Lecture 14-a

Foreign Direct Investment and the

Emerging China Circle:
A Key Engine of Development
 FDI in the Socialist Period

Closed to foreign investment … after

Soviet’s left in 1960, “walk on two legs”
 Deng and FDI
• 1978 -- decision to stop isolation
• Two motivations:
– Need for foreign exchange (to import new technology)
– Fear of falling further behind East Asian neighbors

• 1979-80: establish Special Economic Zones

(SEZs)
– Cautious
– Incremental
– Geographically isolated
Geography, Revisted:
In the beginning …
First Special Economic
Zones … in the South …
areas isolated from the rest
of China
Geography of first 4 SEZs not an accident …
Tapping the Overseas Chinese connections!

Xiamen
Taiwan

Shantou

Shenzhen

Zhuhai Hong Kong

Macau

South East Asia

Shenzhen: the
symbol of China’s
miracle growth …

From 1980 …

… until 2000

But it did not

happen over night!
 Figure 17-1: Total Foreign Investment

50

45

40

35

30 Direct Foreign
Billion US Dollars

Investment
25

20
Loans
15

10

0
1982

1985

1986

1991

1992

1994

1996

1997

1998

1999

2000
1983

1984

1987

1988

1989

1990

1993

1995
1979-81

Small … but a lot more than

before!!! And, big impact
 The Early SEZs
• Law of Joint Ventures
• Foreign Equity: 25% or more / no maximum limit
• CEO had to be Chinese national (until 1990)
• Lower tax rates
• Simple administrative procedures

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

• First JV (make airline meals for Air China)

• Oil exploration
• Mining (especially coal)

• But also other trend:

– Early Hong Kong processing operations
– Much like EPZs of rest of Asia …
Export Processing Zones: Why Chinese SEZs are Similar
China’s special economic zones are a particular type of export processing zone. The
first export processing zone in Asia was established at Kaohsiung in Taiwan in 1965. In the early
1970s, Japan relaxed its restrictions on investment abroad and began to invest in Asia to move
labor-intensive manufacturing to lower cost environments. In 1972, Korea established the Masan
Free Export Zone and the Philippines set up the Bataan Export Processing Zone to attract these
investments. By the 1980s, there were 35 EPZs in Asia, and most countries had them.

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

Asian EPZs offered a way to move toward export promotion without fundamentally
overturning the structure of protection in place for domestic manufacturers. EPZs produced
benefits in terms of employment created and foreign exchange earned, but at a cost of giving up
significant tax revenues, and foregoing potential linkages to the remainder of the domestic
economy. Most EPZs started slow and ended up costing far more than initially envisaged; but the
policies have typically been seen as ultimately successful in most of the countries which tried
them. EPZs primarily attracted “footloose” investors in such sectors as garments and electronics
assembly because of low wages and easy conditions for moving goods in and out. Turnover has
been substantial, but some zones have clearly contributed to the ultimate establishment of
successful industries in their countries. One example has been the Penang Free Trade Zone in
Malaysia which initiated the development of Malaysia’s now substantial electronics industry.

Chinese SEZs share all these fundamental characteristics with other Asian EPZs.
 Export Processing Zones: Why Chinese SEZs are Different

From the beginning, Chinese SEZs were inevitably bound to be more “special” than other Asian EPZs. This f
ollows from the fact that the other Asian EPZs were established in economies that were basically market economies, albeit
ones that were sheltered from world markets and competition. However, because of the very early stage in the economic
reform process in which China’s SEZs were created, the difference between the “rules of the game” in the domestic
economy and that in the open and relatively uncontrolled economy in the SEZs was bound to be large. Moreover, China’s
SEZ are much bigger than other Asian EPZs. As Table 17-1 shows, the typical Chinese SEZ was many times the size of an
Asian EPZ. This larger size reflects their multiple roles and greater importance to the domestic economy. China’s SEZs
were seen alternatively as transmission points for world advanced technology; “windows” on the world for political and
economic purposes, and “laboratories” for economic experimentation. In concrete terms, some of the key distinctive
characteristics of the Chinese zones include:
---Chinese domestic enterprises have also had a substantial incentive to invest in the SEZs. By setting up their
own subsidiaries—even if they are not joint ventures with foreign businesses—Chinese domestic enterprises enjoy greater
administrative flexibility, lower tax rates (15% income tax rather than 30%), and less complicated access to the outside
world. Aside from taxes, these are largely reflections of the continued restrictions imposed on firms by the remnants of
China’s bureaucratic economy.
---The SEZs sometimes serve as “laboratories” for experiments with economic reforms. For example,
Shenzhen SEZ was an early pioneer of both flexible wage systems (no limits to incentive payments) and tender bidding for
construction projects. Experiments with development of land markets through leasehold, and equity markets have also been
significant.
---Shenzhen in particular has been developed as a “comprehensive” site, including tourism, housing, and other
services for Hong Kong people.
---Initially, the SEZs were allowed to retain all tax and customs revenues; and all foreign exchange earned for
their own use. This reflected the large task of infrastructure construction in these relatively un-developed sites (check this).
Before 1988, they were allowed to keep 50% of tariffs. Before 1992, they also kept foreign exchange. In 1994, integrate
into national fiscal system. In 1996, pay full tariffs on commodities imported into the zones themselves, as opposed to 50%
previously (?). Thus, the SEZs were governmental bodies with unusually high levels of autonomy, compared to EPZs.
During the 1990s, the SEZs have tended to become “less special” as other parts of the Chinese economy have
been opened, and some special provisions have been scaled back.
Table 17-1: Size of China's SEZs and Asian EPZs (km2)
Initial 1980 Size Size in 1990
Shenzhen 327.5 327.5
Zhuhai 6.8 121.0
Shantou 1.6 52.6
Xiamen 2.5 131.1

