[MUSIC] One of the key dimensions of globalization in China has been the massive inflow of foreign direct investments from other countries into the country. In this presentation, I want to talk about how China attracted FDI from the rest of the world, in particular through its Joint Venture Law and the establishment of special economic zones. And then I want to talk about some of the distinctive features of foreign investment in China. And finally have a discussion of what the benefits have been to the Chinese economy of this FDI, and also what the costs have been. And similarly, from the standpoint of the foreign firms that are investing in China, what have been the advantages and disadvantages of coming to China. So one of the first things that happened after Deng Xiaoping came to power and normalized relations with the United States was that Deng took a trip to the US. And immediately announced the establishment of a joint venture law designed to encourage foreign technologies to come to China, foreign firms to come to China, mainly to bring their technologies that could help the Chinese economy advance. And when Deng visited the US, he very explicitly went to high-tech cities, including Houston, Seattle, to signal that what China really wanted was to collaborate with high-technology firms. Now, the Joint Venture Law carried a number of specific provisions designed to entice foreign firms to invest in China. The first was that it provided very generous tax breaks. So in this figure, you see an example of a firm that comes to China to invest. And maybe in the first couple of year, it doesn't make any profits. And then it starts to make profits, and those profits increase over time. So these numbers are fictitious. But the key provisions of the Joint Venture Law were first that while you're losing money, no taxes. And once you started to make money, there were still two years where you would be completely tax exempt. And the tax rate on a net income of enterprises has been 15% in China. After the two years of no taxes during profitable earnings years, then the subsequent three years you would be taxed at just 50% of the normal rate. And it would only be five years after starting to make profits that you would have to pay regular rates of taxes. So this is quite a benefit for joint ventures. Now, the Joint Venture Law also provided extra benefits for larger investments. It allowed for some imported inputs and some consumption goods, like imported cars and other materials or equipment that many firms would want to have in their firms in China, to be exempt from duties. And a lot of the export taxes on foreign invested firm production also were exempted. And finally, after the foreign companies earned money, there was no remittance tax on the profits that were sent back home to the originating countries. Now, the second thing that China did, in addition to creating this Joint Venture Law, was to establish what are called special economic zones. And initially they set up four zones. Shenzhen, Zhuhai, Shantou in Guangdong Province, right near Hong Kong, and Xiamen in Fujian Province, also on the coast. Later they established open coastal cities and economic and technological development zones. And finally, a free trade zone in Pudong. That's the most recent innovation, where the free trade zone is designed to loosen a lot of the normal restrictions on international capital flows into and out of the trade area. So here is a graphic representation of the expansion of these economic development zones. We start with the four SEZs, then we add the coastal cities and the delta cities here, delta areas. And then we finally add some of the inland ports along the Yangtze River and the border cities. And so all of these are development zones designed to provide particularly good conditions, environments for manufacturing. So what are the other feature of the special economic zones that were attractive to foreign investors? The first is that a lot of money was spent to build very strong infrastructure in these areas, reliable electricity supply, etc. Secondly, there were, again, favorable policies for firms that established new investments in the zones. Favorable taxation, conditions, land rights, less regulation. The zones often focused on exports and, initially, joint venture enterprises. And because the zones had a provincial level of authority, they could get reforms and requests approved directly to the central government without having to go through provincial or other local government levels. So one of the real innovations of special economic zones in China was they were much bigger than the types of development zones that had been established in other countries previously. These were really city-level experiments. And in fact, Shenzhen has often been viewed as being a model example of what Paul Romer calls a charter city. Paul is the new chief economist of the World Bank. And he pushes this idea that cities should be innovative and allowed the space to try new things. And Shenzhen basically was a new city found on open reform policies. Now, how large have FDI flows been into China? This figure plots both the absolute amount of FDI utilized in China and also FDI as a share of GDP. So you can see that, even though Deng announced these opening up to foreign investment in the Joint Venture Law in 1979, nothing actually really happened until a decade later, when the conditions finally became right. After 1992, a famous trip by Deng to southern China kind of proclaiming the entrenchment of economic forum, there was a big increase in FDI. And then again after WTO entry in 2000, another big increase in the trajectory of FDI. But what's interesting is that if you look at the blue line, which plots FDI as a share of GDP, you see this big jump in 1993, but then it declines. And that is because the overall economy in China is growing so fast that even though FDI is growing fast, it's falling as a share of GDP. And if we look at all of the fixed investment occurring in China, again we see that FDI as a share of investment increases to about 1997 and then declines steadily. So that now FDI really accounts for just a fraction of fixed-asset investment in China. Which isn't to say it's not important in what it brings in terms of technology and linking China to global production chains. But in terms of just mobilizing capital, its importance is no longer very obvious. Now, what