FDI in China: Institutional Evolution and its Impact on Different Sources

Transcription

1 FDI in China: Institutional Evolution and its Impact on Different Sources Chen Jing 1 Yuhua Song 2 Zhejiang University, P.R.China Abstract The institutional infrastructure towards FDI in China has experienced a fundamental change attributing to the economic reform since It plays an important role in establishing a business-friendly environment for further FDI promotion. From 1979, China has devoted arduous efforts in earning strict confidence from foreign investors due to the foregone socialist planning economic system. At the early stage, Hong Kong (including Macao) dominated the FDI inflows to China. From 1987, Hong Kong reached its turning point and changed its invest patterns. The confirmation of economic reform and policies has updated the institutional infrastructure since 1992 and brought huge FDI inflows both in kinds and volume. The proportion of the different sources was changing. China entered WTO began a new era for China s FDI inflow. This paper intends to examine such an argument via the following focuses: (1) to trace the legal opening up and FDI specific policies in four stages, (2) to study the 1 Correspondence to: Chen Jing Chukechen Honors College Zhejiang University P.O.Box 1312, Zhejiang University, P.R. China evita1027@hotmail.com Ph: Professor Yuhua Song Department of Economics Zhejiang University, P.R. China syuhua@hotmail.com Ph: Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

2 different patterns of different FDI sources in the different stages, (3) to analyze the institutional impact on the patterns and behavior of different FDI sources from formal and informal institution, and build up a model based on Neo-Classical growth model. Results of the study demonstrate that the changing proportion of the different FDI sources in the different stages is correlated with the institutional evolution. And certain institution variables play a significant role in affecting the proportions of FDI from different sources. I. Introduction Since 1979, China has begun to open its front door to the foreign investors. Through the two decades, the institutional infrastructure towards FDI in China has experienced a fundamental change and China has become one of the most important destinations for foreign direct investment in the world. In 2002, China s FDI inflows even surpassed that of the United States and became the biggest host country for FDI in the world. Comparing with an inflow of $US 30 billion into United States, FDI into China amounted to $US 53 billion in The institution towards FDI in China is composed of formal and informal institution. The formal institution can be divided into direct and indirect institution. The direct institution is China s FDI policy, which will directly influence the behavior of foreign investors. The indirect institution is the pertinent policy towards State Owned Enterprises, qua the institutional foundation of FDI, which has an indirect impact on foreign direct investment. The informal institution is the marketization of the investment environment of China s inward FDI, which is mainly represented by the significance of culture and hometown connection to the different investment sources. The institutional evolution towards China s inward FDI has a great influence upon the proportions of FDI inflows from different source countries. Figure 1 shows the percentages of actually used FDI inflows into China by developing and developed Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

3 source countries from 1984 to (According to Appendix 1) We can clearly observe that the proportions of FDI from different sources greatly changed through years. Therefore, we divide the institutional evolution towards China s inward FDI into four stages according to the data. The first stage is from 1979 to During this stage, investment from developing countries, especially from Hong Kong (including Macao) dominated the FDI inflows to China. From 1987 to 1991 is the second stage. In this stage, the proportion of developing countries greatly increased comparing to that of the first stage, Hong Kong even reached its turning point and the proportion of developed countries decreased at the mean time. The third stage is from 1992 to During this stage, FDI from developing countries shrunk from 81.55% to 53.56%, while FDI from developed countries greatly expanded from 13.55% to 26.64%. The gap of the proportion between developing countries and developed countries gradually decreased. The fourth stage is from 2001 to present, in which period several institutional transformations occurred after China entered WTO and a distinct change of the proportions of different source countries can be anticipated. Figure 1, Actually Used FDI inflows into China by Developing and Developed Source Countries, (Percentage ) Source: Appendix 1 This paper tries to validate that the institutional evolution towards China s inward FDI has a great impact on the proportions of FDI inflows from different source countries Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

