I.1 FDI to China
Nowadays, China has 1.3 billion people and become the world’s fastest growing economy. Over the past decade, it recorded an average of 8.2% of GDP growth. It is measured as the world’s 7th largest economy and 4th largest trader to date (Jintao 2003). The rapid growth is, in a large part, derives from China’s considerable and ongoing economic reforms; including its 2001 WTO accession (“People’s Republic”, 2005). China has been famous for its dramatic shift from a relatively closed economy prior to 1970 to the world’s largest recipient of Foreign Direct Investment to date.
Since the late 1978, the country conducted a massive makeover of its foreign trade policy (Coughlin, 1999). As the first policy of allowing limited amount of foreign investment has seemed to work very splendidly, the government figured that it was a good idea to let ‘a little more’ money coming in. The foreign investment grew until it become one of the main pillars of China reforms and played a key role of China’s integration to the world of Economy. Analysts believed that FDI would still play a major part in the development of China (Coughlin, 1999). Thus we can say that to some extent, China’s economic development can be observed trough the activity of FDI inside the country.
Recent development stated that FDI inflow patterns in China is forming an obvious trend. The technology-intensive industry has attracted more and more FDI in-flows. Along with condition, FDI inflow to traditional industries like footwear, travel goods, toys, bicycles and electrical appliances have been declining. Experts believed that the trend will reasonably continue in the future (‘China’, 2002). This paper will contributes to the discussion regarding how, for what reason and how the trend is affecting China’s Economy.
I.2 Research Questions
During the past 6 years, Transnational Corporations (TNC) like AMD, Ericsson, Hitachi, Luccent, Microsoft, Motorola, Nokia, Seagate Technologies, Mitsubushi Electric, Sony, Cannon , Dell Computer, Minolta, NEC and Toshiba have expanded their investment in the form of production facilities of electronics and communication products (‘China’, 2002). These companies are all using high tech equipments to produce it products, which implies that the companies have spent a considerable amount of money and opportunity cost to bring-in their technological and research equipments.
How does it happen? A brief background of the case would help us to understand the measurements of the issue discussed.
What could be the cause of the trend? For years, people believed that China is a place to produce sneakers and not high tech equipments. It is interesting to find aspects of FDI growth in China that resulted the trend of high tech area’s investments..
How does it affect China’s economy? As FDI is a very significant part of China’s economy, the trend would obviously resulted a considerable effect that is worthy of academic.
I.3 Hypothesis and Theories
In order to increase whole elements of a countries’ or organization welfare, leaders might take various policies: tight money policies, policies to increase full employment, policies that encourage the use of technological to drive more output, and many other policies.
Moreover, policies to increase the full employment level of employment (e.g., population growth, increasing labor force participation or decreasing frictional and structural unemployment) can increase potential GDP in the long run. Under such circumstances, a government might reduce income tax rates to include increasing take-home pay for all employees. In turn, the greater wages will drive the people to spend on leisure and encourage people to supply more labor (either work longer hours or enter the labor force). The long run supply of labor will shift to the right, reducing equilibrium wages and increasing potential GDP
Another approach to stimulating economic growth is technological change. Technological change refers to new production techniques that increase the output produced by any combination of capital and labor. Interestingly, as technology maturity takes some years, it suggests that at each stage will results in different number of outputs.
Relating to the change of China’s FDI in-flows to high tech areas there are a few suspicions and theories which will be elaborated in this study. The first mentioned that the trend is a part of natural stages of Foreign Direct Investment. It is a part of the natural evolution of the case and the shift to high tech areas are the next logical step in the value chain of FDI (‘The Emergence’, 2004).
The second hypothesis stated that the trend is, to some extent, caused by Chinese government policies which encouraged the FDI to flow into high tech industries (‘Venture’, 2002). Since 1985, the Chinese government had issued many policies which given more and more freedom and opportunity in high tech investments.
Despite the reasons of the trend, high tech investment and R&D in China had influence the economy significantly. The later part of the paper will elaborate the changes impacted by the high tech FDIs, but previously, we will describe how the trend change in FDI inflow occurred
II. Methods and Methodology
There are two basic research approaches, qualitative and quantitative. The qualitative approach presented a model of research where the researchers conducted detailed investigation toward a single object of study to gain an in-depth understanding of the object. The variables resulted from this study might be unique and uncommon depended on the object of the study. The purpose of this type of research is to explore unique characteristics of the object and describe it in a logical and critical manner.
The quantitative approaches on the other hand, are efforts to generalize a theory inside limited environment of study. This type of research usually investigates only one relationship between several factors and trying to find the justification of the connections.
