Analysis of China as a Potential Destination for Foreign Direct Investment

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The report is an analysis of China as a potential destination for foreign direct investment (FDI). An assessment of Political, economic, cultural, and technological environment indicates that there is minimal risk associated with doing business in China. At the same time, the reports conclude that China's natural resources and factor endowments, more so the availability of skilled and non-skilled labour gives China a competitive advantage. Moreover, the current state of foreign currency and exchange is said to have helped in boosting China's export industry. At the same time, China's trade strategies, more regarding the country's existing policies import, export, and other investments have played a crucial role in ensuring steady economic growth over the years and attracting FDI across the globe. However, according to the report, China's discriminatory institutional structures is widely seen as a challenge by most investors doing business in the East Asian nation. Barriers such as weak protection and execution of international property rights, corruption, opaque anti-monopoly enforcement, and extreme cybersecurity requirements have been highlighted. Finally, while considering China as a potential destination for FDI, it is vital to note that China is already the second largest receiver of FDI worldwide. 

Country Analysis

Foreign direct investment (FDI) has become increasingly important as a source of capital for many emerging countries (Tembe and Xu 2012, p69). As much as greater domestic private sector is vital, new emerging markets have recently realized immense growth through foreign capital flows and transfer of knowledge and technology, which are critical in raising productivity and boosting economic growth (Gould, Tan and Emamgholi 2014, p.134). As such, many developing nations have been working towards creating favourable conditions that can attract FDI (Tembe and Xu 2012, p.70). Studies reveal that there is a difference among countries when it comes to attracting FDI due to their varying business environment, such as the state of infrastructure, policies, economic conditions, and other factors that might influence decisions of foreign investors (Erkekoglu and Kilicarslan 2016, p.218).  Using different literature about FDI and official sources, this paper assesses China as a potential destination for FDI. The analysis will be based on critical determinants to of FDI to China.       

General Overview of the Country

China is a country located in East Asia and the world's most populous nation. With a population of more than 1 billion, it is the second largest economy in the globe (BBC News 2018). As much as China is a communist state since 1949, the country has moved away from the Maoist radicalism (BBC News 2018). Nonetheless, the nation’s communist party tightly controls the government and society, an aspect justified by the need for stability. Regarding the economy, recent reforms have replaced state socialism and facilitated rapid growth, making China one of the world's biggest economies (BBC News 2018). However, China remains a developing country, as its per capita earning is still a fraction of that in developed nations and its market modifications are inadequate. Additionally, issues such as increasing inequality, countryside poverty, rising inequality, and ineffective state sector could continue to hinder the country’s progress (BBC News 2018). On the international stage, China has recently played an important and influential role in the development of the global economy (Balooch et al. 2015, p.40). For instance, it is the most significant single contributor to global growth since the world financial crisis of 2008 (BBC News 2018). Gaining such new strengths has made China more assertive on the international stage.

Political, Economic, Socio-cultural, and Technological Influences

Political, economic, cultural, and technological environment are crucial elements that can be used to assess a country's potential and opportunities for FDI. For instance, the political risk-directed at foreign companies operating in the country remains minimal. As much as there are reports of numerous protests across the country, the Chinese government is adept to handling protest without violence (U.S. State Department 2018). However, in the past, foreign investors have reported various challenges related to China's investment climate. For instance, the government has often used broad industrial policies to protect and promote state-owned and local firms (U.S. State Department 2018). At the same time, there have been cases of selective enforcement of laws and regulations as well as restriction of controlling ownership of foreign entities, an aspect that could discourage FDI (U.S. State Department 2018). In contrast, China’s economic situation remains favourable. The country’s economic transformation over recent years makes it an attractive destination for FDI (Efic 2018). For instance, China's financial state is characterized by a steady growth of GDP and a strong domestic demand (Efic 2018). The country's recent economic reforms continue to open up the economy to FDI. As such, China may offer many opportunities for the foreign investor, advantage driven by China’s huge market potential (Efic 2018). However, recent trade wars with significant economies such as the US is seen as the main downside risk to growth (U.S. State Department 2018).

