THE FDI: THE CHINESE EMPIRE
Many studies have focused their attention on the impact of the Foreign Direct Investments worldwide. Instead, I, through this thesis, would like to focus on the analysis of the Foreign Direct Investments in general, talking about their characteristics and the different types of them that exist, but especially I would like to focus on the importance that, especially in the last period they have had in the entire global economic context, and the role played in terms of FDI by China.
The work starts with the analysis of the FDI in terms of growth effects that they have had in the market and the more various forms that the capital movements there has been across the countries. The FDI in fact, plays an important role in the development of the international trade and in the building of long-run and direct contacts between the countries, in a world that is always more interconnected and that is always more global and for this reason the relations and the contacts with the other states are fundamental. In the first part, I show that the FDI determinants
Table of contents
Chapter 1. The Foreign Direct Investment
- The definition of Foreign Direct Investment;
- Types of FDI: Inward and Outward, Horizontal and Vertical FDI;
- The major FDI theories and the eclectic paradigm of Dunning and the VRIO framework;
- Political ideology toward FDI;
- Forms of FDI;
1.5.1 Join Venture enterprise;
1.5.2 M&A (Mergers and Acquisitions) and Greenfield Ventures;
1.5.3 Wholly owned subsidiaries;
1.5.5 Licensing and the power of the Intellectual Property Rights;
1.5.7 Turnkey Project;
1.5.8 Strategic Alliances.
Chapter 2. Role of FDI for development of an economy
- The global context: economic policies and new technology and the global supply chain theory;
- The advantages and disadvantages of the FDI;
- Foreign direct investment and international trade like as inseparable binomial and the importance of MNEs;
- FDI promotes the changing market structure and the integration in the global economy, enhancing the technology;
- Factors of attraction of the FDI in the new economy and the key role of job creation;
- The competitive policy as an element determining the investment in the international markets.
Chapter 3. China as destination
3.1 Chinese conditions;
3.1.1 Political environment;
3.1.2 Economic environment;
3.1.3 Social/Cultural environment;
3.1.4 Technological environment;
3.1.5 Legal environment and the fiscal incentives for the FDI;
3.2 The development path and the political attractions of the FDI;
3.2.1 Experimental stage: towards liberalization;
3.2.2 Stage of gradual development;
3.2.3 Stage of developing rapidly;
3.2.4 The stage of consolidation and improvement;
3.2.5 Views on the development of the FDI in the twelfth five-year plan;
3.3 The destination of the FDI and the incentives in the related sectors;
3.3.1 The main countries of origin of FDI;
3.3.2 Sector distribution of the FDI;
3.3.3 Geographical distribution of the FDI;
3.4 The classification of the economic development zones and the principal interesting zones;
3.5 The historical development of the Special Economic Zones (SEZ);
3.5.1 Exploration phase;
3.5.2 Expansion phase;
3.5.3 Constant Growth.
Chapter 4. China as investor
4.1 The transition from a destination of the other investors to a principal investor abroad;
4.2 The Chinese economic growth and its go out policy;
4.3 New normal;
4.4 The Chinese shopping in Europe, especially in Italy, and in Africa;
4.4.1 The Chinese investments, the case of the United Kingdom, of Polish and of Hawuei;
4.4.2 Chinese investments in Italy, in Switzerland and in Africa.
Conclusion: The future predictions.
- The Foreign Direct Investment
- The definition of FDI
Nowadays we live in a world that is always more characterized by the concept of globalization, a world that does not know boundary, a world that, many scholars define like as integrated, where differences between people or goods do not still exist. Exactly regarding this latter consideration, it is fundamental to talk about the central role that the Foreign Direct Investment and the Multinational Enterprises are having in the current period.
At this time the debate about the MNEs and the FDI is still very heated between many economists and also the definitions about these concepts are really different and varies, with a literature that covers both theoretical and empirical studies. Nevertheless the topic is really important and current, “their scientific analysis constitutes a young discipline, in fact most studies begun in the 1960s when the FDI was experiencing an enormous growth, which attracted economists’ attention”.
Before talking about the Foreign Direct Investment, it is fundamental to give the definition of Multinational Enterprise, considering that we are operating in a global world. “The multinational enterprise is a firm that controls and manages establishments located in at least two countries. More precisely: MNEs are firms that own a significant equity share of another company or operating in a foreign country”. Through this definition, it is easier to understand the concept of FDI and how this mechanism has been used, since in the past, by the firms to become international and to increase their profit, creating an integrated world and exploited the strengths of the different countries, facilitating their growth, reducing their costs and increasing their efficiency.
The definitions of FDI are varies and different such as possible to read in the table below:
In addition to the definitions above I would like to add other definitions that I consider useful in order to better understand the FDI and their evolution in the world economy. “The Foreign Direct Investment is an investment in a foreign company where the foreign investor owns at least 10% of the ordinary shares, undertaken with the objective of establishing a lasting interest in the country, a long-term relationship and a significant influence on the management of the firm”.
Foreign Direct Investments are, in fact, distinguished from “portfolio investments in which an investor merely purchase equities of foreign-based companies”, FDI implies a direct or lasting interest in, and control of, an enterprise (Loungani & Razin, 2001).
The International Monetary Fund’s Balance of Payments Manual defines FDI as “an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor’s purpose being to have an effective voice in the management of the enterprise”. (Imad A. Moosa-2002-p1).
Another definition is present on the website of the United Nations Conference on Trade and Development, where the Organization for Economic Cooperation and Development (OECD) states “Foreign direct investment (FDI) is a key element in this rapidly evolving international economic integration, also referred to as globalisation. FDI provides a means for creating direct, stable and long-lasting links between economies. Under the right policy environment, it can serve as an important vehicle for local enterprise development, and it may also help improve the competitive position of both the recipient (“host”) and the investing (“home”) economy. In particular, FDI encourages the transfer of technology and know-how between economies. It also provides an opportunity for the host economy to promote its products more widely in international markets. FDI, in addition to its positive effect on the development of international trade, is an important source of capital for a range of host and home economies”. According to this latter concept that it is possible to note how the importance of the FDI has grown in the last period (Figure 1) and also the related GDP (Figure 2) in the countries that have collected the benefit of this mechanism or that have operated investing abroad. How it is possible to see in the charts below the only moment of default was recorded in the 2008 due to economic crisis.
At the end, it is fundamental to highlight that the FDI is not just linked to the initial investment made by a firm in a foreign country, but also all transactions which follow one another between the investor and the investment company. Organization of Economical Cooperation and Development gives a model about the FDI calculation in the graph below, demonstrating that the total benefit of the investment is given by different elements, the sum between the first three minus the last one. The first element is formed by the retained earnings directly connected with the investment, the second one by the less purchases that the investor has to sustain, the third by the increase in the long-term and short-term loans or credit that the investor gives to the enterprise and the last one by the capital that the foreign enterprise borrowed by the investor:
Procedure for calculating FDI flows
- Types of FDI
FDI can be distinguished by two different perspectives: host and home countries, through two diverse perspectives: the Direction and the Target.
Regarding the direction the definitions are between the Inward FDI and the Outward FDI.
The inward FDI regards the perspective of hosting country, when a foreign owned company buys a national company or opens a new affiliate in the host country.
The outward FDI regards, instead, the perspective of the home country and occurs when a domestic firms acquires a foreign firm or opens a new affiliate in the foreign country.
According the definition of the United Nations the “FDI net inflows are the value of inward direct investment made by non-resident investors in the reporting economy, including reinvested earnings and intra-company loans, net of repatriation of capital and repayment of loans”, while the “FDI net outflows are the value of outward direct investment made by the residents of the reporting economy to external economies, including reinvested earnings and intra-company loans, net of receipts from the repatriation of capital and repayment of loans”.
Both the inward and the outward FDI have positive and negative effects.
The inward FDI is encouraged by the tax breaks, low interest loans and subsidiaries, in addition the long-term gain is stronger than the short-term loss. The disadvantages are linked, instead, by ownership limits and different level of performance required.
The outward FDI is encouraged by the incentives given by the government to cover the risks, but the restrictions regard the subsidiaries given to local business rather than to international one and for tax incentives or disincentives for firms that invest abroad.
A striking example of inward and outward FDI is that of Coke that opened a subsidiaries in Italy. From the Italian point of view this is an inward investment while from the American perspective this is an outward point of view.
Analyzing the FDI from the target definition, it is fundamental to distinguish the horizontal FDI from the vertical FDI. The first one occurs when a firm invests abroad in the same industry, with the same activities in which it works in house. An example is Toyota because its production system is based on the owned assembly plants, obtaining the necessary components by external suppliers. This mechanism is in contrast with the option to produce the good domestically and then export it to the foreign country, if this could be convenient on one side because in this way the firm exploit plant-level economies of scale in its domestic plant, on the other side the Horizontal FDI is convenient because in this way the firm can save trade costs, principally costs linked to transport and tariffs though adapt to local tastes and local laws or culture is more difficult. This is known as the proximity-concentration hypothesis to whom Lael Brainard in the 1997 found strong evidence. The horizontal FDI are seen as Geographical extension. Many economists refer to this concept as Internationalization, and this foreign expansion can create profit because it is a source of competitive advantage, thanks to exploitation of new strengths. In addition this should be a strategy in order to exploit the current competitive advantage, exploiting the current strengths in a new market or seeking new competitive advantage with new strengths in new market. The benefits of this strategy are many, first of all on the demand side the transactional benefits with the market, natural resources and low-cost seeking, in addition the arbitrage opportunity that can arise, with regard the collection of financial resources and the possibility to exploit the more favourable institutional framework and fiscal burdens, and at the end the possibility to use the competitive leverage in terms of risk reduction, new knowledge bases or communication strategies. This strategy is useful in order to operate, in new market, exploiting the better transportation costs and transport conditions, in order to continue to sell the product that in the current market has achieved the maturity phase and in order to exploit the band-wagon effect and exchange the threat, if we consider that the foreign companies can entry in the national market and capture part of our consumers.
Regarding the vertical FDI, it occurs when a firm invests abroad in a different industry and with different activities in which it operates in the home country, the different industries are usually positioned upstream or downstream from the domestic industry. Sometimes we talk about vertical MNEs separated geographically according to economic convenience of different stage of production. This mechanism, in fact, is based on the search for low-cost inputs and the possibility to sell their output to their subsidiaries “through intra-firm export”. The concept of intra-firm export cannot be overlooked because, especially in the current period, it characterizes a part always bigger of international trade.
The vertical FDI is associated with the concept of Vertical Integration or better with the choice between Make or Buy. In fact, the vertical FDI concerns the boundaries that the company choices to have, this is linked to the choice regarding the activities that a firm wants to produce on its own with respect to those that it decides to purchase from the market. The comparison is between the market and so the price mechanism rather than the hierarchy and so the administrative mechanism. The choice is made according to what in economic language is known as Transaction cost. Coase, in the 1937, defined these costs as the non operation costs of the market price mechanism, but the costs that occur when there is an economic exchange in the market and that characterizes the transaction before, during and after itself. The transaction costs are determined by the actors involved that are characterized by limited rationality and opportunistic behaviour, being human, by the resources involved that are specific and rare and by the goods or services exchanged, elements characterized by high degree of uncertainty and volatile frequency. These kind of costs concern the research and selection for choosing the best transaction, the renegotiation and monitoring costs during the transaction itself and at the end the costs linked to the management of the transaction consequences and the related control, in this latter step it is useful to mention the opportunity and agency costs. The vertical integration is characterized by four dimensions: degree, width, direction and extension. Regarding the degree, it concerns the involvement of the company for each input important for the final production, and this involvement can be total, where the firm own 100 percent of activities that formed the value chain or near, where the company does not own all activities necessary for the final goods. In addition, many economists talked about the conic integration, when a firm depends in part from external source, quasi integration, when a firm creates a long-term relationships, having in this way control on the partners, but not being integrated and No or DE-integration, when a firm uses only the market for the entire needs, the advanced form of this strategy is the offshoring. The width is, instead, the degree of dependence of the company from his own sources, while the extension regards the length of the activities made in house. This strategy can create many problems with regard the increasing bargaining power of the buyers and suppliers when they become necessary in order to obtain the inputs or outputs necessary for the production, the risk of diffusion and especially the risk of quality erosion because the processes to control are many and the complexity increases and, at the end, the strategic risk in missing material. The best choice should be a fair compromise in order to produce part of the inputs in house and externalize certain activities to external companies, activity that is known as outsourcing.
At the end, it is useful to note how the benefits of the vertical integration are high. I would like to mention the cost reduction because the company exploits the economies of scale and the scope economies and eliminate the transaction costs, in addition it defends the market power, eliminating the risks to transfer know-how, but having in this way exclusive rights and quality control, with the possibility to apply successful differentiation strategy and attack forward and backward the business. Nevertheless also the disadvantages are high. The costs increase because the control is bigger and also the level of investments, the flexibility will be lost and this implies less diversification and high exit barriers, necessity to maintain a determined level of balance between the differences activities in order to not spent useless time and at the end the managerial problems for the higher heterogeneity and complexity of the structure. At the end it is possible to say that the choice between make or buy depends by the following formula: Cp + Ca > < p + Ct, where Cp is the production cost; Ca is the administrative cost; p the market price and Ct the transaction cost, if the first part of the formula is bigger than the second one, it is more convenient to buy the input rather than to make internally and vice versa, in the case in which the two parts are exactly the same the two choices are indifferent.
An example of vertical FDI is Intel, that has located the skilled-labour-intensive part of production process in developed countries while the unskilled-labour intensive part in developing one, but everything is fully owned by its. In this case it is fundamental, before taking this decision, to valuate the average cost at which the firm wants to produce the good and especially the activities of the entire value chain that it wants to make rather than to acquire from the market. One option should be to produce all activities domestically while the other one could be to invest in vertical FDI and produce part of the activities abroad. In the former case the firm could save a lot trade costs that otherwise occur, but in the latter case the firm could exploit cross-country differences in factor price. This is possible exploiting the skilled-labour-intensive activities in skilled-labour-abundant countries, where the related price will be of course lower, and unskilled-labour-intensive activities in unskilled-labour-abundant countries, because also in this case, being the supply large, the price will be low. Regarding the vertical FDI the importance of the economies of scale is less than in the horizontal one, because in this case occurs the concept of outsourcing. In fact, in this case the trade-off concerns the trade costs and the possible reduction in production costs.
- The major FDI theories and the eclectic paradigm of Dunning
Like it is possible to note above, different authors give different definitions of FDI and this has characterized the entire economy since their birth in the world. Birth that was before the 1960s, in fact, “Baldwin and Martin (1999) describe two waves of globalisation which are related to a rise in FDI flows. The first in the period between the 1820 and the 1914 and was characterized by North to South FDI in primary product sectors and railroads, while the second started in the 1960s and still continues nowadays, this latter wave is more concentrated on the developed nations with a focus on manufacturing, services and outsourcing”.
The first definition about the FDI, it is linked to Perfect Competition Approaches in 1960s, when the FDI was considered like a capital movement across countries and the model aligned with the Neoclassical Trade Theory. Through this view, Mundell (1957) and MacDougall (1960) predicted that the flow of FDI was directed from the countries with abundant capital to poor counties. Mundell tried to explain this concept through the model of Heckscher-Ohlin (2x2x2), taking in consideration two sectors, two countries (foreign and home) and two factors (labour and capital). He was able to demonstrate that a capital inflow does not influence the product and factor prices, and so “the factor price equalisation theorem does not hold, unless factor endowments differences between two countries are extreme”. This occurs because the countries with a high amount of capital produce and export capital-intensive goods, especially in countries where there are not goods and in this way the country-producer can obtain a benefit because the return on capital will be much higher, while on labour much lower and this continues until prices will become exactly the same (Feath 2009). The important element of this model is that the firm can have advantage because it has to operate using the abundant resources that it has available. As it is possible to note below, this model is based on five assumptions. The first assumption is based on the same technology to which all producers have to have access, in this way should be possible to eliminate the costs advantages. The different customers’ preferences and tastes are, instead, not taken in consideration. The same Pilinkiene said that the trade relationships are more frequent and useful when among countries there is similar history, development level and similar economies. The third assumption is based on the concept that the firms have to operate in a condition of perfect competition, in this way nobody has the possibility to influence the price of the goods or services, but they have to purchase accepting the price imposed by the market itself. In the reality this kind of market does not exist. According to the forth assumption the goods become always more specialized, while the last one is based just on the two factors of production. This model is also more aligned with the theory of Feith (2009) who said that companies belonged to the richer countries and having stronger currency and subsequently lower fluctuation, used to borrow money from countries that have lower power especially from the currency point of view, this because the interest rate is low and the related risk too.
Basic Heckscher-Ohlin Model Assumption
Source made by author according Pilinkiene (2008)
Through this model Mundell demonstrated also that the capital inflow automatically reduced imports, this implies that the “trade in factors is a substitute for trade in goods”. According to this model MacDougall demonstrated a positive effect of the FDI in receiving economy, telling that this mechanism was able to increase the labour productivity and consequently the welfare of the country. This theory was linked to a consideration of investment responding “to differences in the expected rates of return on capital”. According to this model, it is really hard to calculate the rate of return, especially if we consider that the attention of the MNEs is focused on the accounting side rather than economic criteria. This implies, for example, that they make transaction and use the differences in price only to obtain profit by the differences in term of tax environment.
Between the 1960s and the 1970s, other economists created “the portfolio theory”, after studying the relationship between the FDI and the rate of return, adding a third element that was defined as risk. Through this model they linked the concept of FDI to a concept of portfolio composed by stocks or bonds. In fact, they considered that only through a perfect diversification that should be possible to reduce the risk, in this way they were going to extent the vision of FDI from capital movement to movements of firms.
Another variant to the model of Heckscher-Ohlin, was the model of Feenstra and Hanson (1996), model in which they focused on the concept of skilled and unskilled labour, the principal factor of production. In this way they considered that the MNEs transferred capital from North to South in order to open new plants, but this mechanism weighed on wages, that were always higher for skilled labour and always lower for unskilled labour.
Considering about the major theories of FDI, it is important to talk about another movements, in 1970s, the Imperfect Competition Approaches. This approach focused a lot its attention on the MNEs, in fact, Hymer (1976) showed how considering the FDI as a capital movement, did not match with the activities of the big multinationals. He explained how was difficult for the MNEs to transfer their assets because of market imperfections. The principal types of problems are two: the advantages of the multinationals in comparison with firms without foreign activities and the transaction costs. Regarding the advantages that the multinationals have in investing abroad, they are linked to particular incentives that the same government can give them or however the access to determined resources and information that, instead, do not characterized the local firms. These advantages compensate the negative elements, that on the other hand, regarded the MNEs, as ignorance of customers’ tastes or preferences or again the legal system or the business environment. Transaction costs arise, instead, when the transactions are made on the market, as for example the necessity to purchase the intermediate product required for the final one, costs that if the product is produced entirely internally, do not occur, this happens because organise the transactions on the market is difficult and the costs do not depend by the producer.
Another important theory about the FDI regards “The product-cycle theory” (Vernon 1966), the model arose after the World War II and it is useful in order to explain the growth of the American MNEs.
International product life-cycle
Based on Vernon, 1996 International investment and international trade in the product cycle. The Quarterly Journal of Economics.
