent higher
than the previous year. China contributed more than a quarter of the global
GDP growth and has become the sixth largest trader in the world supplying six
percent of global exports.
Despite this phenomenal growth, criticisms leveled against China include its
inability to ensure regional equity in distribution of the benefits of economic
development among its people and across its geographic profile. However, the
new economic geography has championed regional inequality as a source of
economic growth because this would enable the exploitation of economies of
scale. Disparities in regional development continue to exist but one can see
that these will disappear over time as the benefits of progress diffuse across to
the less developed areas.
Foreign direct investments and trade have played a major role in the
transformation of China. This report explores the impact of these factors and
the emergence of China as a source of increasingly sophisticated goods not
produced in this country earlier.
FDI is the result of an internationalization process of the ‘multinational’ or
‘transnational’ corporations that now have cross-border multi-facility operations.
FDI certainly has the possibility of contributing to economic growth by
enhancing capabilities of the host nation to produce certain goods or services
competitively, and boost trade; but researchers have different views about the
impact of FDI on growth. The whether it does so, and the extent to which is
does depends significantly on other factors that are specific to the local
environment and the nature of the investment i.e. for new capital investment or
for the take-over of existing operations.
The positive impact of international trade on economic growth has been widely
documented as trade yields larger economies of scale to help local industry
leverage investment, increase human capital, and obtain higher technology to

drive sustained economic growth.
The result, for China is that it has arrested population growth on the one hand
and on the other, used FDI and trade as instruments to improve its per capita
GDP from US$45.77 in 1980 to US$1,053$ in 2004. Its exports also reveal a
strong trend towards higher technology use in manufacture. This growth has
also allowed it to attract more FDI at the cost of other countries; today China
holds the third highest stock of investment after the US and the UK.
This progress has come through a carefully worked out strategy that has
sought to open Chinese markets in stages. Many multinationals that have set
up their production houses here and created an environment of intense
competition that helps fuel further growth.
Foreign Investment, Trade, and Economic Development

in China
Introduction
Preliminary findings of our regression analysis on the impact of FDI on trade

suggests that for every 10 percent increase in U.S. FDI in China there was a
6.3 percent increase in the level of imports from China to the U.S., with no
statistically significant effect on the level of exports from the U.S. to China.
Kate Bronfenbrenner (2001)
The emergence of China as a trading nation and manufacturing center following the
adoption of liberal economic policies under Deng Xiao-Ping in 1978-79 is perhaps
the single most important development affecting the world economy in the 21st
century. While official statistics may exaggerate the true accomplishments of the
country (Sachs and Woo, 1997), they are stunning nevertheless. In 1979, the
Chinese government looked to decentralize its economy, and began to move from a
planned economy to a market economy (Xinzhong, 2005). The new reform policies
would increase economic growth and raise living standards. The central government
reforms “initiated price and ownership incentives for farmers” (Morrison, 2005:
CRS2), enabling them to sell portions of their crops to the free market; and
established four new economic zones to attract foreign investment, boost exports, as
well as allow importing of high-technology products into China. Many of the reforms
aimed at decentralizing the economy, involved opening the Chinese economy to
international trade (Morrison, 2005).
In 2006, the Chinese national economy maintained a steady and fast growth.
Estimates put the gross domestic product (GDP) for the year at 20,940.7 billion
Yuan, up by 10.7 percent; the increase was up 0.3 percent than that of the previous
year. Of this, the value of the primary industry was 2,470.0 billion Yuan, up by 5.0
percent; secondary industry stood at 10,200.4 billion Yuan, up by 12.5 percent; and
tertiary industry recorded 8,270.3 billion Yuan, up by 10.3 percent. In terms of the
four different quarters, the GDP growth was 10.4 percent, 11.5 percent, 10.6 percent
and 10.4 percent respectively (NBS, 2007).
Eichengreen and Tong (2005) cited reports to state that China contributed more than
a quarter of the global GDP growth in recent years and it has become the sixth
largest trader in the world supplying six percent of global exports. In 2004, China
was the third largest trader in the world after the US and Germany (NBS, 2005), and
its economic the growth has continued unabated while industrialized countries
struggle with the present economic crisis. This transformation from a poor nation,
almost completely cut off from the rest of the world economy, to a nation that
supplies the largest share of labor-intensive manufactured products, is subject of a
constant debate that seeks to understand the underpinnings of the change.
One change evident is that with the emergence of the Chinese economy and with
the country opening its doors to world trade, it has become the favored destination
for foreign direct investments (FDI) and trade. Companies seeking to capitalize on
the abundance of low-cost labor and the vast markets created by the large
population have flocked to China with investment and trading opportunities. What the
foreign investors sought from the economic liberalization are easy access to the local
market, and production incentives in the form of cheap land, raw materials, tax
exemptions, and ultimately attractive profits.
Asia leads the world in labor productivity growth at 3.4% between 1990 and 2002.
China leads the way in labor productivity growth, at 6.5% annually driven by massive
restructuring and privatization. This productivity increase is also associated with

foreign investment and trade that allowed import of better technologies and
management methods and their diffusion to the locally owned industries as well.
Despite this phenomenal growth, criticisms leveled against China include its inability
to ensure regional equity in distribution of the benefits of economic development
among its populace and across its geographic profile. However, the new economic
geography has championed regional inequality as a source of economic growth
because this would enable the exploitation of economies of scale. Porter (1998), for
example, has advocated the development of industrial clusters as geographical
centers of excellence. He posits that when faced with fierce competition, parts of the
production chains can gain comparative advantage by locating close to each other
thus forming industrial clusters.
This thesis seeks to develop an understanding of the role played by the FDI inflow
and international trade in China’s recent economic growth and transformation.
Specific data that highlights China’s achievements in the economic field is
presented, followed by an analysis to understand how this growth and transformation
occurred and to draw conclusions about the main drivers of economic change in
China.
However, there are limitations in this study due to the vastness of the subject matter
and many nuanced implications of different factors (e.g. labor, resources factors) so
that this thesis’ focus on FDI and trade reflect only part of the process of growth.
Nonetheless, given that China is experiencing considerable trade surplus with the
United States and European Union, and is the principal destination of inward FDI,
this project should shed some light on the importance of the aforementioned two
factors on its economic development.

Literature Review
This section reviews the findings of earlier research concerning the prime drivers of
economic development and growth of a nation. It pays attention to the role of FDI
and trade on the economic performance of China.
FDI as Driver of Economic Growth
FDI encompasses the transfer of physical capital and intangible assets such as
technology and knowhow between countries. According to economic theory,
accumulation of capital as well as technological innovation drives economic growth.
Robert Lucas Jr. (1988) analyses different models for understanding economic
development, and emphasizes the need for theory to explain existence of sustained
growth combined with sustained diversity in income levels. He stresses that
explanation of growth rates through analysis of shifts in trade is a possible route that
can help explain the ‘growth miracles’ of some emerging Asian economies. The
growth of these economies is related to increase in exports, “and more suggestively
still, with exports of goods not formerly produced in these countries” (Lucas, 1988:
38); this emphasizes the importance of technology growth.
The motivation for foreign direct investment (FDI) is the need to attain specializations
in key areas. Hence corporations go abroad to invest capital and knowledge, to
source goods and services from areas that offer such specialization, and to improve
competitiveness driven by the availability of cheaper labor, specialized skills,
availability of inputs, logistics etc. This in turn contributes to the economic
transformation of the host country as capital investments and trade increase.
Therefore, FDI is the result of an internationalization process of firms that now have
cross-border multi-facility operations (Alfaro et al, 2005) or the so-called
‘multinational’ or ‘transnational’ corporations (TNCs).