4 and some institutional factors have different significance to the source counties. In the second section, we study the different patterns of different FDI sources. In the third section, we build up a model based on the neo-classical growth model and induce 5 institutional variables. In the fourth section, we explore China s FDI policy evolution in 4 stages and its impact on different source countries. We then analyze the pertinent institutional evolution towards SOEs, who serve as the institutional foundation for FDI, and its contribution to the structural changes of China s FDI. At last, we work over the marketization of investment environment and research on the role of culture and hometown connection in investment decisions. We hope our research can not only reveal the significance of certain factors in attracting certain kind of FDI, but also forecast the further trend of the changes of China s FDI inflows by analyzing the institutional evolution towards China s inward FDI. We hope we can contribute to the further studies of China s FDI inflows to some extent. II. Comparisons of invest patterns of different Sources i. FDI from Developing Countries FDI from developing countries mainly include FDI from Hong Kong, Taiwan, Macao, Singapore and Republic of Korea. From Table 1, we can clearly observe that the FDI from developing countries is more than half of the total inflow, which is the most dominant force of China s inward FDI. FDI from developing countries aim to fully utilize the cheap labor costs in Mainland China to develop the traditional labor-intensive industry, in which China has comparative advantages, just like assembly and processing operations. The comparative advantages of the investment from developing countries can be seen in various aspects. First, most of the FDI from developing countries are vertical 3 (export-oriented) FDI (Markusen,1995; Zhang and Markusen,1999), which highly 3 The vertical FDI, motivated by foreign cheap labor, fragments the production process across countries by production stages based on labor intensities. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

5 matched the export-promotion FDI regime in the early stages of China. Second, most of the FDI from developing countries are small and medium sized business that are involved in industries which China has comparative advantage. It makes FDI from developing countries easy to operate and flexible to retreat from such an uncertain environment in the early times. Third, in China, a nation emphasizes the role of relationship and network in business, developing countries appear to own much superiority in information collection. They are much more familiar with the market than the developed countries and it can greatly help them to avoid the informal barriers in China. As FDI from developing countries can always find informal channels to solve problems, such as friction and complex procedure, they do not have the strict request for institution infrastructure in the investment environment. It seems that the competitive edge of developing countries rests primarily on managerial and marketing advantages in entering, marketing and selling light consumer goods (USCBC, 1991). Fourth, a large portion of FDI from developing countries is provided by oversea Chinese. They prefer to invest in coastal areas which they have hometown connection, such as Guangzhou, Fujian. The cultural and language advantage play an important role in investment decision. Therefore, most of the FDI from developing countries prefer to build up equity joint venture and cooperative joint venture, as the transaction cost for them is much less than that of developed countries when building up the same enterprise. At last, about 50% of the Hong Kong FDI represented a recycling of capital from Mainland China, called Round-Tripping FDI, which sought to take the advantage of preferential treatment given to foreign investment. (Lardy, 1996). Furthermore, domestic capital tends to be relatively immobile between regions, some Round-tripping FDI can be seen as a result of the intra-regional barriers to capital flows within China. Comparing with the FDI from developed countries, who aimed to the huge market size, Round-Tripping FDI is superior in profiting from the preferential policies than developed countries to some extent. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

6 The comparative disadvantages of FDI from developing countries are obvious. They appear to lack ownership advantages such as advanced proprietary technology and established brand name. The spillover effect of the FDI from developing countries is much less than that of developed countries. Besides, the small and medium size firm benefits less from economies of scale. ii. FDI from developed countries FDI from developed countries mainly include FDI from United States, Japan, United Kingdom, Federal Republic of Germany, France, Italy, and Canada. From table 1, we can clearly see that the FDI from developed countries is about 1/3 of the total amount. And since 1992, FDI from developed countries has gradually increased and become one of the major sources of China s FDI inflows. The target of the FDI from developed countries is the huge market size of China. And this kind of FDI is called horizontal 4 (market-oriented) FDI (Markusen, 1995; Zhang and Markusen, 1999). FDI from the US, EU and Japan have been focused on large import substituting areas such as automobiles and off-shore petroleum and other natural resource sectors, in which China does not have comparative advantage. The comparative advantages of FDI from developed countries appear in following aspects. First, FDI from developed countries usually prefer to build up larger enterprise size and the larger market size in China offers greater opportunities to realize effectively economies of scale (Zhang, 2000b). Second, in contrast to FDI from developing countries, FDI from developed countries hold advantages of ownership, such as advanced proprietary technology and established brand names. They are perfectly matched with the technology-promotion FDI regime of China in the latter stages. And the spillover effect of management and technology is much greater than that of developing countries. 4 Horizontal FDI are induced by foreign market access build plants in multiple countries to serve local markets. (Zhang, 2000b) Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