Through this model the FDI are seen like an answer to the fair to lose market when the product achieves the stage of maturity and as mechanism of searching cheaper factor to face competition. According to this theory, during the first stage the product is innovative and it is sold in the country in which it is produced, usually in developed country because the technology is developed and it is easier to get consumers with higher income. In this way the producer tries to satisfy the local demand and at the same time to acquire notoriety and coordinate in efficiency way the three most important activities for a firm: research, development and production. During the second stage the product could be exported, this implies that in this countries could arise some competitors, but in the third stage the home country could start to think about the possibility to open a subsidiaries both there and in less developed countries to exploit the cheaper resources as labour. The only positive reason of this mechanism is the major competitiveness that the firm can create in the market, enlarging its piece of market. Also this theory is not so simple to take in consideration, as the same Vernon said, because the market is evolving and because many firms could prefer the exportation rather than the FDI especially if we considered the developing countries where to find skilled employees is, of course, really hard (Hymer 1976). According to this theory, it is necessary to say that in order to develop a new products or services into the market, it is necessary to have high amount of capital and technology and also qualified labour, all elements that characterized the rich countries. In the mature stage, it is possible to transfer the product to developing countries gaining advantage thanks to cheaper labour that characterizes them and the possibility to exploit the economies of scale. Thanks to this model, Pilinkiene said that it is possible to valuate when a product has to be produced in mother country and when it is more convenient to transfer the production abroad. Vernon’s view focuses on the attention that the firms decide for the FDI in a particular stage of their products’ life cycle. This particular moment is exactly equal to the moment in which the “product standardization and the market saturation give rise to price competition and cost pressures”. The only merit of Vernon is that he explained how the firms could invest in foreign countries and, especially in this case we talk about the developing ones, only in the moment in which the demand is enough large to support local production, and at the same time this is an useful element because takes the firm to invest in low-costs countries exactly in the moment in which the pressures becomes heavy. The problem, of this model, is that it, completely, ignores the possibility to export or to license, simply focusing on the concept that when the foreign market is large and can sustain the local production, the firms must operate through the FDI. It is really useful to note how this model is more connected with the model of the industry life cycle that will be, exactly, the supply-side equivalent of the product life cycle. This model gives rise to S-shaped growth curve with four stages: introduction, growth, maturity and decline. The first one is characterized with low sales and market penetration because the products are unknown and customers are few, but at the same time risk-tolerant and innovation-oriented, this explains the reason why the products are developed in the developed countries, there where the consumers have the possibility to spend part of their income for a product that is not perfect and for which they do not know the efficiency and efficacy. In addition the driver of the industry life cycle is the Knowledge and this gives the possibility to understand why a product necessary has to born in a developed country, where “over the course of the life, consumers become increasingly informed”. The growth stage is based on increasing efficiency and market penetration, thanks to technical improvement, and this implies more notoriety and larger piece of market. The maturity stage comes exactly after the market saturation that arises with the growth of the market share, this stage implies that the consumers are ready for replacement, this means that the producers should they wish to continue to earn on that products, should invest abroad. This is exactly what Vernon had explained through his model. He did not want to avoid the decline stage, a period in which the new technology creates superior substitute products, and where a competition becomes a really price wars, from which you should flee focusing on differentiation, even if because this is impossible, but he wanted only to permit to the producers to exploit as much as possible the profit linked to their investment also if this implies to invest abroad and at the same time to be forecast in the home country and answer to new needs of their consumers.
Before talking about the modern theory of the FDI, it is fundamental to give attention to the work of Dunning, what is known as eclectic paradigm. He started with the importance to talk about MNEs before focusing on the FDI, and so for firms become Multinational enterprises is possible only through three conditions: “Ownership, Location and Internalisation” (Brouthe et al., 1999).
This model explains that the firms use the FDI in order to enter into the foreign market, but Dunning, through his theory, wants to demonstrate also why products can be produced and sold into foreign market. This method stresses not only concept as elements that affect the demand and prices, but also elements as risk, market size and especially the three advantages that it is possible to note in the table below.
Source made by author, according Dunning and Lundan (2008)
FDI advantages according eclectic theory
The ownership advantages are based on the “power” that the firm could have in obtaining patent rights and so the following possibility to use the right alone exploiting as much as possible the monopoly power. The ownership rights could be tangible because linked to machines or plants that the firm has rather than intangible and so obtained in legal way. Other kind of ownership advantages are the innovative capabilities and this is stronger especially if we talk about the developed countries and their ability to work with the skilled employees especially the younger one that have a greater propensity towards the technology and the innovation. Another important element is the accumulated experience, in fact, it is possible to note in many studies during the past how to do always the same activities reduce the time required and increase the efficiency of the product. In addition with the experience it is possible to avoid to make the same mistakes. The last benefit linked to the ownership is the possibility to have access to factors of production and so to build a competitive advantage on this factors that the other firms cannot have.
The location advantages is a concept linked to a possibility to exploit the FDI theory in order to enter and operate in a market where the conditions are favourable, considering different elements like: lower price for the primary factors of production, access to the secured domestic market because the firm knows the tastes and the preferences of its country better than the competitors, lower transportation costs or production costs, with high level of productivity and low level of risk and again favourable taxation policy. This explains why the major part of the companies belonged to the developed countries have decided to transfer part of their production abroad, especially in country where the legislation and the costs of the labour is low.
Considering the internalization advantages, Dunning explained that for a firm should be more convenient to obtain benefit for the market management, but considering its ownership in the mother market rather than to sell license to other independent firms and consequently to risk to suffer the restrictions imposed by the government of the foreign countries.
At the end of this analysis Dunning wanted to highlight the difference between who uses the FDI in permanent way, being willing to get production effectiveness, and who is focused in one time investment, trying to capture as much market as possible through the natural and human capital, focusing on the location and internalization advantages. The same Dunning tries to test the theory through two hypothesises:
- First hypothesis: international competitiveness, companies obtain benefit thanks to a competitive advantage linked to a domestic production and ability to export;
- Second hypothesis: location advantage, based on a ratio between the amount exported and the local production, ratio known as form of involvement.
Dunning at the end of the test, made through the analysis of data related to American manufacturing companies, operating in seven countries, showed how, regarding the first hypothesis, market side had negative effect in comparison with skilled employees. Considering, instead, the second hypothesis, he discovered that the ratio export-import was negative respect of the ratio export-production. Finally, it is possible to say that the FDI depends on various elements like ownership advantages, infrastructures, property right, transportation costs, market size, government restrictions and so on. The most important concepts “of the OLI paradigm have also been introduced in a dynamic framework known as the Investment Development Path (IDP)”, this concept is linked to inward and outward investment, elements of which I have discussed above. It is possible to say that the model of Dunning is considered a sort of summary of all FDI theory above explained because takes into account different and crucial determinants, considering also the concept of Horizontal and Vertical FDI. Dunning, through his model, wanted to focus on the concept of the location-specific advantages. This concept means that the advantages arise in a moment in which the firm combines specific resources endowments or assets that are characterized of a specific location with its own unique assets, like technological or management capabilities, this is for Dunning more useful than to license or export. The only way to exploit the foreign resources is to undertake FDI. Penrose in the 1959 stated that “The firm is a collection of resources”, resources that can be divided into three categories: tangible, intangible and human. The tangible ones are the financial and physical assets, for example we talk about the borrowing capacity or the internal funds generation or the plants, the raw material, the buildings and the land required for the production. For intangible resources we refer to technology, reputation, knowledge and relations assets. The patents, the copyrights, the intellectual property rights or again the customer loyalty, the company reputation with the government or with the consumers or again with the suppliers and the brands belonged to this latter category of resources too. At the end there are human resources characterized by training, loyalty of employees or adaptability and especially by experience. Through the VRIO framework, a manager can understand if it is possible to invest abroad focusing on their resources or not. In fact, this framework permits an analysis about the value, the rarity and the imitability of the resources and an analysis that regards the structure in terms of control mechanisms of the organization, in order to valuate if it fits with the ability of the employees, giving them the right incentive in order to exploit the resources. The analysis of the value of the resources gives the possibility to understand if that resource permits to firm to increase its revenue and decrease the costs, exploiting an external opportunity. Regarding the rarity’s analysis, it is important because only if the resource is rare that the perfect competition has not set in and the firm can gain profit from its competitive advantage. At the end the analysis of the imitability gives a sort of time in which the firm can operate in terms of “monopoly” in the market because the competitors do not know the resources on which the firm base its competitive advantage and they do not have access to them. This time will be longer of the competitive advantage is based on intangible resources because those are more difficult to be imitated thanks to legal forces too. The theory of Dunning and the VRIO framework explain why the developed countries have decided to undertake FDI in the oil sector, exploiting this location-specific resource with their valuable managerial capabilities and it is the same considering the cost of the human labour and the reason why the most famous brands have decided to invest abroad, in developing countries, brand as Nike for example. Another important example regards Apple or Hewlett-Packard and Intel, the world’s major computer and semiconductor companies that are located in California at Silicon Valley. There, where, probably, according to the study of Dunning, there is a concentration of intellectual talent. This could arise by a sort of informal contacts that bring firms to have benefits from each other’s knowledge, many economists called this phenomenon like Externalities and many studies have demonstrated that many firms have obtained large benefit, locating their plants close to these sources. Another demonstration of this useful mechanism is given by the investments that the same Europe and Japan have made in that place in order to wish to gain benefits and knowledge by these externalities.
- Political Ideology toward FDI
Now, I would like to talk about the political ideology toward FDI, ideology that sees on one hand the completely hostility to all inward FDI for the host countries and on the other hand the idea of the free market economics. Between these two really opposite theories there is another approach that is known as pragmatic nationalism.
Before talking about this new approach, I would like to introduce what means the “radical view” and the “free market view”. With the first theory, many economists saw the MNEs like “an instrument of imperialist domination”, in fact according to this concept that the FDI are seen not just as an instrument of development, but as an instrument of domination. This because, the home countries invest abroad and try to obtain benefits and profits, bringing them to their countries, giving nothing in exchange to the host countries, but only exploiting them as much as possible. This view was famous and frequent in the past especially if we consider the Easter Europe between the 1989 and the 1990 or many socialist countries in Africa or again nationalistic countries as Iran or India. At the end of the 1980s, it is necessary to underline that this concept saw its collapse thanks to three important historical reasons: the end of the Communism in Easter Europe; the economic performance that at the end of this historical moment characterized that countries and the volunteer to go out from this poor condition also encouraged by the growing belief that the FDI was an important source for technology and jobs, increasing the economic growth; the intensive growth that the countries that embraced the capitalism view, had.
The free market view is based on the concept of the comparative advantage. In fact, according to this concept that countries have to focus on the productions of goods and services for which they are more efficient and specialize, purchasing from the other countries the goods that they are not efficient to produce. According to this concept, the FDI should increase the efficiency of the entire economic world. Great Britain and the United States are the countries that more than the other undertake the FDI even if many restrictions from the government exists in terms of inward FDI, regarding for example the limits of 25 percent that the foreigners cannot outweigh in purchasing the U.S. airlines.
The intermediate approach is completely different from both the two theories discussed above. In fact, according to this concept, the FDI are seen as elements that have the positive and negative effects. Of course the FDI strategy is convenient only in the moment in which the benefits outweigh the costs for a country that undertake it, but it is also more important to underline that the benefits are however a lot also for the host country. An important example regards the possibility that, investing abroad, the developed country brings there capital, technology, skills, all elements that can give a contribution for the development of those poor countries. Many countries are, however, concerned that the foreign firms can bring many components from its home country and this implies a negative answer for the host country’s balance of payments. Another important aspect of this approach is the tendency of the host country to give grant and tax benefit to foreign MNEs, this is exactly what is happening in Europe, in the countries that at all costs want to host the American investments or the Japanese FDI.
In a world always more global, many countries have adopted the free market policy, but not the free market view that is so radical and difficult to apply in the reality. Exactly for this reason that many countries are embracing the latter strategy, countries as Italy, Spain or Japan, but also countries that have recently liberalized the FDI as some countries of Latin America or China.
- Forms of FDI
The MNEs decide to invest abroad in order to increase their profits. This kind of decision is linked to what in economy is defined as strategic decision and it is of course not easy and with a grade of risk so high. In fact, the companies arise for creating value for the society, for the organization and for the capital and product market and through this decision that they have to satisfy the shareholders and the stakeholders, gain profit and consequently grow. Before deciding to entry in a market a company has to do what is defined like PESTEL analysis, an analysis that bring it to be sure about the industry in which it wants to entry and the possible profit that it can gain. This analysis is focused on the Government and Politics, the natural environment, the social structure, the technology, the national and international environment and the demographic and legal structure. After this analysis the company can decide through what form it wants to enter in new market. In the following paragraphs, I am going to explain the different possible way for entering.
- Joint Venture enterprise
A joint venture is a separate business entity created by two or more other independent companies that have decided to share ownership, risks and returns and the entire governance of the new company that they create. To enter in a new market the most popular way could be the possibility to create a joint venture with the foreign firm. The most common way to create this kind of company is the 50/50 venture that implies that the two parties have the same risk, the same ownership stake and the same control on the new company through a team of managers. A famous example of Joint Venture is given by Fuji-Xerox that arise by Xerox and Fuji Photo in the form of 50/50 venture even if nowadays it is characterized by 25/75 venture with Fuji Photo holding 75 percent.
The main characteristics of the Joint Venture are: the number of the parties involved in this mechanism and the contribution that each part decides to give to new venture and the relative ownership that each part has. All other elements regard the post-deal, in terms of profit shaping for example, if this happen in proportion to equity ownership or not, the governance and the control, the structure that the parties decide for the new company and the relative Human Resources model and at the end the technology, the production and the entire value chain within which the parties want to operate and then create the Joint Venture. The operation of the Joint Venture is based on the capital that each part gives to the new entity. So as all other forms with which the company could decide to enter in new market, also the Joint Venture has advantage and disadvantage. Regarding the advantages, first of all the firm that decides to invest through this mechanism can benefit from the local partner’s culture, language, knowledge, political and business system and especially the possibility to benefit from the reputation that the company already has in the market and the loyalty created with the local consumers. Regarding this point the most important element regards the culture. In fact, for a company, in order to obtain notoriety in the market and increase its reputation among the consumers, it is necessary to know the local culture because this is the only way through which will be possible to meet the needs of the consumers and to obtain their trust. In addition, the culture is the only asset that is not possible to purchase through capital, but that should be achieved through the passage of time because it is necessary to endorse the local values and principles and this requires time and experiences, time that should be cut if the company decides to gain new market exploiting the knowledge and the experiences that the local firm already has. Another important advantage is the substantial costs and risks that a company that decides to invest abroad, necessary, has to sustain. In the case in which it decides to invest through the possibility to create a Joint Venture, this ,of course, reduces the expenses required to open new plants and to purchase new machines and at the same time, this reduces the risk exposure for each individual company. The third and latter advantage concerns the case in which from the political view the only way through which it is possible to enter into determined market is the creation of Joint Venture. This occurs, because in many cases this mechanism reduces the interferences of the government, especially in countries where the nationalism is high. In this way the local partners can have positive influence on host-government policy.
Regarding the disadvantages, the first, that is fundamental to take in consideration, is that creating a Joint Venture the company risks to reduce its competitive advantage based on particular technology that during the time it had achieved. In fact, it has to share everything with the other part, sharing of course also the control of the technology or of particular know-how. It is fundamental also to say that Joint Venture agreements can be created minimizing this risk. First of all the company can choose for a majority ownership and in this way it has more control and reduce the necessity to communicate everything to the other part and to give to it the control on all, but this of course is not the simply way, considering that to find a company that choose for the minority is not easy. A second disadvantage is based on the element that is difficult to find in the market a Joint Venture that gives a company the tight control over the other partner, having for example need to realize location economies or to increase its knowledge for operating alone after. This fair arises in the local companies of the host countries from the possibility that the foreign companies could want to do global market attacks against its rivals and for this exploit this strategy.
Another disadvantage is the shared ownership that can create battles among the parties or because they do not share the same vision and strategy through which to manage a company or because the goals of the investor can change during the time and this create conflict if it is not shared. Many studies have demonstrated that this conflicts are many especially because the ideas and the goals and especially the strategy that each part wants to apply are different and this is more intensive between parties of different countries and at the end this conflicts bring to the dissolution of the Joint Venture, with the ownership in the hand of the part that at that time has more bargaining power. During the time the foreign firm acquires always more knowledge about the local policy, culture and values and so will have always less need of the local part and this increases its power reducing those of the other part.
- M&A (Mergers and Acquisitions)and Greenfield Ventures
Through the world merger and acquisition we refer to a concept in which the ownership of a company will be transferred or combined. Through this choice the company can grow or die or change the nature of its business and its competitive advantage. A merger arises when two or more companies combine creating a new entity. An acquisition, indeed, arises when one company decides to purchase another one and this does not create a new entity, this is frequent when a small firm will be absorbed by the parent organization. The advantage of the M&A is that, first of all, the company can increase its competition, because the name of producer is known and because in this way it can reduce the expenses of the Research and Development activities and the costs linked to delivery costs. The disadvantage is not only to create job, but the jobless on the host country and this could remark the interferences of the host government.
Regarding the acquisition, it is a lot compared with the Greenfield Venture, in fact, in the following paragraph I would like to discuss about the differences and the advantages and the disadvantages of the two different mechanisms.
The first and most important advantage of the acquisition is the ability for a firm to acquire a local firm and entry directly into new market, the target one. This is important because in this way the company is able to cut the time and gain competition and profit. The second advantage is the pre-emption of the competitors especially if we talk about markets in which the globalization is high. This mechanism is important and efficient especially in markets where the deregulation and the liberalization are high and so consequently the possibility to enter through FDI. At the end the last advantage is that the managers consider the acquisition less risky than the Greenfield venture. In fact, through the acquisitions the companies purchase something about which they already know the assets and the profit that they produce, especially purchase not only tangible assets but also intangible assets like local brands or knowledge about the local needs and tastes, elements that in the case of Greenfield venture are absolutely unknown and that can create a risk for a new company really high considering the ignorance of the local national culture. At the same time, the disadvantages of the acquisition are several. First of all, sometimes the acquiring firms overpay in comparison with the amount of assets that they obtain in exchange, especially if more than one firm is interested in the company that is element of the transaction, the manager, in addition, is sometimes too optimistic and this brings him to pay a lot. This is known as hubris hypothesis, approach that states that the manager overestimate the company that they are going to purchase also because they overestimate their position in the company and their ability to create and generate value. Many acquisitions fail because of the different culture between the acquired and acquiring firms. For example the employees cannot agree with the new manager and so change their work and this create in the acquiring firm a high level of turnover and this can create a loss of talent employees and consequently a loss in the economic performance of the company. Other failures can be linked to a volunteer from the managers to create synergies that do not occur because the differences also in terms of management philosophy can create a slow integration and many problems. Many issues are, in addition, caused by a not careful pre-acquisition screening, without an attention analysis about the potential costs and benefits that could arise, the expectations can be high and unrealized. The most important way through which a company can reduce these failures are the necessity to create a plan of integration next the acquisition.
Regarding the Greenfield Venture, the biggest advantage is the possibility for a company to build in the foreign market the company that they want in terms of culture, knowledge, technology and values, this is easier than purchase an organization and after deciding to change it. As well as it is easier to establish determined activities in a new firm rather than to change the process of a company that already exists. The problem is that Greenfield Ventures are difficult to establish for the time necessary and especially the costs and the risk exposure required. A high level of uncertainty linked to future revenue streams and profit characterized this forms of investment, a risk more than compensated by the possibility to face with unpleasant surprise, element that, indeed, characterizes the acquisition. At the end it is possible to say that do not exist the best way to enter in the market, but that all depends. If the firm wants to enter in the market in which already exists a strong competition the acquisition will be the best solution, indeed, if a company wants to enter in a market in which there is not any incumbent competitors to be acquired, will be better to choice for a Greenfield Venture. 1.5.3 Wholly owned subsidiaries
In the wholly owned subsidiaries, the firm is the only owner of the stock. This investment can occur through two different ways: the first is similar to the Greenfield Venture, while the second gives the possibility to the company to acquire a local firm in the host nation, using it in order to promote its products. Also in this case there are many advantages and disadvantages. The first advantage is the possibility to enter in a new market without losing any kind of control over the own competences, this is the best way for the high-tech companies. This mechanism gives, in addition, to a company the complete control over all operations in different host countries and this permits the global strategic coordination. This way is also important if a firm wants to realize experience curve and location economies. Through this mechanism the national subsidiary can, for example, focus only on determined part of production, exchanging parts and products with other subsidiaries in the global production system with a central control on it, system that takes decision about how much they have to produce, how they have to produce and at which price the product will be sold. The problem of this investment is that it is the most expensive mechanism in order to serve new market, expensive not only from the capital point of view, but also considering the risk at which the firm will be exposed, considering that it does not have any knowledge about the country in which it is going to invest.
At the beginning, many companies start their global expansion as exporters. Exporting implies to produce in the home country and only then to decide to export, selling the products abroad.
The advantages of the exporting are, first of all, the possibility to avoid the high costs necessary in order to open new establishments and plants in host country, second the firms will be able to achieve scale economies thanks to global sales volume and at the same time experience curve and location economies.
The first negative element is, indeed, that exporting from the home country forces the producers to sell at the price that in the foreign countries could be high in comparison with the local costs for the similar products and then companies focused on the standardization strategy rather than differentiation one. From this perspective should be more convenient to produce where the mix of resources required is cheaper and then to export, but from that place and not form the mother country. Another disadvantage is that exporting can require high transportation costs especially for bulk products, for which should be more convenient to produce them regionally, because otherwise it does not give the possibility to gain from scale economies. Another drawback is constituted by tariff barriers that can reduce the possibility to sell the products abroad because this increases the costs. The last disadvantage arises when the company decides to a local firm its marketing, sales or other services in order to promote its products, but this does not do the work in the same way as the firm would.