The debate on whether FDI contributes to economic growth has its supporters and
others who report inconclusive and even negative results. All these arguments have
one commonality; and that is that the effect of FDI on economic growth depends
largely on specific conditions prevailing in the host country and the tools used for
understanding economic growth and development. These conditions vary greatly
between countries and comparisons may lead to erroneous results if factors such as
the entrepreneurial approach of companies are not accounted for and a common set
of tools is not developed (Alfaro et al, 2004; Greenaway et al, 2007).
Many researchers report contrasting findings in their exploration of the impact of FDI
on growth. For example, Poon and Thompson (1998) report a positive influence of
FDI on economic growth (see also Mullen and Williams, 2005). Alfaro et al (2008)
conclude that FDI induces economic growth only in the presence of certain economic
conditions such as the presence of a threshold level of human capital, institutions,
and economic policies that encourage foreign investments and trade. Contrary to
these findings, Carkovic and Levine (2005) demonstrate that FDI has no significant
effect on the economic development of the receiving country. Mencinger (2003)
shows a negative relationship between inward FDI flow and economic growth.
The above suggests that there is controversy about some of the basic drivers of
economic growth. Some studies (e.g. de Long and Summers, 1991; 1992) show that
the rate of capital formation determines the rate of growth. On the other hand,
Blomstrom et al (1996) argue that fixed capital investment is important but other
factors are even more critical, for example, institutions, the political and economic
climate, inflow of FDI, low population growth, and efficient use of the investments.
Poon and Thompson (1998) analyzed FDI flows and growth based on data between
1987 and 1994, and concluded that Japanese manufacturing FDI to Asia, and the
US FDI to Latin America contributed to the economic growth of those regions. de
Mello (1999) shows that FDI results in technological upgrading and knowledge
spillovers, and this drives growth; also the effect is sensitive to the degree of
complementarities and exchangeability between FDI and domestic investment. de
Mello (1997) concluded that the final impact of FDI on output growth relies on the
scope for efficiency spillovers to domestic firms. Through such spillovers, FDI leads
to increasing returns from domestic production from better value added production
and thus improvement in the competitiveness of certain production in certain areas,
which in turn attracts more FDI.
Mencinger (2003) analyzes the impact of FDI on different East European countries
where FDI is concentrated in the tertiary sector, i.e. investment, insurance, finance
etc; or on mergers and acquisitions of existing companies. He finds very little
spillovers of technology; rather FDI resulted in more imports than exports and
increased the indebtedness of the local economies (see also Rodrick, 1999).
Mencinger (2003) thus concludes that FDI does not have a direct correlation with
development of human capital in an economy since this depends on the social and
political development of the country. Simply put, FDI certainly has the possibility of
contributing to economic growth, but whether it does so, and the extent to which is
does depends significantly on other factors that are specific to the local environment.
Most of the literature on the impact of FDI on the economy of the host nation ignores
the fact that FDI can take several forms. Other than pure investment in the stocks of
promising companies for a profit motive (an aspect that is not within the scope of the
present study), FDI can occur through mergers and acquisitions (M&A) of domestic
companies or through green-field investments. Wang and Sunny Wong (2009) use a
sample of 84 countries between 1987 and 2001 to differentiate the effects of the two
modes of investment. They find that investments that target setting up new industry
promote economic growth of the host country while M&A investments have a
negative relationship. Their study may explain the conflicting findings of previous
studies since the latter do not take modes of FDI into consideration (Wang and
Wong, 2009).Echoes of this thinking are seen in Mencinger (2003) who speculates
that the entry mode may be a factor that explains the negative relationship he finds
between FDI and economic growth. Support for the negative impact of FDI when it is
used to take over domestic industry may also be found in UNCTAD’s (2000: xxiii)
observation that, “… FDI entry through the takeover of domestic firms is less
beneficial, if not positively harmful, for economic development than entry by setting
up new facilities. At the heart of these concerns is that foreign acquisitions simply
transfer ownership and control from domestic to foreign hands.” This is because
layoffs of employees or the closing of some production or functional activities often
accompany such transfer.
Blonigen and Slaughter (2001) conclude that M&A is a better option compared to
new investments since the latter does not contribute to skill upgrading in the host
country. Conyon et al (2002) suggest that M&A helps improve productivity. Despite
these observations, most mergers and acquisitions do not yield long-term benefit for
the acquiring company or for the one taken over. For example, studies by
Ravenscraft and Scherer (1987) and Ravenscraft (1991), reveal that efforts to
enhance market position through mergers yield no better performance, and
sometimes worse. Statistics show the failure rate of most mergers and acquisitions
lies somewhere between 40 and 80%. If one were to define 'failure' as failure to
increase shareholder value, then statistics show these to be at the higher end of the
scale at 83% (Cnnfn.com 19991).

1 quoted in http://www.kwintessential.co.uk/cultural-services/articles/intercultural-
mergers.html accessed on July 15, 2009)
FDI and Technology Transfer
The above discussions highlighted the emphasis placed on technology transfer and
spillovers (Bransetter, 2006; and de Mello, 1997). While FDI does include the
transfer of technology, the results of such transfers are not as evident. Aitken and
Harrison (1999) looked at the affect of FDI for 4000 firms in Venezuela and found
that productivity did increase in small factories (less than 50 employees) with foreign
equity participation. Among large companies, the effect was not so evident. On the
other hand, the productivity of locally owned factories that engaged in the same
industry actually fell. The study also found no evidence of technology spillovers from
the foreign owned factories. The overall affect on productivity was quite small.
A report by Chuang and Lin (1999) reports completely contrary findings; these
researchers studied 8,846 Taiwanese firms and found beneficial technological
spillovers to domestic companies. Grouping the companies by industry, they point to
an average of 1.40 to 1.80% increase in the productivity of domestic firms for every
1% increase in FDI in that particular industry. Despite establishing this direct link
between productivity and FDI in an industry, this report concludes that the flow and
dispersion of technology reduces the incentive for domestic firms to conduct their
own R&D and increase their dependence on technology transfusions from the
foreign investing companies. Therefore, it is essential that developing countries
adopt policies that encourage local R&D once the country’s technological capacity
has reached a certain level.
One sees that technology transfer and spillovers is highly dependant on the market
structure and the level of interaction between the giver and receiver of FDI. In a
situation of intense competition, it is obvious that the transfer of higher and most
recent technologies could occur to the local affiliates to enable them to meet
competition. Introduction of the latest technologies may also result in the elimination
of the local competitors thereby reducing overall competition. This is especially true if
the foreign firms engage in unethical anti-competitive practices such as price rigging
through absorption of losses in their transnational operations to drive out local
competition.
Therefore, each country has to determine the appropriate role of FDI in the larger
context of domestic development strategy.
Drivers of FDI Flows
All companies confront cycles of competitiveness in their business. As
competitiveness diminishes, a company faces the challenge of increasing
competitiveness. A viable alternative is to establish facilities on foreign shores in
countries that offer benefits not available in the home country. This can take the form
of transfer of the entire operation, or the setting up of affiliates that take up part of the
business. This process cascades as the company faces decreasing competitiveness
in the new location leading to migration to other cost-effective and competitive
location. The result of these processes over time is the establishment of areas of
specialization in different parts of the world. As each area improves skills through
‘learning by doing’, the tendency is for the national income and its internal structure
to improve as local enterprise moves towards higher technology industrial products.
Some commentators have debated the benefits of FDI for economic development as
they looked at FDI as a form of neo-colonialism or neo-imperialism. However, these
ideas do not seem to have a significant impact on large-scale investment flows.
Major flows of capital took place from Britain and Europe to the US after the Civil
War for investment in production and infrastructure. Neoclassical economics sees
such capital accumulation as central to increase in productivity and new investments

