EU FDI IN CHINA: LOCATIONAL DETERMINANTS AND ITS ROLE IN CHINA S HINTERLAND

Transcription

1 Proceedings of the 15 th Annual Conference of the Association for Chinese Economics Studies Australia EU FDI IN CHINA: LOCATIONAL DETERMINANTS AND ITS ROLE IN CHINA S HINTERLAND Bernadette Andreosso-O Callaghan # Xiaojun Wei University of Limerick, Ireland ABSTRACT The Western Development Strategy launched by the Chinese government in the year 2000 is aimed at addressing the growing problem of regional disparities in China. Based on attracting foreign direct investment (FDI), the FDI-led Economic Development strategy in China s hinterland may ultimately benefit both the whole of China and the foreign investors themselves. The question of how to prevent a potential danger of further developmental disparities caused by FDI in China is imperative to the current Chinese economy as well as to its political authorities. This paper mainly analyses the EU FDI location determinants in China. It also addresses briefly its role, along with the other major stakeholders in promoting Chinese economic integration in China s hinterland. This article focuses on the disparities of FDI allocation as well as on the comparative advantage and barriers to FDI in China s hinterland. Following a background literature review, the article will analyze the spatial determinants of EU investment in China, using # Correspondence to: Dr. B. Andreosso-O Callaghan Jean Monnet Professor, Head, Department of Economics Euro-Asia Center, University of Limerick IRELAND bernadette.andreosso@ul.ie Tel: Fax: ( bernadette.andreosso@ul.ie) Xiaojun Wei PhD Researcher, Euro-Asia Center, Graduate Center of Business, Univeristy of Limerick, IRELAND xiaojun.wei@ul.ie The help of Ms Jun Zhang, in the collection of relevant data at the initial research stage, is greatly acknowledged

2 of a comprehensive data set of EU FDI in the late 1990s; it will then discuss the role and benefit of EU FDI in China s hinterland. For many years, MNCs as main FDI players in China, - either market seekers or resource seekers -, have been benefiting from locational advantages, labour advantages and government policies such as the special economic zones and the export promotion development strategy in Coastal China; foreign investors have in turn been contributing to this area s dramatic economic boom. Yet, these players are discouraged to venture into China s hinterland, a disadvantaged location congested with SOEs (State Owned Enterprises), thereby further exacerbating the economic disparities that have traditionally existed. However, in the long term, foreign investment, especially that originating from an area such as the EU, characterized by its commitment to the Chinese domestic market more than to exporting, is expected to flow substantially into China s hinterland, if and only if more open government policies are introduced to enhance the comparative advantages therein. KEYWORDS Spatial Determinants of FDI in China, E.U. FDI to China, FDI to China s Hinterland - 2 -

3 INTRODUCTION Due to its large economic scale and special political background, China s open door policy and development strategy through FDI constitute a unique and vast laboratory for the study of economic and social change in China, as well as its influence on the world economy. In addition, these are also a testimony of the successfulness of the economic policies introduced by the Chinese authorities. It is well acknowledged that China s current foreign investment regime remains far from open, and that FDI is still too much concentrated in the more developed eastern sea belt region 1. On the one hand, the investment policy allowing the approval of projects involving FDI was transferred to special economic zones and/or cities in the coastal regions since the open door policy was implemented. The existence of foreign MNCs helped build a healthy cycle in improving the investment environment attained in these areas. On the other hand, the unbalanced development strategy and the concentration of FDI in the eastern coastal areas have caused constantly growing regional developmental disparities ever since the Chinese economic transformation. The Chinese Central Government has devoted lots of energy and resources to address this issue. Nevertheless, the Western Development Strategy 2 launched in 2000 may seem to address more a political will than a pan-economic reality. It may be that the FDI-led Economic Development strategy in China s hinterland (Central and West regions) 3 could benefit both the whole of China and the foreign investors themselves. The question of how to prevent a potential danger of further developmental disparities caused by FDI in China is imperative to the current Chinese economy as well as to its political authorities. Virtually no study on FDI in China has failed to point out the gigantic gap of foreign capital inflows between Coastal and Hinterland China, and its fatal consequences in terms of Chinese economic integration; however few have really addressed the possible ways in improving the situation. In addition to the analysis of current FDI location determinants, this paper takes one step forward by discussing briefly the role and benefits of FDI along with other major stakeholders in promoting 1 According to the national administrative division, the Eastern region includes Beijing, Tianjin, Shanghai, Liaoning, Hebei, Shandong, Jiangshu, Zhejiang, Fujian, Guangdong, Hainan and Guangxi (3 Municipalities and 9 Provinces). 2 The West Development Strategy adopted by authorities also includes Guangxi and Innner Mongolia. 3 The Central Region includes Inner Mongolia, Heilongjiang, Shanxi, Jilin, Henan, Anhui, Jiangxi, Hunan, Hubei (9 Provinces). The Western Region includes Chongqing, Shannxi, Ningxia, Ganshu, Sichuan, Qinghai, Xingjiang, Tibet, Yunnan, Guizhou (1 Municipality and 9 Provinces)