To talk about this form of investment, it is fundamental to explain what is the intangible property, specifically, the intellectual property right. The European Directive 2004/48/EC states: “The protection of the intellectual property is important not only for promoting innovation and creativity. But also for developing employment and improving competitiveness”. The power of the patents is really high because they permit to the company the possibility to operate in the market with a monopoly power thanks to a protection from the legal forces. This power is linked to a possibility to have incentive to innovate, in fact in the current period there has been the “patent explosion” with an “analogously unprecedented explosion in the amount and quality of scientific and technological progress”. According to this latter state, there are two hypothesis, on one hand who sustains that the increase of patents has been the cause of the acceleration of innovation, on the other hand, indeed, there is who states that the increase of patents has been the effect of the continued growth of innovation.
Regardless this difference, it is useful to note how the intellectual property has in the current economic market an importance always higher, and the licensing agreement is exactly linked to this element and specifically to the case in which the licensor grants the possibility to exploit this right to another entity for a determined period and in exchange the licensor receives a fee from the licensee.
The first advantage is linked to a possibility to entry in the foreign market without sustaining the costs and the risks required, in fact this form of investment is attractive for whom that has not enough capital to penetrate in new market or however when a firm is unwilling to engage much financial resources for a risky market that could be volatile. This form is convenient also when the foreign market is prohibited by many barriers. Another and last advantage is that the firm has lot properties, but it does not want to develop them alone and so it decides to grants the license to other firm or more than one.
Regarding the disadvantages, the first one is, of course, the fact that this form does not give the tight control on the entire process that is necessary if the firm wants to realize economies of scale and location economies and experience curve. In fact, through this mechanism the licensee has to set-up the production process in a centralized location and this can delay the development of the location economies and experience curve. Another drawback is the impossibility to use the profit that a firm has to earn in a country against the attacks that the firm faces in another country and through the licensing method the coordinated strategy is really difficult to apply. The last problem linked to licensing is that when the firm grants the property right loses its tight control on its know-how and consequently it loses the principal part on which it bases its competitive advantage. In fact, nevertheless many companies believe that also with the licensing agreement they are able to preserve their power, this is absolutely not true and possible. The useful way in order to reduce this risk is to enter in cross-licensing agreement with a foreign firm, through this agreement the licensor wants to obtain not only the royalty fees in exchange of his right, but also that the foreign firm grants part of its know-how, through this mechanism the companies are not interested into opportunistically behaviour because in a moment in which one of these violates the agreement, the other will do exactly the same. Another way for reducing this risk should be the possibility to create a Joint Venture through this know-how where the two parties have an important equity share, this is exactly what has happened in the case of Fuji-Xerox.
Franchising is quite similar to licensing, but it involves long-term commitments. In this case the franchiser not only grants intangible assets, but he undertakes to comply with strict rules to franchisee. In addition the franchiser receives the payment of fees.
In terms of advantages the franchising is exactly similar to the licensing, in fact through this method the firm reduces the costs and the risks of opening in new market, building profitable process as quickly as possible. Regarding the drawbacks, they are less pronounced than in the licensing. In fact, in this case the firm has not interest in creating location economies or experience curve and neither interest in sustaining the attacks in one country with the profit achieved in another one. The only one important disadvantage of the franchising could be the possibility to lose the quality control and consequently to damage the image of the brand. In order to solve this great problem the only way should be the possibility to create wholly owned subsidiaries in the foreign market or at least to create Joint Venture with local firms in order to preserve always a determined degree of control.
- Turnkey projects
The turnkey projects are more common in determined sectors like pharmaceutical, or chemical one, and the reason is that through this method the contractor creates every detail of the entire project for a foreign client, considering also the training for the employees and after he sells this project. At the end the client will have the “key” of the entire project that is now ready to be used in the market. Exactly from this characteristic that arises the name of this method. The advantages are many. First of all, the know-how, in the sectors in which this mechanism is used, is really high and gives the possibility to earn high economics returns, this incentives to entry into the market through this form of investment rather than through the FDI because the interferences from the government should be really hard. In addition, the local firm could want to exploit their resources, but do not have the necessary technology required and for this reason that they decide to purchase its through the turnkey project. Another advantage is linked to the case in which for a firm enters in an unstable environment from the economical and political point of view could be dangerous and risky, while exploiting this method it could reduce the risk.
Regarding the disadvantages, first of all the firm through the turnkey project demonstrates that has not long interest in the foreign country and this can create problem if during the time the country proves a good market for the entire process, so the possible solution should be the opportunity to maintain always an equity interest in the operation. In addition, a firm through this mechanism creates necessary a foreign competitor especially if we consider that the know-how sold through the turnkey project could be the dominant part on which the company has created its previous competitive advantage.
- Strategic Alliances
Strategic alliances are seen as a sort of agreement between potential and actual competitors. This contract is based on two or more firms that have equity stakes, but for short-term, in order to operate on a particular project.
The first advantage concerns the easy to entry in a new market especially through the collaboration with local foreign firm. In addition, this kind of collaboration helps the firm to share costs and risks linked to a new and great investment in developing new product. The third advantage is the possibility to create synergies thanks to complementary assets of each, synergy and skills that neither firm is able to develop alone, at the end this could be an optimal mechanism through which the firm creates technological standards from which the firm itself will benefit. At the same time many economists say that this method gives to “competitors a low-cost route to new technology and market”, exactly what happened between Japan and United State. The problem of the strategic alliances, is also that many companies can give more than what they receive. In fact, according to an economic study, it is demonstrated that a lot of alliances fail within two years of their formation. In order to avoid these frequent failures, it is fundamental to do careful screening about the partners, in fact a good partner has to share the same goals and has to help the company in order to achieve these goals, sharing the costs and the risks. In addition, the partners has to have capabilities that the other part lacks in order to create synergies and exploit them and not have opportunistically behaviour, but create a familiar environment. After a selection, it is fundamental to create the alliance structure, in the way that each part knows its rights and its risks and there is not the opportunistic risk also because the parties have to extracts in advance the know-how that each of these has to share. At the end, it is fundament to manage the alliance, having sensitivity to cultural differences and trying to maximize the benefits, stressing the concept of relational capital that is one of the most important point that helps to create trust and respect among the parties.
- Role of FDI for development of an economy
- The global context: economic policies and new technology and the global supply chain theory
The Foreign Direct Investment has an important role in the entire world economy, in fact, it can reduce in the indirect and direct way the poverty that still exists in several countries. Through this mechanism, it is, also, possible to change the direction of welfare and capital flows. In fact, it is known that for reducing the poverty in some developing countries, it is possible to increase the employment and consequently the income of the employees that can, in this way, spend money and so to rise the entire country’s welfare. If this latter tool should be considered as the direct element through which to reduce the poverty, the indirect one should be the necessity to increase the capital technology, to change the market structure, if necessary, and especially to increase the integration in the entire world context and consequently to operate and to trade with the other countries.
In order to discuss about the topic above stated, I think that is fundamental to introduce the concept of globalization, so as to understand the context in which we live.
Currently we are living in a world that is always more globalized, where do not exist boundaries, but where each country is more interconnected and integrated with the other one. In fact, “Globalization refers to the shift toward a more integrated and interdependent world economy”. The concept globalization involves not only the globalization of the markets, but also and especially the globalization of the products.
The globalization of the markets is connected to the new trend that has fused the historically distinct national markets into one huge global one. This element characterized the company that have to offer the same basic product worldwide in order to create a global market, but the element that still characterizes the current market, is that the companies do not have the characteristic to be multinational giants and consequently do not benefit at all from the globalization market. In addition, significant differences among all countries still exist, along consumer preferences or distribution channel or again legal system and business regulation as well as the most important one that is the cultural and value system.
The globalization of the products, instead, refers to the place in which it is more convenient to purchase or to produce determined intermediate products, where this convenience is linked to cheaper cost and high quality. In this way the companies can offer their product in the market in more efficient way and consequently they can increase their competitiveness.
We are talking about what is defined as international economics and it is important to highlight how that braches is exactly the same of the national one because the purpose of this behaviour is the internal or international transactions in order to reap the benefits.
It is fundamental to underline a difference between the pre-globalized world and the current world. In fact, if during the past, each country produced exactly the amount of products that it was able to consume, now the condition is really different because the countries produce not only what they can consume, but also an amount of goods and especially services that they can offer abroad and export or however produce directly abroad. This element is possible thanks to industrial revolution and especially in the 21st century, thanks to technological revolution, a revolution that has increased the communication and the possibility to transport a large amount of goods with a really few capital. In addition, the ICT revolution made possible to coordinate the complex production at distance because it facilitate the control, reducing the costs and the risks linked with the combination between the technology of more advanced countries and the labour of poor countries. This combination was possible thanks to the wage differences between the developing and the developed nations. This trend characterized the world in the 19th the century, when there was a sort of converge between the North, formed by industrialized countries, and the South, formed by de-industrialized one, instead if we consider the 21st century, it is useful to note how there has been a converge between the North and the South and this has bring a de-industrialization for the North and a rapid industrialization for the South that has created an excellent performance along several countries, especially considering China. What characterizes the 21st century, are different elements. First of all the international investment, but in sectors as training, technology, focusing on the long-term business relationships, secondly the cross-border know-how like intellectual property right and tacit form of know-how that can be transmitted only with the direct work abroad, and lastly the development of the infrastructure that has helped to coordinated the production worldwide. In order to talk about the global value chain and the global supply chain, it is important to talk about nations that have developed a deep industrial base in order to become competitive, we refer to these countries as emerging ones.
In fact, in order to talk about the globalization, it is more important to outline that the value chain and the supply chain have assumed an important role in the economic context, involving all countries, from the richer to the less advanced one. The trade and the investment openness, in fact, are the principal components of the policy reforms in G20 countries, where the purpose is to implement an effective framework for sustainable, strong and balanced growth in order to bring all countries to reap benefits. In fact, I would like to talk about the global value chain and to try to understand who, in terms of country, is able to catch the benefit from that behaviour. Richard Baldwin talks, instead, about the global supply chain and how it has changed the world, creating a rapid growth due “in part to its impact and in part to rapid technological innovations in communication technology, computer integrated manufacturing and 3D printing”.
The concept supply chain is referred to a series of plants necessary in order to obtain the outputs, while the value chain is popularized since the past by Michael Porter as a broader concept. Porter, in fact, said that the companies spent a lot of their time to produce inputs or intermediate goods for which they had not competitive advantage. He focused a lot on the Ricardian principle of comparative advantage and so to produce what you are able to produce in order to reduce the costs and increase the profitability and for which you have abundant inputs at lower costs and consequently to purchase from abroad the products for which your costs are high and competitiveness low. This requires a careful analysis of supply chain that according to Baldwin, have to be divided into “four levels of aggregation: products, stages, occupations and tasks. The first level is in the reality at the bottom of the chain because it concerns the last step and the after sales services, while the last one is at the top of the chain because it regards the all elements in order to permit that the good achieve the hand of the consumer. Considering the stages and the occupation levels are intermediate and while the first regards the tasks performed by each employee, the second one concerns the collection of occupations performed together. Regarding these latter two levels are often steps that the companies prefer to give in off-shoring rather than to focus on individual tasks. An optimal incentive to this, it is given by the ICT revolution, because it creates the optimal compromise between the specialization and coordination. In fact, this revolution, has reduced the costs of specialization, but at the same time the benefits too and this because increase the standardization. In fact the communication technology increases the possibility to transmit ideas and information quickly and cheaper, but good coordination increases the costs favouring few tasks per occupation and at the same time few occupation per stages. At the end, as Bloom in 2006 said: “A better coordination technology reduces the cost of specialization, but a better information technology reduces the benefits of specialization”. Nevertheless this trade-off, it is really important to say that this revolution has increased the global aspect of trade, first of all considering that the supply chain involves or producing abroad or invest in long-term relationships and rely in broader suppliers and secondly the importance to coordinate the production of the facilities. According to the importance of the technology, I would like to remind about the Moore’s Law which predicts that in the 21st century the power of the microprocessors would reach higher levels at really low costs and this would implied an increasing global communication with the costs that, thanks to which is called as WWW (World Wide Web), will be plummeted. In addition, it is fundamental to say how more depends on the policy and its ability to give an incentive to the more productive activities, reallocating the resources and creating an improvement in the average wages and employment conditions and at the same time to develop training programmes or work-experience programmes, helping to dislocates the employees in order that they can have benefit from the new job opportunity, as it is discussed below.
- The advantages and disadvantages of the FDI
It is now possible to talk about the importance that in this context the Foreign Direct Investments have and especially to focus on the advantages and possible disadvantages that they create not only in the host country, but also in the home one.
Considering the perspective of the host country, the main benefits are linked to: resource-transfer effects, employment effects, balance of payments effects and effect on competition and economic growth.
The FDI, in fact, can give high benefits to the host countries if we think that, operating abroad, they bring, in the host countries, management resources and especially capital and technology that in the opposite case never can reach those places, increasing their growth rate. Considering the capital, the Foreign Direct Investments are made by MNEs that thanks to their size have access to capital market from which can borrow money, access that the local firms do not have and so they create financial opportunity to these firms. In addition, the MNEs have enough capital to invest in research and development and so develop the skills necessary in order to build up their in house product and process technology. In fact, the technology can be incorporated in the product or in the process required for the production, but if this mechanism is possible in the developed countries, it is not the same considering the developing one. In fact, for those countries to have capital to invest in the activity of Research and Development is not possible because the capital to which they have access, is used in order to produce and offer the products in the market. In addition, according to a study made by the Organization for Economic Cooperation and Development about the FDI, the developed countries not only invest in their country in order to develop always more technological process, but invest also in the country in which they had invested in order to upgrade the existing technology or create new technology and not only to transfer to them the technology already developed in house. The management skills are other important factors that the host countries can acquire. In fact, they are useful in order to develop a high level of efficiency and efficacy through which to operate and coordinate the processes within the company. Another benefit, linked to the managerial skills, exists, if we consider that who has these skills can go to operate abroad in the local firm and so in this way to help who occupies that position to acquire those skills, stimulating competition. Considering the employment effects, the FDI for sure brings in the host country job opportunity. In fact, when a MNE decides to operate abroad, it brings employment for host-country citizens, but at the same time it creates job opportunity in the local firms for the increasing in the local spending or as effect of the investment itself. If we consider the acquisition rather than the FDI itself the consequence should be a temporary reduction of the employment, but because the company has to restructure the operations of the acquired firms, increasing the efficiency, after this period a new phase of growth arises that brings the company to hire new people faster than the local firms. In addition, many studies have demonstrated that foreign firms tend to pay higher salary in comparison with the local one and also the quality of the employment is higher and this because the level of skills and the knowledge is higher.
The balance-of-payments-effects concern, instead, the amount that the good exported and imported in the host country. In fact, the current account deficit exists if the country imports more than the amount that it exports, while the surplus occurs when happens exactly the opposite thing. There is only a moment in which it is possible to talk about the current account in deficit and it is in the moment in which the country sells assets to foreigners. However, the FDI can bring the country to be in surplus because they are an optimal substitute for the imports of goods and services and at the same time the MNEs uses the local subsidiaries to export and this increases the balance of the payment in this country. Considering the effect on competition and economic growth, many economists say that the efficiency in the economy is achieved when in the market there is a high level of competition and this can be reached through the FDI. In fact, the Greenfield investments, for example, create a new competitive firm that can operate in the market but not only from the global perspective, but also considering the national market, because this not only decrease the price of the goods offered, but increases in this way the consumers’ welfare and in the long-term this process can bring to product and process innovation and greater economic growth. In addition, the FDI helps to develop the services sector, investing abroad, and this because they rise the competition in the telecommunication or retailing services, where the possibility to export is not permitted. This law has been made recently because before, these sectors were monopolized by one giant that operated worldwide not stimulating investment and decreasing the price that the competition, created later, has brought.
From the perspective of the host country, exist also three costs about the FDI.
First of all the adverse effects on competition, in fact, the host government sometimes should be worried about the power that the foreigners can achieve on the local companies. In this way the MNEs can monopolize the market and consequently can increase the prices in comparison with the competitive market’s price and this creates high problem within a nation that is already not developed. Another problem arises when the foreign investor decides to acquire one or more local firms and then to merger them because this reduce the competition in the market, creating disadvantages for the consumers that do not have high choice among products and are also forced to pay high prices. This latter problem could be blocked because the national institutions have the power to avoid big mergers in the case in which there is evidence that this operation can reduce the competition and create problems to the development of the national economy.
The second disadvantage of the FDI is the adverse effects on the balance of the payments because the positive effect of the capital inflow should be replaced by the negative effect of the outflow of earnings from the local subsidiaries to the foreign parent company. Also in this case the government can operate in order to reduce the amount of earnings that the company can outflow toward the parent one. Another problem can arise when the foreign subsidiary does not exploit the local resources, but imports from abroad a large amount of inputs, creating for a host country a debit position toward the rest of the world.
The last cost of the FDI for the host country regards the national sovereignty and autonomy. In fact, there are always more governments that are worried about the limit to the independence that the FDI can bring to the host country in taking key decisions where the host country government has few inefficient controls. According this latter problem, many economists argue that is not possible to think that in the global context, in which the firms now operates, the MNEs can believe that they can invest in other market, trying benefit without creating at the same time problems to themselves.
Analyzing the perspective of the home country, the benefits regards fist of all the country’s balance of payment that arises considering the possibility to inflow the foreign earnings and also the possibility to benefit from the demand made by the foreigners about the possibility to import the capital requirements or the complementary goods or intermediate ones. Another benefit is linked to the creation of job opportunity because, for example, for determined position within the subsidiaries are required employees with high skills, skills that the local employees do not have. The last benefit is a sort of reverse resource-transfer effect and so the possibility for the home country to invest abroad to acquire valuable skills and then to back them at home and exploit in order to become always more international and acquire new piece of market, contributing to the economic growth too.
Considering, instead, the costs of the home-country, the first one regards the balance of the payment because invest abroad implies an initial borrow not indifference also if this effect is more than compensated by the future capital inflows. Another cost can arise if the purpose of the investment is the will to exploit the low-labour-cost because this implies high unemployment in the home country and at the end the last cost, that is also the most important, occurs if the FDI become the substitute to the exports and especially to the local production because this creates problems to the entire local economy.
Reviewed the costs and the benefits of the FDI from the host and home perspective, it is now also possible to underline the policies that the both categories of countries can take in order to avoid that the costs outweigh the benefits.
The home country policies can encourage the outward FDI, reducing the risks and the costs necessary in order to invest abroad, creating some funds or banks that the firms can use in order to invest in poor countries. Another solution can be the elimination of double taxation in both foreign and home country. In addition, the home government can use their influence in order to persuade the host government to reduce the restrictions against the foreign investments. At the same time, however, the home country policies have to restrict the excess FDI outflows and first of all for the problems linked to the balance of the payment and the impossibility, linked to foreign law, to bring back at home the earning achieved. In addition, the problem could arise when countries manipulate the rules in order to force their firm to invest in local sectors, hoping in this way to increase the job opportunity for the local employees, other restriction can regards the political reason, the striking example regards the U.S. that has prohibited the possibility to invest in Cuba or in Iran because their policy are in contrast with the ideology of the U.S..
The host country policies, at the same time, can encourage and restrict the inward FDI. The reasons in order to encourage the FDI are above discussed, while the ways through which the governments try to do this are for example the tax concessions or the possible grants and subsidiaries given to the foreigners’ investors or again the possibility to give loans at very low interest rate. The reason is the will to capture the resources that in the future can stimulate the economic growth of the country and at the same time the desire to avoid that this investment can be directed toward other host countries, losing a possibility to grow.
Regarding the restrictions, the governments use many controls, but the most common are two: ownership restraints and performance requirements. The first regards the impossibility for the foreign companies to invest in determined sectors unless the local firm has a significant part of the company’s equity. The reason of this should be the will to preserve part of competition and at the same time to increase the national security for sectors that are considered particular and important for the entire local economy. Regarding the performance requirements, instead, it concerns the control on the behaviour of the local subsidiary, the reason is to reduce as much as possible the costs, increasing the benefits. The requirements concern the technology or local contents or managerial skills required in order to invest in the target country. This policy is more common in the advanced countries rather than in the developing one.