Additionally, China potential for FDI is influenced by the country’s socio-cultural environment. For instance, the Confucian culture in China has had a substantial effect on the Chinese legal system (Ying 2018, p.1). Foreign investors have reported difficulty in becoming accustomed to China's legal system because it is not only functioning in a complex communist system but is also infused by a long history of tradition (Ying 2018, p.2). For example, despite China’s economic openness, many of the country’s bureaucratic traditions and lack of democratic process negates the country’s efforts to attract FDI (Ying 2018, p.2). Finally, concerning technological influences, China has recently emerged as a new science and technology powerhouse. For instance, according to the World Economic Forum (2015), China's spending in R&D is projected to surpass that of European Union and the US. As such, it is an indication that China can rise and lead the global innovation, thereby providing an immense opportunity for FDI (The World Financial Review 2018). However, limiting factors such as weak intellectual property rights, forced technology transfer policies, and internet censorship could hamper China’s attractiveness as a destination for FDI (U.S. State Department 2018).

National Resource and Factor Endowments That Create Competitive Advantage

China has massive land, with plentiful natural resources and different types of land resources (Ministry of Commerce, PRC 2018). In absolute terms, China’s land resources, cultivated land, forests, and grassland are vast, covering millions of hectares. Besides, China ranks first in high in terms of the total reserve for waterpower resources, which amounts to 680 million kW (Ministry of Commerce, PRC 2018). China is also one of the countries that have abundant mineral and marine resources. So far, 171 types of mineral deposits have been discovered (Ministry of Commerce, PRC 2018). The metals comprise ten types of energy wealth such as oil, natural gas, coal, and uranium as well as 54 classes of mineral resources, for instance, iron, manganese, copper, aluminium, lead and zinc (Ministry of Commerce, PRC 2018). Moreover, there are 91 varieties of non-metallic minerals, for example, graphite, phosphorous, sulphur and sylvine (Ministry of Commerce, PRC 2018). Having abundant natural resources are a source of competitive advantage for China. For instance, China is one of the nations in the globe with more than 15 billion tons of useable oil reserves (Ministry of Commerce, PRC 2018). Additionally, it makes China one of the few countries in the world that have comparably complete assortment of non-metallic mineral resources (Gulley, Nassar and Xun 2018, p.4113). However, it could be argued these resources are abundant in absolute terms but small on a per-capita basis. Hence, it does not create a competitive advantage that the country would desire.

Factor endowments, on the contrary, can impact a country’s comparative advantage because they affect the opportunity cost of specializing in the manufacture of certain commodities relative to others (Ma and Chen 2010, p.1). Labour and capital are major factor endowments that give China a competitive advantage when it comes to global trade (Ma and Chen 2010, p.1). For instance, a cheap source of labour has led to wage differentials that favour production in China. The wage advantage is arguably a factor for the recent increase in Chinese export for the past decade. However, in current years, China has experienced an upsurge in the skilled labour force in China, an aspect that has led to increasing wages, and China had begun specializing in more complex manufactured goods (Ma and Chen 2010, p.2). Regardless, China’s massive rural population and growing numbers of "floating" city workers suggest that China still has a comparative advantage when it comes to low-cost unskilled labour (Ma and Chen 2010, p.2). Availability of substantial capital is also a factor that gives China a competitive advantage. For instance, it has facilitated China's ability to acquire foreign-based assets and gain access to foreign markets (U.S. State Department 2018). Today, China is one of the largest outbound direct investors worldwide. China invested over $200 billion globally in 2016 alone (U.S. State Department 2018).

Foreign Currency and Exchange Influences

Foreign currency and exchange influences is also a vital factor that affects FDI, mainly because of its power in the export business. For the past decade, the Chinese Yuan has been undervalued against significant world currency (Mertens and Shultz 2017, p.2). As much as the Yuan has stabilized and appreciated against major currencies in the past, its value has always remained low relative to key global exchanges (Cardoso and Duarte 2017, p.871). The issue of undervaluation of the Yuan has been the subject of several controversies in many countries, more so regarding how it reflects upon international trade (Cardoso and Duarte 2017, p.871). In particular, the Yuan has become caught up in the trade war between the United States and China. For instance, there is an argument that the recent decline of China's currency is a plot to keep the value of the Yuan artificially low in a bid to boost export industry (Weightman 2018). Besides, the basis behind this assertion is that if the Yuan appreciates, the Chinese labour-intensive trades will lose competitive advantage, consequently leading to the deterioration of the China balance of trade (Shane 2018). In other words, the Chinese currency does not currently trade freely like other major currencies such as the dollar and the pound (Tan, 2018).

