FDI strategies need to be refined

According to the "World Investment Report 2004: The Shift towards Services," released on September 22, China topped global foreign direct investment (FDI) inflow with a realized total value of US$54 billion in 2003.

As a comparison, FDI to the United States, the traditional No 1 destination, dipped to US$30 billion. Other major destination countries were France (US$47 billion), Spain (US$26 billion) and Ireland (US$25 billion).

China has ranked among the top five destinations since the burst of global mergers and acquisitions in 2001.

It reflects China's overall strength in attracting the relocation of global production bases and its relentless efforts in bringing in multinational companies (MNCs). Yet we need to keep in mind that China needs to refine its FDI strategies in order to sustain its lead and leverage FDI to promote economic growth.

The fundamental factor in driving a large amount of FDI to China is no secret: fast gross domestic product (GDP) growth with stability and a big open domestic market. Despite all the potential statistical imperfections, China is growing fast with tremendous improvement in human resources and infrastructure. The first lesson other developing countries can learn is to do their own homework right. For those who feel "threatened" by China's growth, the immediate response will be the eloquent remark recently made by Secretary-General Rubens Ricupero as he left the United Nations Conference on Trade and Development (UNCTAD): "The problem is not that there is too much growth in China, but that there is too little in other developed countries, in the LDCs (less-developed countries), in Africa, Latin America, Europe and Japan."

If other countries can do as well in their home markets, they will help each other generate more investment and growth.

That said, we still cannot be blind to China's FDI policies and specific locational advantages. Examining them can enable us to understand China's success and its future directions better.

There are two sets of factors driving China's restless efforts in attracting FDI: The first set is standard, and has to do with introducing technology, acquiring management know-how and expanding export markets; The second set is unique in China. There are institutional barriers for State-owned enterprises (SOEs) to operate based on the market mechanism. To set up joint ventures becomes a way to enjoy both preferential treatments and economic freedom. These two sets of factors will evolve differently and have different implications on FDI flows to China.

The first set of factors will remain essentially intact but the realization method will change. In recent years, China has accelerated its opening up of previously closed industries to foreign investors. Meanwhile, China has also tried to channel FDI into desired industries emphasizing high technology, export orientation and environmental friendliness. But World Trade Organization accession commitments mean China needs to abide by the national treatment principle. Various performance requirements such as local content, technology transfer and export performance need to be gradually eliminated. In other words, the investment regimes will be further liberalized not just in the sense of market access but also overall investment policies.

Removal of entry barriers will bring in more FDI especially in services, which will be market-seeking in nature. This will not generate more pressure on other economies as market-seeking FDI is not a zero sum game: if there are more open profitable markets, global capital flows to these markets can increase simultaneously.

The introduction of national treatment and elimination of performance requirements will reduce the cost of investing in China, thus boosting efficiency-seeking FDI. This may lead MNCs to shift away from the economies that require more stringent performance requirements to China.

Multilateral systems such as the GATS (General Agreement on Trade in Services), TRIMs (Trade Related Investment Measures) and TRIPS (Agreement on Trade Related Aspects of Intellectual Property Rights) aim at creating a comparable market environment for all member states, but there is a lot of leeway for national governments to formulate their own policies. The actual result will depend on how the policies will be shaped gradually in the process of conforming to accession rules. This itself closely relates to the second set of factors and China's domestic reform agenda.

The second set of factors relating to SOEs will change significantly, altering the market environment foreign firms will face in China. A large portion, if not the majority, of China's best SOEs in the industries accessible to foreign investors have set up joint ventures with foreign companies. In the foreseeable future, as the shares of SOEs in the national economy continue to shrink, China will broaden the entries for domestic private firms and phase out distorted preferential treatment granted to foreign investors. MNCs will tend to build up their own affiliates rather than look for China's domestic partners.

For domestic partners, there will be rising shares of private firms. At the same time, MNCs will face more competition from private Chinese firms. All of these will overall become attractive features of the Chinese market.

In addition to these factors, China needs to make more efforts to deepen Asian production integration, which is critically transforming FDI structure in the region. It is inevitable that a country crowds out the FDI of other countries if countries compete for FDI of the same nature. For instance, if China and India both struggle to obtain FDI in clothing from Italy, they will be engaged in competitive relations.

Competition itself is not necessarily detrimental as it can compel countries to improve their investment climate. But too much, especially in granting preferential treatment to foreign investment enterprises, may have a distorted impact on the domestic economies of competing countries. As manufacturing constitutes two thirds of the FDI to Asia, there is a rising danger of Asian countries competing too strongly with each other. To curb this vicious competition and fully utilize the benefits of regional integration, China and other Asian countries might want to proceed to encourage a division of labour among themselves.

The ASEAN Investment Framework encourages Japanese companies to build regional production networks, with individual member states playing different roles at different stages of production. This may increase the economies of scale and create regional competitiveness. Similar initiatives should be actively pursued on a wider regional scale. In doing so, individual Asian countries and cities may concentrate on nurturing specific advantages and encouraging bilateral investments. For instance, Hong Kong, Singapore and Shanghai along with Tokyo may become the financial centres of the region. Production bases of clothes, textiles and toys can be established in China and India, as can software development. Electronic parts and components can be produced in Thailand, Malaysia and Singapore. Electronic assembling and telecommunication equipment can go mainly to China and Indonesia. Plants of different models of cars can be spread around Thailand, the Republic of Korea and China. The countries in the region can deepen their co-operation in information technology infrastructure as well as research and development.

Should the ASEAN, plus China, India and the Republic of Korea, integrate as a single market, it would contain the largest population and the third largest GDP. If Japan is included, these economies will form the largest trade union with market size bigger than the North American Free Trade Agreement countries and European Union combined.

In short, China can lead as a prototype in attracting FDI and leveraging FDI for development by upgrading its institutional environment and deepening integration with its neighbouring countries. China can and shall become a responsible leader without undermining other fellow developing countries.

The author is a consultant at UNCTAD. The findings, interpretations and opinions expressed in the article are solely those of the author and do not represent the views of UNCTAD.

Source: China Daily