are the countries investing in China? This figure provides some information about the structure of the sources of investment over time. And one thing you note is that Hong Kong plays a dominant role. Hong Kong, Taiwan, and Macau, but most of this is Hong Kong money. And some of the Hong Kong money are from firms that have been set up by firms from other places, including domestically in China itself. So that type of capital is called round-trip FDI, which obviously is designed to allow domestic firms to qualify for the benefits of being a foreign invested firm without actually finding foreign investment. But other countries, too, often find it sensible to set up a base in Hong Kong and from there invest into China. So this is very significant. Other East and Southeast Asian countries are also important. And the green bars are the industrialized countries. And many of them are investing in China to try to capture the China market. What about the ownership form of FDI into China? Initially, almost all of the FDI coming into China was in the form of joint ventures, where a foreign company would partner with a domestic company. And over time you can see that the joint ventures, both the equity joint ventures in green and the contractual joint ventures in red, decline and are replaced pretty much entirely by wholly foreign-owned firms. So once foreign firms figured out how to do business in China, they no longer felt the need to have to partner with a Chinese enterprise. And WTO also mandated that this restriction of having to partner be lifted and allow foreign enterprise to set up their own firms. Finally, let's talk about what FDI has done for the economy, what are the benefits and costs for China. If we think about the benefits, the first is, initially at least, China lacked capital. It's a poor country, many poor countries need more capital. So this just provided more funds for investment in the early period. But of course later became less important. Yasheng Huang, a political scientist at MIT, has argued that some firms, and especially private-sector firms, had difficulty getting loans in China. And so the best way for them to get funding for investment was actually to get foreign partners through FDI. Of course, the big benefit that Deng himself highlighted, emphasized was technology. Technology transfer through partnering, having Chinese firms partner with foreign firms. Now, of course, foreign firms often want to limit the technology transfer, because they don't want to support eventual competitors. But obviously, part of the technology has to come into the country for the joint venture or foreign investment to work. And because workers from these enterprise can leave and start their own enterprises. And domestic firms can observe the products up close and understand how they're produced a bit better. Then there are many ways in which the technology diffuses into the local economy. Finally, foreign firms bring management practices, which can also be a kind of technology, that can benefit domestic firms as well. And initially, China really wanted the foreign firms to come in to help them develop a capacity to export and earn foreign exchange that could be used to purchase imports. And finally, FDI, by establishing new firms that are profitable, employs workers. And so it helps the government realize its goal of employing workers, providing manufacturing jobs that tend to be higher paying than, obviously, rural-sector jobs. Now, what about the costs? Are there any downsides to allowing so much FDI into China? Some countries are a bit reluctant to allow foreign capital into their countries too freely. Now, obviously, a cost is that many of the profits earned from FDI firms don't stay in the country. They leave, which is different than a domestic firm. And secondly, there may be some concern if foreigners are owning a large share of domestic assets. That in times of crisis or difficulty, it will be hard to control or influence those firms. And, of course, a big potential problem is that a very efficient firm that comes into China and sets up a factory, they may put the domestic competitors out of business. So there's this competitive pressure. Now, of course, competition can also be good in kind of instilling an incentive to be innovative and competitive among the domestic firms. So that can be a double-edged sword. And finally, there has been some concern in China and elsewhere that too much FDI, especially in the form of joint ventures, can actually inhibit innovation. So if Chinese auto producers can make a ton of money by partnering with US automakers, producing cars based on US company models and selling and making a ton of profits in China. They may have little incentive to develop their own capacity, to develop their own models and brands. Which over the long term may actually slow their development. For instance, Korea did not allow foreign firms to come into Korea in the auto sector, and they put a lot of pressure on their own domestic firms to develop cars. And we know there a lot of Korean cars now on the market that have been very successful, Kia, Hyundai, etc. What about the perspective of foreign firms coming into China? What are they thinking about in terms of the advantages and disadvantages of coming into China? Well the benefits, especially initially, to coming to China was the low wages of labors. So you could produce, labor intensive products in particular, extremely cheaply, and therefore export them at very competitive low prices. Many were attracted by the domestic market as well. And China also had a pretty well-educated, disciplined labor force. And cheap, many workers coming from the countryside as rural migrants. And China maintained a pretty stable political, low-cost production environment, which is what managers care about the most. And finally, over time, the links to suppliers and customers that were possible in China allowed for lots of efficiencies in terms of opening a manufacturing enterprise. because you could get pretty much everything you needed locally. Now, what about the costs? Well, most international, multinational firm managers are worried about risk factors like corruption, anything that creates something that's unpredictable. The undeveloped legal system, the lack of property rights protection, especially intellectual property rights protection. And of course, there may be other political risks, etc.