7 The comparative disadvantages of FDI from developed countries are as follows. First, the foreign investors from developed countries are not quite familiar with the investment environment due to the cultural and customary barriers. They lack advantages of collecting information, entering and marketing comparing with FDI from developing countries. Second, FDI from developed countries have higher requirement for human capital and infrastructure in the host country. They strictly require intellectual property protection and prefer to use the formal channel, just like judiciary and administration, to solve problems. They apt to invest in Shanghai, Jiangsu etc, where has better market infrastructure and labor quality. Third, in order to protect the advanced technology, FDI from developed countries usually prefer to adopt Wholly-Owned Subsidiaries or have better asset control, thus the transaction cost is much greater than FDI from developing countries. iii. Comparison of FDI from different sources. Table 1 gives out a direct comparison of FDI from developing countries and developed countries. Thus we can get a thorough understanding of the invest patterns of FDI sources. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

8 Table 1. Comparison of FDI sources LDCs DCs Target Low labor cost Huge market size Advantages Export-oriented Small and medium size Managerial and marketing advantages Cultural and language advantage Enjoy preferential policies Larger enterprise size Advantages of ownership Disadvantages Lack ownership advantage Benefits less from economies of scale Cultural and customary barriers Higher requirement for human capital and infrastructure Higher transaction cost Source: The Study III. Institutional Model of FDI (1) Variables i. Preferential Policy (T): The Preferential Policy is measured by the tax, and its expected impact should be negative. ii. The Degree of Openness (DTD): The Degree of Openness is measured by the degree of trade dependence, and its expected impact should be positive. iii. The Market Entry (CIR): The Market Entry is measured by the control of industrial and region, and its expected impact should be negative. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

9 iv. The Steadiness of Institutions (PCI): The Steadiness of Institutions can be measured by the persistence and continuance of institutions, and its expected impact should be positive. v. Market Perfecting (MSM): The Market Perfecting can be measured by the market size and marketization. Marketization includes the relationship between government and market, development of Non-state economy, maturity of product market, maturity of factor market, maturity of market agency and the environment of juristic institution 5. Its expected impact should be positive. (2) Model (1) Q= AF( K, L) (2) K = (1 δ ) Kt 1 + I + FDI (3) FDI = φ( T, DTD, CIR, PCI, MSM ) (4) K = (1 δ ) Kt 1 + I + φ( T, DTD, CIR, PCI, MSM) (5) φ = B( CIR, PCI, MSM ) G( T, DTD) (6) φ = φdc + φldc (7) φ = B ( CIR, PCI, MSM ) G ( T, DTD) + B ( CIR, PCI, MSM ) G ( T, DTD) DC DC LDC LDC α β (8) G = λ T ( DTD), α + β <1 DC χ γ (9) G = µ T ( DTD), χ + γ <1 LDC (10) φ = B ( CIR, PCI, MSM ) λ T ( DTD) + B ( CIR, PCI, MSM ) µ T ( DTD) DC α + β <1, χ + γ <1 α β χ γ LDC Hypothesis 1: As FDI from developing countries is superior in profiting from the 5 According to NERI Index of Marketization of China s Provinces (2000), Fan Gang, Wang Xiaolu, National Economic Research Institute, China reform Foundation. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

10 preferential policies than developed countries, the marginal revenue of tax is negative, and the marginal revenue of developing countries is lower than that of developed countries. Therefore: dg LDC dt < dgdc dt <0 Hypothesis 2:As most of the FDI from developing countries are export-oriented; a higher degree of trade dependence of the host country would provide larger market for the FDI from developing countries. Thus the marginal revenue of the Degree of Trade Dependence is positive, and the marginal revenue of the Degree of Trade Dependence of developing countries is higher than that of developed countries: dg LDC ddtd ( ) > dg DC ddtd ( ) >0 Hypothesis 3: As FDI from developing countries have managerial and marketing advantages, in contrast, FDI from developed countries have higher transaction cost, the Control of Industry and Region have higher negative effect on FDI from developed countries: φ B DC DC dbdc φ < dcir ( ) B LDC LDC dbldc <0 dcir ( ) Hypothesis 4: The cultural and language advantages of FDI from developing countries can usually help the investors to avoid the institutional risk, therefore the marginal revenue of the persistence and continuance of institution is higher for the FDI from developed countries, who usually have cultural and language barriers: φ B DC DC dbdc φ > dpci ( ) B LDC LDC dbldc >0 dpci ( ) Hypothesis 5: As FDI from developed countries aim to the huge market size in China, and they usually have larger enterprise size and advantage of ownership, their higher Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