4 Chinese economic integration in China s hinterland. Particular emphasis is placed on EU FDI, given the fact that EU MNCs have already played an important role in the area. The focus is on two aspects: Part I addresses briefly the disparities of FDI allocation, the comparative advantage as well as the barriers to FDI in China s hinterland. In Part II, after a general survey of the characteristics of EU FDI in China, a background literature on the FDI regional bias and on location determinants to China in general, as well as a preliminary statistical analysis of EU FDI to China in particular are provided. This analysis will rely on the use of a comprehensive data set on E.U. FDI in China in the late 1990s. A further discussion of the role and benefits of EU FDI along with the other major stakeholders in China s hinterland is also addressed in Part II. PART 1: FDI REGIONAL DISPARITIES, COMPARATIVE ADVANTAGE AND BARRIERS 1.1 DISPARITIES OF FDI ALLOCATION IN CHINA Over the last two decades, China has emerged as the largest FDI recipient among the developing countries and, for the first time, surpassed the United States, positioning itself as number one FDI recipient in the world in the year Although the number of countries investing in China is quite large, only a few countries account for the majority of investment (take in Table 1). 4 Motivated either by resource or market considerations, FDI to China swarmed and congested in the coastal location, albeit however with different concentration levels. Taking advantages of the coastal location, low labour costs, traditional cultural links, the introduction of SEZs and the government s policy based on export promotion, FDI from the NIEs (Newly Industrialized Economies) mainly crammed in Guangdong and Fujian Provinces. FDI from the Triad (EU, Japan and US) is stretching widely, albeit also clustering in specific coastal locations such as The Pearl River Delta (Guangdong), The Yangzi River Delta (Shanghai, Zhejiang and Jiangsu) and the Bohai area (Beijing, Tianjin, Hebei, Shandong and Liaoning). The transfer of downstream, labour intensive stages of production from the NIEs not only helped Eastern China to 4The main FDI players in China can be classified as European MNCs (mainly from the UK, Germany, France and Netherlands in the EU-15), American MNCs (US and Canada), Japanese MNCs, non-japanese controlled Asian MNCs (mainly from the Newly industrialized economies such as Hong Kong, Taiwan, Macau, Singapore and Malaysia) and those from Free Ports (Virgin and Cayman Islands)

5 become integrated in the international production process, but it also helped maintain the NIEs competitiveness on the world market. Moreover, capital and technology-intensive FDI from the developed Triad, taking advantage of China s human and natural resource endowments, helped to upgrade constantly the Chinese economic and productive structure. As for the entry strategy of the MNCs, the joint venture has been the main form of investment whereas a growing number of wholly owned foreign enterprises have been the feature of the late 1990s (take in Table 2 and Figure 1). 5 Furthermore, with more flexible ways of MNCs entry strategy other than that of Greenfield investment in the Chinese market, a new wave of FDI is increasingly based on the mode of mergers and acquisitions. Just as the FDI distribution is uneven in China, FDI allocation across industrial sectors is also imbalanced. The manufacturing industry accounts for the higher proportion (59.6 %), and real estate comes next with a share of 24.4 % (take in Table 2). Within the manufacturing sector, approximately half of contractual FDI has been directed towards the labourintensive industries. Technology-intensive and capital-intensive sectors share almost equally the rest, with the proportion of the former being 26.9% and the latter 22.7% (OECD Report, 2000). With respect to manufacturing oriented FDI, a bipolar structure has developed with small-scale, export-oriented enterprises on the one hand, and large-scale, local-market oriented enterprises on the other. While the former are mostly joint ventures by Hong Kong and South East Asian investors, the latter are mostly FIE (Foreign Invested Enterprises) with European and US interests (Tian, 1999). In other words, FDI from NIEs such as Hong Kong and Taiwan tend to focus on low labour-intensive production technology and standard manufacturing products, e.g. textiles, plastics products, etc., while FDI from developed economies such as the EU leans towards high technology and differentiated products, e.g. chemical fibres, automobiles, electronics and telecommunication equipment. This dichotomy is in line with the Dunning-Ozawa FDI development path (Ozawa, 1992). 1.2 COMPARATIVE ADVANTAGE AND BARRIERS TO FDI IN CHINA S HINTERLAND By the end of the first half of the year 2003, China had received a cumulated amount of approximately billion US dollars of realized FDI, which is equivalent of about 10 percent 5 A constant growing percentage of Wholly Owned Foreign Enterprises was seen in the last decade. (From around 30% in early 1990s to 62.14% in 2002). Its share is expected to further increase as China meets its WTO commitments in the coming decade

6 of direct investment worldwide and about 30 percent of FDI directed to all the developing countries put together. However, during the twenty-five years since 1978, more than billion have gone to the Coastal area which accounts for around 85 percent of total FDI inflows (take in Figure 5). In the year 2000, China s hinterland, which covers 86.5% of the national territory and 58% of total population, contributed only for 35.7% of the nation s GDP. Its per-capita GDP equals 67% of the national average and reaches merely 40% that of the eastern region. In terms of per capita realized FDI, China s hinterland has attracted only 10% of the amount flowing to the eastern region, representing 15% of the national average in the same year (take in Figure 6). In order to lessen the significant uneven spatial distribution of FDI, the year 2000 has seen the introduction of the Chinese government Western Development Strategy. However, little improvement has been experienced so far. In the year 2001, China s Hinterland received only 12.85% of all FDI inflows, a figure, which is even lower than that for the former year (at 12.88%; take in Figure 5). The reasons behind this can be summed up as the follows: first, it should be stressed that the locational advantages a region offers to attract FDI inflows can only be partly shaped by government intervention. Second, the Coastal provinces with larger GDP, higher per capita income, higher levels of FDI stock, more intensive transport infrastructure and higher level of telecommunications are thus more attractive for foreign investors. Consequently, the returns on capital investment in the Coastal provinces are much higher than in the rest of the country, thus attracting more FDI into the region and causing more growth disparity. To overcome the vicious cycle - FDI attracts FDI - an innovative and long-term strategy based on China s hinterland comparative advantages needs to be formulated. Obviously, until the implementation of the Going West Strategy, barriers to FDI in China s hinterland far outweighed its comparative advantages. A 22-year discriminatory policy, in favour of coastal areas and a lack of central government investment in the western and central areas, combined with harsh climate circumstances, natural conditions, poor infrastructure, a relatively limited market size compared with the eastern sea board, a substantial brain drain, an outflow of labour, and a faltering over-weighted state sector, all call for a different type of FDI strategy in the west. This is based on the mergers and acquisitions mode of entry, a process made easier with WTO entry, instead of replicating those FDI development strategies, which succeeded in eastern China. Since the comparative advantages of China s hinterland lie in rather low labour costs, rich natural resources, sound industrial bases, a relatively - 6 -