The research questions are qualitative in nature. It aims to investigate the unique causes of FDI strategic shift to high tech areas and the effect of the trend if we are to establish that the study would use the qualitative approach, then we must lower down the activities of trying to compare our findings with other objects of study (comparing China’s FDI to US’s FDI, for example). We must focus on the single object which is the characteristics of FDI in China. There might be questions of the justification of our findings, but we should not be tempted to make a generalization of the characteristics we discovered. This is ethically justified in a qualitative research.
Relating to the nature of the study, mathematical calculations are not an obligation. Therefore, the exploitation of secondary data is justified. We suggested that this research use non-participation observations by means of previous research, publications and statistical data of the China’s economic growth and the FDI flow to China. The conclusion however, should be independently developed and supported by a solid frame of logic.
III. Literature Review
III.1.2 Motivation of FDI Flow to China
Various studies mentioned that China has achieved remarkable success of attracting FDI by altering their foreign trade policy. They also facilitated the FDI by building infrastructures to produce market size-growth and urged their political leaders to maintain stability both in politics and economy. To some developing countries, these massive changes could be interpreted as ‘surrendering to foreign powers’ and therefore, not many has really gone that far. What could be the motivation of the capital and time consuming effort of bringing in foreign investors? A study by Xiaodong Wu (2003) about job openings in China would reveal some of the answers.
In the 20th century more and more Chinese workers are leaving their land and going to the urban areas to find jobs. The government was having so much difficulty to absorb the massively increasing number of labor as the only source of employment at the time (prior to 1970’s) was the State Owned Enterprises (SOE). These SOEs provided only a fraction of the needed number of jobs. The problem, together with the absence of social institutions to deliver basic social services and the government effort to privatize the SOEs, presented a poor quality of life for the new jobseekers and thus increasing the social tension level in China’s urban areas (Wu, 2003).
The first effort of solving the problem is by requesting an urban citizenship license for those who would be SOE employees. Hopefully the announcement of these employment requirements would prevent more rural farmers to migrate into urban areas. But the solution was proven to be ineffective as more people come to the cities without any opportunity to find jobs, creating more tension and problems to the city’s management (Wu, 2003).
The only solution left is to find another source of jobs that would release the burden of social tension and unemployment and thus allowing the SOEs to continue with their reformation plans (Wu 2003).
III.1.2 Opening to the Market
Starting from 1978, China has liberalized its restrictions on FDI with intentions to gain advantages from foreign presence inside the country. The advantages could come from foreign investments, technology transfer, management skills transfer and foreign exchange benefits. In 1979 the Equity Joint Venture Law allowed legal entry of FDI in the Special Economic Zones (SEZ) and also established a statutory basis of building joint ventures in China (Berkun, 2001).
The decision seemed to be the right one since quickly after the policy is stated, thousands of multinational corporations invested in China bringing billions of dollars in the form of FDI and thus creating new jobs for urban workers. The government which beginning to felt the benefits of having FDIs coming in, stated a new law in 1983 and 1984 which stated detailed aspects of joint venture operations and also and agreement to extend investment in China’s territory, beyond the previously stated SEZ. For justification purposes, the government argued that these private sectors is considered supplement to their socialist economy (Berkun, 2001).
In 1986, Chinese government established the Foreign Exchange balance Provisions and the Encouragement Provisions which facilitated FDI and make foreign exchange problems solvable. But the second round of massive reforms in China’s foreign trade policy started in 1994, where the official exchange rate was deactivated and the market rate took place along with the abolishment of exchange quota retention system (Berkun, 2001).
Despite the massive reforms, there are still a few barriers left discouraging the foreign investors. But government was very sensitive regarding the issue and in 1996, they stated that they are adopting IMF article A, which removed all remaining restrictions on foreign exchange transactions. This is the final and the largest action proving China’s commitment in global trade. All of the steps taken by the government have created a very strong regulatory framework, thus increased investors confidence in the market and bringing in even more cash flow in the form of FDI (Berkun, 2001).
After the gradual change, many multinational companies recorded to take advantage of the new market having 1.3 billion consumers and a relatively cheap labor market. Kodak who entered the market not too long ago, for example, has stated that China is its second largest market for consumer film and paper. The annual rate of FDI increase by 40% in the early 90’s and peaked in 1993 with a 175% increase. The total Value of Foreign Direct Investment rose from zero in 1978 to $320 billion in the year 2001 (Berkun, 2001).
III.1.3. Development of China’s High Tech R&D Investments
Some of the indication of the FDI shift to high tech industry can be described by the flow of foreign high tech R&D in China. Foreign high tech R&D first emerged in Mainland China in the Mid 1990’s. After then the numbers have grown very rapidly, especially due to the increasing foreign investment in the computer and telecommunication industry.
