Within three decades of reform and opening up China has become a top destination of Foreign Direct Investment (FDI). The United Nation Conference of Trade and Development released a report on 23 October 2012, stating that China replaced the US as the world’s top destination for FDI by attracting US$59.1 billion in the first six months of 2012. Meanwhile, FDI flowing to the US was US$ 57.4, witnessing a decline of 39.2 per cent as compared to the last year.
Why is China the top destination for investments despite all doomsday stories? What has the government done to make China attractive? Is this a new phenomenon?
Reasons for China being the top destination
Zhang Xiaoji, Director of the Foreign Economic Relations Development, said that China’s biggest attraction to global investment is its huge market and low cost production. The 12th Five Year Plan (2011-2015) has emphasized on consumption-driven growth. In order to increase the consumption, the government has planned to increase the household disposable income, most likely through raised minimum wages and increased social safety nets, such as health care and social welfare payments. China’s economy is undergoing a fundamental shift where domestic consumption is the key driver. Huge domestic market attracts FDI seeking to produce standardized goods. The most preferred sectors are the service sector followed by the real estate and the manufacturing sector (new sectors of China’s economy are opening up for foreign investors).
In comparison to the US and the European Union economies that are suffering from medium and long term troubles, the Chinese economy has withstood the litmus test. In 2009, when global trade contracted by 12.2 per cent both Germany and Japan experienced deeper recessions than the US. Conversely, China was able to avoid recession through fiscal and monetary incentive that succeeded in increasing domestic demand. China is well connected to its global liner shipping network and has topped the UNCTAD statistics on liner shipping connectivity index (LSCI). Thus it is noteworthy, as at a time when global FDI is squeezing due to European debt crisis and looming US sub-prime crisis, China is proving the most attractive place for investment.
Role of the Government
Establishment of Special Economic Zones (SEZ) has played a major role in drawing FDI into China. In 1978, FDI’s were permitted only in SEZs along the coastal areas. During 1980-1990 the Chinese government authorised municipalities to establish SEZ’s based on their geographical location, industrial condition and human capital. There were 222 state-level economic zones and 1346-muncipal level economic zones by 1994 and China began to see consistent, sizable investment across provinces.
Accession to WTO in 2001 broadened China’s “opening up” policies and led to continued FDI flow towards the economy. Today, China is a major importer of raw materials, manufacturer of basic goods, and exporter of consumer goods. The Chinese government itself plays a significant role in economy in general and FDI’s in particular. The government gives huge tax deductions to the companies when they enter domestic market. They encourage MNCs to enter the domestic market with advanced technologies and this way the country’s economy gains access to newer technology more quickly. The Chinese Government has worked extensively to better the investment environment, which has a huge appeal to the world. According to UNCTAD, “China is experiencing structural adjustments in their FDI flows, including the relocation of labour intensive and low end market- oriented FDI to neighbouring countries”.
Is it a bubble or a new Phenomenon?
This is not the first time that China has been the largest recipient of FDI; it also claimed top spot in 2003 (soon after accession to WTO). Nor the last time, as other countries could claim that distinction, as initial indicators show that FDI flows to the US might be stronger in the second half of 2012. Vice Premier Li Keqiang has proposed to cut taxes, this would spark more foreign investment in the country.
However, there is an apprehension that China may get entangled into the “middle-income trap”. The Managing director of J.P. Morgan has expressed faith in Chinese economy stating that given its still rapidly growing productivity China can avoid this. Despite this factor, China will be the most preferred FDI destination for the simple reason that it is more politically stable and, its macro economy is relatively stable as has been evident during the global financial crisis. The Purchasing Market Index that rose to 49.1 in October-highest in three months makes the economy all the more optimistic. There are no indications that the new leadership will change the “reform and opening up policy”. Thus, FDI attraction will remain an important element of China’s state policy of economic openness and liberalisation.