as an essential condition for rapid and sustained economic growth. Developing
countries quickly recognized this. Suffering from capital shortages, they saw the
need to attract investments from rich countries. The result was the opening up of
their economies to foreign trade and foreign investment offering a diverse set of
incentives. The structure and the quality of institutional framework also have a
significant impact on the host country’s attractiveness for FDI and therefore
economic growth. While most East Asian countries attracted FDI in the 1960s and
saw rapid development, China followed this trend only in the late 1970s. This
‘liberalization’ transformed and continues to transform the Asian and Chinese
economies from their dependence on agriculture to industrial products as technology
levels gradually increase. Technology transfer is an integral part of investment flows
of multinational firms and is of vital importance for sustained growth in the host
country (Bransetter, 2006). A reverse causality also exists: High economic growth
attracts more foreign investment (Hansen and Rand, 2006).
International Trade as an Engine of Growth
International trade refers to the exchange of goods and services across international
borders. The importance of trade especially as it affects the economic growth and
development of trading nations is important for the purpose of this essay. As an
‘engine of growth’, it played a pivotal role in the growth of the economies of the
developed nations of today in the 19th and the 20th centuries. Trade revolved around
primary commodities e.g. wood from Sweden, coal from Australia, wheat from
Canada etc. As is evident, not all products are equal on the demand-supply
equation, and therefore their impact on the economy varies. Since the end of World
War II international trade has multiplied but the primacy of trade in primary products
has waned. However, there have been numerous examples of economic growth led
by trade in industrial or manufactured goods. Prominent examples since the 1970s
are Hong Kong, Singapore, Taiwan, South Korea, and more recently China.
In the works of David Ricardo, the 18th century British economist, we find the first
theory that links international trade to ‘comparative advantage’2. Ricardo theorized
that trade would take place when one country is relatively more efficient in the sense
of lower opportunity costs (i.e. relative prices) than the other is in the production of
the traded commodity. These gains come, Ricardo observed, because each country
specializes in producing the good for which its comparative cost is lower. However,
Ricardo considered only one factor of production – labor. Other factors like climate
and the environment could also determine comparative advantage. These thought
hold today also if we consider environmental ‘cost’ as a determinant of comparative
advantage.
The neo-classical theory extends the classical theory by adding capital as a second
factor of production leading to cost differences. This is vital from the viewpoint of this
essay since it shows the importance of capital as a determinant of comparative
(competitive) advantage and therefore international trade. With FDI flows enhancing
capabilities of the host nation to produce certain goods or services competitively,
they help boost trade.
Trade has expanded at an accelerating rate since the end of World War II. Statistics
show that between 1950 and 2004, global trade increased 145 times at a rate of
2.6% per year. Trade grew even faster over 2000-2004, increasing from US$13,069
billions to US$18,220 billions in 2004 at a rate of 9% p.a. (UNCTAD, 2005).
Evidently, global trade grew faster than the overall economy during the time. The
2 David Ricardo (1772-1823)The Concise Encyclopedia of Economics,

http://www.econlib.org/library/Enc/bios/Ricardo.html accessed on July 25, 2009
factors that affected this were advances in transportation and communication, and
improvement in the trading environment through different trade agreements.
Nevertheless, the most important factor was the opening of national economies to
international trade through the lowering of tariffs and trade barriers.
The perception of international trade as a driver of economic growth does not suffer
from the ambiguity associated with FDI. The positive impact of international trade on
economic growth has been widely documented (for example, see Grossman, and
Helpman, 1997 who examine the issue from a theoretical standpoint; and Keller,
2004 for a practical view). Keller (2004) pays special attention to the technology
spillovers that accompany trade, which makes it possible for less developed
countries to improve productivity within their own industry through examination of the
imported goods. This increase in knowledge assists in improving competitiveness in
world markets as the domestic companies learn how to produce better quality and
lower costs leading to more trade and thus enter a cycle of economic growth. An
additional benefit that accrues is the access to capital goods offering better
productivity without the need to invest in expensive R&D to develop them
indigenously.
Therefore, international trade can potentially play a crucial role in fueling the
economic growth of less developed countries, because of the dual effect of
improving the production of goods for export, and foreign exchange for importing
capital goods. The diffusion of knowledge helps harness local resources effectively
and efficiently. These three factors combine to increase the pace of economic growth
– international trade thus becomes an “engine of growth” (Cyper & Dietz, 1997).
The literature on economic growth through international trade suggests that it is
more likely that potential export capability must originate from a successful sector in
the domestic economy. For any developing nation with a large population,
indigenous production will remain an important factor for economic growth. Exports
that yield larger economies of scale could help local industry leverage investment,
increase human capital, and obtain higher technology to drive sustained economic
growth (Cyper and Dietz, 1997). Successful domestic production and international
trade complement each other to accelerate economic growth. With economic growth
comes improved capability to export and trade. Therefore, a positive relationship
exists between trade and growth.
Economic development also encompasses the concept of growth and equity in the
distribution of the benefits of growth amongst the population. Frankel and Romer
(1999) investigate how international trade affects standards of living. The findings of
their study show that trade appears to raise incomes by spurring the accumulation of
physical and human capital, and by increasing productivity. This is also true, the
researchers find, of trade within the country. As a result, larger countries have more
opportunities for internal trade that leads to higher incomes. However, these
researchers do not analyze equity issues related to the distribution of the income
among citizens.
Rehbar and Grega (2008), attempt to understand the ‘justice’ aspect of international
trade through an examination of intra-generational and inter-generational disparities.
In their definition, justice stands for judicial use of environmental resources keeping
future needs in view and “the balanced distribution of wealth among the present
generations (distributive justice)” (Rehbar and Grega, 2008: 476). Having defined
their concept of justice, these researchers conclude that current trade practices
across the world do not serve these two goals whether among nations or within the
countries themselves. Their recommendation for developing countries is that they

