Investment and explain the determinants of FDI in

Investment from foreign countries has played a vital role in China’s development as a country. One of the major international investment is foreign direct investment (FDI) an investment in business made by individual or a company from another country which the investor has control over the purchased company. Developed country has been dominating developing country in terms of investment for the past 10 years. For example, American food chain like McDonald’s and Starbucks are available anywhere in the country more than the traditional Chinese food cart that sells pork bun. This essay attempt to assess the types of FDI and determinants of FDI in China. This study will focus on why China is remaining the top FDI destination in the world and the determinants of FDI in the country. The rest of the paper is organised as follows. The first section explains what are the major types of FDI in China. The second section presents and explain the determinants of FDI in China. The third section concludes.

 

 

 

1        Major Types of FDI in China

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According to Beijing International (nd), there are three types of FDI that are  

1.1   Sino-foreign Equity Joint Ventures (EJVs)

Probably the most widely used type of FDI in China. Sino-foreign Equity Joint Ventures (EJVs)

is a type of company that jointly set up by Chinese and foreign investors in China in which 25 percent of the overall investment generally was put by the following. The profits, risks and losses shall be shared with all of the parties in joint ventures. EJVs might also be highly involved in a wider range of activities and sectors than Wholly Foreign-owned Enterprises (WFOEs).

1.2   Sino-foreign Cooperative Joint Ventures (CJVs)

A Sino-Foreign Cooperative Joint Venture (CJV) is a joint venture jointly between China and foreign investors in China’s territory. The contract determines all issues: cooperation, the division of earnings, the sharing of risks and losses, capital recovery, management and business operations of the venture, and ownership of the remaining property upon termination of the contract. China generally provides the labour, land use rights and factory buildings, whereas the foreign company contributes in the technology and key equipment, including the capital. This type of FDI is more flexible in terms of investment and business management.

1.3   Wholly Foreign-owned Enterprises (WFOEs)

A Wholly Foreign-owned Enterprise (WFOE) is a company established in China that is wholly owned by foreign investors. The foreign investor has full managerial and operational control over the designated business. Since 2000, the WFOE has been the most popular investment bridge to connect foreign investors into the capital city of China, Beijing. 15 and 30 is generally the longevity of WFOE and it is only permitted to conduct activities within its own business scope. Certain restrictions still apply even though WFOEs can be engaged in wide range of sectors; these limitations are specified in the Catalogue of Industries for Guiding Foreign Investment and industry-specific regulations.

1.      FDI Determinants in China

1.1.   Market Size and Growth Potential

Walsh, J. P. and Yu, J. (2010) state that higher foreign direct investment may be related with larger host countries’ market that has larger potential demands and relatively lower costs due to scale economics. The population of China is about 1341.41million and international investors believe Chinese market is the greatest market in world. Since few years ago, China’s market oriented FDI has been increasing because of the increasing purchasing power with dramatic economic growth. As of 2010, GDP growth rate of China has been increased to 10.3%. The future estimates for China are also prospect that will keep China remain attractive market for FDI. Artige and Colini (2005) believe that the most potent FDI determinant is market data that is measured by GDP or GDP per capita. For example, Investors tend to lean towards countries in Central and Eastern Europe with larger population, Resmini (2000); Bevan and Eastrin (2000) also claim identical result. While Market size is the determinant for horizontal FDI, it is unrelated to vertical FDI. Davies (2013) states that market-oriented FDI (Horizontal FDI) aims to set up enterprises to supply goods and services to the local market. This type of FDI may be undertaken to exploit new markets. The degree of development of host countries are very important location factors for market-oriented FDI apart from the traditional reason for circumventing tariff barriers, the market size, prospects for market growth. Commonly, host countries with larger market size, faster economic growth and higher degree of economic development will provide better opportunities for these industries to exploit their ownership advantages and, therefore, will attract more market-oriented FDI.

 

 

1.2.   Exchange Rate

The relationship between FDI and exchange rate was identified by Cushman (1985) and Froot and Strein (1991). The increase in vertical FDI might be expected from the weak exchange rate; lower price will be taken as advantages. Froot and Stein (1991) find evidence of the relationship: ‘a weaker host country currency tends to increase inward FDI within an imperfect capital market model as depreciation makes host country assets less expensive relative to assets in the home country.’ Blonigen (1997) argues that exchange rate depreciation in host countries tend to increase FDI inflow. But on the contrary, foreign companies might increase domestically produced products: as a sense of barrier that mostly increase horizontal FDI. Nonetheless, this hypothesis does not appear to have attracted much support in the empirical literature.