7 skilled labour force in state and military enterprises (a legacy of the Third Front Strategy) 6, and a cluster of research and academic institutions (mainly in Sichuan, Hubei and Shannxi Provinces), the strategy should be to attract resource and market seeking FDI first to the provincial capitals, namely Wuhan in Hubei Provinces, Xian in Shannxi Province and Chengdu and Chongqing (a municipality) in Sichuan Province, so as to build technological and logistic centers and to position them as leading developed service centers, from which, trickle-down effects to adjacent areas would materialise. The imperative question is what kind of FDI will be most likely to pour into China s hinterland by using the comparative advantages of the area. We will use EU FDI as an example to analyse China s location determinants, its role as well as benefits to China s hinterland. PART 2: STATISTICAL ANALYSIS OF EU FDI REGIONAL DETERMINANTS IN CHINA 2.1 CHARACTERISTICS OF EU FDI IN CHINA With regard to the weight of the EU-15, realized FDI accounted for 7.57% of total FDI inflows to China, and ranked fourth in cumulative terms up until the end of 2002(take in Table 1). However, the EU-15 has been positioned as the largest investor in China for a consecutive three years from 1998 to 2000 (excluding Hong Kong, which represented the lion s share of FDI inflow either based on yearly or total cumulative value terms). Apparently, a catching-up process of EU firms in China started in the mid-1990s, and expanded from (take in Figure 2). This can be summarized by the following characteristics: In the first place, among the Triad, the EU lag in the Chinese market, with respect to other investors, started to narrow from the mid-1990s. The years 1993, 1994 and 1997 have seen EU realized FDI 6 During the early 1960s to the mid 1970s one of the main features of China s economic policy was the third front strategy. Due to the expecting danger of the outbreak of a new war, the Chinese government tried to transfer the industrial backbone from the Coastal to the Hinterland area

8 inflows climb from US$ 671 million, to 1,538 million and 4,171 million respectively; this corresponds to year-on year growth rates of %, % and 52.39% respectively (take in Figure 2) In contractual EU FDI value terms, the year-on year growth rates jumped to 91.72% and % in 1993 and 2000 respectively. The triple-digit growth of realized FDI in 1993, 1994 and contractual FDI values in 2000, together with a decline of Japanese FDI to China due to the Asian Financial Crisis in 1997, has made the EU, for the first time, the largest non-chinese investor both in realized and contractual value terms, although this lasted only for periods of three years and one year respectively. Nevertheless, and as in the case of other investors, a great gap between realized and contractual EU FDI values is easily identifiable through the and periods (take in Figure 2). This phenomenon can be explained as follows: on the one hand, the extreme caution of EU MNCs vis-à-vis the Chinese market could be the fundamental raison d être for the quiet period right after Deng Xiaoping visited the southern coastal economically opened areas and SEZs in 1992, a famous tour which led to deeper, faster and wider economic liberalisation. It is only after the settlement of EU-China Human Rights Disputes and the Chinese government s commitment to a market-oriented economy (i.e. since ) that stable and substantial EU FDI inflows have materialized. On the other hand, the dramatic jump and fall of contractual EU FDI in the period reflected the growing enchantment and disenchantment of EU MNCs regarding the Chinese WTO accession. In 2000, with the reaching of US-China and EU-China WTO accession agreements, both contractual FDI from the US and the EU to China increased considerably. However, as the process dragged on, FDI pledges from both sources have not been realized. As China gained its WTO membership in 2001, a boost of FDI inflows from the Triad is thus expected, at least in the medium-term. In the second instance, the contribution of EU FDI by country source, and its allocation in the Chinese market are both uneven. Due to the differences in terms of economic scale and stages of development among the EU countries, the UK, Germany, France, the Netherlands and Italy contributed together for 82% of total EU projects, 90% of contractual and 92% of realized FDI until In contrast with the labour-intensive investment projects, - mainly from Hong Kong and Taiwan, which congested in Guangdong and Fujian Provinces -, EU investment mainly concentrated in the Yangzi River Delta (accounting for 43% of EU investment projects until 1999), and in the Bohai Area (24%), where excellent industrial infrastructure was present (Wang Luolin, - 1 -