11 requirement for human capital and infrastructure also make them more benefit from the Market Size and Marketization, therefore: φ B DC DC dbdc φ > dmsm ( ) B LDC LDC dbldc >0 dmsm ( ) IV. Policy Evolution towards FDI in China. Since China s economic opening in 1978, law making, reform in institutional infrastructure and regional opening FDI specific policy adopted can be represented by a four-stage evolution process. (1) The first stage ( ) The promulgation of Equity Joint Venture Law in 1979 is the milestone of China s opening up in FDI specific area. During this period, law making to provide legal status for FDI related activities in socialist economy were pursued (Chyau Tuan and Linda F.Y.Ng, 2002). A checklist of the land-marked legislation for the four stages is given in Appendix 1. During this stage, law making was focused on Equity Joint Venture. Several specific laws and regulations about Equity Joint Venture were promulgated, including registration, labor management, accounting system, foreign exchange and etc. Equity Joint Venture served as an example for FDI in other organizational forms. And Wholly Owned Subsidiaries was still a concept in law, but seldom in practice. In this period, regional opening was launched on leaning by doing basis. (Chyau Tuan and Linda F.Y.Ng, 2002). First, four special economic zones (SEZs) were set up for accommodating FDI inflows in Preferential policy towards foreign capital was implemented on a trial basis. Five years later, 14 coastal port cities including Shanghai & Guangzhou were opened for FDI. Economic open regions were announced for Yangtze River Delta, Pearl River Delta (PRD) and Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

12 Xiamen-Zhanzou-Chunzou Triangle in This period, the policy towards FDI was still on trial, thus there were great restrictions on FDI activities, such as restrictions on foreign exchange, domestic market entering and equipment purchase, etc. Thus the accumulated amount of FDI inflow ( ) was still small, about US$7.5 billion or US$0.9 billion per year on average. Investment from Hong Kong (including Macao) dominated the FDI inflows to China. Most of the Hong Kong investment projects were in form of cross-border (SEZ s and proximate cities in Guangdong) manufacturing/processing of labor-intensive products, real estate development, and hospitality business. By utilizing the advantage of familiarity of the market and investing in the industry which China has comparative advantage, FDI from Hong Kong (including Macao) was much easier to operate, thus Hong Kong served as a pioneer in China s FDI inflow. (2) The second stage ( ) This stage was mainly represented by enlargement or fine-tunes of FDI specific legislation and allowance of more open areas (Chyau Tuan and Linda F.Y.Ng, 2002). During this stage, several laws and rules were enacted and improved, including the laws of Joint Venture and Wholly Owned Subsidiaries and the critical mass in terms of legal, institutional and physical infrastructing might be also formulated around 1991/1992 in some early opened areas. More coastal areas such as Shandong and Liaodong peninsulas, and Hainan (SEE) were opened in Pudong New Area of Shanghai was also established in During this period ( ), FDI inflows increased by almost 4 times than the first stage to account for US$ billion, or an annual average of 3.34 billion. In addition to the export-promotion regime in this period, State Government promulgated Provisions of the State Council Concerning the Encouragement of Investment by Compatriots from Taiwan in 1988 and Regulations for Encouraging Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