- Foreign direct investment and international trade like as inseparable binomial with the importance of the MNEs
The continuously and quickly growth of the FDI and the evolution of the International agreement, regarding this topic, have created a heated debated and interest about the relation between the FDI and the international trade, in order to understand if the FDI could be consider a substitute of trade or if they are complementary of this and in what measure they can impact on the growth of a nation.
The relation between the FDI and the international trade is always stronger for different reasons. First of all the trade has been, since in the past, as fundamental element in order to increase the economic growth and the development, while the same investments have been seen as important tools for the distribution of assets and services on the market and especially as process that can increase the internationalization of the production, influencing the direction and the composition of the economic world. The FDI, instead, as always more frequent element in the global world, is influencing the approach of the government in the regulation of that, being the key element in the development of the country itself. Nevertheless the commerce and the investments are characterized by an interrelation always stronger, in the current period the conditions are a little bit changed because the global scene, in which the companies operate, has changed. In fact, until 1990s the governments are not used to manage the FDI, this changed with the impact of the World Trade Organization (WTO) in 1995. In fact, this organization promotes the international trade, but nor only regarding the goods, but also the services. Before this period, it was not possible that the services were produced where they were not consumed, while with the born of this organization this became possible and this implied the necessity for the institutions to regulate and manage the FDI. This creates a liberalization of the FDI that implied also a sort of fair in the institutions because an excessive investments by the foreigner investors could bring to a slow growth in the economy of each nation. Nevertheless many agreements have been created in order to regulate rather than avoid the FDI, this investments are increasing thanks to reduction in the barriers for the movement and the exchange of services, goods, capital and especially employees. This liberalization has created the possibility to transfer abroad without problems the inputs necessary for the production and the same capital required for initiate a new production process. The first consequence has been the international production, in fact many companies have become transnational and there has been the passage from the little family firms to the multinational enterprises. That passage has created and will imply the increase in the investments made in not only developed nations, but also and especially in the developing ones, like it is possible to note in graph below.
The projections made in the 2014 have been more than confirmed about the growth that the FDI have been in the last two years. The new economic environment has given the freedom to the new companies to entry into the markets in different ways. In addition they have access to determined inputs, necessary for the production, more simply through the import process or thanks to a specific investment, this not only has reduced the costs, but it has brought them to cover and satisfy the market not only regional, but also national and global one. The combination between the FDI and the international trade create strong stimuli for the national growth and require the necessity to coordinate a system that can integrate the two elements that are now, more than in the past, essential. To talk about that, it is fundamental to talk about the MNEs and the characteristics of these giants that, currently, affect our economy.
“Foreign-owned MNEs employ one worker in every five in European manufacturing and one in every in US manufacturing; they sell one euro in every four of manufactured goods in Europe and one dollar in every five in US” (OECD 2001b).
MNEs are really different from the national one and the institutions want that the companies invest in their nation because, it is only in this way that they can hope to raise their welfare and to have fortune in their career. The foreign countries, in fact, try to attract them with strong competition because, first of all, thanks to that they can obtain the possibility to acquire skills, financial and new technology that otherwise it is not possible to obtain quickly. The MNEs are not defined in this way because they are characterized by a big size, but the concept is quite larger.
The MNE is an enterprise that should be also small or medium, with little power in national market, but that has one or more subsidiaries abroad. In fact, this is a strategy through which the company can grow and at the same time can be followed by other firms. To define the multinational enterprise I would like to take in consideration the definition that the OECD has made, considering those firms as enterprises that have significant equity share, more than 50% in a foreign company and their activities are measured by their index as the number of employees or the size of their sales, but this is quite difficult considering that it is not easy to find these data on the web, being sensitive data. The linkage between the MNEs and the FDI is easy, in fact the FDI is also defined by the OECD in 1993 as an investment in a foreign company where the investor has to have at least 10% of the ordinary shares, having in addition interest in the foreign country in order to establish long-term relationship there. The FDI implies capital, financing resources and earnings, all elements that are required by the MNE in order to invest abroad. This implies that the MNE in order to acquire or create a new foreign subsidiary can undertake the FDI. The trend and the growth of the FDI in the last period is growing, in fact as it is possible to note below after a peak in 2007 and a plummets during the period of great depression for the global economic crisis in 2008, the flow of the FDI is increasing with investments that are achieving the two billion of US dollars. This demonstrates how this mechanism is always more famous, in order to invest abroad, for companies that would like to increase their competitiveness and market share and at the same time this process is also encouraged by governments, otherwise this growth should not be possible.
Source by UNCTAD: “Global FDI”
- FDI promotes the changing market structure and the integration in the global economy, enhancing the technology
The changing in market structure is a fundamental consideration that each investor has to take in consideration if he wants to undertake FDI. In fact, this is necessary not only considering the domestic environment, but also the internationalize one, because it is only in this way that will be possible to enjoy about the development of the global market. To change the market structure means to be able to adapt to the requirement of the global market in order to suit the global needs and so to be competitive in the market itself. Through this mechanism will be possible to build a structure based on resources that will be competitive and that can attract FDI in a very simple way. On the other hand the same FDI, once that are been undertaken, changes the market structure and this happen because the new foreigner investor can decide to invest into determined fields, giving new technology and new resources that bring the country to develop strong segments with high labour productivity and at the same time to increase their percentage in national economy. This means to bring the country to move from one specific segment, in which it operated, toward another one, and often happens that the country moves toward segments, and so consequently market structure, always more based on the high technology with a high degree of innovation, leaving the sector where the labour is manual and where the possibility to be competitive in the global market is really hard. In fact, the same FDI not only change the market structure, but also they enhance the technology and the degree of innovation in the host country. This happens because when the foreigner investor decides to invest abroad, he brings not only capital in terms of money to the host country, but also and especially know-how and real capital equipment, manage expertise, labour skills and more advanced knowledge. In this way the host country knows a market always more characterized by high technology, by employees with high skills and knowledge, elements that are fundamental in order to modernize and industrialize itself. The employees are subjects to training in order to better understand the use and the applicability of the new technology, in this way the foreigner investor helps the host country to combine the local resources with the foreign skills in order to be valuable and competitive in the market. This changes, of course, also the institutions and the regulation that they have to undertake in order to avoid that the costs of this modernization process can overweigh the benefits.
In this way, it is evident as the FDI gives the possibility to the domestic economy to be in touch with the global market in order to integrate itself with this latter world. This creates more competition and the possibility to operate in the global environment, through employees that have, now, the skills and the capability adequate to allow the economy to grow. The fundamental concept is to be in comparison with the rest of the world because only in this way, that seeing the different, the country will be able to imitate and to overweigh the other countries. The same exporting activities is important because through this mechanism that the country can compete with the other and have advantages. It is evident that for the developing country to be in competition with the industrialized country is difficult, but through the FDI, this becomes possible because the foreigner investor, through the investment, helps the products of the host country to look out on the world markets and, through the skills transferred and by now acquired, to integrate with them.
- Factors of attraction of the FDI in the new economy and the key role of the job creation
As it is possible to read above, the FDI help the host countries to quickly achieve high social-economic standards, becoming dynamic regions with a high degree of competition in order to operate in the global context.
The FDI are important also considering the foreigner investor. It is fundamental, in fact, to say that the investor is not a benefactor, but that he works, investing abroad, because he can reap many benefits in this way. Regarding this concept that as I have stated above, I would like to explain the three reasons, according Dunning, that are considered the factors of attraction of FDI from the perspective of the foreigner investor.
Dunning, in 1993, described three many types of FDI in order to explain the benefits that the investing firm could obtained. The first is known as Market Seeking, the purpose is to know and discover new markets that can increase the profitability of the company because are more productive or because for example they are place not served by other firms,. Dunning linked to this view the concept of horizontal FDI because it involves the possible replication of the production process in the host country in order to better serve those markets, through market size and growth and especially local production. The firms in this way can avoid the problems linked to tariffs or fees that, if they wanted to operate through the exporting, they should have to support.
The second advantage is called Resources Seeking. This is really important if we consider that the investor can decide through this element to invest into determined market rather than in another one. In fact, through this analysis, he is able to understand where is the convenience in order to better exploit the resources. In fact, he can decide to invest abroad to have access to resources that in his country are not available, like raw material or natural resources or especially low-labour cost. This latter advantage is the most important and explains the principal reason that brings the investors to invest abroad because through this mechanism they can have the possibility to produce the products at low costs and so have more benefit than the competitors, selling at lower price, capturing a large part of clients or maintaining the same price, but having a higher profit margin. This advantage is, instead, linked to the vertical FDI, because it concerns the possibility to relocate part of the production chain abroad, there where the convenience is higher in terms of low labour cost or abundance of the resources necessary.
The third factor of attraction is the Efficiency Seeking. This latter concept arises when a firm can enjoy by the subsidiaries or grants given by government. The host government because has incentive if the firm invest in its country and increase the market competitiveness in the global context and in the home country in the case in which it is able to achieve economies of scale and scope.
The World Investment Report, UNCTAD, has analyzed the determinants of the FDI, classifying them into three groups: the business facilitation and the economic and politic factors.
It is fundamental to underline that in addition to the factors above explained, others are the variable that bring the investor to choose one market rather than another one. Regarding to this concept, that it is possible to talk about the theory of Jordaan (2004), who said that the investors will move towards countries where the GDP per capita is higher and consequently the purchasing power of the consumers is higher. In this context the projection of the market expansion and growth are high and the firms in the long-run can potentially receive high profit and high return on the capital invested. This implies that invest in the market with a large size is convenient because create the possibility to have economies of scale and at the same time to exploit in the best way the resources (Charkrabarti 2001). Even if this theory is more relevant, many are the economists that say that the real GDP per capita should be inversely related to FDI/GDP and this implies that also if the GDP is higher the return on the investments should be lower. So they consider that other factors are taken in consideration. First of all the degree of openness of the host country toward international trade, in fact, if the country is open in receiving the investment the obstacle that the investor has to suffer is low and the will to invest is high. This implies to avoid the tariffs, the fees or the transaction costs that for example in other countries the firms should be forced to sustain. Another important relevant factor is the political risk because the investors are more willing to invest where the political condition is stable in order to avoid surprise after the investment that bring them to come back and loose the capital invested abroad. Another element connected to the political factor, is the possibility to analyze that the government permits to the investor the access to particular resources in order to exploit them and to use them in the production process, a striking example is given by oil or natural resources. Another factor that has to be analyzed, before investing, is the level of infrastructure in the host country, that according to ODI (1997) should be an obstacle and an opportunity. An opportunity because, in this way, the foreign investors do not have problem to transport the raw material or the plants, all elements fundamental for the production process, in the host countries and an opportunity also considering the importance that the infrastructures have in distributing the goods produced, as element that permit to the goods to achieve the consumers’ hand. The obstacle given by the infrastructure is, instead, linked to the concept that a place where the infrastructures are more developed brings the other companies to invest in that specific country and this could, of course, not stimulate the foreign investor because he has to entry in a country where the competition level could be already so high. Jordaan (2204) stated that a good level of infrastructure is fundamental in order to increase the potential productivity of investments, stimulating the FDI, where for infrastructure he talked about the roads, ports and telecommunication system. Another important positive element to take in consideration regards the taxation, in fact the investors go to invest there where the tax are favourable in order to have a return on the investment higher than in home country. Regarding this latter concept, the idea is however not consensual, in fact Hartman (1994), Grubert and Mutti (1991), Hines and Rice (1994), for example believed that the tax has a negative effect on the FDI.
The last positive factors that I would like to take in consideration regards the growth of the host country with the impact that the FDI has on the wages and on the job opportunity.
Charkrabarti (2001) stated that the rapidly growing economy is an important element to take in consideration in order to decide if to invest in determined market and the growth wave of the market influences the labour wages and the opportunity job. In fact, the same Charkrabarti had said that the wages are an indicator of labour cost and this element as we have noted above is really interesting in the study of FDI. The maximization of the profit is the main element that brings the investor to undertake the FDI and consequently the cheap labour is the key factor that allows the investor to choose the developing countries as investments destinations. In this way the number of employees that each day work in the foreign companies are always more and this not only creates new opportunities job, but also the possibility to increase the capabilities and the skills of the employees thanks to training programmes and the necessity to adapt to the global context and consumers’ needs, being able to manage the high technology. The improvement in the human resources’ skills has a high impact in the host country considering the possibility that the employees can leave the foreign firms and go to work in the domestic ones, creating competition and increasing the role of the entire country in the global market. I have said that the investments create job in the host country, but this point is important not just considering the level of unemployment, rather than analyzing the importance that this element has on the entire life of the employees themselves. In fact, in this way, the employees increase their income and this implies to be able to spend more, improving also their healthy condition and the children’s education that contribute to enhance the standard living. This concept is fundamental because through this process the distance between the poor and the rich country will be cut and the inequalities will disappear. It is fundamental to say, as I have explained above that the investor is not a benefactor and so he decides to invest abroad because the labour cost is low also because the employees is quite unskilled, but it is however important to note that, as Brown et al. (2003) has said, the multinationals pay higher wages in comparison with the domestic firms and this gives an incentive to the employees to choose them rather than the local companies, having a negative impact on the domestic firms’ salary, but at the same time incentivize them to improve their characteristics in order to better compete in the market space. This process can bring the employees to work in the MNEs in order to acquire the knowledge and the skills that would otherwise not learned and then to transfer to the domestic company in order to help the development of the country from the internal point of view and to permit them to increase in size and consequently in paying a higher salary.
- The competitive policy as an element determining the investment in the international markets
Public policies are considered as an attraction factor in themselves for the FDI (Mudambi 2005), but at the same time they can be considered also as a factor that reinforces the other factors considered determinant to attract the foreigner investors. The key activity that the public policies have to do in order to incentivize the inward investments, is to stimulate the Research and Development activity because through this process that will be possible to influence the elements that are considered like drivers for the decision of the investor. These elements, as we have seen above, could be the low-labour cost or the presence of other multinational enterprises or again the quality of life, all tools that more or less influence the purchasing power of the consumers and consequently the decision for the location of the investment. It is fundamental to underline that the attraction factors are influenced by the public policies in different ways, in fact, there are many of them that could be influenced in the short-term rather than other ones in the long-term. Again there are many of these factors that are outside the control and the influence of the policy and so the policy itself has to operate a sort of second role based on the ability to make them visible to the investor, being able to influence his idea. This latter mechanism is known as inward investment promotion rather than the first strategy that is called as innovation policy. The determinant role of the innovation policy is the ability to develop an environment favourable for the R&D, identifying the national strengths and the weaknesses around the innovation system.
The innovation policy can operate through the fiscal and financial incentives to corporate R&D, it has to operate in order to enhance the research infrastructure in order to stimulate skilled-employees and promote the collaboration among different research centers and technology parks in all sectors. These infrastructures are attractive for the foreigner investors because they facilitate the networking with the other multinational enterprises and at the same time offer a pleasant working environment. This creates also a high degree of collaboration and interaction, emphasizing the “Triple helix”, the efficient mechanism among the industry-university-government (Etzkowitz and Leydesdorff 2000). In this condition the policy has to promote the linkages between the foreign firms and the local subsidiaries, diffusing the existing knowledge and creating the new one (Chaminade and Vang, 2006). In addition, in order to attract the investments, the institutions sometimes decide to give grants or incentives in the nation in order to increase the number of skilled employees through the specific programmes for the university and the possibility to promote the exchange programmes between different nations and between the private and public spheres. This implies to be able to promote the development of the human capital because it is in this way that can develop the right strategy in order to attract the talent employees, and at the same time to develop them from inside, enabling the mobility of the employees between the companies. This process could be promoted through a legislation that reforms the immigration laws and reducing the taxation for the immigrants with high skills and, of course, facilitating the accreditation of the qualification obtained abroad by the local students. The other important factor, that the innovation policy has to consider, is the necessity to improve the regime of the intellectual property rights. This latter concept is fundamental because if the policy is adequate in order to avoid any duplication and any inappropriate use of the IPR the investor is more encouraged to spend money in order to innovate and to acquire a right according to this innovation process that allow him to use its in monopoly way for a determined period that will be more than enough for recovering the initial investment done. This is possible just if the policy operates sanctioning who does not respect the law. The most common strategy used by the policy is the incentives for the business R&D from the financial and fiscal perspectives, but the problem of these tools, is that sometimes they are discriminatory and so directed just to determined sectors or activities. The European Commission in 2005 have said that the criteria under which these incentives were to be given, had to be very precise and based on transparency, openness and non discriminatory, but in reality the governments prefers to respond faster to the investments made by the foreigners and they, sometimes, follow the same strategy that they use for the local firms or again they prefer to have a direct contact with the multinational enterprises negotiating their incentives. Many economists believe that the R&D are not the element on which the investors made their choice, but it is however useful to note that in the case in which the other attraction factors are quite similar this condition becomes determinant (Zanatta et al, 2006; UNCTAD, 2005; Cantwell and Mudambi, 2000).
Considering the inward investment promotion, the first activity should be the necessity to focus on a determined R&D degree on which the government wants to base its system, building an image of the country as R&D location. In addition, they have to provide specific investment front to the activity of R&D, focusing on the after-care services through the implementation of policy advocacy. These activities are better made through the aim of the Inward Investment agencies, that sometimes, is part of the ministry of foreign affairs and has the role to promote the nation through marketing campaign, facilitating the investments in the country itself and giving incentives to the investors. This activity should be done through the advertising, focusing on the image of the country and on the ability to build an image that fit with the perception of the investors. As it is possible to note in the graph below, considering the last period from 2007 till 2015, the expenditure in the R&D activities has grown, not only in consideration of the developed countries, but also and especially for the developing one. In fact, the percentage of growth for the more advanced countries, in comparison with the less advanced one, is lower, nevertheless the growth is high and the numbers in billions of US$ are really important and have a huge impact on the total costs sustained by companies and governments for the development of the entire economic context.
Change in corporate R&D Spending by Region, 2007-2015 in US$ Billions
Source: “Strategy& 2015 Global Innovation 1000 analysis”. 2015 Pwc.
That said, it is possible to say that the policy influences the choice of the investors, but in order to understand the way in which the policy has to operate, it is fundamental that it knows the reasons for which the MNEs decide to locate their investments in determined market. These reasons could be summarized into three groups: parent company strategies, host country characteristics and subsidiary potential (Birkinshaw, 2003). All of these elements have been more than discussed above, so now I would like to focus on the importance of China in the entire world sphere especially considering the FDI, highlighting the way and the reason for which this mechanism has characterized exactly the Chinese market.
- China as destination
- Chinese conditions
As Jean-Claude Berthélemy and Sylvie Démurger said, few years ago, “The dramatic economic growth of the People’s Republic of China over the last twenty years has generated an increasing number of empirical studies aimed at explaining this performance”. Regarding this latter concept, in fact, if we are going to compare China with the other developing countries, it is really easy to note that the case of this huge country offers a striking example of triumph. This success is, certainly, connected with its policy to open up to foreign countries and at the same time to many reforms made in economic and social environment by Chinese government, reforms based on attracting foreign technology and capital in order to give incentives to the entire country. Exactly these elements have given to China, the possibility to become, among the developing countries, the first recipient of FDI in the 1994 and, in the entire global context, the second after the United States. As it is possible to note in the first graph below, the Inflow Foreign Direct Investments have characterized the Chinese context in all possible sectors, even if, as we will read later, several sectors are closed, and this is explained by the fertile environment that have found to develop. While as I have stated above, the second graph underlines that China is still in the 2015 the second largest country in the world to attract FDI.
Source: UNCTAD. “Asia tops the world in FDI”.
Now, in order to better understand this development in China, I would like to talk about the conditions that characterize the Chinese context, in terms of political, economical and social forces.
- Political environment
In 1978, after many years of strong imposed isolation, China was finally ready to reintegrate itself with the entire world economy. In that period, in fact, China was still concerned about the Soviet threat in the Far East and especially in the 1975 when the Soviet encirclement was dramatically intensified, caused by the unification of Vietnam into the Soviet area. These changes caused close relationships between the Chinese empire and the West capitalism especially considering the United States.