9 2000). For the same reason, there has also been a relatively important presence of EU MNCs in large cities such as Chongqing in China s Hinterland. Third, EU FDI is characterized by a relatively high-realized value per project, and by a higher degree of technology-content. Among the top five FDI contributors to China (Hong Kong, US, Japan, EU and Taiwan), EU FDI positioned itself as having the lowest percentage in terms of project numbers (less than 4%; take in Figure 3), but it ranked number 1 when assessed on the basis of the realized value per project (take in Figure 4). The main reason behind this is that EU FDI mainly focuses on technology-intensive manufacturing industries such as automotive, chemical, electronics; communicate equipment and pharmaceutical and instruments. For example, a questionnaire survey from the Investment Research Unit in the Academy of Macroeconomic Research attached to the National Development and Reform Commission of the PRC in 1998, disclosed that a small percentage of EU FDI projects in automotive (8% of total projects) and medicine, medical device (4%), represented however 27% and 21% of the realized FDI values in the above industries respectively (Wang Luolin, ed. 2000). Another example is represented by the case of the energy sector, and in particular of the nuclear sector, in which key technologies and equipment have originated from the EU. Because the energy sector is capital intensive, the average size of EU investment projects is bigger than FDI projects in other industrial sectors. Finally and most importantly, EU FDI tends to be market-oriented, and thus more committed to the Chinese domestic market than to foreign markets through exports. This is in contrast to Asian FDI, in particular to Japanese FDI. Most of China s imports of machinery, electrical machinery and vehicles have come from the EU, and more than a third of China s imports from the EU concern machinery and equipment goods. This phenomenon can be directly linked to FDI activities, and it is testimony to the fact that EU FDI in China is characterized by relatively capital-intensive projects (OECD Report, 2000). In addition, despite a rather low per capita GDP, the current Chinese economy has the second largest total GDP (in Purchasing Power Parity terms) in the world, thus making it attractive to foreign investors such as those from EU countries with competitive industrial sectors such as pharmaceutical and chemicals, electronics, automobiles and telecommunications to invest

10 2.2 BACKGROUND LITERATURE Contrasting with the availability of a substantial body of literature on the identification and explanation of international inflows of capital investment at the national level, much less attention has been devoted to the spatial distribution of FDI in the case of developing countries. Although there is a growing interest on location determinants of aggregate FDI inflows in fast growing developing economies like China (Broadman and Sun 1997; Chen 1997; Wei, Liu, Parker and Vaidya 1999, Huang 1999, Wu 1999, Coughlin & Segev 2000, Andreosso-O Callaghan and Cassidy 2002), empirical studies on the regional determinants of EU FDI in China have been quite limited. Studies on EU investment and Technology Transfer to China have tended to remain very much at the macroeconomic level, given the difficulty of obtaining appropriate and reliable data at the regional level (Andreosso-O Callaghan and Qian 1999). The broad picture reveals however that in general, FDI in China would have tended to flow to specific areas with a large market size, high economic development level, well-developed infrastructure, skillful labor, and highly developed service industries. The empirical work on the spatial distribution of FDI in China identifies the different variables that influence, with various degrees, the MNCs locational decision. We can group these variables into two groups: (i) the non-institutional and economic variables (such as GDP, GNP, inflation rates, domestic investment, savings, current account, etc.), and the noninstitutional and locational variables (such as transportation, geographical location, energy consumption per capita, adult literacy, labor quality and the service industry); (ii) the institutional variables (such as the investment and trade policies, the attitude to foreign investors and cultural links, financial restrictions, corruption, effectiveness and efficiency of the legal system, etc.). In the case of China, a selected variety of these determinants have been tested by the above-mentioned literature, yielding however different results. With regard to the tests on the institutional determinants and non-institutional determinants, a general convergence of results and conformity with the theory has been reached. For example, Wei et al. (1999) found that pledged FDI was positively influenced by a preferential investment policy and by closer links with overseas Chinese. Most of the literature sees the investment policy as the most important institutional variable, and coastal location, infrastructural development, labor quality as the most significant locational variables, showing a positive correlation with FDI distribution. Unsurprisingly, coastal location was unanimously identified as positively related to - 3 -

11 FDI and significant in the analyses by Broadman and Sun (1997), Chen (1997), Coughlin & Segev (2000) and Andreosso-O Callaghan and Cassidy (2002). Illiteracy was the chosen labor quality variable in Broadman and Sun (1997), Chen (1997), Coughlin & Segev (2000) and was found to be negatively associated and significant. However, in the case of Japanese FDI, Andreosso- O Callaghan and Cassidy (2002) found it still negative but insignificant, whilst, by taking tertiary education as an alternative variable, it was found positive and significant. With respect to infrastructure, the studies referred to above showed highways, paved roads and inland waterways to be positively significant determinants of FDI inflow respectively. Coughlin & Segev (2000) found paved roads to be positively related and a significant determinant of FDI inflows in China. However, Andreosso-O Callaghan and Cassidy (2002) disclosed that when paved roads were controlled for, they were positively related to Japanese FDI stock in China, but not significant. Transportation infrastructure in the form of air-staff was positively correlated but not significant in the work of Coughlin & Segev (2000), whilst Andreosso-O Callaghan and Cassidy (2002) found air-staff to be negatively related and insignificant to Japanese FDI in China. By contrast, the tests highlighting the non-institutional determinants of FDI, such as the economic variables, produced contradictory results. Taking efficiency wage as a proxy for labor costs, Chen (1997) and Coughlin & Segev (2000) showed it to be negative and significant. On the contrary, Broadman and Sun (1997) and Andreosso-O Callaghan and Cassidy (2002) found it positive and insignificant. With respect to the market size variable, Broadman and Sun (1997) and Coughlin & Segev (2000) used provincial GNP, while Chen (1997) and Andreosso-O Callaghan and Cassidy (2002) chose provincial GDP. Andreosso-O Callaghan and Cassidy (2002) did not find it significant as in the case of the other tests. This result is in line with the fact that Japanese FDI in China is not primarily of the market seeking type, but rather is the result of de-industrialization in Japan (kûdôka). The finding supports Kojima s Theorem, which highlighted Japanese FDI as being trade-oriented

