Role Of Government Policies In Attracting FDI

This research studies the effect of the government in China when it makes some polices in attracting foreign direct investment (FDI) inflow. We use data and figures to analyze the economic development in China and the policies adjusted by Chinese government since 1978, pointing out how the government policy plays a significant role in attracting FDI inflow. It said that from 1978 Chinese reform the economy to now, because Chinese polices attract FDI, China became the biggest recipients among the most of developing countries. Policies including the “The reform and opening-up policies” China establish four Special Economic Zones (SEZs), along with favorable geography location to attract investment from Asian economy and help Chinese government receive the investment from Western countries as well. Next is exchange rate, through the currency policies adjustment to adopt the economic development and leading to more foreign enterprise investment. In addition, the government also used taxation extensively and selectively, combined with the exchange rate policy. Facing this situation, FDI inflows in China has had a positive trend since 1978. In conclusion, by researching these policies, we aim to make a clear view about the role of government and its significant effect in FDI attraction process in not only China but also in developing countries.

Table of Contents

Appendices 14

Introduction:

In the global economy, foreign direct investment (FDI) is a major catalyst for economic development and plays an important role in development process around the world. It accumulates physical and human capital, increasing the rate of employment and revenue. Investment needs consideration the effect of environmental investment. Cheap labor, raw materials, investment in labor, protection of labor rights and technology education, and these all drive investment development. FDI also was directed to the development of manufacturing enterprises and to natural resources.

Foreign direct investment (FDI) has two forms: outward FDIs and inward FDIs inflows. About outward: local capital, which is being invested in some foreign resource. The latter case, in the local resource occurred investment of foreign capital.

The global trend in FDI from US $55 billon in the early 1980 to annual worldwide FDI rose to just over US $200 billion and then in 2000 rose dramatically to almost US $1.4 trillion over six years.

When going through the whole economy, for developing country, FDI has a positive trend. Developing countries gain from the huge expansion during this period. FDI flows to developing countries rose from just under US $40 billion in 1990 to over $240 billion in 2000. In 1970, FDI to gross domestic product (GDP) is below 1 percent, however, the data is increase to 4 percent in 2000.This situation tells us for developing country, investors have more interest in seeking technology and investment in developing countries. Due to this, there is competition between the government of the developing countries around the world to attract FDI inflows to their own country. In our assignment, we focus on the case of China, the most successful region in absorbing FDI between the developing nationals, and their government’s strategies to compete with the other countries.

Background

In China, around 20 years ago, a baseline of FDI inflows was lower US $19 billion, which grew US $ 300 million in FDI in the next 10 years. Even though in 2009 there was a global financial crisis, there was still an increase in FDI. China is a major leader in growth, compared to other developing countries. Since 1978, China in FDI has rapid growth. In addition, China has the largest FDI recipient among most of the developing countries. In the fixed assets, foreign investment turns to more and more significant resources in China. In 1996, it appears the peak of 12 percent. During the 1997, because of the Asian financial crises, it made the FDI inflows decease to 9 percent, 7 percent respectively. Recently, from 2004 to 2006, FDI inflows to China have an increasing and stable trend, around US $ 800 million every year.

During the 70-80s, China started to reform their traditional economy and began to transfer farming to household activities with increasing foreign direct investment. The government set economic zones (SEZs) and OPRN CITIES. In 1980, it also set up four Special Economic Zones (SEZs) in Shenzhen, Zhuhai, Shantou, and Xiamen. In December 1982, Chinas government decided to open up China to the world economy. With China holding the Olympic Games and access to join the world trade organization (WTO) in 2001, China increased in industrial comparative advantage. More and more foreign enterprises, which consider opportunities and risk, do business in China. China also experienced the changes in policy toward FDI. They find the advantage of factors in China, namely cheap labor, politically stable environment, and relatively developed infrastructure compared to other developing countries.