US computer industry entered China in 1985. It was IBM who was first set-up shop on mainland China. Not long after, Hewlett Packard (HP) also entered by means of high tech joint ventures. The step taken by these two large companies was soon followed by many more multinationals attracted to the large size of Chinese market. To date, the number of R&D centers, programs and labs of multinational corporations in China has been multiplied since the first years (‘The Emergence’, n.d).
III.1.4. FDI Shifted to Mainland China
Recent development however, describes the change of FDI high tech inflow to China. Taiwan was considered one of the largest recipient area of FDI, but the development suggested that the new FDI inflows generated by multinationals are targeting the mainland as a potential market. At the same time, 90 % of Taiwan’s high tech firms are worried that Taiwan based foreign investment will move their production facilities out of Taiwan (China, 2001).
Businessmen and women in China are very much pessimistic that Taiwan’s economy will stay in their present ‘good’ position in years to come. One of the reasons of this condition is the deteriorating economy attributed to political actors. Other reasons are the industry exodus and government policies (China, 2001)
III.1.5. Relationship with Foreign Investors
China has maintained good investment relationship with many economically powerful countries. United States, for example, is one of the largest contributors of high tech FDI to China. US and China have formed several organizations in order to maintain their international relationship. One of the most well known form of cooperation is the North American Chinese Semiconductor Associations NACSA.
NACSA is a professional organization dedicated to the advancement and collaboration among Chinese professionals in high tech industries. The rapid industry growth has made the community of entrepreneurs and engineers in both the Silicon Valley and China experienced a tremendous Growth in recent years. As the industry is still rapidly growing, so is the number of these engineers and high tech professionals. Since it was built in 1996, NACSA has been the provider of networking and information sharing which will allow career growth for these professionals. The main purpose of NACSA is to build a high tech professionals community with a Chinese Heritage. Their expertise includes various aspects of high tech sector involving design, processing, manufacturing, testing, packaging, software, marketing, technical, communication, accounting and law (NACSA, 2004).
III.1.6 China’s Area of Growth
As every area have their own characteristics, the study of how the FDI penetrate each area would give us a pattern of FDI investment behavior and present us the connection between FDI and the characteristic of every area. Through the observation we can detect any tendencies of FDI shift to high tech sectors.
Researchers have conducted a study within the same framework and discovered a few interesting conclusions:
The investment of FDI in China for the recent years has been shifted to business sectors involving less extraction activities and higher technology and labor utilizations. For illustration of the trend, data presented that among the three sectors existed in field of FDI, the first sector (containing agriculture, mining and petroleum) accounts for 40.9 % of China’s FDI in 1984, but in 1993, it holds only 3.1% of the FDI. The second sector (which incorporate the manufacturing industries) and third sector (real estate and transport) have gradually taken over by each accounting for almost half of China’s FDI in 1993 (Coughlin, 1999)
The MNCs preferred coastal areas to the mainland China. During the early years, FDI was highly concentrated in the original four Special Economic Zones which are Guangdong, (56 %), Fujian, receiving (5 %) Beijing (8 %) and Shanghai (7 %). But due to the policies aiming to spread FDI to other areas, Guangdong’s share decreased to 28 % in 1995 and new areas, like Jiangsu, gain 14 %. However, overall observations stated that FDI did not go far from the shores. Mainland provinces as the Hunan, Jiangxi and Hubei accounted for no more than 70 million in 1980 (Coughlin, 1999)
The MNCs are attracted to a larger size of market. It is difficult to measure the size of a province’s market and so is to measure the total amount of supply and demand in a market. Therefore, analysts used the output of a province to determine the connections between market size and FDI in-flows. Data indicates that the flow of FDI has a positive relationship to the increase of Gross Provincial Product (GPP). A province with larger GPP attracts more FDIs (Coughlin, 1999)
III.2 Reasons of the FDI Changes
III.2.1 Role of Culture and Geography
A theory stated that cultural and geographical condition is one of the factors supporting the abundant FDI. This theory can be related to the peculiar nature of FDI in China which is rather insensitive to labor cost compared to FDI in the United States and Japan.
A study by Ting Gao in 2002 mentioned that the success of China in attracting FDI does not only attributed to factors like market size, cost of labor, liberalized DI policy, improved infrastructure, etc. The underlined factor being less emphasized is Chinas natural advantages in the forms of cultural ties with emerging Asian FDI source, as Taiwan, Singapore and Hong Kong and the geographical proximity of China to this regions plus Japan and South Korea. The research did not present detailed numbers regarding the case, but it suggested that significant part of FDI in China can be attributed to its cultural and geographical proximity to Asian sources (Gao, 2002).
