International trade in China

Overall, FDI is strongly associated with international trade in China. In 1995, the trade share of FIEs was 39. 1 percent of China’s total trade (Chen 1997a: 3-4). In terms of exports alone, the share of total exports produced by FIEs went from less than one percent of China’s total exports in 1984 to 27. 5 percent in 1993 (Lardy 1994: 72). In the past few years, trade by foreign affiliates accounted for as much as half of China’s total trade (UNCTAD 2000: 54).

Much of this increasing share is largely a result of the transfer of production of labor-intensive manufactured exports from Hong Kong, Taiwan, and to a lesser extent from other NIEs in East and Southeast Asia, to obtain lower production costs (Naughton 1996: 314), as the timing of China’s FDI reform policies coincided with the upgrading of technology and economic restructuring of China’s higher income neighbors (Chen 1997a). Timing was certainly not everything; vast networks of overseas Chinese in countries like Hong Kong, Taiwan, Singapore and Malaysia were poised to take advantage of the confluence in policy and economic change.

Despite increases in industrialized country investments into China, which tend to be larger and more capital intensive than investment from developing source countries, FIEs overall tend to be in labor intensive industries (Chen 1996, 1997b; Sun 1998). In an empirical study of inter-industry variation in FDI using data from 1995, Chunlai Chen (1997b) finds a negative and significant relationship between an industry’s capital-labor ratio and FDI (as measured by FIE assets). He also finds that the share of FIEs in an industry tends to be higher the more labor

intensive the industry, and that the share of FIEs is also higher in fast-growing export-oriented industries. Using data on China’s 3,000 largest FIEs in 1994, which is biased towards larger and more capital intensive enterprises, Chen (1997c) splits industries into labor, capital, or technologically-intensive categories, and counts the number of enterprises in each category. 2 2 He uses number of enterprises instead of reported value of capital invested to “avoid problems associated with differences in valuations by date of investment” (Chen 1996: 23).

Categories are as follows. Labor intensive sectors include: food processing; food manufacturing; textiles; clothing and other fibre products; leather and fur; timber processing; furniture; paper and paper products; printing; cultural, education and sports goods; rubber products; plastic product;, non-metal mineral products; metal products; and others. Even with data biased towards capital intensive industries, of his sample he finds that 52 percent of FIEs are in labor intensive industries, 25 percent in capital intensive and 23 percent in technologically intensive sectors.

Among FIEs, Hong Kong is by far dominant across almost all manufacturing industries. In addition to the investment patterns in manufacturing described above, the real estate sector has also been a significant recipient of FDI in China. Between 1984 and 1987, FDI into real estate increased rapidly, attracting more than a third of inward investment flows and peaking in 1986 at 49 percent of all inflows, mostly at the expense of inflows into industry. This proportion declined in 1988 as a result of tighter macroeconomic policies, but was on the rise

again beginning in 1992, the beginning of another economic boom (Chen 1996). In recent years real estate has held steady at around 12 percent of FDI inflows, partly as a result of central efforts to constrain speculative FDI. III. The Impact of FDI in China on Growth, Productivity, Wages, Employment and Investment The Chinese government ranks high among the world’s boosters for foreign investment. Along with many Chinese economists, the official line is that FDI has played an enormously important role in the development of the new China.

Indeed, many observers believe that as FDI began to falter in the late 1990s, the Chinese government accelerated its efforts to join the WTO primarily to attract more FDI, presumably because of their belief in its importance for Chinese economic development. Yet, despite all the scholarly work devoted to the impact of FDI on China by Chinese economists and others, there is still very little hard evidence that FDI has had a large salutary impact on the Chinese economy, and if so, what exactly it has been.

To help fill this gap, we have studied empirically the impact on a number of key macroeconomic variables. Two of the areas where there has been a fair amount of empirical work has been on the impact of FDI on growth and productivity. Because China has been so tremendously successful in attracting FDI, this literature is an important part of assessing the promise of foreign investment in a developing country context.

Beginning with growth, applications of the most standard type with some combination of capital and labor explaining GDP growth, find that FDI makes significant contributions to growth (Chen, Chang and Zhang 1995; Sun 1998). These types of studies should be treated with Capital-intensive sectors include: beverage manufacturing; tobacco; petroleum refining and coking; chemical materials; chemical fibres; ferrous metal smelting and pressing; non-ferrous metal smelting and pressing; and transport equipment.

Technology-intensive sectors include: medical and pharmaceutical; general machinery; special machinery; electrical machinery and equipment; electronics and telecommunications equipment; and instruments and meters.

(Chen 1997c: 16-17) caution, however, because FDI could be capturing the contributions of public policy to growth and therefore overstating its effects. We deal with this issue by constructing the policy variable “liberalization,” discussed below. Also, these studies do not address the direction of causality: it is just as likely that GDP growth induces FDI as the other way around. In another study, Shan, Tiann, and Sun (1999) test whether industrial growth in China is Granger-caused by FDI or vice versa.

They find a two-way causality between industrial growth and FDI, that both FDI-led growth and growth drawing FDI are supported by the empirical evidence, indicating that the relationship between FDI and growth is more complex than simple studies would suggest. More complex approaches draw on the insights of endogenous growth theory, emphasizing the indirect effects of FDI on growth through productivity spillovers and forward and backward linkages. These analyses are based on the premise that much of the value of FDI comes in the form of ideas and technological spillovers, as multinationals bring with them managerial know-how, international connections, and technologically advanced production processes, all of which combine to enhance a locale’s overall productivity beyond what FDI directly contributes to domestic investment.