As the Chinese Foreign Minister Huang Hua said in the 1977: “China needed to win the United States over to its side to struggle against its archenemy- revisionist Soviet social-imperialism”. After this period the Gross Domestic Product had grown at an average rate of 2.5 and 3%, an average so high compared with then China’s neighboring countries. In fact, after nearly 30 years of serious problems, in 1971 a Representative of Republic of China sit on the Chinese seat at the United Nations Assembly and the UN Security Council. Since 1971, most countries in the world recognized the People’s Republic as the legitimate representative of China in the international scene, closing formal diplomatic relations with Taiwan, and in 1971 the UN passed Chinese seat to the People’s Republic. In addition, after the death of Mao Zedong in 1978 the Chinese Communist Party under the leadership of the new General Secretary Deng Xiaoping began a series of economic reforms that marked the transition to the so-called socialism with Chinese characteristics and market socialism.
Nowadays in China the fundamental political system is based on the People’s Congress System that with his Committee has many powers not only regarding the legislation, but also considering the authority to elect or remove the national leaders and the relative President. The President of People’s Republic of China is the Head of State and he exercises the domestic power, but also and especially the power in terms of foreign affairs, in terms to receive the foreign diplomatic representatives or to built agreements or again to abrogate treaties. The State Council is the highest body in terms of State Administrative, in fact, it is responsible for the National People’s Congress and its Standing Committee, reporting to them about its work. The Supreme People’s Court has, instead, the juridical power, without any kind of interferences by administrative and public organs, but controlled by the Supreme People’s Procuratorate.
China is based on the socialist market economy and the Government has only the possibility to regulate the economy, but in terms of market basis, in fact the price or the amount of resources are market based, but only a really small part of goods are priced by the State or under his government. Labour is free and the enterprises can operate with extreme autonomy under the respect of the law.
- Economic environment
The economy of the Chinese Empire is growing and it is in continuously progress thanks to political power, to infrastructure adjustment, ample reserve of necessary commodities for the production, a good improving in the standard living and growing in domestic market and international balance of payments. China is accelerating always more the possibility to use the foreign capital and consequently the foreign investment as it is possible to note in the table below, given exactly by the Chinese Government. A decline is highlighted in 2012, but it reappeared in 2013, year in which the amount of FDI is quite equal to $ 117.586 billion and a growth of 5.25% in comparison with the previous year. Also the rate of the unemployment is lower, even if about a small percentage, in comparison with the previous years, it is exactly equal to 4.05%, that considering the number of Chinese population, it has a huge impact on the work environment.
- Social/Cultural environment
China is playing on the strategy to rejuvenate the population thanks to an improvement in the science and education, putting this last element at the centre of the entire Chinese strategy. It is based on nine-years of education with a number that since in 2012 are increasing always more. In fact, in 2012 the number of students enrolled in graduate program was equal to 590.000, 1.72 million were the students that worked in Masters’ programmes and 480.000 accomplished their graduate programme. Many are the students that finished their education, in fact the government talks about a value equal to 16.608 million. The education becomes always more important for the development of an entire nation especially if we talk about the potentiality of China, where the number of population is so high and the possibility to develop a high professional class is important and strategic in order to improve the efficiency of the entire nation and to avoid to be forced to import the knowledge and the high skills labour. In fact, China is the largest nation in term of number of population, with 1.35404 billion people by the end of 2012 and this number is subject to continuously grow, with a birth rate of 12.10%. Exactly for this reason that the Chinese Government has developed a series of Education Management System based on the necessity to improve the quality and the time for the education.
Regarding the culture system, it is exactly the same since in the past and it is based on a system of high modesty, frugality and community oriented value characterized the Chinese life day by day. Within the huge Chinese empire there are 56 ethnic groups and it is this high number that making them to be willing to integrate themselves with foreign cultures and to be at the same time open to new culture in order to learn by them. The Chinese society has had a transformation from the agricultural system towards the industrial ones in order to become, currently, what is defined as information society. In addition, it is important also to note how the integration process has brought China to assimilate part of the western culture. Regarding this latter concept, I would like to mark the religious impact that the Catholicism and the Christian has had in the most important Chinese Cities, cities that before this period were absolutely atheist.
- Technological environment
As it is possible to read above, at the beginning China was more devoted to agricultural industry because its culture was based on this particular aspect of life, but it is useful to note how this aspect during the years, has been subject to many changes, in fact in only twenty years China has changes his structure from the use of agricultural and heavy industry to open and information driven economy.
Since 1970 the Foreign Direct Investments have created a strong base in China in order to upgrade its industrial technology. In fact, according to many studies, in 2001 China became a country with 145 million of mobile phone users and 179 million of fixed phone lines. An important data that I would like to underline is the ability of China to undertake in 2010 the United States in using the laptop and the internet connection with a number of 80 million of users. China, now, export a huge quantity of high-tech products, with a number of $ 110.3 billion, but the important question that the economists make is if China is able to sustain an endogenous development of technology in order to feed its ability to be competitive in the global market.
The big issue of the Chinese market and its internal technological production of goods regard the property rights that the Chinese corporations do not have, in fact a huge part of the export made by China regards products that are going to infringe the foreign patents, a striking example regards the DVD players in 2002 when Sony, Philips and other big brands started a legal battles against this illegal market in the European Union court. In fact, the invention patents in China remain still very few in comparison with the other offered in the rest of the world and this slows down the entire national economy. The problem is that the same companies do not have interest in develop these kinds of right because they are more oriented towards the utility model linked to a sort of unsubstantial modification. Another issue is linked to a concept that the same Chinese enterprises do not have interest in engage the domestic institutions in order to learn by the efforts made in R&D activities, in fact since 1980 the governments has spent many resources in order to increase the supply side of technology within the national borders, but the enterprises prefer to acquire the knowledge from abroad. This sort of rigidity between enterprises and policy creates the impossibility to develop directly the technology using the domestic resources and at the same time the lack in the will of the domestic entrepreneurs to use the technology imports in order to obtain a license. The following graph underlines the invention patents granted in China with values expressed in percentage and it is so evident that in comparison with the foreign countries the percentages are really low and this does not bring China to be so strong in the market as it could be. Also if this data are based on a study of 2002 the percentages are not so changed in the last ten years regarding this tool, even if the importance of the R&D activities has changed.
Source: National Bureau of Statistics and Ministry of Science and Technology (eds), “China Statistical Yearbook on Science and Technology 2003”, op. Cit., p.434.
However, as measured by Trade Competitiveness, in the first graph, China’s high-tech trade has an important role in the entire global and national context considering the imports, the exports and the trade balance and with regard to its competitiveness, as it is possible to note in the second graph below, it has overweighed the United States. So, nevertheless, the problems that it has regarding the IPR, its importance in the market is always stronger.
China’s high-tech trade expressed in $billion.
Source: National Bureau of Statistics and Ministry of Science and Technology (eds), China Statistical Yearbook on Science and Technology 2003, Peking, China Statistics Press, 2003.
Competitiveness of China’s high-tech trade.
Sources: National Bureau of Statistics and Ministry of Science and Technology (eds.), China Statistical Yearbook on Science and Technology 2003, op. cit., and National Science Board, Science and Engineering Indicators 2002, Arlington, VA, National Science Foundation, 2002.
At the end, I would like to underline that nevertheless the issues stated above with regard the companies, in the last period there has been an increase in the annual sales revenue on R&D, with Huawei, Datang and Zhongxing Telecommunications that lead the way, devoting, each of these, 10% of their revenue to R&D activities. According to other studies, however, the other small-medium enterprises spend almost 5% of sales for the technological development. This improvement has been given by the incentives of the government that since in 1997 during the National Conference on Technological Innovation has promoted the importance of the R&D and the role that the enterprises have to be in this context, in fact the same government forced the high-tech enterprises to spend at least 5% of their revenue in this activity.
- Legal environment and the fiscal incentives for the FDI
In order to create an environment in which should be possible to develop the entire economic system and consequently the welfare of the entire nation, since 1979 the Chinese government has created a series of laws and regulation that could be useful in order to attract foreign investors. In fact, regarding this latter concept that, it has created a real foreign investment policy system that involves the industrial, tax, national and regional policies.
For example, the major foreign investments laws regard the law about the equity joint ventures and its implementation or the contractual joint venture and its implementation or again the wholly foreign-owned enterprises or the enterprise income tax law. Other kinds of laws regard the protection of the investments of Taiwan or the provision of M&A of a Domestic Enterprise by the foreigners or the provision to give them in a moment in which they want to constitute joint stock limited companies. Many of these laws are discussed below according to the historical period in which they were created and consequently according their applicability in the Chinese context. Instead now, I would like to talk about two important international treaties that China has formed in 2013. The first one regards the Bilateral Investment Treaties with 132 countries and regions in October 2013, while the other one, in June 2013, regards the Bilateral Agreement on the Avoidance of Double taxation with 99 countries and regions. The first agreement regards the relationships between China and Africa and I would like to talk about this concept in the fourth chapter, where I am going to focus on the outward investments made by China, while the seconds one, it is useful because it enhances not only the corporate income tax, but also the individual income tax, withholding taxes and dividends taxes among others. This mechanism is useful not only considering who operates in both nations, but also and especially considering the trading companies that are not present in the territory in permanent way. Regarding the dividends tax, for example, China tax only 10% on the profit created in China, but repatriated overseas. Regarding the withholding taxes, they vary according to different services that are made, but it is about the 10-20 percent on the total invoice value. All of these regulations have given a really impact on the development of the FDI within the entire nation.
3.2 The development path and the political attractions of the FDI
Now, I would like to analyze the trend, the impact and the role of the Foreign Direct Investment in the Chinese Context and especially in the economic growth that has characterized China in the last period, in particular considering determined historical institutional phase in which China has undertaken different attractions’ strategies of foreign capital.
The Chinese political guidance over the years has followed two parallel and complementary ways, the first of which aims to increase productivity by attracting FDI to export-oriented type in the special economic zones and other open areas, especially in the east of China, in order to expand reserves and finance imports of capital goods. The second one concerns the government that seeks to protect vulnerable local businesses by limiting the access to foreign companies through protective tools.
The first graph underlines the only trend in 2015 and it is useful to note how in just one year the inward FDI have characterized the entire Chinese context in terms of millions and millions of dollars.
In order to better understand the trend that has characterized the entire Chinese context, it is necessary to underline and understand the second graph that make in evidence the trend since the 1980 until the current period and how this has given its impact to the Chinese context and the entire world economy.
Source: Ministry of Commerce of the People Republic of China.
Source: UNCTAD. “The FDI flows in China and the impact in the world shares”
According to the analysis of the phenomenon of FDI, as it is clear from the graph,
studies show four main stages characterized by specific economic policies, laws and regulations undertaken by the Chinese government in order to attract a considerable amount and high quality of foreign capital.
At each phase corresponds naturally certain types of FDI, in particular are identified an experimental phase (1979-1983), a phase of gradual development (1984-1991), a rapid development stage (1992-2000) and at the end a phase of consolidation and improvement (2001- present day).
Among the reasons why foreign companies operating in China, it is possible to observe that between 1978 and 2000, the majority of businesses are resource-seekers or efficiency-seekers types, the investments are, therefore, undertaken to produce primary goods that satisfy the foreign market, generating a flow of resource to be exported (commodities, infrastructure physical, technology) or trying to obtain access to cheap labour in China locating labour-intensive segments of the production process exactly in that zones. More recently, particularly since 2001, investors’ strategies were addressed to the penetration of the territory of the host country and have focused on consumers’ preference and on the structure of the domestic market.
After the global financial crisis that has hit China, multinational enterprises, having discovered the added advantages that China offers (excessive liquidity, skilled labour, new technology), have decided to operate as strategic asset-seekers, this implies to invest in the country in order to acquire experience in research and development attracted especially by cheaper human resources, and infrastructures.
We can say that Chinese FDI fall into the category of Southeast Asia (Southeast Asian pattern), in particular way considering that economies are open to FDI flows, particularly to the type of manufacturing export-oriented. This category is opposed to that typical of the Northeast (Northeast Asian pattern) which includes the economies of Japan, Korea and Taiwan.
Foreign investors in China have implemented different strategies: those from Hong Kong, Taiwan, Korea and Japan are concentrated in sectors with a high labour intensity and establish in China bases for exporting; American and European investors are revealed more interested in the Chinese domestic market, head towards sectors that require capital and technologies which China is lacking, in this latter case the most striking example is that of automobile industry and also especially in the last months the one of the football sector.
Now I would like to talk about the different development steps that have characterized the Chinese growth and the particular elements that have regarded as each of them.
3.2.1 Experimental stage: towards liberalization
Since 1979 China pursues a policy of openness towards the foreign countries, a policy that supported measures at local level in order to attract Foreign Direct Investment. It is an operation aligned with the Policy of the Four Modernizations, (Si ge xiandaihua), made by Deng Xiaoping. It based on a series of tax provisions for companies that decided to invest abroad. Take this policy means for China to make a step forward in the codification of designated commercial laws based on the attraction and regulation of foreign participation in the Chinese economy.
In 1979 it enacted the first law relating to joint ventures Sino-foreign, the Law of the People’s Republic of China on Chinese Foreign Equity Joint Venture (Zhonghua remin Gongheguo zhongwai Hezuo Jingying Qiye). The Law on EJV (Equity joint venture, Zhongwai Hezi Jingying Qiye venture capital and management mixed Sino-foreign) specifically permits to “foreign companies, enterprises, other economic entities or individuals to built themselves, within the territory of the People’s Republic of China, into equity joint ventures with Chinese companies, enterprises or other economic entities and the stand shall not nationalize or expropriated foreign investment interest”.
The EJV is a joint venture made up of at least one foreign entity (individual or entity) and a legal Chinese person (in fact there is a ban for Chinese individuals to participate in joint ventures Sino-foreign). In practice, the foreign party provides capital, technology and know-how while the Chinese side provides the capital (in the local currency), the right to use the foreign land, factories and facilities. Choose a joint venture as an investment tool involves restrictions, the Chinese government carefully identifies the foreign partners for local business, consequently the flow of FDI growth is therefore very limited.
The creation of MOFERT in 1982 (Ministry of Foreign Economic Relations and Trade), the entity responsible for economic affairs and trade between China and the foreign countries, is an additional measure in order to try to move towards a global market economy.
The promulgation of the Law on joint venture is accompanied also from opening, in 1980, of four Special Economic Zones (SEZs, Jingji tequ): Shenzhen, Zhuhai, Shantou in Guangdong Province, Xiamen in Fujian province. These zones have a separate regime, are called upon to introduce experimental forms of cooperation with international economy, by encouraging investments and consequently the introduction of technology and management foreign advanced methods through instruments such as the creation of joint ventures between Chinese and foreign capital. Within there may be multiple sub-areas specifically dedicated to certain activities or sectors. Initially, it is not granted establishment of WFOE (Wholly Foreign-Owned Enterprise), except as an experimentation policy within the geographical boundaries of the SEZs, the extension of this type of investment in all areas of China dates back only to the mid ‘80. During the early stages the low-labour cost is the main reason that attracted the investments, while in the ’90 there was a change towards FDI of market-oriented type, in areas where China does not demonstrate a particular comparative advantage. In this initial period the level of economic development of the country it was still low and the environment of investment was poorly satisfactory, that is why there was the need to attract investments whose major amount comes from the so-called Chinese Overseas (Haiwai huaren). The initial FDI flow is moderate, the Chinese use the expression “Guanwang” (wait and see) to indicate the uncertainty of behaviour of foreign investors in respect of their operations in China, especially before the implementation of the Law on EJV.
Until the 1986 foreign direct investment are “permitted” rather than “encouraged” by the Chinese government.
After 1986, FDI in some sectors, especially those addressed to export, were actively promoted. The amount of investment was oriented to export labour-intensive products, such as shoes, clothing, toys and electronic equipment, none of which requires a large capital commitment and sophisticated technology. All investments, instead, in the service sector (wholesale, retail, real estate, energy sector) are classified as market-seeking as they aim to supply the consumers and local businesses.
The main sources of origin of FDI flows at this stage were Hong Kong and Taiwan, while the flow coming from other countries was small. The geographical proximity of Hong Kong facilitated the reduction of transport costs and the import of raw materials and semi products used in the export process and assembly operations. The advantage of Hong Kong investors was linked to the element that they share with China the same cultural background, and quite similar language, in addition they have a more experience with the Chinese bureaucracy, made the experience of operating in China more favourable. Despite the gradual introduction of regulations in the investment world, the legislature was still dominated by bureaucratic control mechanisms, therefore, undertake activities in China at this stage for investors it was still limiting.
3.2.2 Stage of gradual development
After the first period of exploration, the use of FDI in China enters into a phase of expansion from 1984 to 1991, the Chinese government aims to build on the success of SEZs and to shift the concentration of capital from real estate and manufacturing to the technology sector, the sector oriented to export and to the infrastructure sector. During this term, the policies and the FDI regulations as well as the environment of investments undergo a substantial improvement. The commitment to Reform is also symbolized by the opening of the Great Wall Hotel in 1984, a Sino-American joint venture in Beijing that welcomes business partners came to China for negotiations.
In 1984, the use of the special economic zone is extended to fourteen coastal cities in ten provinces. In 1988 the province of Hainan it was proclaimed the largest SEZ in China. Twelve of the fourteen cities open are designated as Technology Promotion Zones in 1985 in order to experience the transfer and the use of technology. This strategy has later evolved with the creation of “development triangle” in the regions of the Pearl River Delta and the Yangtze, this last as part of the broader Shanghai economic revitalization program.
In 1990, the Pudong district in Shanghai is referred to as a new area in which special policies are applied, aimed at economic and technological development to coincide with the area of the Yangtze River. From 1986, the Chinese government introduced a series of regulations and policies taxation with the aim of encouraging the flow of FDI, especially favourable to the joint venture aimed at export and those that use advanced technologies. In this regard they are issued a series of laws, including “The Provisions of the State Council of the People’s Republic of China for the Encouragement of Foreign Investment” (Guowuyuan Guanyu guli waishang Touzi de guiding) in 1986, providing preferential treatment of taxation, freedom to import material and equipment and enhance simple licensing procedures.
Since 1986 with the enactment of the Act on capital companies exclusively abroad (The Law of the People’s Republic of China on enterprises operated exclusively with foreign capital, Zhonghua renmin Gongheguo waizi wiye) it is made possible to all foreign investors, although limited to for investment projects that brought high technology and that were oriented to export, establishment of legal entities under Chinese law without a local partner.
From ’90, many of the restrictions established by the WFOE on legislation (Wholly Foreign Owned Enterprises, Waishang Touzi Qiye) are loosened and at the same time were reduced the areas closed to entirely foreign investment. With the latest legislative changes 2000-2001 necessary in view to accession to WTO (World Trade Organization) is finally been generally permitted establishment of WFOE in any sector as long as not falling in categories prohibited or limited by law. The WFOE is currently the type of FIE more acceptable to foreign investors. The reference legislation remains the WFOE Law as last amended on 31 October 2000 and its implementing regulation, as amended on 12 April 2001. The WFOE is a sort of “limited liability company” in legal Chinese system, whose share capital is wholly owned by foreign people or by Chinese citizens residents abroad.
Alongside the EJV in 1988 is enacted the law on CJV (The Law of the People’s Republic of China on Sino-Foreign Contractual Joint Ventures, Zhonghua renmin Gongheguo zhongwai Hezuo Jingying Qiye). Except for a few sectors or types of operations, the CJV (Cooperative joint venture, Zhongwai Hezuo Jingying Qiye) are less common than the other forms of foreign investments, representing only approximately 3%. The CJV is a form of cooperation between a foreign investor and a Chinese one for conducting a joint entrepreneurial activities, but does not involve necessarily the creation of a new legal entity: if the EJV always give rise to a Chinese law, the CJV can be of two species: one of these has legal personality while the other one no. In CJV without legal status, it does not come to a new life entity, the parties that maintain their subjectivity, thus realizing a mere contractual relationship, a temporary association between companies.
The aspect that, most of the others, distinguishes the CJV by other tools of foreign investment is the added flexibility they have. In fact, the CJV are no doubt very popular among Chinese overseas investors. The business related to tourism, dominated by Hong Kong investors, often takes the form of the CJV.
In addition to the improvement of the legal system, at the same time, in China it is accelerated the construction of the transport system, the energy sector, telecommunications and other infrastructure, tools necessary to provide an adequate environment to the needs of investors.
At this stage the industrial structure of FDI in China is significantly expanded. There has been a dramatic change in FDI flows initially targeted at tourism-related services, and then focused on manufacturing and infrastructure projects. It is a positive sign that it manifests a greater confidence of investors in Chinese institutions, that now guarantee property rights, in fact, the Research Institute of MOFERT reported that 60% of 48 FIEs in 1986 undertake long-term investments in China. Investments from Hong Kong and Taiwan were dominant, while those from the US and Japan begin to grow.