12 2.3 STATISTICAL ANALYSIS OF EU FDI REGIONAL DETERMINANTS IN CHINA DATA, MODEL AND SPECIFICATION OF VARIABLES One has to admit the fact that exact yearly data on EU FDI at provincial level in China are difficult to obtain. Cumulative data at the provincial level is also unavailable. As far as the source of the data is concerned, there are two reliable ways of finding relevant information. One is to use the chronological versions of the Almanac of China s Foreign Economic Relations and Trade, where the source of foreign investment of each province and municipality is documented in the section on Local Economic Relations and Trade. However, this data should be used with great care, since some provinces only disclosed the top 10 source countries of FDI, and since the data is based on individual EU (major) countries rather than on an aggregate figure for the EU-15 as a whole (The only exception is Zhejiang province, for which the EU-15 figure is available); also it is not clear whether the data refers to contractual or realized values. As most EU FDI comes from the UK, Germany, France, the Netherlands and Italy, FDI from other EU-15 countries is therefore neglected from this data source. However, it does show a general picture of EU FDI allocation in China. Since EU investors have a preference for coastal locations such as Yangzi River Delta and Baohai Area, 36.1% and 30.95% of EU FDI in the periods flowed to these two areas respectively. This is in contrast to the fact that overall FDI inflows mainly concentrated in Guangdong and Fujian Provinces (accounting for 38.03% of the total cumulative FDI inflows in China until 2002). Only 14.49% of EU FDI flowed to these two provinces between 1996 and In the same period, a very small proportion of EU FDI went to China s hinterland (about 11.79%). This is roughly the same proportion as the total FDI flowing into China s hinterland until 2002 (14.44%). In China s hinterland, EU FDI primarily favored 4 provinces e.g. Shannxi, Sichuan, (including Chongqing before 1997), Hubei and Jinlin, which account for 6.46% of inflows from altogether 7 (take in Table 4). 7 This could be explained by the fact that major industrial cities in China s Hinterland are located in provincial capitals within these 5 provinces e.g. Xian in Shannxi Province, Wuhan in Hubei Province, Changchun in Jilin Province and Chengdu and Chongqing in Sichuan Province. (Chongqing was granted municipality status in 1997) - 5 -

13 Another way of finding relevant data source is to trace back the statistical yearbooks of each province, where realized FDI from major European investing countries is documented. This source of data is the most reliable for the statistical analysis. 8 As shown by chronological and cumulative EU data at national level, EU FDI in China increased dramatically in 1997 and remained constant in the late 1990s. Therefore, EU FDI at provincial level in the late 1990s (from ) may be seen as the crest of a wave of EU FDI inflows, and it would therefore be the most convincing data for any statistical analysis of EU FDI regional determinants in China. In order to test the relative determining importance of the chosen variables in the location decisions of EU FDI in late 1990s, a model using ordinary least squares regression is constructed: EUFDI inflow = α + β 1 Per capita GDP + β 2 Market Proximity + β 3 Efficiency Wage + β 4 Education + β 5 SOE + β 6 RCA + β 7 LOC + U Where, EU FDI yearly-inflows from on a provincial level is set as the dependent variable and 7 independent variables are chosen, namely: PGDP (Per capita Gross Domestic Product), MKT (Market Proximity), EW (Efficiency Wage), EDUC (Education set as labour quality), SOE (Economic benefit of Stated-owned industrial enterprises), RCA index (Revealed Comparative Advantage) on a provincial level from The economic benefit of SOEs is calculated as the SOE s value-added divided by its gross output value in a given period ( ) at the current prices. A dummy variable for coastal location is also added to the model. All variables used are further described in table 5 (take in Table 5) RESULTS AND INTERPRETATION Despite shortcomings due to the scarcity of available data, this pioneer study does present a first insight into the EU FDI location determinants in China (take in Table 6). In model I, LOC and RCA are found to be statistically significant, Efficiency Wage is found negative and insignificant, whereas PGDP and MKT are positive and insignificant. In testing for multicollinearity and using stepwise regression method in model I, variables such as EW and SOE are found as having a high 8 Statistical yearbooks of provinces such as Sichuan, Jilin, Heilongjiang, Guizhou and Tibet are lacking such data

14 level of minimum tolerance. The results of Model II show that PGDP is found positive and significant, while MKT and EW are also found positive but insignificant. In both models, SOE is found negative but insignificant. Generally speaking, the results from the tests are in conformity with the hypothesis. First, variables such as PGDP, Location, and RCA, where Coastal China maintains a substantial comparative advantage (and still will in the long term), are the most influential factors in attracting current EU FDI flows. Second, given the fact that Per capita GDP and MKT (even by taking the population size in of each province into consideration when specifying of variable) vary greatly at a provincial level in China, the results show that PGDP is positive and significant determinants of EU FDI location decisions, substantiating the hypothesis that EU FDI is more market-oriented than other types of FDI (Japanese for example). Third, as far as the future role of EU FDI in China s hinterland is concerned, the result pertaining to the SOE variable brings a new dimension to the study of the determinants of FDI in China. This result needs to be considered in light of the fact that FDI, especially that from developed economies, is more attracted by regions with a mature market economy, which implies a lesser involvement of SOEs. Results with regard to the SOE variable are in conformity with the hypothesis. However, it cannot be ascertained that higher SOE performance in a region is a noteworthy determinant to block EU FDI inflows. A priori, the results pertaining to efficiency wage are contrary to most findings on direct investment in developing countries. However, given that EU FDI tends to be more high-tech than other foreign investment, regions with a higher development rate, higher skills (and therefore higher labour costs) are more attractive for foreign investors. Also, these results reveal a new general trend of rapidly growing labour costs in coastal China. Therefore, future low labour-cost seeking FDI projects are likely to flow either to China s hinterland or to boarder countries such as Vietnam. From a Chinese point of view, the first alternative is preferred although this depends very much on the quality of the infrastructure and on overall policies. Therefore the data of these provinces is based on the Almanac of China s Foreign Economic Relations and Trade in this analysis