13 Investment from Overseas Chinese and Compatriots from Hong Kong and Macao in 1990, which was a great encouragement for the FDI from Hong Kong, Taiwan and oversea Chinese. FDI from developing countries, especially from Hong Kong, Taiwan and Macao drastically increased and the proportion of developing countries in FDI inflows also gradually increased to 68.40% in From the fourth quarter of 1987 and thereafter, the volume of the re-exports from Hong Kong exceeded her domestic exports. The accumulated effects of cross-border processing from 1979 to 1986 finally pushed Hong Kong s manufacturing reach the turning point by moving toward a more complete division of labor between regions (Tuan and Ng, 1995b). Hong Kong s successful experience in Guangdong helped China to earn international confidence finally by build-up of her track record in its policy consistency. But as the restriction of foreign exchange in China, it s still hard for investors from developed countries to retract capital. Contrarily, most of the investments from developing source are export-oriented, which will avoid the foreign exchange restriction. Besides, FDI from developing sources can always find the informal channels to solve the problems, such as entering and complex procedure, which made much contribution to the surge of FDI from developing countries. But it worth to mention that maybe the huge amount of actual FDI from Hong Kong is overestimated due to the Round-Tripping FDI, which is the capital flight flow out of China and then flow back into China as the foreign capital in order to enjoy the preferential policy and avoid the immobility of domestic capital. (3) The Third Stage ( ) Mr. Deng s speech in October 1992 began a new era for FDI inflow in China. China s determination in establishing a Socialist Market Economy as a national policy gave foreign investors great confidence in investing in China. FDI inflows increased by almost 19.5 times than the second stage to account for US$ billion, or an annual average of billion. FDI regime in China turned administrative-oriented into market-oriented. The extended openness can be seen not only in the open area, Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

14 but also in the national institution. Six riverside port cities, 13 inland border cities and 18 provincial capitals were opened and delegation of FDI approval was granted in Opening has been continued and in fact expanded to cover all mainland areas. And cities like Shanghai, Suzhou, which has better institutional infrastructure and purchase power, became the hottest destination for FDI, especially FDI from developed countries. The institutional infrastructure has been much more systematic and standard. The government tried to attract part of the investment from eastern coastal cities to western cities. In this period, the amount of FDI has increased rapidly and its contend also altered. USA, Japan and European Union gradually expanded their share of FDI inflows to achieve nearly 30% of FDI in China. FDI from developing countries decreased its share from 81.55% in 1992 to 53.56% in The institutional infrastructure towards China s FDI has been much improved since Several specific laws have been announced, not only to protect the legal status of foreign investors, but also to meet the higher institutional needs of the western investors, including simplify the procedures, specify the rules and standardize the regulations. Thus the FDI from developed countries greatly increased during this period. As the foreign exchange controls in this period has been much released, investors from developed countries no longer worried too much about retracting capital. It would boost up the confidence of FDI from developed countries and it must be one of the major reasons for the expansion of the share from developed countries. Since the Ninth Five-Year Plan ( ), attraction of technology intensive FDI has become the priority of many local governments in China, more pro-active FDI policies has enabled the participation of FDI to extended from labor-intensive manufacturing to capital/knowledge-intensive manufacturing and services and from public to private ownerships (Chyau Tuan and Linda F.Y.Ng, 2002). China used some policy tools to attract Hi-Tech FDI. With Pudong as an example, the major policy tools, on top of the other FDI preferentials, including financial measures as follows Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

15 (Lin, et.al, 2000): (1) full (100%) return of value-added tax and business income tax for three years for computer hi-tech, medical and material industries; (2) full tax return for two years for other recognized hi-tech industries; (3) full or partial tax concessions in new technology importations, transfer of technology, and new technology exhibitions; and (4) government express services in taxation, registration, various purchasing assessments, and permissions, etc. Further, areas such as Suzhou Industrial Park, Suzhou New Zone, Shengzhen SEZ, and Zuihai SEZ had been provided with similar attraction in the past few years. FDI from developed countries exactly met the need of China s national policy. The revision of Guideline for FDI in 1997 clearly indicates the transference from export-promotion FDI regime into technology-promotion FDI regime. Hi-tech industries have been much increased in catalogue of hortative industries, at mean time been much decreased in catalogue of restrictive industries. (4) The Fourth Stage (2001-present) In order to meet the criteria of WTO, China has begun another institutional reform since A series of laws and regulations has been revised and several new rules have been promulgated. The investment market of FDI in China has been more open, systematic and technology-oriented. The extended openness of China s FDI market in this period can be seen in two aspects. The first one is the market which permits foreign investors entering has been expanded. According to the Catalogue for the Guidance of Foreign Investment Industries, the hortative industries have been much increased, at same time, restrictive industries and inhibitive industries have been much reduced. It is worth to mention that the financial sectors and service sectors have been opened to a much better extent. And foreign investors are permitted to sell products in domestic market more freely. The second aspect is represented by the looseness of restriction, including the restrictions of foreign exchange control, employment requirement, distribution and etc. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