Kaohsiung, Taiwan 0.7

Penang, Malaysia 1.2
Batam Island, Indonesia 36.6
Bataan, Philippines 3.4
 If a little “SEZ action” is good,
then a bit more is better!
• In 1984-87: 14 Open Coastal Cities
(OCCs)
• All were “open” before, but now got to offer
the same special preferential treatment as
the SEZs ..
• Also: opened up other “isolated” previously
unplanned areas, surrounding rural areas
(in Pearl River Delta—Guangdong—and
Lower Yangtze Delta—Jiangsu)
 Northernmost:
Dalian

14 Open Coastal Cities

Southernost:
Beihai
 Stop and Start policies
• Boom of investment and new contracts …
• But, also allowed to import with little restrictions
(and easy access to foreign exchange)
– Invest or import? All foreign firms / domestic firms face
this choice (though often constrained, e.g., severe import
constraints)
– When loosen import controls, booming imports!! …
slowed FDI
– Gov’t responds, restrict all imports … also affects
imports (can’t import equipment or raw material for
processing firms) … slowed FDI more …
– So finally regularized policies: gave access to foreign
exchange; more legal changes; more tax reductions;
power to approve small/medium investments without
upper level approval … finally began to rise again …
– Surge in investment from the US: “Beijing Jeep”
 Figure 17-1: Total Foreign Investment

50

45

40

35

30 Direct Foreign
Billion US Dollars

Investment
25 14 OCCs

20
Loans
15

10

0
1982

1985

1986

1991

1992

1994

1996

1997

1998

1999

2000
1983

1984

1987

1988

1989

1990

1993

1995
1979-81

Continue the gradual rise …

Tiananmen Incident (June 4, 1989)
• Cooled enthusiasm for many to invest …

• But Taiwanese took advantage of new

round of incentives …

• Korea began to enter in NE …

 The Explosion (third wave)
• Deng’s visit to the south …
• Shanghai’s Pudong (this is going to be the biggest SEZ
yet) … and draw more FDI than anywhere else … larger
than Shenzhen … already a population of 1.1 million ..
• Open up most of the country … SEZs, become less
“S”(pecial) …
• Open up new sectors: Urban real estate; open housing
and building; open retail and some of service sector
• Gave local gov’ts more control …
• Competition among SEZs/regions intensified …
• Bonded areas established (this will be important for trade
next time) …
 Figure 17-1: Total Foreign Investment

50

45

40
During Asian Crisis,
35
an unprecedented
30 Direct Foreign amount of FDI
Billion US Dollars

Investment
flowed into China
25
… a safe haven!
20
Deng’s
southern Loans
15 trip
10

0
1982

1985

1986

1991

1992

1994

1996

1997

1998

1999

2000
1983

1984

1987

1988

1989

1990

1993

1995
1979-81

Stories: investment funds and

the search for “deals”
 XVII-2: China: Foreign Direct Investment as Share of GDP

7%

6%

5%

4%

3%

2%

1%
Never more than
2% in Japan; Korea
0%
or Taiwan
1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001-half
 Surging in past 8
years
Figure 17-1: Total Foreign Investment