3.2.3 Stage of developing rapidly
The period between 1992 and 2000 is witnessing of a rapid growth FDI flows. What caused a huge flow of investments in China was the change in direction of Chinese politics led by Deng Xiaoping during the famous journey to South China in 1992, during the which he stated that the continuation and the deepening of the economic reforms was vital to the legitimacy of the party and for its ability to keep popular consent. The growth of the use of annual FDI increased from $ 4 billion in 1991 to more than $ 45 billion during the peak period between 1997 and 1998. In 1992, following the opening of the Pudong District in Shanghai, are open to investors six cities along the Yangtze River and the region of the Three Gorges, including Wuhan and Chongqing. In the same year, eleven capital internal cities of the provinces are opened, including Taiyuan, Hefei, Nanchang, Zhengzhou, and Changsha. While the coastal regions of east benefit positively the policy of opening up, China’s western area slows down. In an effort to maintain a favourable environment for business related to relations with foreigners, government policies begin to focus on the relationship between foreign capital and local industry objectives. During the peak period between 1992 and 1993 the imperative of Deng Xiaoping is to accelerate economic reform and developing the industry of export, it is then expanded foreign ownership, foreign investors are granted the right to selling more freely in the local Chinese market. The Government offered special incentives for investments in certain sectors and preferred open new areas in the trial of foreign investment (finance, tourism, shipping, resource and development).
In 1993 China became the largest FDI receiver among the developing countries, and second in the world after the United States. Although FDI, it remained strictly controlled by the state policy, the approval of some small projects was granted to provincial governments and municipalities. About 60% of incoming FDI flows in segments of high technology and export-oriented, especially in the coastal provinces, but also begin to develop strategies aimed at the local market. Despite
the spread of the Asian crisis in 1997, especially in the area of Hong Kong, the China’s economy is affected in part due to limited convertibility of the yuan.
Between 1994 and 1999 the FDI, of market-seeking type, become the main motivation for investment by foreign operators, while resource-seeking kind of FDI decline.
The use of high capital outlay FDI is aimed primarily to the domestic market, despite the multinational companies still offer a significant contribution to export activities. The type of WFOEs overcome for the first time the EJVs. Some developed countries like USA, UK, Japan, Germany, France and Italy impose themselves in the Chinese market, particularly in the field of infrastructure. Potential due to the size of the market, policies in favour of the government, low labour costs, attract large number of multinationals especially in the telecommunications industry of motoring and petrochemical.
3.2.4 The stage of consolidation and improvement
After 1992, the phenomenon of FDI has seen an escalation. Over the past ‘90 years, China has become the second country recipient of FDI after the United States; in 2002 the first country in the world. In the period 2008-2009, as a result of the international crisis, FDI in China was declining. Considering the data, China was less exposed to the global financial crisis compared to other countries, after an initial drop of 12% in 2009, the flow of FDI has recovered in 2010, rising to 21%. According to statistics of the Ministry of Commerce of the PRC the FDI flow used in 2012 amounted to 111.716 billion dollars, showing a decrease of 3.7% over the previous year.
However in the first six months of 2012, China was in first place in terms of foreign investment managing to overweigh the United States. Also if the US results will improve in the second half of the year, China data symbolize a turning point for the investments in the world economy: foreign investment, in developing countries, for the first time in the history, exceeded the investments in developed countries. The step that marked the beginning of this phase of consolidation is represented by China’s accession to the WTO (Shijie Maoyi Zuzhi) in 2001. The entry into the WTO has given the country a boost deciding to implement the regulation of the economy and align the Chinese economic environment with the globalized world, placing as aims to conquer a place in the world, ensuring a transparent regulatory environment and develop competitive companies. This has resulted in a gradual reduction of customs duties on all products imported in China, the elimination of the quota system in 2005 in all sectors of the various exchange activities between China and foreign countries, the progressive liberalization of foreign investment in most sectors of economy. For example, the insurance sector was opened to foreign investment, and distribution sector (long precluded by foreign intervention) was liberalized. At the political level, in addition to the fundamental entered the WTO, there was not later a marked change of direction of strategies by the Chinese government, which has continued to liberalize investment framework, pushing them towards the realization of infrastructure projects.
3.2.5 Views on the development of the FDI in the twelfth five-year plan
The Twelfth Five-Year Plan (Wunian Jihua) on use of foreign investments, the official document in which periodically the Beijing government shows its political objectives and cost at the state and regional level, it turns out to be an important guide for the economic and social Chinese development. The plan provides a careful analysis of the investment environment, of the strategic targets and about the corresponding policies on the extent of use of foreign capital in China.
As for the investment landscape, the Plan related to the period 2011-2015 stands out from the background to the determination of Chinese policy makers to prioritize the quality of development rather than the amount of rising. Foreign capital must thus be used in projects that focus on the introduction of advanced technology, qualified staff and high quality management. In addition, it reiterated the will of the government to free the country from labour-intensive activities, and at the same time it feels also the need to combine the use of foreign capital with the improvement of the Chinese industrial structure, safeguarding the environment
and focusing on energy efficiency. The decision by the Chinese government to implement a selection of the FDI type is a reversal trend in comparison with the guidelines on which the revolving policy of “open door” operated, a strategy that stems from the increasingly widespread belief in China that FDI have exhausted their role as catalysts for development, and should reduce China’s reliance on investment to point, instead, on the advanced technology acquisition.
Source made by author according to BUCKLEY (2010), CAVALIERI (2010), HUANG (2005), JUN (2000), LAU (2008), LEMOINE (2005), SAMARANI (2008), XIAO (2004), ZANIER (2011), agichina24.it,china.org.cn, chinabriefing.com., fdi.gov.cn, leggicinesi.it, mofcom.gov.cn
- The destination of the FDI and the incentives in the related sectors
Now, I would like to analyze the main characteristics of the Foreign Direct Investment in China, focusing on the principal country from which the foreign capital come and the sector and geographical distribution.
3.3.1 The main countries of origin of FDI
Since 1979 Chinese Government has been able to attract million and million of FDI from every part of the world, many economists talk about more than 120 countries, among these countries the Government reminds the principal countries and the percentage with which each of these has contributed to the growth of the entire China. In the following table the most recent data regards the study made by ICE, but if we consider the second table, taken by the website of the Chinese Government it is easy to note that the principal countries are not so different and especially that in the course of the years they are not so changed.
Source: Ice. Values in billions of dollars, between January and July of 2016. Values in million of dollars.
Sources made by author based on the data of the Chinese Government.
Hong Kong has always maintained the first place among the sources of origin of FDI flows with an average of over 50% until 2010, but in comparison with the percentage given by the other States, the percentage is however so high also considered the trend of 2017. Among Asian developing economies Taiwan and Singapore follow Hong Kong, respectively, with 2.16% and 4.73%. Special case is Japan, which despite during the early nineties was in the second place with 12.2%, in the recent years has significantly decreased the flow of FDI until arriving at 3.56%. It is very likely that the prolonged economic stagnation that has plagued Japan is the main explanation of the decline of investments in the last ten years. The FDI flow by industrialized economies such as the US and Europe becomes significant in the early nineties, 7.4% for the US and 5.63% for the European Union in 1991. In particular, in recent years the American and European multinationals settling in Chinese territory in order to satisfy the domestic market, unlike Asian companies tend to invest and then export products. What emerges, from the analysis of data on origin countries, is that for the most part investment flows come not only from Hong Kong, but also from British Virgin Islands and Islands Cayman, known tax havens where in the last decade, many foreign investors (including Hong Kong and Taiwan) founded the company. This latter analysis is evident in the first table where the countries following Hong Kong are exactly these islands. In 2010 the flow from Virgin Island is around 9%, and now around 5 millions of dollars while the coming from the Cayman Islands to 2%, with an amount that now is nearly 4 millions of dollars. At this point of data analysis is necessary to ask why China successfully attracts the most FDI flows from Asian economies, and not by the US and European powers, which are the largest investors in the world. The economic proximity, which includes geographical distances, sharing cultural elements such as language, reduction of protectionist barriers, definitely has an effect on relationships of investments between countries, this explains why the flow from Asian economies is so significant, in comparison with the investments from the other parts of the world. The analysis of the sources of FDI requires careful handling, especially when it is referring to the domain of flows from Hong Kong and those from the so-called tax havens. Many Chinese, residents abroad, reinvest in the mother country and such flows are reported as coming from European or American countries, but this not right. The problem of “return” on investment (FDI Round-trip, Fancheng Touzi) comprises the flow of capital outside the China, which is then re-invested as “foreign capital”, in order to benefit from the tax programs for foreigners investors. According to the research conducted by UNCTAD (2007) a significant share of FDI flows in China according to round-tripping mechanism, for mostly go through Hong Kong and recently via economies tax havens. Only in the case of Hong Kong, the estimates of round-trip investments hovering around 30% of total FDI from Hong Kong to China. From this raises the dense economic network that the Chinese and who lives overseas weave in international and transnational level (bamboo network).
3.3.2 Sector distribution of the FDI
In 1995, it is issued by the National Commission for Development and Reform and the Ministry of Commerce (MOFCOM, Shangwubu), the catalog on the foreign industrial investment (Waishang Touzi chanye Zhidao Mulu), an economic planning document to which are subject the Foreign direct investment, which will later be the subject of numerous amendments (1997, 2002, 2004, 2007 and last December 24, 2011, entered into force January 30, 2012).
The ranking list of investment sectors is based on three categories: encouraged, restricted and prohibited. All industrial activities not included in the list may be considered eligible. The encouraged sectors will be presumably approved automatically and will benefit from preferential tax incentives. They include technologies saving energy and raw materials, necessary for the agriculture and that promote economic development; limited areas include those areas using obsolete technology or that are harmful to the environment or again those sectors considered strategic, such as telecommunications, insurance, printing of publications etc., for which the will is to limit the presence of foreign investors. The forbidden areas are, instead, those that threaten the national security, undermine the public interest, cause pollution, bear damage to natural resources and that use agricultural land for non-agricultural purposes or undermine military installations. Generally investments in encouraged activities enjoy some tax advantages (such as the duty free goods contributed capital) and leaner constitutive procedures, while those in limited activities can usually only be achieved by means of joint venture with Chinese parties and usually require a central authorization by government. The proposed renewal of the list focuses on promoting investment in high-level manufacturing sector, including areas such as new technologies, innovative services, new energy, energy-saving and environmentally-friendly industries. As for investment in services, instead, liberalization proceeds slowly, affected by both the physiological tendency of governments to consider the services market with a more protectionist approach than in the case of market of assets, both for many specific obstacles and for particular difficulties, the privatization attempts to rise in some primary sectors in progress in China since few years. A series of preferential measures for investment in central areas and in the Western China are specifically arranged by list for the Encouraged Industries for Foreign Investment in the Central and Western Regions (Zhongxibu Diqu waishang Touzi Youshi chanye Mulu) modified for the last time in 2008. The list pushed towards the encouragement of using foreign capital for the development of high level of craftsmanship, high and new technology industry, and modern service industry, renewable energy and for the industry of environmental protection and energy saving, while at the same time will be strictly limited to highly polluting production with a consumption of high amount of energy and resource, and the low-tech projects with excessive capacity expansion. As it is possible to deduct from above and especially from the table below, the investments in the different sectors among the years in China have been subject to many changes.
Source made by author based on the data of the Chinese Government.
Based on the classification of the National Bureau of Statistics of China (Zhonghua renmin Gongheguo guojia Tongji ju), the table above identifies the percentage of foreign direct investment flows received by the three basic sectors of economy. The primary industry (Di yi chanye) comprises sectors of agriculture, forestry, livestock and fisheries. The secondary sector (Of er chanye) includes the construction and mining, electricity, water and gas. The tertiary (Of St. chanye) covers the transport, the wholesale and retail trade, catering, financial services, tourism, etc..
Source made by author based on the data of the Chinese Government. Www.fdi.gov.cn
The industrial distribution of FDI in China has undergone over the years a number of changes, during which the secondary industry was expanded greatly. The proportion of FDI in the secondary sector, 62.08% of the total inflows in 2010, is higher than the average level of other developing countries (around 45%), and expected to grow further. In the secondary industry we find all those activities that belong to the textile industry, electronics and other occupations labour-intensive, where the largest number of foreign companies are based. The main sources of FDI, Hong Kong, Macao and Taiwan, in fact, focus on the manufacturing sector. At the moment, as the carrier industry of “China’s national economy,” manufacturing activity is the dominant sector for growth and economic transformations of the country, presenting values that are around at a higher average than 40%. In particular, the manufacturing sector (Zhizaoye) “as the main symbol of the improvement of comprehensive national power of China in the past over 20 years, has enabled China to primarily establish the status as a big country of manufacturing and laid the sound foundation for China to transformed to be a strong country of manufacturing”. The high concentration of FDI flows in manufacturing sector reveals the fact that foreign investments are not only efficiency-seeking, but intended to export. The sector distribution of investment is enough unbalanced, industrial distribution is different than other developing countries. The proportion of investment in the primary sector is very low, in 2010 it only counted the 2.5% of total FDI and nowadays the value is not so much changed. The tertiary sector started to grow in 2006, it has increased by 23.91% in 2003 to 35.87% in 2010. In the tertiary industry the real estate sector (Fangdi chanye) absorbs the majority of investment flows with 20.91% in 2010, but given the recent liberalization of the sector regarding financial restrictions and other activities of the service sector, it is expected that this sector grow more. In addition, there are the areas linked to leasing and business services (Zulin he Shangwu fuwuye) with 21.6% and wholesale and retail trade (Pifa he lingshouye) with 5.75%. In particular, the business of selling at wholesale and retail trade has grown rapidly thanks to investments undertaken by foreign multinationals in major supermarket chains in major Chinese cities. One of the key areas in the services sector, affected by a deep reform, is the financial and banking environment, which process transformation has been accelerated by the Asian crisis and from the closer entry into the WTO. They are assigned to the Central Bank more control powers, regional and local banking systems are organized in order to further reduce the influence of the local authorities and especially that of regional governors and mayors of the Presidents of banks. The financial industry has therefore faced an amazing growth going from 0.42%, in 2003, to 8.82%, in 2010, and again grow. Despite the dominance of the manufacturing sector in recent years, it has been a rapid development of the sectors related to high-tech, to scientific information and to production of computers (Jishu Fuwu he gaojishu chany). China has become one of the key destinations where multinationals establish their research and development (R&D, Yanjiu Kaifa). Over 340 of the 500 largest companies in the world have already established their R&D institutions and the number is expected to increase. According to estimates of the Ministry of Commerce, in China there are currently more than 1.200 research and development centers, of which the technology companies occupy about 40%, followed by automotive industry with around 20%. Rapid urbanization is driving the development of the service sector, whose sectors tend to concentrate in regions with higher density, giving life to production cluster, in which, for example, chain stores show a better performance.
3.3.3 Geographical distribution of the FDI
The important and huge development, that has characterized the entire Chinese empire in the last twenty five years, does not have a homogeneous wave, in fact, it has had an impulsive impact in the coastal areas, generally richer, increasing in this way the difference between cities and little villages.
Source made by author based on the data of the Chinese Government. Www.fdi.gov.cn
In the table above, it is possible to note that the provinces of East (Dongbudiqu) receive an average that goes beyond the 80% of the total of the flows of foreign direct investment.
The central part (Zhongbudiqu) has attracted an increasing share of FDI in the nineties and reached an even more rapid growth after 2000, with 7% higher values for more driven by domestic demand. The majority of FDI flows come from Hong Kong and are headed to the provinces of Guangdong and Fujian precisely because of geographical proximity. The western provinces (Xibu Diqu) remain even those most disadvantaged, despite a slight growth in recent years which presents the 10.5% of the value of FDI. The Chinese government expects rapid growth in areas adjacent to coastal provinces, particularly the provinces of Yunnan and Henan. Despite the development path is still very long, Liaoning Province in North-east has overtaken Guangdong in 2010 finishing second place among the major receiving areas of FDI flows. Also in the north-east of the city Dalian and Shenyang are having a huge development linked in particular way to automotive and electronics industry. In order to support the balanced development of the different regions of the country, November 17, 2012, the State Council of the People’s Republic China has officially approved the Plan for the Economic Zone of Central Plains (2012 – 2020). The proposed economic zone in the plan, should cover the whole province of Henan, and twelve other municipalities and two counties in the adjacent provinces of Shangdong, Anhui, Hebei and Shanxi. The Economic Zone of the Central Plains (Central Plains Economic Zone, CPEZ) as well as being the widest economic zone of the country in terms of area and population, with a total area of 289,000 meters square and with a population of about 179 million inhabitants, it is a driving area in agricultural production. Some problems still today more obvious, such as the deterioration of arable land, the reduction of food production, the degradation of the environment, which meets region in its path towards the modernization, are here more serious than in other parts of the country. To solve these problems, the plan tries to offer to CEPZ a coordinated approach to address the urbanization, the industrialization and the agricultural modernization without compromising agricultural development, food security and environment. The Central Government will attempt to transform CEPZ into a national model of coordinated development in industrialization, urbanization, and agricultural modernization. However, the uneven distribution of foreign direct investment provoked a series of damage to the economic and productive Chinese system, such as an increase in social tensions among the farmers and the urban population, the expansion of urban areas that reduces the farmlands and poses serious problems of governance of increasingly large urban structures, the progressive abandonment of rural areas with negative effects on production of consumer goods that China has to buy. According to estimates released by the Chinese government every year 30 million farmers leave the countryside and head for the cities of coastline in search of a job. The social phenomenon of internal migration of the population has given rise to what is called the “floating population”, which indicates the movement of persons within a province or between more provinces, between town and country, without entailing the change of residential status (rural or urban). There is obviously also a “legal” migration, opposed to the first, which is established on the basis of annual quotas. The internal migration has however provided a decisive contribution to urban economic boom, providing labour for factories along the coast for the construction sector that has experienced extraordinary growth and for hotels, restaurants and varies services.
- The classification of the economic development zones and the principal interesting zones
Now, I would like to highlight the main economic development zones and their historical evolution linked to the policy in order to attract foreign direct investment, in particular considering the main areas of concentration of foreign capital.
As a result of the economic reform policy undertaken since 1978, the Chinese government has created special economic development zones in order to attract capital and thanks to foreign technology to promote the development of the country. The economic environment within these different areas has allowed foreign companies to operate more freely away from bureaucracy and the limitations that often characterize China. The development zones receive a series of regulatory and benefits privileges that aim at the reduction of the investment costs and the facilitation of imports and exports. These benefits include decrease in the cost of land, repayments and tax exemptions, facilitated customs clearance and ease of access to domestic market. The support and participation of the government in the areas of economic development are reflected in the range of legal services, assistance accounting, marketing and consulting, for investors who decide to operate in these areas, so as to ensure an environment with legal standard and legal transparence and in line with those of the most advanced economies. This indicates a willingness to stimulate the growth of these areas, implementing an improved political framework conditions conducive to legal standards and more transparent legislation.
The classification of economic development zones turns out to be complicated, as these areas are generally defined according to industry or to the sector to which they address (high-tech, light and heavy industry, services, agriculture) or according to the location where they are, in addition they must meet a series of requirements, such as the territory, in order to be strong in term of interest by foreigner direct investors, must have a yearly income more than 100 billion RMB and an export volume remarkable.
In relation to the sector or according to the locations in which they arise, areas of economic development are further classified into Special Economic Zones (SEZs), Economic and Technological Development Zones (EDTZs) High-tech Industrial Development Zones (HTDZs), Free Trade Zones (FTZs), Bonded Logistic Zones (BLZs), Cross-Border Economic Zones (CBEZs).
The broader types of development zones and more complete in China are the Special Economic Zones (SEZs, jingji tequ). A zone “Special Economic” is a geographic region with an economic legislation different from that in force in the rest of the country, whose purpose is to attract foreign investment and provide a tax regime easier for companies operating within it. In general, they enjoy a strategic location close to important transport hubs and offer excellent infrastructure, they are also provided certain benefits for workers moving in these areas.