16 The competition between foreign capital and domestic capital is fairer. In order to meet the standards of WTO accession, China has promulgated series of specific laws and regulations. The accounting system, instauration procedure and operation measures have become more systemic and normative, which would highly meet the criteria of developed countries. Although we do not know much about the share of China s FDI inflows by different sources in this period, another surge of FDI from developed source can be anticipated. Keeping on the technology-promotion FDI regime, China gives more privilege to Hi-Tech industries, which can be observed in series laws. It can be also seen in the Catalogue for the Guidance of Foreign Investment Industries, more Hi-Tech industries are in catalogue of hortative industries. V. Pertinent institutional evolution towards State Owned Enterprises Because of the policy and legal restriction in the early period, most of the FIEs in China took the form of joint ventures with Chinese shareholding firms and most of the Chinese shareholding firms were SOEs. After 1990s, state assets have become more acquirable; some FDI inflows take the form of acquisition of existing assets rather than green-field investment, especially state assets. Thus, institutional evolution towards SOEs, which serves as the institutional foundation of FDI in China have great impact on FDI inflows. Some findings suggest that the debt obligations on the part of the SOEs and the local control of the SOEs promote the growth of FIEs and that some of the foreign direct investment (FDI) inflows result in acquisition of existing assets and shift assets control from SOEs to FIEs. (Yasheng Huang, 1999) Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

17 In the early stages (Before 1990) In the early stages of China s FDI inflows, vast majority of the FIEs were joint ventures between Chinese firms and MNEs, which were mainly formed by developing countries, vast majority of the Chinese shareholding firms were SOEs. In these stages, SOEs were protected by government and all the profit and loss were balanced by the state budget. The SOEs could hardly realize the low efficiency and high waste and didn t highly require for changes. They took the alliance with MNEs as strategy alliance and asset of the SOEs were not easily acquirable, SOEs sought to ally with MNEs with high asset control. From table 3, we can clearly conclude that MNEs who took the alliance with SOEs with low asset control in this period were FDI from developing countries. In this period, SOEs may view alliances with MNEs as an access to the deep financial and technological base of the MNEs, either to launch new products or to gain markets as the Chinese competitive landscape intensifies. Another related motives is to raise cash quickly to service the onerous social and policy burdens placed on the SOEs, such as funding pensions of retirees, medical expenses and unemployment contributions. Shares in FIEs may yield dividend payments that match better with SOEs liabilities than their operations. (Yasheng Huang, 1999). Chinese SOEs are divided into central and local enterprise. Local governments plan a prominent supervisory and financing role in economy. 6 As of 1995, according to the 1995 Industry Census, there were 87,905 SOEs, of which 83,167 of them were local SOEs. Local SOEs accounted for 54 percent of the industrial value added and 65 percent of the assets in the state sector. Local governments are extremely motivated to seek foreign alliance in the early years. Because FDI can not only help to solve the problem of unemployment, but also has advantage of mobility comparing to the domestic capital, local governments compete with each other to capture a bigger share 6 See [Montinola, Forthcoming #1225] Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

18 of the capital inflows. Capital competition often prompts local governments to grant generous tax concessions, subsidized bank credits, and undervalue Chinese equity contributions (often in the form of heavily subsidized land usage charges.) In the late Stages (After 1990) After 1990, majority of FIEs are still Joint Venture, but the number of Wholly Owned Subsidiaries and Joint Ventures with higher foreign control are increasing due to the boom of FDI from developed countries in the 1990s. Merger and Acquisition of state assets become a prevalent form of establishing FIEs in China. In the later stages, as more SOEs faltered, more of their assets were acquirable. SOEs no longer create Joint Venture with MNEs as strategy alliance, but more as the result of financial distress. SOEs gradually lost the assets control to their foreign copartners in order to raise liquidity, and it would just match the need of high assets control of FDI from developed countries (Table 2). Besides, after China entered WTO, encouraging foreign investors to join the reform of SOEs by means of transitional M&A is a major breakthrough for China s FDI regime. Some findings suggest that some of the FDI inflows take the form of acquisition of existing assets rather than green-field investments in 1990s.Thus acquisition of existing assets, especially state assets was a prevalent way and will be a more prevalent way for investors from developed countries to build Wholly Owned Subsidiaries and Joint Venture with high assets control. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