“concentrate their efforts on investment policies and projects with a special focus on
human capital, land, water, property rights, management, technology infrastructure,
and strengthening farmers’ organizations” (p: 476). This particular article is of
specific interest as we examine the industrial growth of the Chinese economy, the
decreased role of agriculture in its GDP, and the concentration of the growth and its
benefits within geographical pockets rather than across the entire country.
Conclusion
This section has provided a literature review of FDI and trade’s influence on the
economic growth of a country. While the FDI-growth relationship is more
controversial, the evidence for trade and growth appears on balance to be more
positive.
On matters of policy change, we find agreement that a country cannot exist in
isolation and must open its doors to world trade. However, there is emphasis on the
fact that each country must proceed with caution keeping its domestic environment
and its needs constantly in focus. Criticism of an open market across the entire
world, a market that provides a level playing field to unequal players, is also quite
strident.
Trade and Investment in China's Economic Development: An Analysis
This chapter seeks to describe China’s economic performance and to highlight some
of the salient features of this performance and growth.
Economic Policy and Growth
Before China’s reform policies began in 1978, the Chinese government had
embarked on a long mission to attain self-sufficiency without success. State-owned
enterprises (SOE) controlled three-quarters of China’s industrial production, and
there were little to no private enterprise or investment. Foreign trade was limited to
purchasing goods not made in China and there were “few profit incentives for firms
and farmers,” very little competition and severe production controls distorted the
economy; all these factors led to China’s living standards being one of the lowest
among developing countries (Morrison, 2005: 4).
The bottom-line of this debate is that China has emerged as a major trading nation
and center for manufacture, especially for goods and services requiring labor input.
More recently, its range in manufacturing ability has begun to include high-
technology products also. China joined the World Trade Organization (WTO) in 2001
and the threat it holds out to manufacturing activity in the developed countries
signals a major change in the economic balance of the world economy. China has
also attracted heavy net inflows of investment from other countries. These have
arguably led to the phenomenal and unprecedented growth of the Chinese economy
to make it one of the largest in the world.
Because of significant reforms, China’s economy grew at an average annual rate of
10.2% in the 1980s and by roughly 10% annually in the period of 1990–2004. This
was among the highest growth rates in the world. In 2004, China’s gross domestic
product (GDP) was 13687.6 billion Yuan, ranked sixth in the world, making China a
significant economic power. Secondary industry that includes manufacturing, mining,
and construction contributes the largest percentage of the country’s GDP, amounting
to 52% in 2004. Tertiary industry, which includes transportation, commerce, and
services together accounted for 40%. Agriculture, together with forestry and fishing,
contributed almost 8%. In fact, the secondary (industrial) industry contributes the
most in the process of the economic growth (NBS, 2007).
Table 1 below illustrates the turnaround of the Chinese economy in the past 25
years. While population growth, a constant worry earlier, has been arrested and
even stabilized, the gross domestic product (GDP) per capita increased from a
meager US$45.77 in 1980 to US$1,053$ in 2004.
Year Populati GDP/ Trade Industry % of

on Capita as % GDP
[million] [$] GDP Primar Second
y ary
1980 98705 45.77 12.62% 30.1 48.5
1985 105851 84.69 23.05% 28.4 43.1
1989 112704 150.03 24.58% 25.0 43.0
1990 114333 162.23 29.98% 27.1 41.6
1991 115823 186.65 33.43% 24.5 42.1
1992 117171 227.34 34.24% 21.8 43.9
1993 118517 292.23 32.54% 19.9 47.4
1994 119850 390.15 43.59% 20.2 47.9
1995 121121 482.81 40.19% 20.5 48.8
1996 122389 554.66 35.55% 20.4 49.5
1997 123626 602.32 36.22% 19.1 50.0
1998 124761 627.96 34.27% 18.6 49.3
1999 125786 652.44 36.43% 17.6 49.4
2000 126743 705.90 43.90% 16.4 50.2
2001 127627 762.49 43.35% 15.8 50.1
2002 128453 818.76 48.85% 15.3 50.4
2003 129227 908.40 60.04% 14.4 52.2
2004 129988 1,052.99 69.80% 15.2 52.9
Table 1: Growth Indicators of the Chinese Economy

Source: Calculated using data from China Statistical Yearbook 2005
Of special interest are the figures relating to the element of trade in the makeup of
the GDP. While trade, domestic and international, contributed only 12.62% of the
GDP in 1980, this grew to nearly 70% in 2004. Table 2 illustrates this through a
detailed breakdown of the items of exports.
Export volume
(unit: billion RMB, 1990 constant Ratio Ratio
Category of price) 2005 2005
commodity % % % over over
of of of
1985 1995 2005 1985 1995
Tot Tot Tot
al al al
Live animals and
4.5 4.3 20.9 3.0 23.7 0.9 5.27 1.13
animal products
Vegetables, fruits and
10.3 9.7 19.3 2.8 29.3 1.1 2.84 1.52
cereals
Animal and vegetable
0.6 0.6 2.1 0.3 1.0 0.0 1.67 0.48
oils
Food, beverages and
3.2 3.0 21.6 3.1 39.5 1.5 12.34 1.83
tobacco
Minerals 29.7 28.1 31.4 4.5 73.9 2.7 2.49 2.35
Chemicals and related
5.7 5.4 39.3 5.7 112.5 4.2 19.74 2.86
products
Plastics and rubber
N.A. 20 2.9 82.3 3.1 4.12
products
Leather and fur 110.
0.5 0.5 26.3 3.8 55.1 2.0 2.10
products 20
Wood and wooden
N.A. 10 1.4 26.7 1.0 2.67
products
Paper and paper
N.A. 5.2 0.7 18.1 0.7 3.48
products
Textile products 167.
26.8 25.3 24.1 380.3 14.1 14.19 2.27
4
Footwear 73.0
1.1 1.0 38.1 5.5 80.4 3.0 2.11
9
Cement, ceramic and 48.1
0.9 0.9 12.4 1.8 43.3 1.6 3.49
glass products 1
Pearls, precious
stones and precious N.A. 8.2 1.2 19.5 0.7 2.38
metals
Base metal products 201. 112.
1.8 1.7 56.4 8.1 7.5 3.58
7 06
Machinery, electric
129. 18. 1137 42. 758.
equipment and 1.5 1.4 8.81
1 6 .5 3 33
electronics products
Transportation 100. 91.2
1.1 1.0 19.1 2.8 3.7 5.26
equipment 4 7
Optical products and 100. 334.
0.3 0.3 21.9 3.2 3.7 4.58
precision instruments 3 33
Others 17.8 16.8 45.4 6.5 166.1 6.2 9.33 3.66
Total 694. 2691.

113.8 25.44 3.88
1 6
Table 2: Sector Growth of Chinese Exports

Source: Huang et al (2008)
The numbers indicate the waning of the importance of traditional sources of GDP
such as agriculture in favor of industry. While the share of industry in the GDP has
remained steady at around 50%, the shift from primary industry to secondary
industry is significant as China increasingly produces more of sophisticated goods
using higher technology. The numbers in the final two columns of table 2 show a
strong trend towards the manufacture and exports of items such as machinery,
electric equipment, and electronic products. The growth in this area appears to be
phenomenal from 1.5 billion RMB exports in 1985 (i.e. 1.4% of total exports) to
1137.5 billion RMB in 2005. This represents a 42.3% growth! The story is similar
when we examine the exports of optical products and precision instruments that
have grown substantially from 1985.
The above, combined with items including base metal products and cement, show
an increased capacity towards capital goods manufacture for domestic use.
Machinery that contributed 18.6% of China’s total exports in 1995 accounted for
42.3% in 2005 signaling the change in commodity distribution. Traditional product
exports have also grown substantially in absolute terms but their share in the basket
of export products has reduced considerably.
These observations support the theory that increasing trade and FDI has potential
benefits to improve technology and productivity through spillovers and learning-by-
doing. Growth itself has fueled further growth and the increasing sophistication and
acceptability of Chinese exports is manifest in the numbers.
FDI and Exports in China