In 1979 in Chinese territory, the first four special economic areas are instituted. The selection of these four preliminary areas is not random, they are established in the vicinity of areas that are already established and well-developed, in fact, the City of Shenzhen is located near Hong Kong, Zhuhai near Macau, Xiamen and Shantou enjoy of influence of Taiwan. It should be noted that the individual ZES are intended to strengthen economic relations with specific enclaves (Guangdong with Hong Kong and Fujian with Taiwan), a task that was in the ‘80 absolutely necessary to strengthen those economic constraints that were failed during the Mao government. Features of these areas are that they enjoy an independent regime: the foreign investment is encouraged by a low tax and simplified administrative procedures. Components and supplies are imported under an exemption, and the same is for the export of goods produced in these particular zones. Within all sections can be more sub-areas dedicated specifically to certain activities or sectors.
The areas are seen as real laboratories of experimentation where to test policy initiatives that, if considered successful, are then extended to the entire territory. Thanks to a special legal framework, the local authorities of SEZ enjoy a high degree of autonomy. They have the power to appoint development plans, organize their implementation, review and approve projects, licenses and permits about the land use, coordinate the taxes and the product inspection at customs. Although the government has used these areas as points of departure for the creation of a policy of liberalization, the exclusive attractiveness of the SEZ is, now, waning, privileges initially granted only in these areas are also applied to the rest of China.
Given the growing disparity of economic development in the different region, the state considers like a priority the development of rural areas and inner regions and it is therefore redistributing the tax advantages gradually to the other special economic zones.
In 2008, the tax reform on corporate income (Enterprise Income Tax Law, Zhonghua renmin Gongheguo Qiye suodeshui) put end to the most tax incentives for the Specific SEZ, including taxation at 15% for companies and other favourable policies. Over the past three decades, however, within the SEZs have been built smaller development areas, such as the economic and technological development zones, the restricted zones and processing zones for exporting, in order to create new incentives. In addition, flexible legislation, advanced facilities and excellent locations continue to make ZES very popular investment regions. The economic and technological development zones (EDTZ, guojiaji jingji Jishu Kaifaqu) are designated areas for the development of high-industries technology-intensive, they offer incentives such as government funding or awards to companies that invest in these areas.
The high-tech industrial development zones (HTDZ, gao xin Jishu chanye Kaifaqu ), instead, are specific areas that are intended to commercialize research and development and encourage high-industries technology, including IT, electronics, pharmaceuticals and new materials. These areas are generally quite similar to ETDZs, but they benefit from additional incentives for innovation. Although many of the old SEZ incentives have now disappeared, companies that are qualified as high-tech companies can still benefit from an income tax to 15% regardless of location.
The areas destined to exporting process and international trade are defined free trade zones (FTZ, Ziyou maoyiqu), generally comprise industrial parks, customs warehouses and processing areas for the export. They are generally created according to the free trade agreements signed between China and other countries, making possible the application of customs duties equivalent to zero or at preferential rates for goods or services exchanged within the zone. Companies in these areas may have tax refunds on both exports and imports. They also facilitate the movement of the workforce within countries involved, thanks to simplified procedures for obtaining a visa. Another category of special zones is represented by logistics zones with customs’ bond (Bounded Logistics Zones, BLZ, Baoshui wuliuqu). Originally they constitute a sort of enclave, located near major Chinese cities, and having the purpose to promote international trade of the country: this objective must be achieved thanks to the construction of warehouses in which it is possible to guard and show goods, (without the application of all entry barriers,) and thus allowing the access to capital and to the equipment of foreign enterprises without these had to pay duties or other taxes. Adapting particularly to the direct exchange of the products, these areas have assumed the role of the logistics hub of the leading multinational companies, consisting in storage of goods in frank areas, in processing and distribution of goods. The incentives to companies operating in the bounded zones consist, generally, in credits tax and reduced income tax rates, exemption from duties and taxes for import-export transactions and concessions sales tax on products. The Cross Border Economic Zones (CBEZ) have to develop exchanges and processing zones for exporting in the border area of China, building cooperation areas and encouraging joint projects with neighbouring countries. To attract investment are typically offered preferential taxes and tariff policies as reimbursement and special tax and other government incentives in order to reinvest in the enterprises. In the following graph, it is possible to see the principal developing economic areas in China.
- The historical development of the Special Economic Zones (SEZ)
The development of economic and technological experimentation areas, it grows in “twenty” years, with reference to the historical classification in the “Report Invest in China” are recognized three main stages: a first phase of exploration begins in 1984 until 1991, a second phase called “Gold period” that goes from 1992-1996 and finally the last phase since 1997, in which the areas of development through a period of steady growth.
- Exploration phase
A first phase, between 1984 and 1991, is understood as early exploration phase of industrial development environment. The goal of the Chinese government during this first phase is to create an opening tiered structure that integrates coastal areas, border areas and inner areas, some of which are characterized by specific tax relief policies and greater liberalization in certain sectors (like financial, distribution, exchange, processing and assembly of goods sectors). The role of the first special economic zones is that of “doors” for the development of an economy oriented towards the exchange with the foreign countries, through the export of products and the import of advanced technologies, also regarding the engines, tools fundamental for the acceleration of economic development of the whole country.
In 1984, it lays 14 Open Coastal Cities (Dailan, Qinhuangdao, Tianjin, Yantai, Qingdao Lianyungang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou, Guangzhou, Zhanjiang and Beihai) and several Open Coastal Regions, in which they have created 17 ETDZs. With economic development and the opening of the market, further ETDZs are created in different regions, some of them include industrial high-tech development zones, processing zones for export and restricted areas.
Since 1985, the policy of openness to foreign investment is extended from coastal cities to the delta of the Blue and Pearl rivers, to the triangle Xiamen-Zhangzhou-Quanzhou, in the southern part of the Province of Fujian, until the peninsulas of Shandong and Liaodong, Hebei and Guangxi up to form a full open coastal strip.
In 1988, the province of Hainan was proclaimed the fifth SEZ, while in 1989 are open to foreign investment the new zone Pudong in Shanghai and the other cities in the Yangtze River valley. It forms so an open-city chain that extends to the plain of the river Yellow, of which Pudong in Shanghai is defined “the head of the dragon”.
In 1990, it formed one of the most important bounded zones in China, the Waigaoqiao Free Trade Zone, located near of the north-east of the new metropolitan area of Pudong, with an area of 10 square kilometres, it has quickly become home to host more than 9,300 enterprises. It is managed by an autonomous institution, the Waigaoqiao Free Trade Zone Administration, and boasting the most efficient peculiar facilities than normal free trade zones. In addition, the Waigaoqiao Free Trade Zone has been promoting since 2003, the “going first and politics trying first “, which has caused an innovation of the system in its overall, aimed at attracting a larger number of foreign investments, strengthen the competitiveness of the area, reducing the operating costs for businesses who work there, as well as to improve the development of trade international activities, transformation for the export and logistic services.
3.5.2 Expansion phase
The second phase from 1992 to 1996 is defined as “Golden age” for the development of the ETDZ. Deng Xiaoping completes its journey in South China, spreading a new spirit of openness and reform. It is a period of great development for these economic zones, in fact, there were a huge amount of foreign investments and consequently the new development projects undergo an exponential increase. The guidelines, which focus on the development of economic sites at this stage, are industrial growth and the use of the FDI, accompanied by the export-oriented strategy, factors that increase the technological know-how, management and policy of openness towards the foreign countries.
Since 1992, the open door policy is extended to several border cities, as well as the capitals of inland provinces and to the autonomous regions. The opening of the city falls within the decision to create two open belts around the two deltas of the peninsula Liaoning and Shangdong. In any open city are built special areas for economic and technological development, which offer similar benefits those offered by the historical ZES and operate aggressively to grab new investors. The EDTZs are lots of land of size much small (about 500 square kilometres) with respect to ZES, defined and planned by local authorities (at municipal level of direct delegation of the Council State). Local governments rely lots in order to give their management to Administrative Committees, dealing to plan and control of management land and real estate, infrastructure, auctions and tenders for the development of EDTZs. The Administrative Committees also hold positions in political functions (direct development policy implementations to specific areas) and proceed to the selection, evaluation and approval of projects.
At the first SEZ are flanked other types of special areas such as 32 Economic and Technological Development Zone, 53 High Technology Development Zone for the economic-technological national development and 15 Free Trade Zones.
- Constant Growth
In the third and final phase (from 1997 till present) economic zones go through a period of steady growth, thanks to fiscal policies adopted by the Council of State. It promotes the adoption of a new requirement: the development of advanced technology applied to the mechanisms of production, giving the areas the task of enhancing the degree of interrelationship between industries, the process leading to the formation of industrial districts. Because of the disparity of economic development in the different regions, the State has prioritized the development of rural areas and of the inner regions, where, gradually, it is redistributing the tax advantages.
The first special economic zones will tend to implement a process of specialization in the industrial sectors cutting-edge and advanced technology and services rather than to continue to operate in the traditional sectors of industry with low added value and intensive use of labour. This last type of industries will move to the internal areas and Western provinces in order to continue to use the human resources at low price. The NEDTZ (national economic technological development zones) are spread further becoming 49, and now they become part of the industrial parks Suzhou, Shanghai Jinqiao, Xiamen Haicang, and Ningbo Daxie Hainan Yangpu.
Nowadays there are 6 SEZ, 54 national EDTZ, 53 High-Tech Zones recognized by the central government, 15 Free Trade Zones, in which the goods can be legally left in an area that is however, outside of the national confines.
Source made by author
- China as investor
- The transition from a destination of the other investors to a principal investor abroad
In 2015 the enterprises of the Asian giant spent $ 145 billion around the world, with particular activism of the financial sector. By contrast, direct investment in China stopped at $ 136 billion.
China is now the second nation with an estimated $ 2.4 trillion in net foreign assets by the end of 2015, in comparison with Japan with only $ 3.6 trillion, but this credit position linked to an increase in net foreign assets is given by the current account in surpluses and this imply that if this condition continues, China in a really short time, will become the biggest net creditor in the entire world in only four years.
The following graph given by the China’s Ministry of Commerce, highlight the China’s overseas direct investment, that call had ODI (Outward Direct Investment), in order to distinguish them by the Inward Direct Investment. MOFCOM reports the annual outflows and the accumulating stock of China’s outward investment, it underlines, as it is possible to note in the graph below, that the ODI flows are a little bit above the $ 100 billion per years, with an increase above $ 200 billion in 2014. In addition, how it is possible to see, the stocks triple between 2010 and 2014, reaching nearly $ 900 billion.
Source: Ministry of Commerce of China (2014). “The stock of China’s ODI expand rapidly”.
The last year many journals wrote about this important change that has characterized the entire economic world economy. In fact, China has, completely, changed its policy and the strategy to use in order to impose its power and its presence in the global market. To do this, the Chinese policy has to modify several acts and the way through which to operate and react to the actions of the other countries.
MOFCOM underlines also the destination of the ODI to the major economies, in fact, about one half of the Chinese investment is directed towards Hong Kong. This is, of course, not the only destination of the Chinese ODI, but it is working about the possibility to increase the Chinese investment abroad, improving its statistics. This is, however, one of the most important element that has characterized the entire world economy, because the being China the largest world’s creditor, the recipient countries welcome accept the investments and for China, that has already a large portion of direct investments, will become more smart to invest and improve its data that consequently indicates its role in the global context. In the current period, the Chinese growth is also characterized by the overseas lending, not only by the direct investment, and it is possible thanks to the Chinese banks, like Export-Import Bank of China (China EXIM Bank) and the China Development Bank (CDB). These lending appear in the balance of the payment and it is fundamental to underline that each bank is lending about $ 100 billion overseas because they is pursuing the “One Belt and One Road” initiative (OBOR). OBOR is an initiative created by Xi Jinping in order to expand principally the infrastructures, but also the other investment along which is known as Silk Road Route, through the Central Asia and along the maritime route in the South of the country through the South-East Asia to South Asia and on the Africa and Europe.
Nevertheless these important resources and these important policies, the amount of capital invested in OBOR, is still few, in fact considering the list of the top ten destination of the China’s ODI, not considering Hong Kong, the first three are United States, Australia and the United Kingdom and none of these giants is present in the OBOR. Again in this list are present France, Canada and Germany. Considering that the major part of the direct investments goes to industrialized economies, the same is for China and the only countries involved in the list of China’s top 10 investment recipients are Russia, Indonesia and Kazakhstan.
It is now, important, to underline that the investments made by China are quite different from the others made by the industrialized countries. In fact, according to a study made by the Australian National University and guided by David Dollar, the Chinese investments are different by the acts and the practises that already exist.
First of all “Chinese investments are concentrated, even if not absolutely, in poor governance environment, second China does not subscribe to global standards of environmental and social safeguards and at last China remains relatively still closed to foreign investment in determined sectors, in contrast with the other developed and developing nations”. These different kinds to invest bring China to impose its role in the global context, but at the same time to reshape local norms in order to be able to invest abroad and so to create norms that can fit with the global practices.
It is useful to note how the importance of China is growth thanks to the investments made in countries where the conditions and, especially, the governance is quite unstable, in fact some of these are: Democratic Republic of the Congo, Venezuela and Ecuador in Latin America and Angola in Africa. At the same time the biggest recipient for the China’s ODI remains the United States with a stock of $ 3.8 billion at the end of 2014.
The relation between the Foreign Direct Investment and the governance is fundamental, because a good and stable government implies the will to invest into determined country, also considering that the purpose of the investments, among other benefits, is the possibility to increase the national market size, measured by the total Gross Domestic Product (GDP) and the will to obtain natural resources in the country in which the invest undertakes the investments. These two considerations are possible and more incentivize only thanks to a good governance environments. The graph below “shows the correlation between the stock of FDI and an index of property rights and the rule of law for 152 countries”. The index, from the Worldwide governance indicators, ‘captures perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence’ (Kaufmann and Kraay 2015). The graph shows a mean of the index exactly equal to zero and a standard deviation equal to 1.0, this implies that a better standard deviation is linked to an increase in 62 percent of FDI. At the end, it is necessary to underline, that in an environment of good property rights and rule of law, the investments are more attracted.
Source: Dollar 2015. “Global FDI strongly attracted to good rule of law”.
Chinese ODI is quite similar to the investments in the other part of the world , but just considering the attraction to larger markets and natural resources welfare, because in consideration to the correlation between the index of the property rights and the rule of law, the Chinese ODI are completely uncorrelated, as it is possible to note in the following graph. In fact, the relation between the ODI made by China and the governance environment is based on the indifference.
Source: Dollar 2015. “Chinese ODI uncorrelated with rule of law”.
According to this graph, it is important to underline, that, in fact, the Chinese government invest not only into countries where the government is strong and better organized as in South Africa (good indicators only in that continent), but other important investments are present also in Angola, Democratic Republic of the Congo and Sudan, all countries with poor and absolutely unstable governments. In Latin America, the largest recipient of Chinese investment is Brazil, a country with the better environment in term of rule of law, with significant investments also in Venezuela, Ecuador and Argentina, where the legal environment is absolutely not serene. At the end considering the Chinese ODI, the major part falls in the worst governance and the same is also considering the lending from the China EXIM Bank and the CDB, in fact Venezuela is the first huge destination of this kind of lending.
This investment strategy underlines the different approach used by China to invest and the reason of its success is connected to the investment made by public company rather than private one, as occurs in the other developed countries, where the private companies has high pressure in order to gain good returns on their investments, while the public companies are less productive and profitable. In addition, the investments of China made in these countries are often part of state to state deals and this brings several incentives that bring it to invest there. It is, however, possible that China is a new comer in the global scene and this implies few experiences that could bring the same in worst investments. It is already note if we consider the investments in the Democratic Republic of the Congo, in fact, in 2007 was signed an agreement about minerals and infrastructures of $ 6 billion by China. Chinese enterprises Sinohydro Corp and China Railway Group Limited have to build roads, hospitals, but having in exchange 68 percent of the stakes in the Sicomines copper and cobalt mine, the largest one in Africa. So the Chinese bank put up $ 3 billion for the building of roads and $ 3 billion for the development of Sicomines, but after eight years “production from the mine has been delayed as a result of crippling power shortages, suffocating bureaucracy and corruption” (Ross 2015). The same problem arose in Angola, where Sinopec has invested in six deepwater oilfields, in collaboration with the state oil group , Sonangol, from 2004 to 2013, but this kind of investment has created more problems because the funds invested by Sinopec has been completely swallowed without generating any kind of returns. “In March 2015, auditors sent by the National Audit Office to screen financial statements of Sinopec International Petroleum and Production, Sinopec’s overseas investment arm, found that investments made in the five oilfields during 2008–13 have amounted to about $10 billion and that poor performance, exaggerated oil reserve estimates and sharp declines in international oil prices will lead to a majority of the investment going down the drain” (Ning et al. 2015).
In Venezuela, instead, China has to renegotiate the condition of the loan because the country was unable to respect them.
According to these examples, it is fundamental to say that to invest in countries with a lot of messy can bring many problems and deficits.
These investments has brought the public Chinese firms to spend the national money, or better people’s money, and during these years they waste tens of billions of dollars in investments abroad and this can generate lost for China. At the same time the change in the investment flows is more than motivated, considering that the investment opportunities within country are reducing and that the rapid ageing of population reduces at the same time the growth perspective of China. So earnings on these kind of investments will help China for the pension system and the safety net. An important study made on the small and medium enterprises has analyzed that these kinds of Chinese enterprises are investing not only in search of natural resources, but also and especially, in services and in manufacturing. In fact, “The manufacturing investment is influenced by the local endowments of capital and skilled labour, which is consistent with profit-maximising investment” (Chen et al. 2015). It is, however, important to say that in some countries the Chinese investments are going to sustain the corruption, a striking example is given by Venezuela that in absence of Chinese investment has been the possibility to ask help to International Monetary Found. Another important element that has to be considered regards the element that China has a fundamental role in sustaining the investments in infrastructures and funder mining, and these kinds of projects carry out many risks cornering the employees and the environmental safeguards. This implies that China has to create adequate rules in order to protect and respect the safeguards, rules that in the reality do not exist, but China in this way goes to respect the rules of the host countries, that if on one hand are useful because in this way none country has interferences with the other one, on the other hand, investing in countries with poor governance can carry out disasters. Another fundamental point concerns the importance of the banks and the loans given to sustain the development of the developing country, a study by Intergovernmental Group of Twenty-Four, in 2015, stated: “One aspect of the business practices of the World Bank and major RMDBs that has a particularly strong impact on infrastructure investment is environmental and social safeguard policies. Safeguards comprise procedures and restrictions on different types of lending operations meant to ‘safeguard’ the project from having negative impacts on the environment and social groups. Safeguards were first instituted at the World Bank in the 1990s, and the other major RMDBs [regional multilateral development banks] followed suit in subsequent years. The World Bank’s safeguards are still considered the most comprehensive and rigorous, but the safeguards of the [ADB: Asian Development Bank], IADB [Inter-American Development Bank], and AfDB [African Development Bank] have been gradually tightened over the years such that the differences between them are relatively small, particularly on the hot-button issues of environmental assessment and resettlement.
As a project undergoes the initial screening process, MDB staff members determine whether it triggers any of the MDB’s applicable safeguards. Should that be the case, a separate series of special requirements must be followed before the loan can be approved and disbursed. The most frequently triggered safeguards in the case of the World Bank relate to environmental assessment and involuntary resettlement, and most frequently affect investment projects in the transportation, energy, and urban sectors. The required procedures are extraordinarily detailed and specific, and in many cases (notably, the World Bank’s IBRD [International Bank for Reconstruction and Development] and IDA [International Development Association]) extremely difficult for borrowers and even staff to fully understand. Requirements often include time-consuming, lengthy studies to be undertaken by third-party experts (usually at the government’s cost), lengthy consultations with affected parties (sometimes including unelected non-governmental organizations), extensive mitigations measures, and lengthy mandatory prior public disclosure and comment periods during which time the project cannot move ahead. These requirements supersede whatever national laws may be in place in the borrowing country—a particularly troubling point of principle for many borrowing countries, beyond the practical impacts of safeguards”(Humphrey 2015: 19). These kinds of procedures taken by the World Bank has created a series of unintended consequences, in fact in this way to undertake investments in the infrastructure sectors causes high costs. In addition, these investments were many in the past, but now they have had a fall by 70 percent to 30 percent and this is the reason why China is better seen by the developing country, being the only county that undertakes investments in infrastructures sectors. In addition China is also more flexible and less bureaucratic and this creates investments with a good combination between the costs necessary and the time required. In order to react to the lack of regulation, was created the Asian Infrastructure Investment Bank (AIIB), after China proposed the new Bank as response of the slow development process of the internal institutions, but also as excess savings. The AIIB has developed a series of norms quite similar to that of the World Bank, but less detailed and learner, in addition this could be the first multilateral bank where the majority of the shareholding is given to developing countries, to countries where are concentrated the major part of the investments.
