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Why FDI into China outperformed the world

By John Ross: 0 Comment(s)Print E-mail China.org.cn, December 24, 2012

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World foreign direct investment (FDI) fell significantly in 2012. Global data is unavailable for the second half of the year, but United Nations Conference on Trade and Development statistics show FDI fell by 8 percent in the first half to $668 billion. Many countries suffered severe declines - FDI into the US fell by 39 percent and into India by 43 percent.

China has been one of the world’s largest recipient countries of foreign direct investment (FDI). [File photo]

China outperformed the global average but nevertheless did not escape the fall - inward FDI declining by 3 percent compared to a year earlier. The trend continued into the second half of the year with a 3.6 percent fall for January to November.

Such trends occasionally generate lurid headlines regarding China such as "FDI continues losing streak." But scare stories about "collapsing" FDI into China invariably turn out to be false. It is therefore worth analyzing the structural reasons why FDI into China will continue to be strong.

Spurious claims regarding a serious decline in FDI into China generally ignore the global context. Naturally China cannot cut itself off from the global economic situation. If world FDI is falling or rising then, other things being equal, it will fall or rise in China. China outperforms global trends but it cannot completely escape them - as the data for 2012 shows.

In the first half of 2012 FDI into China, $59 billion, was larger than into the US. FDI into the US was $57 billion. China is unlikely to retain first place, as the fall of FDI into the US was particularly severe in the first half of 2012, and as at market exchange rates the US economy is approximately twice as big as China's. But inflows into China are larger than into the US in proportion to the size of their economies.

The reason FDI into China remains stronger than world trends is clear. Multinational companies for decades have been used to China being the world's most rapidly growing major economy in percentage terms. The new factor is that the absolute increase in the size of China's market in dollars each year is now larger than the US.

To show how much more rapidly China expands than other markets, in 2007-2011 EU GDP, that is its market size, increased by $575 billion and the US by $1,132 billion. But China's GDP grew by $3,804 billion. China's market expansion was more than three times that of the US and six times that of the EU.

This effect was not simply due to the US recession. In 2011, when the US economy was recovering, the expansion of the US economy was $647 billion and China's $1,367 billion. The dollar increase in China's market has been greater than the US each year since 2007 and given the relative growth rates of the two economies this will continue. China is therefore no longer simply a base for exports but the world's most rapidly growing market. As Zhang Xiaoji, director of the Foreign Economic Relations Development Research Center of the State Council, rightly put it: "China's biggest attraction to global investment is now its huge market."

The result is the statistics from the Ministry of Commerce indicating that more than 480 of world's top 500 companies have established subsidiaries in China. Nearly 1,000 R&D centers have been set up by international companies - in 2010 alone foreign investors established 194 R&D centers.

This feature also points to the real importance to China of inward FDI. For overall investment financing FDI is marginal for China. China's total fixed investment in 2011 was $3.2 trillion. Over 95 percent of finance for China's investment comes from domestic sources.

But FDI brings technological and managerial expertise. For example, while China and the US have approximately the same manufacturing output, China requires over 100 million people to produce this while the US needs only 11 million. Despite China's economic size its productivity is far lower than high income economies. The inflow of technology and management from FDI helps speed up China's productivity growth and achievement of world standards of production.

The nature of FDI flows into China consequently changes as its productivity increases. As the income of China's population grows, and it is likely to double by 2020, their own purchases move up market and the nature of China's exports changes - medium and high technology exports gaining and products depending on very low wages declining in importance. As Zhang Xiaoji noted: "For investment oriented with low costs, pulling out is normal and will continue in the future owing to China's rising costs and appreciation of local currency." However China's lead over other developing economies in infrastructure and cost innovation means it continues to be not only the world's most rapidly growing market but also the world's largest base for manufacturing exports - a fact confirmed by foreign owned firms - accounting for approximately half China's exports. Consequently, while overall FDI into China fell in the first half of 2012, FDI in technology focused industries rose by 6.6 percent.

Inward investment into China's service sector is also playing an increasing role, with FDI in this sector reaching $39.5 billion in the first nine months of 2012 - 47 percent of the total.

Given these clear trends why do media "scares" regarding FDI into China periodically appear from companies? Bluntly an important reason is simply that foreign investors are naturally looking for the best possible deal and claims that foreign investment will collapse is a tactic in order to try to extract concessions.

I had direct experience of this tactic in another context. During the time I ran London's economic policy, meetings with bankers habitually included their explanation that unless their taxes were reduced they would leave London. I understood it was their bargaining tactic. Taxes were not reduced, and during an eight year period London pulled ahead of even New York in rankings and media coverage as the world's number one financial center and city. Similarly for China, in the first half of 2012 frequent complaints appeared in the press from companies claiming that China's climate for FDI was severely deteriorating - just at the moment when data show China was the world's number 1 FDI destination!

As always, what people do is more important than what they say. The data show the huge inflow of FDI into China. The strong growth of China's economy and its rising technological level clearly explain that trend. Because China's economy will continue to grow strongly it will remain one of the world's top FDI targets.

The author is a columnist with China.org.cn. For more information please visit: http://www.china.org.cn/opinion/johnross.htm

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