Figure 1 below traces the growth of GDP and the exports over the past 10 years. FDI
inflow is plotted to demonstrate the connection between the three items. GDP growth
appears to be steadily moving upwards but one can observe a small connection to
the inflow of FDI. This relation is more evident in the case of exports if one considers
a logical time lag between the FDI and its results in terms of enhanced production
and thus exports.
Figure 1: GDP, FDI, and Export Trends

Source: Calculations using China Statistical Yearbook, 2005
However, one needs to add a note of caution in the interpretation of the trends. FDI
flow and exports have a large dependence on the international money markets and
other economical factors. Therefore, the changes may be response to other stimuli.
The share of FDI attracted by China compared to other countries in the world as
well as to other developing nations is more revealing. Figure 2 below evidences the
fact that increasingly China is emerging as the favored destination for FDI flows.
After the initial surge in 1991 to 1993, the share for China dropped due to the fears in
some quarters about the overheating of the Chinese economy and continued until
the world economic crisis in 2000-2001. Once that was over, inward investments
began to surge once again and China’s share in the total FDI flow across the world
rose to nearly 10% by 2003. The situation with regard to China’s share of FDI flows
to developing countries follows an almost exactly similar pattern indicating that
throughout the period under review the world FDI flows found a favorable place in
China.
Figure 2: FDI Flows to China

Source: (Eichengreen and Tong, 2005)
With all developing countries opening up their economies there arose intense
competition among them for attracting FDI. China, in this regard, has been an
exception. China has seen the result of ‘herd behavior’ – a term that is frequently
applied to behavior in financial speculation. First attracted by the enormous size of
the market, its large reservoir of cheap labor, and geographical proximity to the
markets in which the products were to be sold, such as Japan, the US, and South-
Asian countries as well as in China itself, companies began investing in China. The
economic growth built confidence and attracted more investments.
Eichengreen and Tong (2005) explored FDI flows between 1988 and 2002 to detect
patterns in the flow and to answer the question: “Has China’s emergence as a low-
cost production and export platform and its growing attractions as a destination for
FDI made it more difficult for other countries to attract FDI?” (p: 7). They found that
China has emerged as a major destination for FDI flows and the country held the
third highest stock of investment after the US and the UK. This increase has to be
read within the context of the overall growth of FDI flows across the world.
Net FDI flows to developing countries rose steadily over the 1990s, and China was a
favored geographical destination. The main sources of FDI remain Europe, the U.S.,
and Japan. Europe was the source of nearly 60 per cent of global FDI inflows in the
1990s. FDI flows increased from US$21 billion in 1989 to US$179 billion in 1999,
with most of the money going to four countries: China, Brazil, Argentina, and Mexico.
Other countries in Asia also benefitted from the broader regional spillovers of FDI to
China, “as if producers in these economies belong to a common supply chain”
(Eichengreen and Tong, 2005:1). Included in their findings is the fact that FDI flows
have even diverted from OECD countries to China. The researchers suggest that
this is due to the need to produce close to the final market for the products and the
need to concentrate efforts in one geographical area for better control of operations.
The result is a reduction of FDI flows to developing countries by 26% between 1999
and 2003 while those to China climbed rapidly.
Therefore, China has acted as a magnet for FDI investment based on its labor-
intensive manufacturing capabilities making it difficult for other developing countries
to attract investment (Wei, 2000). There are worries in Japan and Korea that the
rapid growth of Chinese industry, fed by foreign direct investment from these and
other countries, is “hollowing out” their own manufacturing sectors. These fears
deepen in face of the fact that even now there are 200 to 300 million underemployed
rural Chinese who are waiting to be integrated into China’s manufacturing system
(Eichengreen and Tong, 2005).
Policy Initiatives on FDI
China’s policies toward FDI can be roughly categorized into three stages:
• Gradual with limited opening

• Active promotion through preferential treatment
• Promoting FDI in accordance with domestic industrial needs (Fung et al.,
2002: 5)
Stage One: 1979-1991. Between 1979 and 1991, the Chinese government
implemented special incentive policies in Special Economic Zones (SEZ); three in
Guangdong and in Fujian provinces (Xinzhong, 2005). During this period, FDI inflow
was highly concentrated in SEZs alone, especially from 1979 to 1983. FDI inflows
were US$1.755 billion during this period. FDI inflows increased to US$10.301 billion
with the opening of the 14 coastal cities and other untapped regions within 10
provinces between the years of 1984 and 1988. Several more locations opened in
1988, resulting in a total FDI inflow of US$11.245 billion by 1991, even with a slow
period in 1989 and 1990 (Xinzhong, 2005). After the 20 years reform, and by the end
of 1991, China had already become the third largest FDI recipient among developing
countries.
Stage Two: 1992-1997. 1992 was a turning point in China’s economic reform and the
time when the Chinese premier, Deng Xiaoping set out on his famous tour of the
southern regions and SEZs of China (Xinzhong, 2005). Deng’s speech during his
tour emphasized his support for China’s economic development with the assistance
of FDI inflows in SEZ and expressed a desire for a fast-paced acceleration of the
market economy, which greatly pushed China’s overall economic reform process
(Wei, 2000). It was at this time that China’s government committed to the market-
oriented economic reform and the open-door policy. It was in 1992 that China began
to implement a policy of equal development of areas within the country from its past
policy of region-based growth. Deng’s speech greatly encouraged foreign
enterprises to invest in China, and beginning 1992, the flow of inward FDI was faster
and higher. This resulted in the quadrupling of inward FDI to reach US$58.1 billion in
1991, a figure that reflected China’s attraction to foreign investors since reforms
began in 1979. By the early 1990s, China had become the second largest recipient
of FDI in the world, next only to the United States.
Stage Three: 1998-2004. This stage is an important period for China’s economy,
much like stage two. Both the turnaround following the Asian financial crisis at the
end of 1997 and China’s accession into the World Trade Organization (WTO)
occurred during this period. Due to the impact of the Asian financial crisis in 1997,
China experienced a temporary setback in FDI inflows with an approximate 40%
decrease and a negative growth rate of almost 12% (Xinzhong, 2005).
As we will see later in this report, most of the FDI flow to China comes from Asian
countries and these countries themselves went through a major economic crisis
during this period. However, as economy of the region and the world began to pick
up and as confidence was restored in the Chinese economy the flow of FDI has
picked up again.
Acceleration of the Market Economy

Several factors are involved in accelerating China’s planned economy to a market
economy where FDI has played a vital role. FDI attracted:
• Capital formation
• Labor training
• Upgrading of industrial structure
• Technology transfer
• Spillovers
• International trade
Attracting foreign capital to compensate for China’s shortage of capital as well as the
engagement of technology transfer to China have been the two main aims for
pursuing a rigorous FDI policy by the Chinese leadership. In order to attract FDI,
Deng established two market promotion zones, and these zones promoted
investment through unique tax incentive packages (Fung et al, 2002: 5). The
promotion zones promoted are:
• Special Economic Zones – Shenzhen, Shantou, Zhuhai and Xiamen (1979-

