A Brief Review of Chinese Policy towards FDI

The history of China’s policy toward FDI is one of careful experimentation and management in an attempt to use FDI to simultaneously develop an export-led and import substitution strategy. The decentralized nature of Chinese administration has meant that some of these centrifugal tendencies have undermined certain aspects of the regulatory process. Over time, however, as the low-wage export-led strategy has run its limit, and as the Chinese government has broadened its liberalization strategy, China has attempted to attract a broader array of FDI, including joint ventures to serve the Chinese market.

At the same time, the sources of investment have evolved from the Chinese Diaspora to a broader set of countries, including those in the U. S. , Europe and Japan. History At the second session of the Fifth National People’s Congress in July 1979, a joint ventures law was passed, granting foreign investment a legal status in China (Chen 1996: 33). In this initial period FDI was restricted to joint ventures in China’s four special economic zones (SEZs) at the time (three in Guangdong province across the sea from Hong Kong (Shenzhen, Zhuhai (contiguous with Macao), and Shantou, and the fourth, Xiamen in Fujian Province, on the other side of the Straits of Taiwan) (World Bank 1994: 221).

SEZs offered significant freedoms and advantages for foreign investors, including concessionary tax policies, exemption from export duties and import duties for equipment, instruments, and apparatus for producing export products, and an easing of entry and exit formalities (Chen 1997b: 8). Pressure from other localities led the State Council in 1984 to extend economic freedoms similar to those of the SEZs to 14 additional “open” coastal cities, and in 1985 to the Yangtze and Pearl River Deltas as well as to a larger proportion of Fujian (World Bank 1992).

Specific encouragement of FDI really began in 1986, with passage of the Wholly Foreign- Owned Enterprise Law, which, in addition to permitting wholly foreign-owned enterprises, also reduced fees for labor and land use, established a limited foreign currency exchange market for joint ventures, and extended the maximum duration of a joint-venture agreement beyond 50 years (Chen 1996; Huang 1998). These policy initiatives coincided with a broadening of the reach of China’s Open Door Policy to include the entire coastal zone in 1988, a shift that became known as China’s coastal development strategy.

Open policies for FDI now extended to the entire coastal region, stressing two main goals: (1) to develop labor-intensive industry in the coastal area; (2) to base the production of these industries in labor intensive export processing of imported raw materials (Chen 1997d: 12). The next watershed came in 1992, when Deng Xiaoping gave his now famous “Spring Wind” speech endorsing continued market reforms and rapid growth in the context of a post.

Tiananmen conservative backlash (Shirk 1994: 39), and the size of FDI flows into China soon accelerated, especially from industrialized countries. It was also at this time that the Chinese domestic market became more open to foreign firms (Cheng and Kwan 2000: 213), certainly a strong incentive for developed source countries trying to get around China’s strict import controls. There was somewhat of a rollback on FDI liberalization in 1994, primarily to cool an overheating economy and discourage FDI in real estate (Cheng and Kwan 2000: 226), but when the economy cooled down liberalization continued. In recent years, FDI policy has also focused on encouraging technologically-intensive investment, as authorities have begun treating FDI as a means for acquiring foreign technology versus importing complete sets of advanced equipment (UNCTAD 2000: 26).

Since the mid-1990s, China’s policy towards FDI can be at least partly evaluated in terms of its desire to join the World Trade Organization. This desire can help to explain the Chinese Government's attempt to rollback some of the special privileges for foreign investors. The idea is that as authorities reduce tariffs, they will also reduce preferential treatment for foreign-invested enterprises (FIEs), but preferential income tax treatment is expected to continue (Chen 1996: 43).

In that spirit the Chinese government announced the removal of duty-free status on capital goods imports by FIEs to begin in April 1996, a measure that was heavily qualified by grandfather clauses. Partly as a result, FDI fell off in 1996-97, and successful lobbying by FIEs as well as provincial officials eager for FDI is having some effect: it has since been announced that previous exemptions, such as exemption from import duties and value-added taxes on imports of

equipment, have been restored (Henley, Kirkpatrick and Wilde 1999: 240-41; UNCTAD 1999: 57). In sum, China’s policy towards FDI was clearly designed to encourage export-oriented FDI, looking externally to draw on both inputs and markets, and granting well-defined freedoms and incentives to the FIE sector. Policymakers, by developing the coastal development strategy that afforded SEZ-like privileges to the entire coast of China, created a kind of gigantic export processing zone, where free markets were defined not so much by geography but more by ownership (Naughton 1996: 302).

It is also important to note that these liberalizing policies were in line with the government’s own import substitution strategies, where FIEs and the limited free market in which they operated were largely separate from the centrally planned and inwardoriented sector (Kueh 1992). It is only recently as the size of the foreign-invested sector has continued to grow and sell to the domestic market that it has begun to exert important influences throughout the wider economy. These will be discussed more thoroughly below.