Gao did not imply that the previous factors mentioned are irrelevant. Without opening to the market in the 1970’s for example, the FDI would be zero. The building of infrastructure and maintaining political stability also improved economic growth, which in turn, will raise MNCs interest for investing to the country. But overall, the amount of China’s FDI would only be a fraction of its current number if not because of its cultural and geographical ties (Gao, 2002).
Relating to some researches aiming to find a formula that was used by China to successfully attract foreign investors, Gao explain that to some extent, the FDI in China is caused by natural advantages that could not easily be copied by other nations looking for FDI in-flows (Gao, 2002). The economic policies of focusing in building its infrastructure and the political policies to facilitate FDI along with maintaining national stability might be a part of the recipe for attracting FDI, but these formulas are rather common and have been applied by many Asian countries in effort of bringing in foreign investors. Some of the funding for the infrastructural building to produce a larger market size is originated from the firsts FDI inflows attracted by the potential of a large market (1.3 billion consumers). The natural advantages are the important part combining all the beneficial factors to produce an attractive field of investment. This factor would logically contribute to the shift of FDI to high tech area. The shift was encouraged by the regional openness to the high tech industries.
III.2.2 Steps of Value Chain
One of the theories explaining the FDI shift to high tech area is the theory of stages of foreign investment. of As Described by the behavior of IBM and other computer companies regarding their FDI in China, the FDI flow to the country is experiencing the common stages of enterprises’ entry to a foreign country. There are several phases of high tech Foreign Direct Investment which will be elaborated below:
Phase I: The initial phase involves opening foreign representatives or sales office in the capital city or appropriate industry center. The purpose is to establish a presence in the market for learning objectives or brand recognition (‘The Emergence’, 2004). In practice, we can se the implementation of this phase in the massive growth of Taiwan and important cities during the 1980’s and early 1990’s. At the moment, Taiwan was considered an important market for the high tech industry, but soon after the phase is over, FDI was no longer dominated by Taiwan.
Phase II: After the multinationals established their presence in the community, the next step is forming a foreign enterprise to build manufacture and production facilities (‘The Emergence’, 2004). In Practice, we can see the implementation for this particular phase in the rapid increase of joint venture companies in China.
Phase III: The next phase is the development of product designs and efforts of localization, usually with the help of native engineers or experts (‘The Emergence’, 2004). This phase is implemented by the rising of much cooperative organization connecting China with their foreign investors.
Phase IV: The last phase is the effort to remain competitive, to upgrade product lines so they would not be outdated and to strenghten individual sustainability for the foreign affiliates (‘The Emergence’, 2004). This step is implemented by establishing R&D centers in foreign countries.
The shift of FDI to high tech sectors is represented by the increasing number of R&D centers and labs all over China. This implies that China is now experiencing the latest phase of the theory. Relating to the investigation of the cause of FDI changes to high tech industry, we can conclude that to some extent, the changes is due to the implementation of the natural steps of foreign investments.
One of the significant factors encouraging the shift to high tech sectors are governmental policies. In 1985, China issued “the Decision on Sci-Tech System Reform”. The decision allowed venture capital to be established in effort of supporting the rapidly changing and risky high-tech development. This concept is the introductory chapter of the FDI flow to high tech industries (‘Venture’, n.d).
In 1991, China provided the multinationals with a special zone for developing its high tech business. In 1995, China further encouraged the process of FDI flow to high tech area by establishing a strategy of developing China with science and education by incorporating foreign investment in join venture capitals. The policies of developing facilitate and promoting the FDI efforts is a continuing activity involving also policy reviews and enhancements (‘Venture’, n.d).
The policies resulted adirect enhancement of FDI flow to high tech sectors, for example, in 1986, China establish the ”Torch Project” and approving its first venture capital company. The second venture capital company of China was established in 1989 promoting the commercialization and industrialization of high tech achievements. After the first venture capital fund was established in 1992, innovation and development was increasing rapidly. By the year 2000, with 10 years of development, 100 venture capital companies had been built with capital up to 8 billion Yuan. Among these companies, 90% were wholly or partially funded by the government.
III.3 Impact of High tech FDI flow to PRC
The large amount of Foreign Direct Investment to China and foreign R&D development has clearly benefited China’s modernization efforts. But on the other hand the process also created certain dependence toward foreign technology, posing an ongoing dilemma for Chinese policy makers. Below is the elaboration of how PRC has benefited from the high tech flow of FDI and also the potential risks to China’s economic and security interest.