1980)
• 14 Coastal Cities – such as Shanghai, Tianjin, Guangzhu, Qingdao and Delia
(1984-1985)
• Dozens of developmental zones (1985)
• Designated inland cities
• Free ports and tax bonded zones (2000)
The provincial and local government was given the economic control of various
enterprises as the central government decentralized industrial production so that
they were no longer under state planning or control, and could operate and compete
on free market principles (Morrison, 2005). Under provincial and local government,
open cities and development zones were created in coastal regions and cities where
experimentation of free market reform took place (Morrison, 2005).
The mid-1980s brought enhanced regulations and encouraged further FDI inflows
into the country. Emphasis was on “export-oriented joint ventures and joint ventures
using technology” (Fung et al, 2002: 3).
The three major sources of capital inflow in China are FDI, external loans and other
types of foreign investment, such as portfolio investment and international leasing
(OCED, 2000). Of the three capital sources, FDI has played the most important role
in economic growth because as pointed out by Poon and Thompson (2001), it is less
volatile compared to portfolio investment. In addition, FDI captures the equity of
foreign investment (e.g. factories) and this tends to be longer term in outlook. This is
because it is not easy to relocate or move networks with Chinese suppliers and
distributors, since they are the result of locally embedded relationships. Furthermore,
because much of the FDI are in special economic zones, they target for exports.
Table 3 shows the leaps in China’s export levels and growth from 1999 to 2004.
These figures continue to be quite high after 2004 but 2008 saw a much smaller
increase due to the current global economic recession.
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Exports 194.9 249.2 266.2 325.6 438.2 593.3 762 969.1 1,218.6 1,428.5
% change 6.1 27.8 6.8 22.4 34.6 35.4 28.4 27.2 25.7 17.2
Imports 165.7 225.1 243.6 295.2 412.8 561.2 660 791.6 955.8 1,133.1
% change 18.2 35.8 8.2 21.2 39.8 36 17.6 20 20.8 18.5
Total 360.6 474.3 509.8 620.8 851 1,154.6 1,421.9 1,760.7 2,173.8 2,561.6
% change 11.3 31.5 7.5 21.8 37.1 35.7 23.2 23.8 23.5 17.8
Balance 29.2 24.1 22.5 30.4 25.5 32.1 102 177.5 262.2 295.5
Table 3: China’s Trade with the World

(In billion $)
Source: The US-China Business Council3 quoting PRC National Bureau of Statistics and PRC General
Administration of Customs, China's Customs Statistics
All of the above came about thanks largely to the development of industries through
foreign investment and industrial growth, and labor productivity has also increased
considerably. Many multinationals that have set up their production houses here pay
higher salaries than local companies and this also increases competition that could
help upgrade local supplier networks through improved inputs and products. China
manufactures most of the world’s clothing and over a third of cell phones. It has
become the biggest producer of steel in the world with output in excess of that of the
U.S. and Japan together4. There is no doubt that the low cost of goods and labor has
helped attract FDI in furniture making to electronic components manufacturing5.
The open-door policies and other economic reforms have reduced tariff barriers,
which has encouraged international trade. The boost in foreign trade is due to duty
3 http://www.uschina.org/statistics/tradetable.html accessed on July 26,2009

4 “Inside the new China,” Fortune, October 2004
5 “The China price,” Business Week, Dec. 6, 2004
exemptions for intermediate products used in the production of exports, according to
OCED & OCDE (2000). Table 4 shows the trends in exports and FIE contribution.
Year Total Total FIEs Shares Exports as %

Exports and Exports in of GDP
Imports and Imports Total
of FIEs Exports
and Imports
1993 1,957.1 670.7 34.3 32.6
1994 2,367.3 876.5 37.0 43.6
1995 2,808.5 1,098.2 39.1 40.2
1996 2,899.0 1,371.1 47.3 35.6
1997 3,250.6 1,526.2 47.0 36.3
1998 3,239.2 1,576.8 48.7 34.3
1999 3,606.5 1,745.1 48.4 36.4
2000 4,743.1 2,367.1 49.9 43.9
2001 5,097.7 2,591.0 50.8 43.3
2002 6,207.9 3,302.2 53.2 48.9
2003 8,509.9 4,721.7 55.5 60.0
2004 11,545.5 6,630.4 57.4 69.8
Table 4: Total Foreign Trade and FIE Shares
(100 million USD)
Source: Almanac of Chinas Foreign Economics & Relations 2003 and own
calculations based on data from China Statistical Yearbook, various years.
As of 2004, China was the third largest exporter in the world, up from number 19th in
1981 (The Almanac of China’s Economic Relations and Enterprises cooperation,
2003/2004). Trade is a major factor of China’s GDP; in 1993, the ratio of total export
and import in GDP was 32.6%. In 2004, this has increased to 69.8% as shown in
Table 4.
Sectoral Distribution
Figure 3 below shows the sectoral breakdown of FDI distribution in China in 2004.
Clearly it indicates that FDI is predominantly targeted at the manufacturing sector
(i.e. 71%) followed by real estate and leasing services (14%). The remaining sectors
contribute much smaller shares with the least amount of FDI going to the primary
sector.
Figure 3:
Sectoral Distribution of FDI in China – 2004
Note: Distribution industry includes transport, wholesale and retailing, Information transmission,
Computer services, Software, and Hotel services. The primary industry includes agriculture,
forestry, and fishing. Data from the China Statistical Yearbook, 2005.
Regional Disparities in China’s Economic Growth
Geographer Dennis Wei (1999) states that regional disparities within a nation
threaten unity and social stability and that it is surprising that not much debate has
addressed the regional disparities within China. Ever since the establishment of
Peoples Republic of China (PRC) in 1949, there have been increasing inequalities
between the coastal and inland regions in terms of resource allocation and local
autonomy (Kanbur and Zhang, 2005). There are many reasons underlying this. Wei
(1999) explains that this is because of the differentials in physical and human
resources inherited from the colonial period, the need for urban-centered
industrialization that limited resources available for development of the interior,

inefficiency in interior investments, access to foreign resources, and the lack of
favorable macro-conditions for economic growth in the interior. The government
encouraged coastal regions to “get rich quick” (Wei, 1999: 51). Hence, regions like
Jiangsun recorded dramatic growth while inland regions have lagged behind (Wei,
1999).The debate whether the gaps between the regions have narrowed or
increased in post-Mao China has supporters on both sides. However, many argue
for a greater attention to regional balance.
However, the new economic geography regards uneven regional development to be
the outcome of increasing returns. Hence, some regions are expected to grow faster
than others, which reinforce regional inequality – at least in the short run (Krugman,
1991). In particular, Porter (1998) has emphasized economic development through
the establishment of industrial clusters. Such clusters are groups of firms that have
commonalities in terms of trade interdependence (input-output relationship) and/or
shared social and cultural relationships that form around a core activity.
Geographical proximity is an important requirement because it lowers transportation
costs while encouraging inter-firm linkages. Such clusters help generate external
economies, and create opportunities for mutual learning, cooperation, trust, and
innovation through extensive networking (Camagni, 1991). Public intervention can
strengthen the competitiveness of the cluster in many cases. According to Amsden
(1989), in the later phases on industrialization, a big push from the state is the main
force behind successful industrialization. She notes that this has explained the
success of several East Asian nations’ rapid economic growth. Given this, it seems
that the Chinese government’s policy of building FDI clusters along the coast would
be consistent with Porter’s view that the state should use industrial clustering as a
means for rapid industrialization. In so doing, the state improves the properties for
continual learning (Scott and Storper, 2003).

