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2013-February-16

Why FDI into China Outperformed the World

 

By JOHN ROSS

WORLD foreign direct investment (FDI) fell significantly in 2012. Global data are unavailable for the second half of the year, but United Nations Conference on Trade and Development statistics show that FDI fell by eight percent worldwide in the first six months to US $668 billion. Many large economies suffered severe declines – FDI into the U.S. fell by 39 percent and into India by 43 percent.

China outperformed the global average but nevertheless did not escape the fall – inward FDI declined by three percent compared to a year earlier. The trend continued into the second half of the year with a 3.6 percent fall from January to November.

Such trends occasionally generate pessimistic headlines regarding China, such as “FDI continues losing streak.” But scare stories about “collapsing” FDI into China invariably turn out to be false. It is therefore worth analyzing the structural reasons why FDI into China will continue to be strong.

The contention that a decline in FDI into China is a serious, structural problem ignores international context. China cannot cut itself off from the global economy. If world FDI rises or falls, then, all other things being equal, FDI into China will rise or fall in tow. China outperforms global trends but it cannot completely escape them, just as the data for 2012 show.

In the first half of 2012 FDI into China, at US $59 billion, was larger than the FDI flow into the U.S. (US $57 billion). China is unlikely to retain its lead, however, as the FDI fall into the US was particularly severe in the first half of 2012. Moreover, the US economy, roughly twice the size of China’s by market exchange rates, has a natural advantage in its capacity to absorb FDI. But China has seen a bigger inflow of FDI than the U.S. in proportion to the size of their economies.

The reason FDI into China remains strong is clear. For decades, multinational companies have been used to China being the world’s most rapidly growing major economy in percentage terms. But in recent years a new reality has hit home in the business community: the absolute increase in the size of China’s market in dollar terms each year is now larger than the U.S.’s.

Statistics help us understand how much more rapidly China is expanding than other markets. In the 2007-2011 period the EU GDP, i.e. the size of its market, increased by US $575 billion. The U.S.’s grew by US $1,132 billion. In contrast, China’s GDP rose by US $3,804 billion in absolute terms. China’s market expansion was therefore more than three times larger than that of the U.S. and six times that of the EU.

This effect was not simply due to the U.S. recession. In 2011, when the U.S. economy was recovering, the expansion of the U.S. economy represented an absolute gain of US $647 billion, while China’s was US $1,367 billion. The dollar increase in China’s market has been greater than the U.S. each year since 2007 and, given the projected relative growth rates of the two economies, this will continue. China is therefore no longer simply a base for exports, but also the world’s most rapidly growing market. As Zhang Xiaoji, director of the Foreign Economic Relations Development Research Center of the State Council, rightly put it: “China’s biggest attraction to global investment is that it represents a huge market.”

According to the country’s Ministry of Commerce, more than 480 of the world’s top 500 companies have established subsidiaries in China. Nearly 1,000 R&D centers have been set up by international companies – in 2010 alone foreign investors established 194 R&D centers. These figures are testament to the attractiveness of the Chinese market.

FDI into China is an opportunity for the world’s investors. But it is also of major importance to the country as it seeks to raise the productivity and technological knowhow of local businesses.

At present, overall Foreign Direct Investment Financing is still marginal in China. China’s total fixed investment in 2011 was US $3.2 trillion. Over 95 percent of financing for investment in the country comes from domestic sources.

FDI brings technological and managerial expertise. For example, while China and the U.S. have approximately the same manufacturing output, China requires over 100 million people to produce its output, while the U.S. needs only 11 million. Despite China’s economic size, its productivity is far lower than that of high-income economies. The inflow of technology and management from FDI helps speed up China’s productivity growth, which in turn adds value to the economy.

The nature of FDI flows into China changes as its productivity increases. As the income of China’s population grows – and it is likely to double by 2020 – consumers’ preferences switch to higher-end goods. The make-up of China’s exports has needed to change alongside this. Medium and high-technology exports have been gaining ground, while low value-added products that depend on the shrinking pool of low-wage workers have been necessarily losing importance.

As Zhang Xiaoji explained: “For investments tied to low costs, ‘pulling out’ of a country in favor of one with a lower wage environment is a normal phenomenon. ‘Pulling out’ of China will continue in the future owing to China’s rising costs and the appreciation of the local currency.”

Despite this, China’s lead over other developing economies in terms of infrastructure and cost innovation means it will continue to be not only the world’s most rapidly growing market, but also the world’s largest base for export manufacturing. This fact is confirmed by foreign-owned firms’ accounting for approximately half of China’s exports.

While overall FDI into China fell in the first half of 2012, FDI in technology-focused industries rose by 6.6 percent.

Inward investment in China’s service sector is also playing an increasingly prominent role, with FDI in this sector reaching US $39.5 billion in the first nine months of 2012 – 47 percent of the total.

Given these clear trends, why do “scares” about companies’ “pulling out” FDI from China continue to pop up in the media? Well, to put it bluntly, many foreign investors are simply looking for the best possible deal – claiming foreign investment will collapse is a negotiation tactic.

I had a direct encounter with this tactic, albeit in a different context. During the time I ran the City of London’s economic policy meetings, I habitually dealt with bankers who would threaten to “pull out” of London unless their taxes were reduced. Such a threat was a bargaining tool, pure and simple: we didn’t reduce their taxes, and during the eight years I worked for London, I saw the city pull ahead of even New York as the world’s number one financial center and city.

China is in a similar position today. The first half of 2012 saw a deluge of media reports on companies claiming China’s FDI climate was severely deteriorating – just as the data showed China to be the world’s number one FDI destination!

As always, what people do is more important than what they say. The data show a huge inflow of FDI into China. The strong growth of China’s economy and its improving technological base clearly explain the trend. And because China’s economy will continue to grow strongly, it will no doubt remain one of the world’s top destinations for FDI.