III.3.1. Spillover and Indirect Effect
The FDI In high tech business sectors of China has benefited not only the economy but also created a spillover effect to other aspects of live for the Chinese society. Chinese Government has a special agenda of benefiting from foreign technologies coming in, which is to reduce the technological gap between China and the modern countries like America and Britain. The FDI flow to high tech sectors causes the establishments of foreign R&D labs and facilities in China. This facilities indirectly helped the government to slowly obtain the benefit they desired (‘Conclusions’, n.d).
Due to high tech sector investment in China, foreign technology is coming in allowing China to enjoy the advantage of sound and highly skilled scientific base. The foreign technology will also accelerate China’s effort of technological modernization. This is a privilege obtained by not many Asian countries (‘Conclusions’, n.d).
National education and training efforts have also accelerated over the past several years following the government decision to accelerate scientific and technological progress in 1995. This tremendous development allowed many Chinese to improve special skills without having to travel abroad. There are many more aspects of the country benefited from FDI inflow to high tech areas, but one of the underlined one is the benefit of increasing defense capability. In some instances, R&D activity has included integrating foreign technology with local systems or making foreign technology compatible with Chinese technical standard, which in turn will make it easier for the country to understand and absorb foreign technology (‘Conclusions’, n.d).
III.3.2. Direct Benefits of Chinese Enterprises
Beside the spillover effect, the country also benefited directly from the business aspect. High Tech enterprises which model themselves after western companies have been increasingly competitive in the local market, designing and producing innovative products distinct from other local or foreign companies. These local brands are now competing with international products in Chinese market (‘Conclusions’, n.d).
Chinese enterprises also benefited from long term relationships with foreign high tech companies. Due to governments 20 years of effort inviting foreign investors, local companies are now enjoying economic and technological advantages from good relationship with foreign companies. Local Companies which have incorporated foreign technology are now striving for market share in foreign market (‘Conclusions’, n.d).
However there several aspects in which the Chinese are still behind due to the small time frame of technology acceptance. First is relating to the fact that Chinese enterprises have difficulties to find internal links among different technology and science, the second is the lack of coordination between the industry sector and the science department which resulted the available technology not maximized.
One of the apparent risks is the increasing dependency level toward foreign technologies. This creates a significant leverage for the foreign countries in influencing China’s long term economy. However, the present condition displays that the cooperation in going to a positive collaboration which benefited both foreign countries and China.
Other risk is the concern of ‘brain-drain’ activities. As mentioned before, FDI inflow to high tech areas in China has also developed China’s education and training method. But despite the increasing quality of students and trainee, there are significant concerns that the brightest and the smartest of the educational institution would in the end come and work for the foreign companies.
China is known for its success in attracting FDI. According to a research, we found that behind the success, there is a strong reason for the gradual changes. With its increasing problem of unemployment and SOEs privatization efforts; the country has no choice but to let in foreign investments. The processes of approaching the market economy were applied gradually from 1978 to 1996 where the country agreed to incorporate IMF article A about eliminating entry barriers. The decision which proven to brought positive results has today plays a key role on China remarkably fast development.
The increasing trend of FDI transfer to high tech area in China would eventually produce the facilities of foreign R&D in China, thus to some, we can coclude that the trend is marked by the increasing R&D investment in China. The trend is increasing not only in numbers but also in area covered. While previous FDI targeted the coastal areas of China, recent high tech investment have also targeted mainland China. The increasing foreign connection in high tech business is also marked by the emergence of cross country organizations. NACSA is a good example of how China has been increasingly connected to foreign economic and technological powers.
The trend is originated from various factors. Some believed that it was due to national and regional openness and demand for high tech business. Experts argued that is was caused by the last natural step of foreign investment which is to build R&D facilities in foreign countries in order to strengthen affiliates’ product quality and economic independence. However, Chinese government has seemed to be the most significant contributor of efforts in directing the FDI in-flows to high tech industry. They have worked on policies facilitating foreign high tech investment for nearly 20 years.
The change of trend has impacted various aspect of life in China. Directly, local enterprises are gaining competitive advantage allowing them to compete in foreign market. Indirectly, the community has benefited from the infrastructure development, education sector advancement and even defense technology. Despite the positive aspects, there are also concerns relating to the increasing dependency and the exploitation of advanced (highly trained) local human resources.
After conducting additional and more detailed data of all the factors mentioned above, the research could focus on finding the level of correlation between the facts of international connections involving high tech investment (as mentioned in the third chapter) and the cause and impact factors. It would present the level of significance of each factors relating to the cause and impact it produces. For further effort of producing a valid conclusion of the correlation, statistical growth and development data would be incorporated.
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