50

45

40

35

30 Direct Foreign
Billion US Dollars

Investment
25

20 WTO and
Loans FDI:
15
autos and
10 autoparts
5

0
1982

1985

1986

1991

1992

1994

1996

1997

1998

1999

2000
1983

1984

1987

1988

1989

1990

1993

1995
1979-81

… and more in recent years …

 And on and on and on …
• Today—the good:
– Fairly liberal investment climate
– Low taxes
– Most sectors are open …
– More opening with WTO …
– Currency conversions fairly easy to deal with
• The awkward:
– Lots of approval
– Still poor legal framework
– Guidelines are not transparent …
 Areas of Investment
• Most in manufacturing
Commercial Other, 4
, 10
• Investment in business
services and finance is Infra-
small structure, 8

• Distribution is biggest Manu-

bottleneck … Real Estate,
18
facturing,
60

• New WTO rules

supposed to open up
finance, services and
distribution and logistics
Story of Syngenta
and distribution
 Main Industries
• Electronics
• Textiles
• Food products
• Transport (autos)
• Electric
• Building materials
A lot of this is
• Chemicals tied to China’s
trade policy … at
least in the
1980s, did NOT
allow for imports
 Figure 17-3: FDI in China: Sources

$50,000

$45,000
In 1992, HK US, EU
$40,000 and Taiwan Other Japan,
accounted for Taiwan:
$35,000
nearly 80% of EU-15 all about
$30,000
FDI U.S.
8-10%
Million US Dollars

Japan
$25,000
Taiwan
$20,000

$15,000
HK is by
Hong Kong
$10,000 far the
largest …
$5,000
but
$0
relative
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
share has
fallen
Stories: Sony
 Bohai Gulf,
including
Beijing, thru
1997:
accounts for
18%
Geography, NOW
Thru 1997: 30% of FDI into
Guangdong (more than
$US 100 billion)
4 southern coastal
province: 45%

Lower Yangtz
Delta thru
1997:
accounts for
25%
Coastal: 45+25+18 = 88%
 Figure 17-4: Modes of FDI in China This is
where
70% Mr.
Equity Joint Venture China
60% resigned
..
Percentage of Realized Investment

50%

40%

Wholly Foreign Owned

30%

20%
Contractual JV

10% Joint Development Project

0%
1989

1990

1996

1997

1999
1983

1984

1985

1986

1987

1988

1991

1992

1993

1994

1995

1998

2000
1979-82

Stories: Mars
 Impact
• Quantity of investment?
– Not real effect! Only a small percentage of
total investment … rest by domestic firms and
individuals
• Ideas:
– Technology
How does this show
– Management up on graphs?

– Spread through economy

Shifting out of PPF!
 New Trends, Powerful Forces:
The “China Circle”

China Taiwan

Hong Kong

Emergence came in response to 3 changes in the economic environment:

1. Success of East Asia’s “Miracle” Export-led Industrialization
2. Reduction in Transaction costs that made it possible to relocate production
to low wage sites (outsourcing)
3. Collapse in resource prices (1980s) that made natural resource-
development strategy unattractive
(4) China’s reform … but this may have been consequence not causal factor
 Basis for China Circle
• Success of Taiwan/Hong Kong in
developing labor-intensive manufactured
exports during 1960s/1970s (directed at the
US market)
• Success had two effects:
– Demonstration effect (China copied T and HK)
– Restructuring effect (Export surplus, currency
appreciation (in T and K); increasing costs—
both wages and environmental  need to
relocate production to low-wage locations
Attractiveness of China in mid-1980s
• China: low wage; land available; operating costs
low (little or no environmental protection or labor
regulation); depreciating currency …
• China became especially attractive to
businessmen in T and HK … language and
customs the same …
• China welcomed them for Capital and
Technology and Learning

[nothing new … South East Asia was also feeling

the boom … through the same dynamics …
Japan was playing a bigger role there]
Taiwan town in suburbs of Shanghai
 Specializations around the Circle
• China: low-wage production
• Taiwan / Hong Kong: high value services and
technology-intensive production

• Created a new economy style (also elsewhere in the

world) of infra-industry trade AND intra-firm trade …
– Organization and financing in T and HK
– Key components manufacturing/technology creation in T and HK
– Ship to China for production
– Export and marketing by T and HK
• Electronics, first … then textiles … other consumer goods …
• Much like semi-conductor industry in SEA … Silicon Valley and
Malaysia]

• Aided / spurred on by breakthroughs in

transport/communications
 The end?
• 1 China; 3 systems?
• 1 China, deteriorating HK, uncooperative
Taiwan
• 1 China, No Taiwan

• More mutual dependence, the more likely

a happy outcome …
• This may be FDI’s greatest contribution