19 Table 2 Equity Shares of the developing and developed source countries (based on the approvals of 1994) Equity Share of FFEs Developing country FFEs(100%) Developed country FFEs(100%) Under 25% <50% <75% <100% % Total Source: Calculated from the Editorial Board of the Almanac of China s Foreign Economic Relations and Trade (1995), Zhangguo Duiwai Jingji Maoyi Nianjian 1995/1996 [Almanac of China s Foreign Economic Relation and Trade1995/96], Zhongguo Shehui Chubanshe, Beijing VI. Marketization of investment environment The marketization of China can be evaluated by the NERI Index of marketization, including the relationship between government and market, development of Non-state economy, maturity of product market, maturity of factor market, maturity of market agency and the environment of juristic institution 7. Before 1992, low level of the institutional infrastructure, low government efficiency and lack of market transparence directly halted the confidence of FDI from developed countries. But FDI from developing countries, just like Hong Kong, Taiwan, Singapore can utilize the cultural ties to solve the institutional barriers, including collecting informal information and averting complex procedures. Information on labor and material costs, suppliers, distributions, and other market conditions is often 7 According to NERI Index of Marketization of China s Provinces (2000), Fan Gang, Wang Xiaolu, National Economic Research Institute, China reform Foundation. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

20 necessary to assess the future profitability of an investment project. The network and personal relationship deeply embed into every Chinese s ethic, so the role of connections is particularly important. Thus FDI before 1992 were mainly FDI from developing countries with cultural ties, invested in Guangzhou, Fujian, where oversea Chinese have better hometown relationship. Some findings suggest that cultural ties with Hong Kong, Taiwan and Singapore alone would be responsible for 60% of total FDI. (Ting Gao, 2002) After 1992, the fast growing marketization of eastern coastal cities, just like Shanghai, Suzhou, attracts large amount of FDI from developed countries. The risen efficiency of government and better market transparence provide a much better investment environment for FDI from developed countries. Besides, the modern concepts of profit, justice and efficiency began to instill into modern Chinese, especially people living in open areas. Thus, FDI from developed countries, which invested in Shanghai, Jiangsu become conspicuous land scenery in China s opening process. VII. Conclusion After more than two decades of openness, the institutional infrastructure towards FDI has experienced a fundamental change in China. The institution is much more formal, systematic, open and improved in order to meet the high requirement of the fast growing development of Socialist Market Economy. The institutional evolution towards FDI has a far-reaching impact on different source countries. With the preferential policies and export promotion regime in the early stages, FDI from developing countries had better return and saved as the dominant force. With the improving law making, loosening restriction and opening competition, continuous institution and better market infrastructure in these 24 years, the share of FDI is diverting to the developed countries. FIEs with high foreign controls, which Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

21 are formed by developed countries has become a prevalent organization form in current years and would be more prevalent in the future. Cities with better market infrastructure, like Shanghai, Jiangzhou, have be the hottest destinations for the increasing FDI from developed countries and the role of cultural ties would be a much less consideration in the future, marketization of the investment environment would be an important factor in investment decision. We can speculate that FDI from developed countries would play a more significant role in contributing to the national economic growth in the near future. Further research can be done to quantify some of the institution indexes and revise the FDI model. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

22 APPENDIX 1 Actually Used FDI inflows into China by Developing and Developed Source Countries, (Percentage) LDCs DCs LDCs DCs Source: Various issues of China Statistical Yearbook, National Bureau of Statistics of China, China Statistics Press. APPENDIX 2 A checklist of landmark Legislation of FDI policy in China Stage 1( ) Equity Joint Venture Law (1979) Regulation for the implementation of the law of the People s Republic of China on Chinese-foreign Equity Joint Ventures.(1983) Wholly Owned Subsidiaries (WOS) Law.(1986) Provision for the FDI Encouragement (1986) Constitutional Status of Foreign Invested Enterprises in Chinese Civil Law (1986) Stage 2( ) Interim Provisions on Guiding FDI (1987) Delegation on Approval of selected FDI Projects to more Local Governments (1988) Laws of Cooperative Joint Ventures (1988) 8 LDCs include Hong Kong, Taiwan, Macao, Singapore, and Republic of Korea. 9 DCs include United States, Japan, United Kingdom, Federal Republic of Germany, France, Italy, and Canada. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