Whether conscious public policy can actually affect the formation and development
of industrial clusters directly is discussed by Wolfe and Gertler (2004:4) who state
that the “evolutionary paths for cluster creation are highly variable. Public sector
decisions can affect cluster trajectories in a variety of ways, though the impacts are
often unpredictable and often unintended.” The Chinese have placed a lot of
emphasis on the development of industrial clusters (Chanye Jigun). However, China
needs to learn how to shape this process in the local arena, not only in adopting
lessons from other clusters but also in seeking to position local industries in the
global value chain and in strengthening their competitiveness in the global market.
As these clusters thrive, the diffusion process will bring about reduction in regional
inequality. Figures 4 and 5 reveal that regional inequalities in FDI clusters would
seem to have remained the same over 1999 to 2003 with the coastal or Eastern
region receiving the bulk of FDI.
FDI Stock in
China
Figure 4: Inequality in FDI investments in China

(Source: Bransetter, L.G. and R.C. Feenstra, 1999)
Figure 5: Regional Inequality of FDI investments in China – 2003
Source: Calculated using data from Data collected from Hunan Statistic Yearbook
2004, p.519
Trade and Investment in the Regional Context: China in the Asia Pacific Region
There is a strong evidence of the link between foreign direct investment and
manufacturing productivity growth in many Chinese provinces. Chen (2002) grouped
23 manufacturing sectors into three big industries and examined them in 29 Chinese
provinces between 1988 to 1994. They provided an estimate of the total factor
productivity (TFP) growth by manufacturing sector in relation to FDI inflows. The
results showed significant differences in TFP growth between manufacturing sectors
dominated by foreign direct investment and those dominated by domestic investment
in the consumer goods industry, confirming the positive impact of FDI on economic
growth.
FDI investments in China are substantially different from that of the rest of the world.
The majority of FDI in China is greenfield. Greenfield here is in reference to new
plants and equipment. The majority of FDI in the world, on the other hand, mostly
targets mergers and acquisitions (M&A) of existing businesses. During the economic
recession, there was a severe decrease in M&A, causing world FDI to decrease as
well (Song, 2005). As Song wrote in the ‘Executive Intelligence Review’, “while world
FDI suffered during the world economic recession, FDI inflow into China continues to
increase” (p: 1). He went on to say that the majority of green-field FDI in China
belonged to the category of labor-centric FDI. As we saw earlier in figure 3, the
manufacturing sector dominates in FDI sectoral composition. Of the total FDI into
China, 70% consists of labor sourcing FDI, especially for cheap Chinese labor. While
investment in labor-sourcing FDI would normally target low-income economies, this
was not the case in China despite substantial increase in wages there. Since 1996,
China has attracted over US$40 billion dollars in FDI, 95% of it targeting green-field
industries (Song, 2005).
Xinzhong (2005) suggests that China’s inward FDI tend to favor locations with the
following characteristics:
• Higher level of economic development (GDP)

• Higher density of population
• Better telecommunications
• Enhanced transport infrastructure
Table 5 below shows the top five FDI investors in China. It may not come as a
surprise, but Hong Kong, Japan and Taiwan are major contributors to China’s
economic development, with the US a distant seventh. Hsu (2006), and Yang (2006),
have documented the reasons for the high levels of Asian investments. Their studies
along with Table 5 suggest that geographical proximity explains much of these
investments. More importantly, Asian FDI is largely motivated by the operations of
overseas Chinese who are culturally familiar with China’s local business environment
and language. Hence, they have a competitive advantage over foreign investors
from Europe and the US.

Country/Region of Amoun Amoun Year-

Origin t t on-Year
Investe Invest Growth
d 2007 ed %
2008
Hong Kong 27.7 41.0 48.1
British Virgin Islands 16.6 16.0 -3.6
Singapore 3.2 4.4 39.3
Japan 3.6 3.7 1.8
Cayman Islands 2.6 3.2 22.3
South Korea 3.7 3.1 -14.8
United States 2.6 2.9 12.5
Western Samoa 2.2 2.6 17.5
Taiwan 1.8 1.9 7.0
Mauritius 1.3 1.5 12.1
Table 5: Top 10 Origins of Non-Financial FDI (Billion $)

Source: MOFCOM
Hong Kong is by far the largest investor in China. It supplies more than 48% of the
total FDI received by China in 2008. As we saw in an earlier section, FDI clusters are
mainly found on the coastal areas. Much of Hong Kong’s investment is located in
Guangdong and more recently, Dongguan coastal provinces. As these provinces are
adjacent to Hong Kong, they have seen an influx of Hong Kong capital as firms in the
city-state relocate their labor-intensive factories to the provinces (Yang, 2006).
Particularly interesting is that British Virgin Islands, and Cayman Islands are also two
of the top ten investors in Table 5. Both islands are tax havens to third countries but
it is possible to speculate here that some of that capital is being recycled through
China as FDI seek lower transaction costs. Surprisingly, none of the literature
reviewed makes any comment of this.
Trade Imbalance Tensions
Since trade exploits principles of comparative advantage and specialization, China’s
trade is intimately related to FDI. This is because a significant portion of FDI is in
China’s special economic export zones. This implies that corporations in these zones
are likely to use the incentives provided in these zones for export to the international
markets. In China’s case, the US has been a major destination for its exports.
Furthermore, some geographers have reported that comparative advantage may be
changing in China and trade has been credited with encouraging the rise of a high-
tech sector (Zhou and Xin, 2003). Huang et al (2008) examined 100,000 Chinese
manufacturing firms to find the reason for the surge of manufacturing exports from
China. Their findings indicate that this rise is not because of the role of low cost labor
and find that the results are inconclusive. According to them, the reasons lie in the
collaboration with foreign investors and fierce domestic competition. That is to say,
multinationals have contributed to Chinese hi-tech exports; evidenced by the fact
that foreign-funded enterprises control more than 70% of China’s high-tech exports
in recent years. Their share in total high-tech exports reached 87% in 2002 (China
Statistics Yearbook on High Technology Industry, 2003). China’s Ministry of
Commerce reports that of the approximate US$400 billion in high-tech export
products from China in 2005, less than 10% of the products bore the brand names of
the manufacturers or with independent intellectual property rights (Xinhua Net
20056).
As part of the Asia Pacific, the US shares strong commercial ties with China and
trade relations between the two countries have been strengthening since the
rapprochement in the early 1970s. This is due to the mutually attractive business
opportunities. On one side is China with its rapidly expanding markets and an almost
endless supply of cheap labor and on the other is the US that offers the best in
technology and some of the largest and strongest business organizations. Despite
this, large imbalances have occurred as exports from China far outstrip its imports
from the US (Table 6 below).
6 http://www.xinhua.net Accessed on July 25, 2009

The volume of trade between the two countries as a share of China’s total trade with
the world was about 12.6% in 1980 and rose to a peak in year 2000. Since then it
has again reduced to 20 % in 2005 and further to 15.9% in 2008. This is primarily
because of China’s diversification off trading partners across the world although the
US has also exerted considerable pressure to narrow the trade gap. Changes in oil
prices (China imports most of its energy requirements) have also affected this
equation though not significantly. On the other hand, China has emerged as one of
the top trading partners for the US.
Year Export Import Total Balance

of
Trade
1985 3,855.7 3,861.7 7,717.4 -6.0
1990 4,806.4 15,237.4 20,043.8 -
10,431.0
1995 11,753.7 45,543.2 57,296.9 -
33,789.5
2000 16,185.2 100,018. 116,203.4 -
2 83,833.0
2005 41,192.0 243,470. 284,662.1 -
1 202,278.
1
2008 69,732.8 337,772. 407,505.4 -
6 268,039.
8
Table 6: U.S. Trade with China (in million $)