15 2.4 PROMOTING FDI TO CHINA S HINTERLAND: THE ROLE AND BENEFIT OF EU FDI IN THE AREA As far as a solution in preventing further FDI allocation disparities and in promoting FDI to China s Hinterland is concerned, the role and benefit of different major stakeholders 9 in influencing the formulation of such a solution is strategically critical. On the one hand, the Chinese central and local governments are playing the role of facilitators of FDI. The responsibility for putting in place investment promotion policies in China s hinterland, and the capability of re-directing resources by improving infrastructure in the west, are lying in the hands of the Chinese central government. 10 The modernization of the banking system, the restructuring of SOEs, the creation of employment opportunities in China s hinterland, as well as at the national level, and the narrowing-down of developmental disparities through the involvement of MNCs, are all favourable conditions for maintaining economic and social stability, thus benefiting the current political authorities and allowing the transformation process to be carried out peacefully. Furthermore, decentralisation has meant that local governments have increased their power of discretion over their own local matters, and that they have become more active in promoting local economic development through attracting FDI. Thus, different local policies in attracting FDI and their implementation are significant for both local economic development and the MNCs presence. 11 However, there have been enormous variations in FDI policies from central and local governments across both provinces and time, with a tendency to increase the level of competition in the area of incentives provided to investors at provincial level. The development of China s hinterland through FDI will also benefit the sustainable growth of the Coastal area. 12 In this sense, 9 There are two decisive groups: one is the Chinese central government and provincial local governments, one are MNCs themselves. However, stakeholders such as FDI source country government, NGOs, International Financial Institutions and International Organizations also have their influence but not regarded as decisive factors, taking the fact that the economic integration between Coastal China and Hinterland China is much less than that between Coastal China and the developed world. In this sense, FDI in China s Hinterland is much more influenced by the stakeholders on regional level than international level. 10 For example, provincial capitals such as Changsha in Hunan Province, Chengdu in Sichuan Province, Guiyang in Guizhou Province, Hefei in Anhui Province, Kunming in Yunnan Province, Xian in Shannxi Province and Zhengzhou in Henan Province have been recently raised from provincial-level special economic zones to national-level status. 11 For instance, Chongqing, the only municipality in China s hinterland, has recently introduced policies to permit foreign-funded high-tech enterprises, with foreign funds accounting to more than 60% of total investment, to draw a certain amount for a risk compensation fund in the first three profit-making years before paying tax. 12 The coastal provinces do have some reasons of their own for wanting the west to develop. Not only will the west provide markets, energy, and a supply of raw and semi-finished materials that will contribute to the east s own economic restructuring, but the environmental and ecological programs of the upstream part of the Yangzi River will also reduce flooding in the eastern provinces. Better infrastructure will allow the east to move its goods more easily to the west s 300 million consumers. Improvements in electrical distribution and the construction of more pipelines will also directly benefit the east (Taube and Ogutcu, OECD Report) - 8 -

16 the central government is playing more a role of mediator, adjusting the diverging interests of various stakeholders. Therefore, provincial government in China s hinterland should aim at attracting resources as well as market-seeking MNCs, which would help the area s integration into the value chains of the business already established by those MNCs in the Coastal area. In addition, policies should also target those MNCs willing to overtake large SOEs in the area, through the implementation of new FDI entry modes such as mergers and acquisitions. On the other hand, MNCs as main FDI players in Hinterland China, especially those from the E.U., have already played an important role in provincial capitals 13 in China s hinterland because of rich natural resources, a potential market, a fine industrial base, lower labour costs and a large supply of technical personnel. 14 Furthermore, as a result of the accession to the WTO, and of further liberalisation of the FDI regime, the primary sector, - including agriculture, forestry and fishing -, where China s hinterland maintains competitive advantages, is likely to attract more FDI. This will only depend on the degree of market openness in the area of agricultural products. The service industries such as finance, telecommunications and wholesale & retail commerce, where EU MNCs maintain well-known competitive advantages, are expected to take up a further larger share of FDI inflows. For example, the telecommunication industry has received appreciably large amounts of EU investments, with Alcatel, Ericsson, Nokia and Simens grabbing large market shares. The entry strategy of the EU telecommunications MNCs, their consolidation and growth on the Chinese market have espoused perfectly the increasing technological awareness of the Chinese government as embodied in its evolving industrial policy (Andreosso-O Callaghan and Qian, 1999). EU telecommunication MNCs like Ericsson and Nokia have been pioneers by investing in the large cities of China s hinterland such as Chongqing, and they are planning to include the western region into their global purchase network. 15 Therefore, with a further strategy of attracting capital or technological-based FDI such as that from the EU, China s hinterland will not only benefit from 13 Taking the fact that, 13 and 18 of the world s top 500 enterprises have invested in the high-tech zone of Chengdu, capital of Sichuan Province and Chongqing respectively until The EU MNCs presence in China s hinterland big cities such as Chongqing, is represented by firms such as BP AMOCO and Glaxowellcome of UK, Carrefour of France, Nokia of Finland and Ericsson of Sweden; these few firms have invested a total of million US$ there up to the end of 1998 (Wang ed.2000). 15 In mobile telecommunication, China is Nokia s second largest market in the world. Nokia s investment in China has reached US$ 1.7 billion in year It has established over twenty offices, eight joint ventures and two R&D centres, with over 5,000 employees in China. Ericsson also plans to double its investment in China and will reach US$ 5.1 billion by the end of It has ten joint ventures, four solely funded companies and employing more than 4,500 workers. Both have two joint venture companies in China s hinterland, namely Guilin-Nokia Telecom Ltd, ChongQing Nokia Telecommunications Co. Ltd; and Chongqing Ericsson Technology Co., Ltd, Chongqing Ericsson Communications Co., Ltd, representing together approximately a 58 million US dollars investment stake up to

