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Lecture 14-a
Foreign Direct Investment and the
Emerging China Circle:A Key Engine of Development
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FDI in the Socialist Period
Closed to foreign investment after
Soviets left in 1960, walk on two legs
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Deng and FDI
1978 -- decision to stop isolation
Two motivations: Need for foreign exchange (to import new technology)
Fear of falling further behind East Asian neighbors
1979-80: establish Special Economic Zones(SEZs)
Cautious Incremental
Geographically isolated
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Geography, Revisted:
In the beginning First Special EconomicZones in the South areas isolated from the rest
of China
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Xiamen
Shantou
Shenzhen
Hong Kong
Taiwan
South East Asia
Zhuhai
Macau
Geography of first 4 SEZs not an accident
Tapping the Overseas Chinese connections!
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Shenzhen: thesymbol of Chinasmiracle growth
From 1980
until 2000
But it did nothappen over night!
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Fi r - : T t l For i I st t
5
5
5
3
35
5
5
-
3 5 3
BillionUS
Dolla
rs
oans
ir ct For i n
Invest ent
S all b t a lot ore thanbefore!!! And, bi i pact
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The Early SEZs
Law of Joint Ventures Foreign Equity: 2 % or more / no maximum limit CEO had to be Chinese national (until 1990) Lower tax rates Simple administrative procedures
But lots of flexibility local experimentation since they were in thesouth: when the Emperor is far away, there is little to hold one back
First JV (make airline meals for Air China) Oil exploration
Mining (especially coal)
But also other trend: Early Hong Kong processing operations Much like EPZs of rest of Asia
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Export Processi g Zones: Why Chinese EZs re imil r
Chinas special economic zones are a particular type of export processing zone. Thefirst export processing zone in Asia was established at Kaohsiung in Taiwan in 1965. In the early1970s, Japan relaxed its restrictions on investment abroad and began to invest in Asia to movelabor-intensive manufacturing to lower cost environments. In 1972, Korea established the Masan
Free Export Zone and the Philippines set up the Bataan Export Processing Zone to attract theseinvestments. By the 1980s, there were 35 EPZs in Asia, and most countries had them.
All Asian EPZs offer an essentially similar set of incentives for investors. First,components and raw materials can be imported duty-free and without administrative formalities;exports leave the zone without export or sales taxes. Thus, the zones are outside the country inwhich they are located, insofar as normal customs procedures are concerned. Second, companyincomes tax holidays are typically granted for a period of 3 to ten years. Third, the administrativeprocedures are streamlined, often through a one-stop shop coordination of permits, and usuallythrough exemption of restrictions on foreign ownership and employment of foreign nationals thatmight apply in the rest of the economy. Fourth, the zone itself often operates as a commercialentity, building infrastructure and utilitiesoften at a subsidized rateto the foreign firms.
Asian EPZs offered a way to move toward export promotion without fundamentallyoverturning the structure of protection in place for domestic manufacturers. EPZs producedbenefits in terms of employment created and foreign exchange earned, but at a cost of giving upsignificant tax revenues, and foregoing potential linkages to the remainder of the domesticeconomy. Most EPZs started slow and ended up costing far more than initially envisaged; but thepolicies have typically been seen as ultimately successful in most of the countries which triedthem. EPZs primarily attracted footloose investors in such sectors as garments and electronicsassembly because of low wages and easy conditions for moving goods in and out. Turnover hasbeen substantial, but some zones have clearly contributed to the ultimate establishment ofsuccessful industries in their countries. One example has been the Penang Free Trade Zone inMalaysia which initiated the development of Malaysias now substantial electronics industry.
Chinese SEZs share all these fundamental characteristics with other Asian EPZs.
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Export Processing Zones: Why Chinese EZs re ifferent
From the beginning, Chinese SEZs were inevitably bound to be more special than other Asian EPZs. This f
ollows from the fact that the other Asian EPZs were established in economies that were basically market economies, albeit
ones that were sheltered from world markets and competition. However, because of the very early stage in the economicreform process in which Chinas SEZs were created, the difference between the rules of the game in the domestic economy
and that in the open and relatively uncontrolled economy in the SEZs was bound to be large. Moreover, Chinas SEZ are
much bigger than other Asian EPZs. As Table 17-1 shows, the typical Chinese SEZ was many times the size of an Asian EPZ.