China’s Existing Trade Policies, Systems, Barriers, and Incentives

China’s remarkable financial and trade performance can be attributed to sound trade policies, and ongoing institution reform during the past decade (Bin, 2015). The existing systems mainly include import, export, and other investment guidelines (Li, Qiu and Xue 2018, p.413). Regarding import policies, the average rate of import tariff is not high. For instance, the country’s simple average most-favour-nation (MFN) duty rate as of December 2017 was 9.3% (WTO 2018, p.11). The rates for agricultural and non-agricultural goods were 14.6 and 8.5 percent respectively (WTO 2018, p.11). Moreover, most regulatory limitations, such as quotas and licenses for imports have been removed. Also, China upholds contingency trade policies (Li et al. 2018, p.413). Regarding export policies, China has eliminated all export subsidies, and export tax is rarely applied (Li et al. 2018, p.414). Additionally, under Chinese trade guidelines, all local excise taxes are entirely rebated upon export (Li et al. 2018, p.414). As much as China’s trade policies have become increasingly transparent, they mostly promote inward investment (U.S. State Department 2018).

On the contrary, institution structures and systems have played a little role in positioning China as a potential destination for FDI. For instance, despite efforts made to streamline business registration procedure, foreign firms continue to protest about the numerous hurdles, including the process of registration and attaining administrative licenses (U.S. State Department 2018). Moreover, China's complex legal and regulatory system is characterized by regulators and government authorities who conflictingly impose rules and control guidelines. Foreign investors rank erratic and subjective regulatory system, as well as lack of transparency, among the main glitches they encounter while doing business in China (U.S. State Department 2018). Besides, China's legal system provides preference to endorse investment in particular sectors and physical locations and to limit foreign investment not considered in China's national interest. Also, it is also important to note that China utilizes a multifaceted system of regulations and activity-specific rules at both the central and provincial level that affects an industry's composition, at times as monopoly or near-monopoly (U.S. State Department 2018).

Additionally, from foreign investors' point of view, barriers related to China's current investment environment include extensive use of business policies to safeguard and promote government-owned and other local companies by using subsidies, free financing, and discriminatory execution of regulations (U.S. State Department 2018). The other barriers associated with China is the limitation on controlling ownership of overseas firms through equity controls, restricted voting rights, bounds to foreign involvement on corporations’ board of directors (U.S. State Department 2018). More importantly, China’s weak protection and execution of international property rights, corruption, opaque anti-monopoly enforcement, and extreme cybersecurity requirements are widely seen as barriers to trade (U.S. Department of Commerce 2018). Such barriers raised worries that China has back-tracked on restructurings that aim to open up to foreign investment further. Finally, concerning incentives, benefits that are granted to foreign investors are generally in the form of tax benefit, comprising value-added tax, custom and earning tax reimbursements.

Existing Levels of FDI in China

China has undertaken aggressive reforms over the last three decades in a bid to open up its economy and attract foreign investment (Balooch et al. 2015, p.41). Since then, the Chinese government has succeeded in opening up markets gradually to overseas capital and achieved extraordinary achievement in attracting FDI over the past three decades (Balooch et al. 2015, p.41). FDI in China has grown from a nearly insignificant level in 1978 to approximately $136 billion in 2017, making China the second largest FD recipient after the United States (United Nations 2018 p.12). According to a report released by the Chinese Ministry of Commerce, approximately 35,000 foreign-financed firms were created in China in 2017, up 27.8 percent from 2016 (United Nations 2018, p.12). Moreover, FDI in China’s 11 free trade zones hit nearly $16 billion in 2017, which was an 18.1 percent growth from last year (United Nations 2018, p56). The primary sources of FDI in China are Hong Kong, Singapore, Taiwan, United States, Germany, Japan, the Netherlands, Denmark, and the United Kingdom (Santander 2018). The existing FDI in China is mainly focused on business service, new technologies, manufacturing, financial intermediation, real estate, and trade (Koty 2018).

Summary and Recommendations

Based on the above assessment, there is no doubt that China is one of the most attractive destinations to FDI. The above analysis is an indication that China has made significant progress when it comes to opening up its markets for overseas investors. By almost all measures discussed, China is undoubtedly a potential and opportunity for FDI, more so given by the fact that it is currently the second largest recipient for FDI. However, based on assessment, there are still areas that China needs to improve on if it is to maintain the same momentum. First, the Chines government needs to do away with its protectionist policies that are aimed at protecting domestic businesses. Second, China needs to make its system more transparent more so when it comes to crucial information that would facilitate business processes. Finally, there is a need for legal system reforms to ensure fair execution of rules and regulations and to give foreign investors more business ownership freedom.


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January 19, 2024
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