China experienced three stages limited opening, active promoting through preferential treatment, and promoting FDI. At first China had several weaknesses because of complex laws and regulatory environment. In a addition, communication systems and process were not well developed in Chinese factories and enterprises. Nevertheless, China’s productivity is improved considerably, leading that more and more enterprises have interested in investment in China. From the mid 1990s, government policies transferred maintaining foreign business environment to linking FDI promotion to domestic industrial objectives. FDI inflow in China, foreign loans, direct foreign investment and other foreign investment like loans from government investment are three forms foreign capital inflow.

Purpose

Based on knowledge about International Economic and Politics, this research tries to find out the contribution of government’s policies in attracting Foreign Direct Investment (FDI) in China. By collecting the empirical data about China’s economic and law during the period from 1978 (when Chinese started to reform their economy) to now, we will bring out that government’s policies play an important role which makes China become the most appealing country for FDI inflows around the world.

Method

The method we used to investigate this phenomenon is to collect required information (figures and graphs etc.) from the articles which are related to the topic. Secondary data will be used in abundance because of its higher efficiency and more qualified database compared to the primary data. Those data would focus on the effect that the government policies have on the FDI inflows into China.

Result and Analysis

According the Table I, before the 1980, FDI accounted for a small part in overall national capital in China, just about 20 million dollars every year. During the period from 1950 to 1978, the inflows of FDI in China were mainly from Soviet Union in dribs and drabs. There are the ideological and political obstacles which prevent the growth of FDI inflows in China. It has used to be assumed that FDI budgets were used like an economic tool for the Western capitalists can control China’s economy such as they did in the Opium War in 1839 when British forced Qing Dynasty to open Chinese port cities by military power. That explained why such a long time about 30 years, Chinese government didn’t receive any FDIs from Western country or non-communist countries. However, from 1978 until now, there are many dramatic changes in Chinese policies to attract FDI, which help China become the world largest receipt among developing countries since early 1990s and the third largest FDI recipient country (after the United States and France) in the world in 2008. In this part of our assignment, we will show some results about FDI attraction of China’s government and analyze their related policies.

Between the various and complicated polices and laws that the Chinese government went through for attraction FDI from 1978 until now, there are three main policies we need to pay attention to: the Open Door policy, the polices about exchange rate, the policies about tax.

The “Open Door” policy :

_ “Open door” polices, also named “The reform and opening-up policies” actually are the combination between many various and flexible policies and laws which were approved by Chinese National Congress from 1979 until now in order to let China become the most attractive market around the world for foreign direct investment. These polices mainly focused on innovating Chinese economic and administrative structure, liberalized Chinese market gradually to the world for international business and absorbed FDI.

_ At the dawn of “Open Door” policy, there were still numerous leaders in China who were unassertive in reforming. That’s why attracting FDI policies conducted step-by-step like an experiment. The first action was that Chinese government announced another policy called “Law of the people’s republic of china on joint-ventures using Chinese and foreign investment” in 1979, which made foreign direct investment a legal status in China. Moreover, at the beginning of reforms, one of the Chinese’s strategies to increase FDI inflows is to attract the investment from overseas Chinese. At that moment, not so much foreigners can speak and understand Chinese culture, choosing overseas Chinese as the main sources is the shortest and safest way in promoting FDI inflows to China mainland. Based on this strategy, Chinese decided to establish four Special Economic Zones (SEZs) in four cities Shenzhen, Zhuhai, Shantou, Xiamen.

_ According to the Figure A, we can see clearly that these four SEZs located in two southeast coastal provinces, Guangdong and Fujian. Shenzhen, Zhuhai, Shantou were all built near Hong Kong and Macau, developed areas in the region. Most of population in these two areas is Cantonese speaking Chinese, whose ancestors emigrated from China. Three SEZs; Shenzhen, Zhuhai and Shantou; were used for attracting investment not only in Hong Kong and Macau but also in other Southeast Asia countries such as Malaysia, Indonesia and Singapore. The last SEZ, Xiamen, was set up near Taiwan and, of course, attracted a large amount of FDI projects from there to China mainland. As the consequence of this policy, investment from overseas Chinese, especially from Hong Kong, accounted for a major part in Chinese’s FDI inflows in total. From the middle of 1980s until 2000, Hong Kong contributed around US $ 160 billion in total, gained nearly a half of actual FDI inflows to China. The investment budgets from Taiwan, Singapore and other Asian economies also are very important to China’s FDI. Taiwan, Singapore ranked at number 3 and number 5 respectively, based on the data on the Table II and Table III.

