Provincial government revenue

Secondary literature confirms this interview information. The so-called “five connections and one leveling” (wutong yipping) – connecting roads, telecommunications, water, electricity and ports and leveling of sites – were the main methods used to attract foreign investment to Shenzen, an SEZ near Hong Kong (Yeh 2000: 52).

These methods have been used in many other parts of the country as well. Once again, these can cost the government significant amounts of money. They can also lead to enormous waste. Literally hundreds of economic and technical ment zones (ETDZs) have been set up around the country to attract foreign investment. Many are established in small towns and villages. Evidently, while some are successful, “most are left idle because the flow of foreign investment does not materialize, leading to much waste of valuable land resources” (Yeh 2000: 56). The other ways in which competition occurs is by promising good political connections so that companies will be able to cut through the various types of red tape that the government throws at them. It is not uncommon for foreign investors to be wined and dined by top government officials or their children with the implicit promise that these connections, or guanxi, will help pave the way to an easier corporate life.

Why are these government officials so anxious to attract FDI? One reason must surely be the fact that they believe it has a positive impact on their communities. But another is that local officials who attract high levels of FDI have a much greater possibility of being promoted in the government and/or party. 19 Furthermore, and not to be underestimated for its appeal, is that attracting foreign investment with an offer to give large subsidies and streamlined regulatory treatment create enormous opportunities for graft and corruption (see more on this below).

One result of this competition may be an erosion of provincial government revenue, at least in the short run. As we have seen, this loss can result from lower tax rates officially offered to investors investing in an economic zone, as well as the loss of fees and other income from the land and other assets. To assess the impact of FDI on tax revenues, we returned to our panel and studied the evolution of provincial government revenue using regression methods.

Table 7 estimates the impact of domestic (adjusted) investment, foreign direct investment, trade and liberalization on the provincial government revenue. All variables are in logs and are measured in first differences. The regressions show that government revenue is negatively associated with both domestic and foreign direct investment. On the other hand, trade is positively associated with government revenue.

These results are certainly consistent with the argument that bidding for investment – both foreign and domestic – appears to reduce provincial government revenue. This seems to be a significant cost of the de-centralized nature of the investment bidding process. As with the other regression results we have presented, however, this conclusion is tempered to some extent by the positive impact of trade. To the extent that FDI contributes to trade, then, indirectly it might be contributing to tax revenue. But, these results suggest that in order to measure the positive impact of trade, one might need to subtract the bidding costs associated with attracting investment.

It also suggests that as foreign investment becomes less and less export oriented, as we discuss below, these trade related gains are likely to be significantly eroded. Corruption We suggested in the introduction that one way in which the possible social gains from FDI can get dissipated is through graft and corruption. It is certainly the case that most Chinese people believe that corruption is a very large problem. Moreover, there have been some very large and well publicized corruption scandals in China in recent years, including one in Xiamen,

Fujian province in which dozens of local officials were convicted of smuggling, and more than ten were given the death penalty. But, as far as we know, there have been no publicized arrests of officials for corruption in the bidding process for foreign investment. However, there is little doubt that such corruption is widespread. Daniel H. Rosen interviewed almost 100 expatriate managers of MNCs in China in the late 1990s. Rosen reports that many managers complained of bribery and bribery related payments to achieve approval of investments or win contracts (Rosen 1999: 218-26).

He suggests, moreover, that having an effective and well connected patron in China, to help firms navigate around the maze of regulations, was perhaps the most important determinant of business success (ibid. ). Shang Jin-Wei (2000), in his provocatively titled paper, “Why Does China Attract So Little Foreign Investment,” claims that given China’s income and population, the amount of foreign investment it attracts falls well below the cross-country regression line which would predict the quantity that ‘ought’ to flow there.

He argues the difference is even greater if one considers that a significant amount of investment is not really foreign: it is Chinese investment round-tripped through Hong-Kong (see the discussion above). He attributes the low level of foreign investment to corruption and other government induced barriers to foreign investment  Either way, it does seem that corruption may well be a costly institution which is reducing the benefits of foreign investment for the Chinese population.

To the extent that such corruption might be an inevitable concomitant of industrial policy in China, these possible costs must be weighed against the benefits that a structure of industrial policy and allocation, performance requirements and import substitution provides. 20 And this becomes particularly important in light of the constraints which China's entry into the WTO will place on its ability to conduct industrial policy.