1.3   Infrastructure

Roads, ports, railways and telecommunication systems to institutional development (e.g. accounting, legal services, etc.) are all known as infrastructure. According to ODI (1997) poor infrastructure can be a major obstacle and opportunity for foreign company. For the majority of developed countries, it is often cited as one of the major drawback. Host governments permit more substantial foreign participation in the infrastructure sector; this points to the potential for attracting significant FDI. Jordaan (2004) claims that increase in productivity potential of investment is highly correlated with well-developed infrastructure, thus FDI inflow rise. Asiedu (2002) and Ancharaz (2003) argues that the standard measurement for infrastructure development is the number of telephones per 1,000 inhabitants. However, this measure falls short, because it only captures the availability and not the reliability of the infrastructure (Asiedu,2002).

 

1.4   Location

Grosse and Trevino (1996); Wei and Liu (2001) states: ‘geographic proximity of the host to the home country of investors reduces informational and managerial uncertainty, lowers monitoring and transportation costs and reduces the exposure of multinationals to risk, theoretically the more the geographic distance between the home and the host country, the less the FDI’. However, Liu et al. (1997) found that that the rapid developments in communication technology mitigates distance factors hence geographic distance was found to have little influence as a determinant of FDI in China. Yet, from another perspective, Yuk and Zhong (1997) found that geographic distance was hugely influenced FDI projects in China that are mostly funded from Hongkong. In China it seems that geographic location within the country rather than distance is a factor for nearby investors, even so, there is no evidence demonstrating whether the location of FDI projects from western countries is related to geographic distance. One of the reasons might be that the geographic distances within China are seen as unimportant assumed the long distance between China and most western countries.

1.5   Human Resources

As the most populated country in the world, China is known for its low-cost human resource. This also lead China to be the world’s largest manufacturing industry since 2011 and rising the country’s GDP rate as Eloot, Huang, and Lehnich (2013) have stated. China have paid great attention to their citizen’s educational matter by establishing nine-year compulsory education. Hence, Chinese labourers are of relatively high quality. It is often argued that in case of FDI, notably export oriented, labor cost is effectively determined by efficiency wage rate, which is accustomed to productivity rather than “absolute wage” (Davies ,2013) and (Faheem et al ,2011). However, Davies (2013) argues that erosion has been faced because cost effectiveness is becoming less important to investors. China’s disadvantages in lack of labour qualification and technology gap will take some time to improve.

 

1.6   Natural Resources

China is very rich in energy resources. According to Davies (2013) production of oil in China is among the highest in the world, also in addition to fuel, China is the largest producer of coal, roughly one third of the world’s total production. Other major resources are also available. The price of the resources is also one of the cause of the increase in FDI inflow.

 

1.7   Acceptance in Foreign Business

China maintain good relationships with another country and known to be open for foreign business. Early in the year 2017, China’s President Xi Jin Ping defended globalization at the World Economic Forum; Li Ke Qiang, China’s Premier, signed China’s action plan to make the world’s second-largest economy force (Rutledge,2017). Charkrabarti (2001) states that there is mixed evidence concerning the significance of openness in determining FDI. The maintained hypothesis is: given that most investment projects are directed towards the tradable sector, a country’s degree of openness to international trade should be a relevant factor in the decision.

On the other hand, horizontal FDI might be associated with decrease in openness, as investing firms might benefit from circumventing trade barriers through building production sites abroad. But Resmini (2000), who is studying manufacturing investment in Central and Eastern Europe, finds that benefit from increasing openness affecting largely vertical FDI flows, in which is a sector for which international trade flows in intermediate and capital goods are important. Singh and Jun (1995) also find that export orientation is very important in attracting FDI and link it to the rising complementarity of trade and FDI flows.

Conclusion

As one of the most famous destination for investment, China has been improving for the past years. Foreign Investors has been targeting China as a leap for establishing international business. China’s policy at promoting FDI has been a remarkable success and led China to be international manufacturing sector that is highly competitive in world market. Positive aspects such as low labour cost, market size and infrastructure has pushed China’s FDI inflow for the past years. As Na and Lightfoot (2006) emphasized: ‘For China to develop a sustainable, nationally competitive advantage, it will have to move from being a country which attracts FDI based on low costs and growing middle class, to one which has strategically located agglomerations – this may mean increasing the support for openness, and FDI in selected regions rather than in all regions.’