_ Along with favorable geography location to attract investment from Asian economies, SEZs also had many advantageous policies which help Chinese government receive the investment from Western countries as well. Depending on the characteristic of every region, each SEZ was given their own preferential treatment. However, in general, SEZs had higher autonomy and less administrative than other cities in China. Local government in these SEZs can accept or reject the FDI projects by themselves without agreeing from central government. SEZs cities also had the right to attract FDI inflows by their own plan which could be out of the state plan, develop their infrastructure as long as they could afford the fee from their profits from these investments or their loans from the banks. Even if, inside SEZs, the local authorities also offered the special tax income rate, removed the import licenses from the raw material, intermediate and capital goods, applied a lower tariff to the sales and imported goods in comparison to full tax and tariff level outside SEZs. Because of these preferential treatments for SEZs, it let Chinese government attract a great number of FDI capital not only in Asian countries but also in European countries and American year by year. As said by Table III, we can conclude that FDI contribution of United State of America in China increase steadily from 4.2% to 10.8% during the period from 1992 to 2000 , ranked this country at the 2nd position between the countries invest to China. Also in this period, the FDI inflows from Germany, England, France also increased dramatically from around 0.5% to 2%.

_ After the success of SEZs and these first policies in attracting FDI inflows, in 1984, the Chinese government decided to take a further step to open up their domestic market to the world and create a larger international business environment, the number of Special Economic Zones was extended to another fourteen coastal cities and Hainan island, which expanded the domestic market further. This kind of expansion effected the distribution of FDI inflows in China. On the word of Table IV , 88% of FDI capital was received by eastern coastal regions after the expansion of SEZs from 4 cities to 14 cities (during 1984 to 2000); whereas, 20 western inland provinces which held about two third of population just accounted for 12% of FDI inflows. Especially, one eastern coastal province, Guangdong, ranked the 1st position in attracting FDI around the China because it was the first place for doing “Open Door” policies and its perfect location for attracting FDI (near Hong Kong , the main source of FDI in China). Thanks for the expansion of SEZs, FDI inflows spread widely to other cities in Eastern of China, such as Shanghai, Zhejian, Jiangsu, Fujian and let them become the places which also receive the most FDI in China. These policies made China’s FDI inflows increase steadily year by year from 1984 to 2000, from below US $ 50 million to more than US $ 500, regardless of the financial crisis in Asia in 1997 , as stated of the Table I.

_ There are five types of FDI project in China: equity joint ventures (EJVs), cooperative operation enterprises or contractual joint ventures (CJVs), wholly foreign – owned enterprises (WFOs), foreign sharing – holding enterprises (SH) and joint exploration. However, during the process of attracting FDI capital in China, the government just focuses on developing three types: equity joint ventures, contractual joint ventures and wholly foreign-owned enterprises due to its effect in absorbing FDI inflows. At the beginning of reform, the authority only allowed foreign investment by joint exploration which made them feel easier in controlling China’s economy. At the same time, the success of foreign enterprises in SEZs made the significant changes in the attracting FDI’s policies. In 1986, State Council proclaimed “Law on Enterprises Operated Exclusively with Foreign Capital” which legally allowed setting up the wholly-foreign owned enterprises outside SEZs. In addition, at the same year, Chinese government also announced another policies called “Notices for Further Improvements in the conditions for the Operation of Foreign Invested Enterprises” ; “Provisions of the State Council of the People’s Republic of China for the Encouragement of Foreign Investment”. These so-called “provisions” provided foreign investors, especially export-oriented companies or using advancing technology companies, with more favorable treatment and such as preferential tax treatment, the freedom to import materials and equipment, the autonomy in management and administration, better and easier access for infrastructure , alternative ways in getting balance their exchange rate. The deeper reform was done in 1990, when the authorities promulgate the new policy “Amendments to the Equity Joint Venture Law and Wholly Foreign-Owned Enterprise Implementing Rules”, permitted that foreigners could become the Chairman of the Board of the Direction, provided the protection from nationalization. These policies, together with expansion of SEZs, helped FDI inflows to China surge gradually from the mid of 1980s to the late of 1990s, reached the peak about US $ 500 million at 1997 before the financial crisis in Asia. As a result of these policies, there was the transfer between the types of FDI project in China. Contractual joint ventures and joint exploration showed the downward trend in their FDI inflow’s contribution in general. It was a steady decline from 45.6% to 15.9% for contractual joint ventures and from 42.5% to 1.1% for joint exploration during the same period between 1979-2000. On the contrary, wholly foreign owned skyrocketed from 3% in 1979 to 46.9% in 2000, accounted for nearly a half of actual FDI inflow in China. It was the same situation with equity joint ventures when it increased from 8.4% to 35.8% within 21 years, as stated by Table V.