23 Revision of Equity Joint Venture Law (1990) Rules for Implementation of WOS Law(1990) Income Tax Law and its Rules for Implementation(1991) Stage 3( ) Trade Union Law (1992) Company Law (1993) Provisions Regulations of Value-added Tax, Consumption Tax, Business Tax and Enterprise Income Tax (1993) Law on Certified Public Accountants (1994) Law of the People's Republic of China on Protection of Taiwan Compatriots' Investment(1994) Provisions for Foreign Exchange Controls(1994,1997) Insurance Law(1995) Law of Commercial Bank(1995) Detailed rules for implementation of Cooperative Joint Venture Law.(1995) Provisions on Guiding Foreign Investment Direction (1995,1997) Further delegation For Approving FDI to Local Government(1996) Industrial Catalogue for Foreign Investment in the Central and Western Regions.(2000) Stage 4(2001-present) Revision of Equity Joint Venture Law (2001) Revision of regulation for the implementation of the law of the People s Republic of China on Chinese-foreign Equity Joint Ventures (2001) Rules for Implementation of WOS Law (2001) Provisions on Guiding Foreign Investment Direction (2002) Source: FDI in China and the Regional Development: From Institutional Reform to agglomeration Economics Perspectives Chyau Tuan and Linda F.Y.Ng, 2002, Revised by the study. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

24 References Chen Chunlai(1997): Comparison of Investment Behavior of Source Countries in China. Chinese Economies Research Center Working Paper, No 97/14. Chyau Tuan and Linda F.Y.Ng (2002): FDI in China and the Regional Development: From Institutional Reform to agglomeration Economics Perspectives Presented in the first International Conference on National State and Economic Policy: Conflict and Cooperation David D.Li(2001): The Changing Pattern of Foreign Investment, Econ 517, 2001 Edward M. Graham, Erika Wada, 2001: Foreign Direct Investment in China: Effects on Growth and Economic Performance, Oxford University Press, GC.comm. (2002): The Foreign Investment Climate, June Xiaojuan Huang (2002): Zhongguo de Waizi Jingji, Zhongguo Renmin Chunbanshe, 2002 Jack W. Hou: China s FDI Policy and Taiwanese Direct Investment (TDI) in China. Kevin Honglin, Zhang (2002): Why does China receive so much Foreign Direct Investment? China & World Economy, Number 3, 2002, Lai Pingyao (2002): Foreign Direct Investment in China: Recent Trends and Patterns, China & World Economy, 2002, No Lee G Branstetter and Robert C Feenstra (1999): Trade and Foreign Direct Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

25 Investment in China: A Political Economy Approach Leonard K.Cheng and Changqi Wu (2001): Determinants of the Performance of Foreign Investment, Jan 2001 Michael Thorpe (2002): Inward Foreign Investment and Chinese Economy. New Zealand Conference of Economists Annual Conference. Milano (2001): Chinese Diaspora In the United States, CEMS Seminar, Nov 23-24,2001 National Economic Research Institute (2000): NERI Index of Marketization of China s Provinces, China Reform Foundation, Jingji Kexue Chubanshe, 2001 Robert C Feestra (1998): Facts and Fallacies about FDI Robert C Feestra (1998): One Country, Two System: Implications of WTO Entry for China State Statistical Bureau (SSB): Statistical Book of China ( ), China Statistics Press, Beijing, China The World Bank (2002): Global Development Finance 2002, Financing the Poorest Country The World Bank (2001): Global Development Finance 2001, Building Coalitions for Effective Development Finance The World Bank (2002): World Development Report 2002, Building Institutions for Markets Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources

26 Ting Gao (2002): Foreign Direct Investment in China, How Big are the Role of Culture and Geography. Xiaohui Liu, Peter Burridge and P.J.N.Sinclair (2002): Relationships between economic growth, foreign direct investment and trade: Evidence from China, 2002,34, Yasheng Huang (1999): The Institutional Foundation of Foreign-Invested Enterprise (FIEs) in China. Chen, J., & Song, Y., FDI in China: Institutional Evolution and its Impact on Different Sources