Source: US Census Bureau7
While both countries enjoy the economic benefits of trade, the US trade deficit has
become a major economic and political issue. The primary tensions that exist are
China’s reluctance to open its domestic markets completely open to foreign
businesses and its adamancy of not allowing the Yuan to become a freely
convertible currency. Despite entry to the WTO, it has been difficult to make China
stick to its commitments towards market reforms. Hence, US investment in China
7 http://www.census.gov/foreign-trade/balance/c5700.html accessed on July 20,

2009
remains relatively low compared to its Asian counterparts even though its imports of
Chinese goods are high.
What this section suggests is that much of China’s economic growth may be driven
by Asian investment and US imports of Chinese goods. While Asian investors are
attracted by China’s cheap labor, exports of Chinese goods arising from these
investments, on the other hand, have been directed at the US market rather than at
their own markets.

Conclusion
Rapid growth and transformation of the Chinese economy since beginning of
economic reforms, driven by trade in the international and domestic arenas as well
as the massive injections of foreign direct investments (FDI) that came into the
country primarily to establish new industry, have underscored its transformation
since 1979. This has resulted in not only the growth of the national economy but also
the individual prosperity of its citizens and increase in its capability to produce
increasingly sophisticated and high-technology goods for the world markets. There
are some anomalies in the growth that has left behind the interior regions. However,
with time it is possible to expect that regional inequality may reduce as the benefits
of economic growth diffuse and filter down to the hinterlands as well.
Economic theory suggests that unfettered international capital flow fosters efficient
allocation of resources, which by itself should promote economic growth. The
economic benefits of FDI are twofold. First, FDI can help countries if domestic
savings are insufficient to finance economic expansion, and second, foreign
corporate presence is associated with positive externalities. However, as seen from
the Chinese example, the composition of the FDI is of vital importance. American
companies have invested only a fraction of the total FDI inflow into China and most
of this has sought to target the tertiary markets or acquisition of existing assets (that
is mergers and acquisition). On the other hand, FDI from Hong Kong, Japan and
Singapore have sought to create synergies through the establishment of new capital
assets (green-field enterprises). Investments have therefore borne fruits of different
kinds. The US is struggling with a massive trade deficit and the situation can get
worse if the Chinese capital markets were to deteriorate or if the Chinese decide to
call in their debts.
However, the data collected and presented in this thesis suggest that Chinese
economic growth may be driven by the inflow of capital from foreign investors and
the growth of it international trade. The empirical data would seem to support the
positive role of FDI and trade for its national development.
Nevertheless, rising wages may erode China’s advantage at least in the labor-
intensive industry. Problems related to loss of jobs in the West due to off-shoring of
work to less developed countries is also another factor that is going to force the
Western countries, particularly the US and United Kingdom, to bring back some of
these jobs and reduce reliance on foreign labor (NAPA, 2007). This may decrease
FDI to China. Moreover, FDI flows may taper down as businesses seek to hedge
their risks by diverting their finances to other developing countries. The trade
imbalance also remains a thorn, as there is a limit to which Chinese exports to the
US can continue unabated. It would seem that trade as an engine of growth has
benefitted China because of accessibility to the US market. But the political climate
in the US is also changing as the recession deepens.
A much larger problem is the artificially pegged currency rates. Despite pressure
from all quarters, the Chinese government has so far resisted floating its currency in
international money markets. If, and when this happens, the Yuan is likely to
appreciate through a huge margin making Chinese export less competitive in world
markets. This may address the trade imbalance to some extent but China may need
to expand its menu of growth engines beyond FDI and trade to maintain its high
growth rates in the end.

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Economic Development in China 1

Foreign Investment, Trade, and Economic Development in China

Table 1: Growth Indicators of the Chinese Economy

Table 2: Sector Growth of Chinese Exports

Table 3: China’s Trade with the World

Table 4: Total Foreign Trade and FIE Shares

Table 5: Top 10 Origins of Non-Financial FDI

Table 6: U.S. Trade with China

Figure 1: GDP, FDI, and Export Trends

Figure 2: FDI Flows to China

Figure 3: Sectoral Distribution of FDI in China – 2004

Figure 4: Inequality in FDI investments in China

Figure 5: Regional Inequality of FDI investments in China – 2003

The emergence of China as a trading nation and manufacturing center

leverage investment, increase human capital, and obtain higher technology to

Foreign Investment, Trade, and Economic Development

Preliminary findings of our regression analysis on the impact of FDI on trade

Kate Bronfenbrenner (2001)

adoption of liberal economic policies under Deng Xiao-Ping in 1978-79 is perhaps

aimed at decentralizing the economy, involved opening the Chinese economy to

international trade (Morrison, 2005).

and 10.4 percent respectively (NBS, 2007).

supplies the largest share of labor-intensive manufactured products, is subject of a

constant debate that seeks to understand the underpinnings of the change.

exemptions, and ultimately attractive profits.

restructuring and privatization. This productivity increase is also associated with

to ensure regional equity in distribution of the benefits of economic development

geography has championed regional inequality as a source of economic growth

example, has advocated the development of industrial clusters as geographical

thus forming industrial clusters.

and international trade in China’s recent economic growth and transformation.

Specific data that highlights China’s achievements in the economic field is

presented, followed by an analysis to understand how this growth and transformation

factors on its economic development.

and trade on the economic performance of China.

FDI as Driver of Economic Growth

technology and knowhow between countries. According to economic theory,

accumulation of capital as well as technological innovation drives economic growth.

growth combined with sustained diversity in income levels. He stresses that

growth of these economies is related to increase in exports, “and more suggestively

38); this emphasizes the importance of technology growth.

in key areas. Hence corporations go abroad to invest capital and knowledge, to

competitiveness driven by the availability of cheaper labor, specialized skills,

availability of inputs, logistics etc. This in turn contributes to the economic

transformation of the host country as capital investments and trade increase.

cross-border multi-facility operations (Alfaro et al, 2005) or the so-called

‘multinational’ or ‘transnational’ corporations (TNCs).

understanding economic growth and development. These conditions vary greatly

of tools is not developed (Alfaro et al, 2004; Greenaway et al, 2007).

conditions such as the presence of a threshold level of human capital, institutions,

effect on the economic development of the receiving country. Mencinger (2003)

US FDI to Latin America contributed to the economic growth of those regions. de

complementarities and exchangeability between FDI and domestic investment. de

and thus improvement in the competitiveness of certain production in certain areas,

which in turn attracts more FDI.

etc; or on mergers and acquisitions of existing companies. He finds very little

layoffs of employees or the closing of some production or functional activities often

accompany such transfer.

enhance market position through mergers yield no better performance, and

scale at 83% (Cnnfn.com 19991).

FDI and Technology Transfer

researchers studied 8,846 Taiwanese firms and found beneficial technological

spillovers to domestic companies. Grouping the companies by industry, they point to

foreign investing companies. Therefore, it is essential that developing countries