_ At the following, to enhance the quality of FDI inflows to China and connect FDI promotion with the domestic industrial, the leaders of China announced a combo of polices from 1994 to 1995: “Circular on Issues relating to Strengthening the Examination and Approval of Foreign-funded Enterprises”; “Provisional guidelines for foreign investment project”; “Guiding catalogue of foreign investment projects”. Throughout these rules, Chinese government determined these main sectors which FDI projects would get the priority such as export-oriented and high advance technology projects; agriculture, transportation, telecommunication, energy and these projects which use the rich natural and cheap labor cost in central and western of China. Even they also divided FDI projects in China into four categories: encouraged, restricted, prohibited and permitted. “Encouraged” projects were those which focus on underdeveloped agriculture, saving raw material and energy or using the hi-tech machines to improve productivity; those which bias on export; those which don’t cause pollution or negative effect to the environment. Some projects, put under “Restricted” label, were the ones which related to the exceeding of domestic demand, caused the natural resources deficiency. “Prohibited” projects were those which affected seriously to the human health, natural environment, or using up the resources in China. It could be the projects which affect to the national security. And the projects that were not belonged to any above group would be named “Permitted”.

_ Recently, after successful accession to WTO in December 2001, Chinas government went on exclaiming the new policies not only in administrative reform but also in economic reform. Most of these policies pay more attention in encouraging investment in high technology and innovation fields, encouraging investment in central and western of China; aiming make China become the most prefect market for attracting FDI inflows. Chinese national parliament promulgated many laws fighting against the discrimination between domestic enterprise and foreign enterprise; and of course; protecting the transfer of technology based on the intellectual property rights signed in WTO agreements. And in the first time in Chinese history, foreign companies have the full rights about trading. It means that they can control directly their import and export without using the Chinese-owned company like a middleman. Moreover, they also can organize their activities in China from finding employee, maintenance, opening their other branches, transportation. Many projects which the labeled “Restricted” or “Prohibited” also were removed in case foreign firms could participate. With the WTO agreement, China agreed that around 50-percent of foreign enterprises can attend the telecommunication filed, life-insurance and non-life insurance, banking and other financial fields (Statistics in 2005). With the appearance of the new laws, FDI in China surged significantly from 2000 to now, especially reached the highest peak around $ US 800 million in 2005 (Table I). These changes opened up the new potential investment opportunity which foreign investor can find and make it be real business in China as the expectation of the Chinese government.

Policy on the exchange rate

_ At the start of Chinese economic reform (open up market to the world, etc.), the Chinese currency kept depreciating from 1979 to 1994. During this period, according to the Table I, the FDI inflow into China raised dramatically, from below $ US 10 million to $ US 400 million. We think that the policy of the depreciation of domestic currency may help explain this phenomenon. As the devaluation of domestic currency continues, the cost of Chinese labor and other production cost will be reduced and became cheaper compared to foreign production cost, which gives domestic labor-intensive industries and export-oriented companies advantages in producing and the selling price, thus strengthening Chinese products’ competitiveness in the world market. So with the benefits that devaluation of domestic currency can bring, the inflows of FDI kept being stimulated. For the other aspects, devaluation of domestic currency can decrease the price of non-current assets like land, buildings, etc, which also attracts foreign investors to buy them.