This larger size reflects their multiple roles and greater importance to the domestic economy. Chinas SEZs were seen
alternatively as transmission points for world advanced technology; windows on the world for political and economic
purposes, and laboratories for economic experimentation. In concrete terms, some of the key distinctive characteristics of
the Chinese zones include:
---Chinese domestic enterprises have also had a substantial incentive to invest in the SEZs. By setting up theirown subsidiarieseven if they are not joint ventures with foreign businessesChinese domestic enterprises enjoy greater
administrative flexibility, lower tax rates (15% income tax rather than 30%), and less complicated access to the outside world.
Aside from taxes, these are largely reflections of the continued restrictions imposed on firms by the remnants of Chinas
bureaucratic economy.
---The SEZs sometimes serve as laboratories for experiments with economic reforms. For example, Shenzhen
SEZ was an early pioneer of both flexible wage systems (no limits to incentive payments) and tender bidding for construction
projects. Experiments with development of land markets through leasehold, and equity markets have also been significant.
---Shenzhen in particular has been developed as a comprehensive site, including tourism, housing, and otherservices for Hong Kong people.
---Initially, the SEZs were allowed to retain all tax and customs revenues; and all foreign exchange earned for
their own use. This reflected the large task of infrastructure construction in these relatively un-developed sites (check this).
Before 1988, they were allowed to keep 50% of tariffs. Before 1992, they also kept foreign exchange. In 1994, integrate into
national fiscal system. In 1996, pay full tariffs on commodities imported into the zones themselves, as opposed to 50%
previously (?). Thus, the SEZs were governmental bodies with unusually high levels of autonomy, compared to EPZs.
During the 1990s, the SEZs have tended to become less special as other parts of the Chinese economy have
been opened, and some special provisions have been scaled back.---
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Tabe 17-1: Szeo na'sSE s and As an E s (k 2)
Ini ial i e Si e in 1990
Shenzhen 3 .5 3 .5
huhai . 121.0
Shantou 1. 52.Xiamen 2.5 131.1
Kaohsiung, Tai an 0.
enang, Malaysia 1.2Batam Island, Indonesia 3 .
Bataan, Phili ines 3.
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If a little SEZ action is good,
then a bit more is better! In 1984-87: 14 Open Coastal Cities(OCCs)
All were open before, but now got to offerthe same special preferential treatment asthe SEZs
Also: opened up other isolated previously
unplanned areas, surrounding rural areas(in Pearl River DeltaGuangdongandLower Yangtze DeltaJiangsu)
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14 Open Coastal Cities
Northernmost:Dalian
Southernost:Beihai
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Stop and Start policies
Boom of investment and new contracts But, also allowed to import with little restrictions
(and easy access to foreign exchange) Invest or import? All foreign firms / domestic firms face
this choice (though often constrained, e g , severe import
constraints) When loosen import controls, booming imports!!
slowed FDI Govt responds, restrict all imports also affects
imports (cant import equipment or raw material for
processing firms) slowed FDI more So finally regularized policies: gave access to foreign
exchange; more legal changes; more tax reductions;power to approve small/medium investments withoutupper level approval finally began to rise again
Surge in investment from the US: Beijing Jeep
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Figure17-1: Total Foreign Invest ent
0
5
10
15
20
2530
35
0
45
50
1979
-
1
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
BillionUS
Dolla
rs
Loans
irect Foreign
Invest ent
Continue thegradual rise
14 OCCs
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Tiananmen Incident (June 4, 1989)
Cooled enthusiasm for many to invest
But Taiwanese took advantage of newround of incentives
Korea began to enter in NE
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The Explosion (third wave)
Dengs visit to the south
Shanghais Pudong (this is going to be the biggest SEZyet) and draw more FDI than anywhere else largerthan Shenzhen already a population of 1 1 million
Open up most of the country SEZs, become lessS(pecial)
Open up new sectors: Urban real estate; open housingand building; open retail and some of service sector
Gave local govts more control Competition among SEZs/regions intensified
Bonded areas established (this will be important for tradenext time)
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Figure17-1: Total Foreign Invest ent
0
5
10
15
20
2530
35
40
45
50
1979
-81
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
BillionUS
Dolla
rs
Loans
irect Foreign
Invest ent
engssoutherntrip
uring Asian Crisis,anunprecedented
a ount ofFDIflowed into China a safe haven!