17 windfall fiscal revenues that can be used to develop its infrastructure, but it will also benefit from a major impetus in terms of regional economic restructuring and openness, thereby contributing to regional even development. CONCLUDING REMARKS For many years, MNCs as main FDI players to China, - either market seekers or resource seekers -, have been benefiting from locational advantages, labour advantages and government policies such as the special economic zones and the export promotion development strategy in Coastal China; foreign investors have in turn been contributing to this area s dramatic economic boom. Yet, these players are discouraged to venture into China s hinterland, a disadvantaged location congested with SOEs, thereby further exacerbating the economic disparities that have traditionally existed. Thus, a new policy from the central government leaning towards a liberalized FDI regime in hinterland areas, and the implementation of these policies by the hinterland s local governments is a prerequisite for sustaining economic growth and social stability. With the efforts of the Chinese central government to improve the investment environment in the hinterland region by steering huge funds for improving local transport facilities and telecommunication infrastructure, China s hinterland now calls for further investment inflows, for a re-organization of its SOEs, an upgrading of skills and an improvement of the local investment environment. Promoting targeted investment in China s hinterland should be a core issue in Chinese FDI policy as well as a decisive approach of achieving a sound solution in the area. As an empirical study of the determinants of EU FDI across China shows, EU investment tends to be more resource and market-oriented, larger in scale, more capital intensive and most importantly, it tends to be characterised by a higher level of technology content than FDI flowing from other countries. In the long term, foreign investment, especially that originating from an area such as the EU, is expected to flow substantially into China s hinterland, thus playing an important role in promoting Chinese economic integration. This can only happen if and only if more open government policies are introduced to enhance the comparative advantage in the region, and if EU firms benefit greatly from locating in the remote parts of China. The presence of EU telecommunication MNCs in China s

18 hinterland shows that this seems indeed to be the case. This is due to the relatively low infrastructural requirements of these firms

19 BIBILOGRAPHY ANDREOSSO-O'CALLAGHAN, B. AND J.P. BASSINO, (2001) JAPANESE DIRECT INVESTMENT IN ASIA AND IN THE EUROPEAN UNION- IS THERE AN INTERDEPENDENCE? IN: THE CHANGING ECONOMIC ENVIRONMENT IN ASIA, ANDREOSSO-O CALLAGHAN, BASSINO AND JAUSSAUD (EDS) PP , MACMILLAN/PALGRAVE: LONDON AND NEW YORK. ANDRÉOSSO-O'CALLAGHAN, B. AND J. JOYCE, (2000), THE DISTRIBUTION OF FOREIGN DIRECT INVESTMENT IN VIETNAM - AN ANALYSIS OF ITS DETERMINANTS. IN: THE EUROPEAN UNION AND THE ASEAN: TRADE AND INVESTMENT ISSUES, R. STRANGE, J. SLATER AND C. MOLTENI, (ED.), PP LONDON: MACMILLAN. ANDRÉOSSO-O'CALLAGHAN, B. AND W. QIAN, (1999), E.U. FOREIGN DIRECT INVESTMENT AND TECHNOLOGY TRANSFER IN ASIA: CHINA AND INDIA COMPARED. IN: CHINA AND INDIA - ECONOMIC PERFORMANCE AND BUSINESS STRATEGIES OF FIRMS IN THE MID-1990S, S. DZEVER AND J. JAUSSAUD, (EDS.). LONDON: MACMILLAN, PP ANDRÉOSSO-O'CALLAGHAN, B. AND W. QIAN, (1999), "TECHNOLOGY TRANSFER: A MODE OF COLLABORATION BETWEEN THE EU AND CHINA". EUROPE-ASIA STUDIES, VOL. 51, N.1, PP ANDREOSSO-O CALLAGHAN, B AND CASSIDY, J.F. (2002) SPATIAL DETERMINANTS OF JAPANESE FDI IN CHINA, WORKING PAPER, UNIVERSITY OF LIMERICK ALMANAC OF CHINA S FOREIGN ECONOMIC RELATIONS AND TRADE 1998/1999, 1999/2000 AND 2000/2001 VERSIONS, CHINA ECONOMICAL PUBLISHING HOUSE