_ From the year 1994 to 2005, Chinese government made the exchange rate fluctuate in a very short range, and this stable exchange rate decreased the risk of investing for foreign investors and helped domestic labor-intensive industries can still keep their advantages in production cost, so the inflow of FDI kept increasing from 1994 to 2005.

_ However, as China witnessed huge trade surplus every year because of the low currency value and exchange rate, it began to be pressured by its main trading partner United States of America to apply a new flexible exchange rate system and appreciate the value of Chinese currency. After the year 2005, Chinese government tried to raise its currency value in a slight range almost every year to protect its export-oriented companies and its cheap production cost advantages. Until 2008, Chinese currency (RMB) appreciated over 18.5% to US dollar in compared with the exchange rate in 2005, as stated of Table VI. Although the inflows of FDI into China seem receiving little negative effect, the amount of FDI is still huge. However, as America keeps pushing Chinese government to raise its domestic currency further, the inflow of FDI into China is kind of hard to predict.

Policy about taxation:

_ The last main policy, but also is the important ones, is the policy about taxation. The Chinese government used taxation extensively and selectively, combined with exchange rate, to improve the attraction of FDI inflows to China. At the moment, there are many kinds of tax for foreign enterprises but just three types can effect seriously in FDI inflows to China: income tax, turnover tax and import tax.

+ Income tax: for standard foreign companies they have to pay around 33% for taxation, but the foreign firms which were established inside Special Economic Zones only pay 15%. A little bit higher payment for tax belongs to the corporations in High Technology Development Zones and Economic and Technology Development Zones with 18%. Moreover, depending on the professional field of each companies, they are offered the various exemption from tax :

Type of foreign enterprises

Tax policy

Foreign investment enterprises

_ Not being collected tax two years after their first beneficial year, and half-collected in next three years

Foreign investment enterprises

_ Not being collected tax two years after their beneficial year, and half-collected in next three years , after these five years , they can maintain another three years for half-collected tax

Advanced technology enterprises established by foreign funds

_ Not being collected tax two years after their beneficial year, and half-collected in next six years ,

Export enterprises

_ Not being collected tax two years after their first beneficial year, and half-collected in next three years

_ if their yearly export value amounts to over to per cent of gross enterprise sales, half of business income tax will be reduced

+ Turnover tax: from January 1, 1994, Chinese government applied the value-added tax, consumption tax for the foreign companies in the same level with domestic enterprises, deleted the business tax for technical transformation of foreign enterprises. More advantageous, if a foreign company buys a device for investment from local enterprises and this device are on the exemption tax list, the value-added tax will be completely got back.

+ Import tax: Also since 1994, Chinese authorities have been reduced their import tax eight times, and the newest tariff tax was around 9.4 % in 2005. In specific sectors, such as information technology, tariff tax dropped at zero in 2005, including computer production, semiconductors. In agriculture fields, the tariff for agricultural production also declined from 31.5% to 14.5%.

Conclusion

In this paper, we try to prove that government’s policies played the most important role in the development of China as well as the attraction of FDI capital to China among the other factors such as cheap labor, rich natural resources, etc…. Overcoming the obstacles of FDI which spring from history and ideology, Chinese government announced the policies which help China become the largest recipient about FDI project among the developing countries. Thanks to the “Open-door” policy which established the Special Economic Zones, formed totally free economic environment for foreign companies, supported for removing the centralization in economy. Along with “Open Door” policy, these polices about tax and exchange rate also made a great contribution to the increasing of FDI inflow in China. Since China joined the WTO in 2001; reforms and FDI attracting’s rules have been supported and been widespread in all of China. There is no doubt that China, valuable and flexible, will become more and more attractive to the investors around the world. The success of the China’s story is going to be the encouragement for the developing countries in attracting FDI and their policies will be the most valuable lesson in absorbing FDI inflows for other countries around the world.