3. Recently the global environment has been experiencing a surge in Foreign Direct Investment (FDI), in particular, in emerging economies. Select an emerging economy of your choice; critically evaluate the impact of inward FDI on this country using various arguments cited in the literature.
The past 30 years have been a great increase in both the flow and stock of FDI in the world economy. Developed countries are the major recipients of FDI and the amount of FDI to developing countries is increasing, especially the emerging economies. In this assignment, I will discuss and evaluate the impact of inward FDI in China.
Beginning in 1978, China's leadership decided to move the economy away to be more market-driven. After more than thirty years of economic reform, China has been the largest FDI recipient among the developing countries since early 1990s in the world. (Lo. D, 2006) Starting from a tiny base, foreign investment increased from $40 billion annually in the 1990s to $70 billion of FDI inflows in 2006. (FDI. net, 2010) Foreign investment enterprises (FIEs) have become an important source for China's investment in fixed assets.
In this section, I will discuss the positive effect of FDI in China. The main benefits of inward FDI in China arise from effects on economic growth and competitive, employment augmentation, increasing tax revenues and transferring more advanced technologies.
In recent years, China has achieved economic growth in high speed. FIEs have played a largely positive role in China's economic growth because inward FDI has enhanced capital formation. From 1978 to 2008, China's GDP grew by 9.1% annually on average from $180 billion to $4.327 trillion (World Bank Database, 2010). It's GDP per capital also increased dramatically at an annual rate of 10.1% from $193 to $3267. (World Bank Database, 2010) According to K. C Fung (2002), there is a positive correlation between investment by FIEs and GDP growth at both national level and provincial level.
The inward FDI in China leads to positive effect on competition. As China's FDI consists largely of Greenfield investment, the result is to establish a new enterprise, increasing the number of players in the market and increase the level of competition in a national market. (Charles W. L. Hill, 2009) FIEs also increase China's manufacturing exports. They not only augment China's export volumes, but also upgrade its export structure. In 1980, China's exports were ranked the 26th globally, with the volume of $18billion and 47% of the exports of manufactured goods, while it was ranked the 3rd in 2005 with $762 billion of volume and 93% of the exports of manufactured goods. (K.H Zhang, 2006)
FDI has also enhanced China's economic growth through employment augmentation and contributed to government tax revenues. The ration of FDI share in gross capital formation increased from 7% in 1992 to 17% in 1996. The share of tax contributions in China from FIEs increased from 4% in 1992 sharply to 21% in 2004. FDI has also reduced China's unemployment pressure. By the end of 2004, FIEs employed 23 million Chinese, comprising about 10% of total manufactured employment. (K.H Zhang, 2006)
FDI benefits China by transferring more advanced technologies. FIEs may provide training of labour and management and benefit domestic firms through training for local suppliers of products, so as to meet the higher standard of quality control and speed of delivery required by the technology and method of operation. FIEs have increased their shares in relatively high technology industries in China. It found that there is beneficial technological spillover to machinery industries, including electric equipment and telecommunication equipment. As a result, China has become the top-15 producer and exporter in most manufacturing products in 2000. (K.H Zhang,
2006)
However, there are some costs of FDI arising from adverse effects on competition within China, adverse effects on the balance of payments, and the perceived loss of national sovereignty and autonomy. First, FIEs may use their advanced technology to drive out local competitors. (D. Farrell, 2004) The effect is that it disturbs the market equilibrium in order to reduce the level of competition in China. For example, big-store supermarkets in China are monopolized by MNCs, such as Wal-Mart, Carrefour and TESCO. Their monopoly could increase prices and reduce consumer choice that would prevail in competitive markets. It may be harmful to economic welfare of China.
Second, FDI in China may suffer adverse effects of balance of payments.
The initial capital flow that comes with FDI must be set against the subsequent outflow of earnings from the foreign subsidiary to its parent company. (Charles W. L. Hill, 2009) When China's GDP rises up, the cost of production will be no longer competitive in China, and then FDI may reduce China's foreign exchange earnings. As this profit outflow may cause a debit in the current account of the balance of payments, this might weaken the external position and lead to a deficit in the current account. (S. Dullien, 2006) According to K.H Zhang (2006), as a result, the contribution of FIE's public revenue may be less than variety of investment allowance provided by the China government.
Third, FDI may be accompanied by some loss of economic and political independence. Foreign investors are the mechanism for exploitation of and gaining controls over developing countries by western industrialized countries. FIEs may influence government policies in directions unfavourable to China's development. China may attempt to loosen their regulations in order to attract more FDI. The competition of FDI may create a "race to the bottom" in environmental and labour welfare. (KR. Gray, 2002)
In conclusion, FDI has been playing an important role in the key factor of China's success. In recent years, Chinese government has improved the infrastructure and loosened the FDI policy such as tax regulation. In my opinion, since FDI is still important to China in terms of building up the relationship "Guanxi" with the relevant authorities, China should improve its legal system to attract even more FDI. Moreover, FDI has a great contribution to the economic growth in coastal cities. It is the time for the Chinese government to improve the condition of inland regions in order to solve the problem of inequality and keep providing cheap labour for FDI. As a result, FDI will continue to contribute in China's economic development.