Stories: invest ent funds andthe search for deals
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XVII-2: ina: Forei n Direct Invest ent as S are of GD
0%
1%
2%
3%
4%
5%
6%
7%
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001-half
Never more than2% in Japan; Koreaor Taiwan
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Figure17-1: Total Foreign Invest ent
0
5
10
15
20
2530
35
40
45
50
1979
-81
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
BillionUS
Dolla
rs
Loans
Direct Foreign
Invest ent
Surging in past 8years
WTO andFDI:autos andautoparts
and ore in recent years
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And on and on and on
Todaythe good: Fairly liberal investment climate
Low taxes
Most sectors are open More opening with WTO
Currency conversions fairly easy to deal with
The awkward:
Lots of approval Still poor legal framework
Guidelines are not transparent
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Areas of Investment
Most in manufacturing
Investment in businessservices and finance is
small
Distribution is biggestbottleneck
New WTO rulessupposed to open upfinance, services anddistribution and logistics
Ot er, 4Commercial
, 10
Infra-
structure, 8
Real state,
18
Manu-
facturing,
60
Story of Syngenta
and distribution
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Main Industries
Electronics
Textiles
Food products Transport (autos)
Electric
Building materials Chemicals
A lot of this istied to Chinastrade policy atleast in the1980s, did NOTallow for imports
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Fi ure 17-3: FDI in ina: Sources
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
$50,000
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
MillionUS
Dollars
HongKong
Tai an
Japan
U.S.
EU-15
ther
US, EUJapan,Tai an:all about
8-10%
HK is byfar thelargest butrelativesharehas
fallen
In1992, HKand Tai anaccounted fornearly 80%
of FDI
Stories: Sony
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Geography, NOW
Thru 1997: 0% of FDI intoGuangdong (more than$US 100 billion)
4 southern coastalprovince: 4 %
Lower YangtzDelta thru1997:accounts for2 %
Bohai Gulf,includingBeijing, thru1997:
accounts for18%
Coastal: 4 +2 +18 = 88%
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Fi ure 17-4: Modes of FDI in ina
0%
10%
20%
30%
40%
50%
60%
70%
1979
-82
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
ercenta
eofRealied
Invest
ent
Equity Joint enture
Joint Develop ent Project
hollyForeign ned
Contractual J
Stories: Mars
This ishere
Mr.Chinaresigned..
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Impact
Quantity of investment?
Not real effect! Only a small percentage oftotal investment rest by domestic firms andindividuals
Ideas:
Technology
Management Spread through economy
How does this showup on graphs?
Shifting out of PPF!
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New Trends, Powerful Forces:The China Circle
China
Hong Kong
Taiwan
Emergencecame in response to 3 changes in theeconomicenvironment:
1. Success of East Asias Miracle Export-led Industrialization
2. Reduction in Transaction costs that made it possible to relocate productionto low wage sites (outsourcing)
. Collapse in resource prices (1980s) that made natural resource-development strategy unattractive
(4) Chinas reform but this may have been consequence not causal factor
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Basis for China Circle
Success of Taiwan/Hong Kong indeveloping labor-intensive manufacturedexports during 1960s/1970s (directed at the
US market) Success had two effects:
Demonstration effect (China copied T and HK)
Restructuring effect (Export surplus, currencyappreciation (in T and K); increasing costsboth wages and environmental need torelocate production to low-wage locations
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Attractiveness of China in mid-1980s
China: low wage; land available; operating costslow (little or no environmental protection or laborregulation); depreciating currency
China became especially attractive tobusinessmen in T and HK language andcustoms the same
China welcomed them for Capital andTechnology and Learning
[nothing new South East Asia was also feelingthe boom through the same dynamics Japan was playing a bigger role there]
Taiwan town in suburbs of Shanghai
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Specializations around the Circle
China: low-wage production Taiwan / Hong Kong: high value services and
technology-intensive production
Created a new economy style (also elsewhere in theworld) of infra-industry trade AND intra-firm trade Organization and financing in T and HK Key components manufacturing/technology creation in T and HK Ship to China for production
Export and marketing by T and HK Electronics, first then textiles other consumer goods Much like semi-conductor industry in SEA Silicon Valley and
Malaysia]
Ai ed / sp rredon y reakthro ghs in
transport/comm nications
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The end?
1 China; systems?
1 China, deteriorating HK, uncooperative
Taiwan 1 China, No Taiwan
More mutual dependence, the more likelya happy outcome
This may be FDIs greatest contribution