The major part of the investor in the world economy is occupied by the industrialized economy, but the condition of China is a little bit different. In fact, it is more unusual that a developing country with has had for many years the major part of the inward foreign investments, has become, now, one of the most important investors in the global market.
The Organization for Economic Co-operation and Development has calculated and index of FDI restrictiveness for OECD countries and many emerging markets. This index not only involves the FDI restrictiveness, but also the restrictiveness that regards the sectors. The most important restriction to be considered concerns the percentage that the foreign investor can have in a domestic enterprise. The following graph shows the restrictiveness index in 2014 for the whole economy also considering the countries that are part f the BRICS (Brazil, Russia, India, China and South Africa).
As it is possible to note, china is the most closed economy, with an index of 0.4, while India and Russia are the less open with an index of 0.2 and Brazil and South Africa are the most open with an index of 0.1. Considering that the value is 0 for the open countries and 1 for the closed ones).
Source: Kalinova et al. (2010). “China is the most closed of the BRICS countries (FDI restrictiveness index, 2014)”.
As we can note, the Chinese index restrictiveness in mining sector is 0.33 against an average of 0.11, in financial services it is equal to 0.51 compared with an average of 0.23 and so on. In fact, some of the major investments by abroad by China, are in reality closed inside the country itself. This lack of reciprocity creates many problems in terms of relationships between China and its partners. For example the Unites States, in order to solve this problem, has negotiated a bilateral investment treaty (BIT), based on the possibility to maintain closed just few sectors, but opening all others. This is however not so easy and many questions concern also the possibility that this kind of Treaty has been approved by US Congress.
- The Chinese economic growth and its go out policy
Since the ’90s, due to the reform of the Chinese market, there was a continuous flow of foreign direct investment (FDI) between EU and China. In the period 2004-2011, investment flows from the EU to China have done registrar an annual average 6-7 billion euro, but then rose sharply to nearly 18 billion euro in 2011.
In the same period, FDI from China to Europe were much lower. Almost non-existent in 2004 and 2005, they reached 2 billion EUR in 2006, before declining again. Although the first signs of a trend the rise of Chinese FDI in Europe, left a big gap in 2011: while EU companies invested almost 18 billion Euros in China, Chinese FDI in the EU were lower than 4 billion euro.
As indicated by the latest estimates, the China-EU report on the levels of investment now seems reversed. In 2014 Chinese FDI in the EU amounted to 18 billion USD, compared to 8 billion USD of EU FDI in China.
Source: Eurochamber 2013. “FDI EU-China (stocks and flows), 2004-2011.
Source: Economic and commercial relations with China, European Parliament , 2015.
Source: Economic and commercial relations with China, European Parliament , 2015.
According to the Commission of the European Union in 2012, Chinese investment in the EU represented 2,6% of the flows of total foreign direct investment in the EU (up from 1.0% the year before). Conversely, the share of FDI flows total EU confirms its 20% solid in China of all FDI inflows. This makes all of the 28 Member States of the EU one of the five largest providers of FDI in China, along with Taiwan, Hong Kong, USA and Japan.
According to data from the Chinese government, only 5% of the FDI has reached Europe in the period 2004-2010, during which the 72% of the FDI reached Asia. Analysts, however, agree that with the financial crisis, Europe has become a favoured destination of Chinese FDI. Since 2011, European countries have begun to accept Chinese investors as a way to compensate the lack of public cash and the difficulties of private companies in order to have access to credit.
At the same time, in line with Beijing’s international development policy, we have been phased out restrictions on the expenses FDI of Chinese companies. Buying technology appears to be one of the main reasons the new investment policy of China. Therefore, it is in Western Europe, where many companies Sector leader with a technological advantage, which concentrates the majority of Chinese investments in Europe. Chinese companies have also diversified their investments over time.
Almost non-existent in 2000, the Chinese investment flows in Europe have reached USD 10 billion in 2011 and the 18 billion USD in 2014. In the period 2000-2014, the majority of Chinese investment in the EU was allocated to projects Greenfield (of “capacity building”) and the expansion of existing activities (70% of all transactions). However, in terms of volume, the bulk of investments is represented by the acquisitions (86% of the total value), given that the agreements M & A (merger and acquisition) are generally more capital-intensive than Greenfield projects and expansions.
With the average growth of Greenfield projects over the past four years, a new trend seems to be defined: according to Baker and McKenzie (2015), Chinese companies have begun to invest in Greenfield projects with high costs for the capital, which include research and development centers (R & D), food processing plants, real estate developments and production of machinery. All this further confirms the structural expansion of the Chinese investors in Europe.
Source: McKenzie and Baker. “Chinese FDI in Europe for investment mode”.
Source: McKenzie and Baker. “Chinese FDI in Europe for investor mode”.
Throughout the 2000-2014 period, public enterprises and sovereign entities accounted for most of the investment value (69%), because they control the high capital-intensive industries in China. Private companies account for only 31% of the total money invested.
In addition, strategic investors represent the vast majority of the operations and related value. However, the past two years, financial investors have emerged as important players outside of China, including also funds, both private and state.
The evolving mix of Chinese investors in Europe reflects the diversity and the recent changes in the corporate landscape in China or in sovereign entities.
From 2000-2014, investments have reached all European countries. But they are concentrated in the largest and most advanced economies, such as Germany, France, UK and Italy, as it is possible to note in the graph below. In 2014, 9 out of 28 EU countries (Austria, Belgium, Denmark, France, Germany, Luxembourg, the Netherlands, Sweden and the UK) have received more than half of Chinese FDI, but before 2011, the same countries concentrated 77% of Chinese investment.
The new investment trends are due to the change of China’s interests and emerging opportunities Europe.
Chinese investors have increased always more their investments in economies severely affected by the financial crisis.
For example, the share of Portugal, Ireland, Italy, Greece, Spain and Cyprus of total Chinese investment in the EU has grown from 8% in 2009-2011 to 33% in 2012-2014. In particular, Chinese investors have seized the opportunities arising from the privatization of state industries such as property and public utilities and infrastructure transport.
In recent years, the new Member States in Eastern Europe have seen somehow increases their share of FDI from China, mainly as a result of so-called mega operations (“megadeals”). However, the economies of Europe Eastern recite a still rather supporting actor role, with only 8% of the total value of investment from 2000-2014.
Source: McKenzie and Baker. “Chinese FDI in Europe countries’ group”.
From a vision for the country, there are clear differences in the EU for the period 2000-2014. They can be five distinct groups of countries.
• The top five countries that concentrate Chinese investment are the UK, Germany, France, Portugal and Italy.
• Following the first five, a group of five other economies that have attracted, each between 1 and 5 billion USD investments in the period 2000-2014: the Netherlands, Hungary, Sweden, Spain and Belgium.
• A third group, including Romania, Austria, Luxembourg, Poland and Greece drew with value operations between 500 million and one billion USD.
• Chinese Investment minor in Bulgaria, Czech Republic, Denmark, Finland and Ireland (between 100 and 500 million USD each).
• The remaining of the 28 UE countries attracted less than 100 million USD each investment: Malta, Slovakia, Lithuania, Cyprus, Estonia, Slovenia, Croatia and Latvia.
Source: Baker and McKenzie, 2015. The first five EU countries for Chinese investment, 2000-2014: location, investment volume and factors.
The 61 billion USD cumulative Chinese investments in the EU in the period 2000 to 2014 span a wide range of sectors. The first recipients sectors of the Chinese capital have been:
Source: McKenzie and Baker. “Chinese FDI in Europe per sector”.
• Energy sector (17 billion USD)
• Automotive ($ 8 billion)
• Agribusiness (7 billion USD)
• Real Estate (6 billion USD)
• Industrial equipment (5 billion USD)
• Information technology and communication (3.5 billion USD)
• Raw materials (USD 3.1 billion)
• Transport and Infrastructure (2.4 billion USD), and financial and business services (US $ 2.4 billion).
More recently, Chinese investments have diversified their targets beyond the initial interest turned to technology, infrastructure and heavy industry. Chinese companies are getting stronger outside the manufacturing industry.
Notably, in the following areas:
• Real estate, emerging as a new destination of Chinese investment. Virtually non-existent before 2013, the European in real estate investment reached USD 2.8 billion in 2013 and $ 3 billion in 2014. A number of the factors behind this surge of investments: pressure on promoters to diversify from a market Internal slowing; desire of institutional investors to invest capital in international activities low risk; finally, the investment boom in real estate also contributed to the increase of travellers and Chinese citizens residing abroad;
• Agri-business, with several major acquisitions motivated by access to supply chains, knowhow European, quality control, technology and trademarks, in order to double the offer and focus on rapid growth domestic demand and the Chinese consumer market; 11 Distribution by type of energy: fossil fuel extraction (7 billion USD), goods and utilities (7 billion USD) and renewable energy (3 billion USD).
• Also transport and infrastructure have exceeded 2.4 billion in 2014. The development of Chinese tourism abroad and the continued expansion of bilateral trade have fuelled investments in commercial air line and in other transportation services;
• Chinese financial institutions are preparing for international expansion since the liberalization of the domestic financial market and the development of bilateral capital flows require a greater international presence.
Baker & McKenzie identify an evolution of the mix of industries in the 2000-2014 period reflects the change position of Chinese companies in global value chains, as well as the evolution of the policy framework of China on FDI outflows.
• Before 2011: entry into the EU market is essentially based on facilitation commercial considerations and desire to access technology in some sectors, with ambitions to fill the gap in areas such as automobile and industrial equipment.
• 2011-2012: the will to technology and other activities to improve competitiveness has spread to other sectors, including information and communication technologies. However, the main thrust element increased investment in these two years is the wave of purchases by Chinese public companies, which they have spent a total of USD 11 billion for European mining companies, the energy sector and the goods and services public utility.
• 2013 and 2014: Chinese investment in energy and raw materials have been reduced to $ 5 billion over two years, with the desire of investors shaken by radical changes in the pattern of growth-intensive resources, from fierce anti-corruption campaign (that led to incarceration of several executives responsible expansion International major public companies) and by changes in European energy markets (such as major reductions in the purchase price of renewable energy).
The decline in investment in resources has been well balanced by a new interest in other areas, while the commercial motivation for investing abroad increased and the continued efforts to liberalize rules on FDI outflows increased the number of those who want to invest abroad, as well as having attributed both to private companies institutional investors, a greater importance in China’s investment abroad.
According to a study made by the Eurochamber in 2013, I would like to report as the European investments’ environment is perceived by China. In fact, The EU is perceived as a stable investment environment with strong technologies, skilled labour and transparent legal framework. Also, is in itself a big consumer Chinese market companies for goods and for services. Most Chinese companies have so far invested in Europe is trying to conquer the continent as a sales market.
The EU’s investment environment, generally considered by Chinese investors as similar to other major developed regions, it is still perceived as more favourable in North America and the Southeast Asia. Obstacles have been reported in the investment approval process, but it was also pointed out that the opposition to Chinese investment for national security reasons EU rare, especially compared to other major developed regions.
Chinese companies are increasingly looking to buy certain technologies, skills and brands, in line with the objectives of the 12th five-year plan. Chinese companies have indicated that the EU should communicate more clearly which sectors are open to foreign investment and which are not are suggesting the usefulness of an EU equivalent of the “Catalog of Foreign Investment in China” (list of sectors open to FDI).
The following main obstacles have been reported in order to operate in the EU:
1) Human resources: includes obtaining visas and work permits for Chinese employees, with problems related to labour law, costs and cultural differences in management style;
2) Lack of international experience in the Chinese talents: the matter concerns direct Chinese foreign investments globally;
3) Understanding of the various operating regulations, such as tax regulations;
4) The perception, sometimes negative, that is present in Europe of Chinese companies.
Nevertheless these obstacles the investments made by China in the UE are always more high.
China has recently broken two economic records. In 2013 the country became the first world trading power, with over 10% of world trade. In 2014, he recorded the world’s largest economic result in equal purchasing power standards (PPS) 14, overtaking the US, for decades before a world economic power. However, in 2015, for the first time, China announced that it would not pass the annual growth forecast of 6.8%; Beijing even considered the risk of not achieving this figure.
Since then, it has developed a wide debate on whether the world would now witnessed the first signs of a slow collapse of the Chinese economy or whether China would continue its growth, albeit at a slower pace.
Without doubt, it is too early to know which scenario will materialize. The assumptions can only be speculative. However, considering the recent Beijing political ads, it is clear that China has chosen a way forward: the Chinese government has called the “new normal” slow growth of the country.
China’s economic slowdown has been extensively analyzed by the media in the current period, but the evolution rate of the GDP growth shows its steady decline from the economic crisis of 2007, as it is possible to note in the graph below. The rate of the Chinese growth peaked in 2007 (14.2%) and then tapering, along with global demand, up to 6.8% in the first quarter of 2015. It is expected that the decline will continue in the coming years, although to a lesser extent, estimates indicate a rate growth of 6% until 2018.
Source: “China’s economic outlook 2015”, European Parliament, 2015”. The Chinese GDP growth.
The slowdown in Chinese growth after 2007 is mainly due to the collapse in global demand, with consequent reduction of Chinese exports, as it shows by the graph below. On the other hand, the increase of internal consumption was very modest. The investment was widely supported by the infrastructure, but, in 2012, investments in the areas real estate and manufacturing sectors fell significantly.
Source: Barone B., and Bendini R., 2015. Contributions to the growth of Chinese GDP.
Urban development has largely contributed to the recent rise of China. Development, however, partially strategies favoured by local governments, intended to finance their spending by selling land rights (in many cases after expropriated farmers). This has fuelled a distortion between supply and housing demand and caused the phenomenon ghost towns or urban areas of new construction, encountered by anyone travelling in China. Urbanization has also been accompanied by an increase in public debt, mainly generated by local governments that have resorted to borrowing to finance local infrastructure. In 2014, China’s debt has reached 282% of GDP, i.e. almost four higher than the 2008 level.
Source: Barone B., and Bendini R., 2015. Chinese debit as percentage of GDP.
The contraction of the housing market, combined with overcapacity in many industries (metallurgy, mining, heavy industry) and the fall in export prices, indicates that China’s economy is at deflation risk. Politics the government cut interest rates (four times in 2015) to mitigate the effects of the slowdown in growth, the drop in prices and the increase in debt has not changed economiche15 current trends. In this scenario, domestic consumption has become a relatively more important element for the promotion growth. The emergence of a large middle class (also linked to the urbanization of China) has fuelled before consumption of manufacturing output, and then, more recently, to increase the demand for services in the tourism sector, finance, private health care and private education.
Source: Barone B., and Bendini R., 2015. Chinese contributions per sector to GDP.
This is also reflected in the importance of the various sectors. In fact, in 2013, services have surpassed the industry as the main economic sector. In China, services account for a smaller part of the economy than many developed countries (60% of GDP, compared to 46% of China’s GDP). However, the service sector is growing rapidly and it seems that there is still ample room for growth.
An important problem that has to be taken in consideration regards the differences between the richer and the poorer in China and consequently who lives in rural and urban areas, nevertheless the number of poor people, since Beijin has made the commercial reforms, has been subject to a good reduction, as it is possible to note in the graph below.
Source: Barone B., and Bendini R., 2015. Percentage of population who lives in extreme poverty.
In fact, the progress made thanks to the economic growth over the past three decades has benefited the entire population Chinese. It emerged great social disparities between regions and between urban and rural areas of China, and between China’s eastern coastal and western inland China. The annual income of urban households is on average three times higher than that of rural nuclei.
Source: Barone B., and Bendini R., 2015. Relation between rural areas’ debit and urban areas’ debit.
In the context of both economic and social problems, the Chinese government has launched a new approach to development. It intended to transform an economy driven by high export intensity of investment and labour economy based on services and domestic consumption. By doing so, Beijing promotes development centered on the population, to meet the demand for a better quality of life. But it also intends to transform the economy from the template growth based on imports to one focused on consumer, knowing that the single-digit growth is considered the “new normal” by the current president Xi Jinping.
This new strategy can be traced back to 2007 when, after nearly two decades of double-digit growth, the prime minister Wen Jibao described the growth strategy of China as “unbalanced, uncoordinated and unsustainable”.
In 2013, the Central Committee of the Communist Party of China adopted a reform framework, in particular the “Decisions on some major issues regarding the deepening of the general reform “(The” Decisions “).
Meanwhile there was the launch of numerous reforms and plans to address the social and economic issues.
• In March 2014 came into force a new law on consumer protection. Traders will be obliged to resume within seven days of the goods sold are returned to them. Online purchases can be returned without stating reasons by the purchaser. The consumer data protection has been improved, as well as the opportunity to present class action.
• A new law on food safety is scheduled for 1 October 2015. The new legislation was prepared with the support of EU officials. The Commission is actively working with China on security food, under the mechanism of consultation and cooperation between the EU and China. In 2010 set up three joint working groups for pharmaceutical, medical and cosmetic services.
• In March 2014, the Government launched the “National Plan for a new model of urbanization” for the period 2014-2020. The plan supports businesses that promote energy efficiency and services consumers. The plan also takes into account regional disparities and addresses the needs of the western regions. The implementation of the plan, however, is provided as a long-term action.
• Is being a social security reform study, which should be adopted by 2017 are underway, at the time, debates on proposals to raise the retirement age, to adjust the retirement age for women that of men, and to align the public social security schemes in the private sector.
• It was announced a land reform, to allow landowners to sell directly to buyers individuals without the obligation for prior sell to local governments.
• There are still ongoing discussions regarding a public enterprise reform. These companies should be open to private capital, but only in non-strategic sectors. So far, the provincial governments have failed to agree which sectors should be considered strategic or not strategic.
Aiming to better integration in the world financial markets, Beijing has begun to liberalize financial markets.
One of the measures was opened to foreigners in the domestic capital market. Easy access to credit has, however, led to the creation of a bubble in the stock market in Shanghai. The recent government intervention to counter the falls of the stock market showed a discrepancy between theoretical and financial liberalization practice. But he has also shown a willingness to Beijing to save from ruin many small investors of the middle class, which often borrow large sums to invest in the stock market.
An important limitation to any reform in China seems to be effective. Interestingly, for only 45% decisions of European companies represent for them an opportunity.
With the slowdown in economic growth, Beijing is focusing on international economic opportunities.
A strategy is not new, but has increased recently, their efforts. The internationalization strategy (“Going global”) dates back to 1999. It aimed to rebalance trade relations between China and the world, supporting Chinese investment abroad in a period when the country had many foreign reserves, but also with the aim of preparing the country itself to international competition in its domestic market following the opening to foreign companies at the level of bulk sample, background on accession to the WTO (in 2001). To do this, Beijing has offered to Chinese companies various forms of support to help them settle abroad, to export and to mitigate commercial risks. Lately Beijing announced a new rationale behind the internationalization strategy: to offset the slowdown domestic economic and international economic development. The following explores the various support systems the Chinese government has made in recent times to support Chinese companies abroad. It is possible to distinguish between three main types of support, respectively, designed to build the infrastructure, to provide financial resources to negotiate access to markets.
For years China finances infrastructure projects in developing countries in exchange for the benefit preferential clauses Chinese companies regarding access to local resources and markets (e.g. raw materials). The strategy involved mainly Africa and South America, and then be extended, in the aftermath of the economic crisis of 2007, Europe
and neighbouring Asian countries.
More recently, China has multiplied its international commitment to offset the sluggish domestic economy and overcapacity. So, in 2013, the government launched the new development strategy called “a belt, a way” (OBOR -” One Belt One Road “). The idea is this: build a large infrastructure network to connect markets and incentives, thus, trade and tourism. It includes two development plans based on two trade routes:
• The economic belt of the new Silk Road, connecting China to Europe via the rail network, via Central and West Asia;
• The way of the Maritime Silk Road, connecting China to Europe by sea, through Southeast Asia and the Middle East.
Maps taken by http://www.globaltimes.cn/content/917943.shtml, 24/11/2015.
All major Chinese companies are under state control, as they are directly owned by the state or, more indirectly, to the close links between management and the party. The government can, therefore, play a role important in the financing of business development strategies in line with the objectives of its policy. A reality also it applies to international investment strategies. In fact, as evidenced by Eurochamber (2011), it is estimated that in 2010-2011 public enterprises they accounted for 72% of total investments, compared to 28% of private companies.
Even the sovereign fund China (China Investment Corporation) created in 2011 plays a central role in the Beijing