20 BROADMAN, H. G. X. S. (1997) THE DISTRIBUTION OF FOREIGN DIRECT INVESTMENT IN CHINA DOCUMENT TYPE: POLICY RESEARCH WORKING PAPER, THE WORLD BANK CHUNLAI, CHEN. (1997). COMPARISON OF INVESTMENT BEHAVIOUR OF SOURCE COUNTRIES IN CHINA, ADELAIDE, THE UNIVERSITY OF ADELAIDE, AUSTRALIA CHUNLAI, CHEN. (1997). PROVINCIAL CHARACTERISTICS AND FOREIGN DIRECT INVESTMENT LOCATION DECISION WITHIN CHINA, ADELAIDE, THE UNIVERSITY OF ADELAIDE CHUNLAI, CHEN. (1997). PROVINCIAL CHARACTERISTICS AND FOREIGN DIRECTINVESTMENT LOCATION DECISION WITHIN CHINA, ADELAIDE, THE UNIVERSITY OF ADELAIDE CHEN, C.H, 1996, REGIONAL DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN MAINLAND CHINA, JOURNAL OF ECONOMIC STUDIES, 23 (2) PP COUGHLIN, CLETUS C. AND ERAN SEGEV (2000), 'FOREIGN DIRECT INVESTMENT IN CHINA: A SPATIAL ECONOMETRIC STUDY', THE WORLD ECONOMY 1, EDWARD M. GRAHAM, E. W. (2001). FOREIGN DIRECT INVESTMENT IN CHINA: EFFECTS ON GROWTH AND ECONOMIC PERFORMANCE, INSTITUTE FOR INTERNATIONAL ECONOMICS. JIANG XIAOJUAN, (2002), CHINA & WORLD ECONOMY NUMBER 2, NEW REGIONAL PATTERNS OF FDI INFLOW: POLICY ORIENTATION AND EXPECTED PERFORMANCE KNOEDLER, HERMANN; ALBERTSHAISER, ULRICH (2001), GLOBALISATION, FDI AND REGIONAL DEVELOPMENT PERSPECTIVES: EMPIRICAL RESULTS FOR WEST GERMAN REGIONS, HWWA DISCUSSION PAPER 117, HAMBURG, GERMANY

21 OECD REPORT (2002) FOREIGN DIRECT INVESTMENT IN CHINA S REGIONAL DEVELOPMENT PROSPECTS AND POLICY CHALLENGES LEONARD K. CHENG AND YUM K. KWAN (2000), WHAT ARE THE DETERMINANTS OF THE LOCATION OF FOREIGN DIRECT INVESTMENT? THE CHINESE EXPERIENCE, JOURNAL OF INTERNATIONAL ECONOMICS, MARKUS TAUBE AND MEHMET OGUTCU, OECD REPORT (2002), MAIN ISSUES ON FOREIGN INVESTMENT IN CHINA S REGIONAL DEVELOPMENT: PROSPECTS AND POLICY CHALLENGES OECD REPORT (2000), MAIN DETERMINANTS AND IMPACTS OF FOREIGN DIRECT INVESTMENT ON CHINA S ECONOMY OZAWA, TERUMOTO,(1992) FOREIGN DIRECT INVESTMENT AND ECONOMIC DEVELOPMENT, TRANSNATIONAL CORPORATIONS 1(1), PP TIAN, GARY (1999), CHANGING PATTERNS OF FDI IN SHANGHAI, IN; WU YANRUI (ED.) (1999), FOREIGN DIRECT INVESTMENT AND ECONOMIC GROWTH IN CHINA, CHELTENHAM-NORTHHAMPTON YINGQI WEI, XIAMING LIU, DAVID PARKER AND KIRIT VAIDYA, (1999), THE REGIONAL DISTRIBUTION OF FOREIGN DIRECT INVESTMENT IN CHINA, REGIONAL STUDIES 33, 9, WANG, LUOLIN (ED.) (2000), REPORT ON FOREIGN DIRECT INVESTMENT IN CHINA, CHINA FINANCE AND ECONOMICS PUBLISHING HOUSE

22 Table 1: Cumulative FDI in China: Top 15 Countries till the end of year 2002 (Billion US$) Projects % Contractual Value % Realized Value % Hong Kong U.S Japan E.U U.K Germany France Netherlands E.U. Others Taiwan Virgin Islands Singapore Korea Macau Cayman Island Canada Malaysia Others Total

23 Table 2: Cumulative FDI by Form till the end of year 2002(100 Million US$) Form No. of Projects % Contractual Value % Realized Value % Equity Joint Venture Contractual Joint Venture Wholly Foreign- Owned Joint Exploration Total Table 3: Contractual FDI by Sectors till the end of year 1998 (Billion US$) Sector Number of % Contractual % Projects Value Manufacturing Real Estate Distribution Industry Wholesale, Retailing, Catering Transport, Warehouse, Telecommunication Construction Agriculture, Forestry, Animal Husbandry & Fishing Scientific Research Technical Service Education, Broadcasting, Film and Television Industry Healthcare, Sports & Social Welfare Other Sectors Total

24 TABLE 4: Cumulative FDI distribution by the year 1999 and EU FDI distribution in (US$ 10 Thousand) Province Total % Total % Total % EU % projects Number Till 1999 Contractual Value Till 1999 Realized Value Till 1999 Realized FDI inflow Beijing Tianjin Hebei Shanxi In. Mongolia Liaoning Jilin Heilongjiang Shanghai Jiangsu Zhejiang Anhui Fujian Jiangxi Shandong Henan Hubei Hunan Guangdong Guangxi Hainan Sichuan