The Determinants of Inward Foreign Direct Investment in China

Topics: Foreign direct investment, Investment, Macroeconomics Pages: 12 (3711 words) Published: October 13, 2008

With the irreversible trend of globalization, trans-national corporations (TNCs) have gain significant power in both the business and political world since the Second World War. Gillies (2005) indicate that the multinational direct investment has grown from 4.4% with respect to the world output in 1960 to 23% in 2003. As an important branch of international business activities, foreign direct investment (FDI) has also experienced a steady increase with an acceleration since 2004 (UNCTAD,2007)

Within the last few decades, China has become a successful story in the area of economics, where FDI contributes tremendously. (Fung, Iliza and Tong,2002) Accompanying with the openness of China, FDI inflows has jumped from 0 in 1979 to more than 35 billion US dollars in 1998 (Sun, Tong et al) Moreover, the figure of FDI has increased to 69 billion US dollars in 2006, ranking as the top one in East Asia(UNCTAD,2007). Trietak (2006) searched more recent statistics and found more rapid increase in the last decade.

Source: Trietak (2006) Is China’s lustre dimming? From a first glance at recent FDI statistics it might appear so, but upon closer inspection … The inside Bureau Issue No.5-October 2006

Various theories around the determinants of FDI inflow were established. Dunnings (1993,2000) established an eclectic framework around the determinant of FDI . He attributed various factors into 3 broad categories, namely ‘ownership advantages, location advantages and internalisation advantages’, and believe FDI only occur when the determine factors are simultaneously satisfied. Navaretti and Venables (2005) examined more specific areas that are concerned more with location factors, including trade cost, size of market and tax. They concluded that these factors jointly impact the decision of FDI. Tseng and Zebregs (2003) studied the determinants of FDI towards preferential policies influence FDI to a large extent. Sun, Tong et al(2002) and Zheng(2001) conducted empirical studies and generated results, highlighting the importance of areas such as market size and trade openness.

This paper will examine the determinants of FDI inflow in China with a critical approach. It will focus on the factors related to location based on Dunnings’ framework and cover the areas of market size, cost and policies. More sub-areas will be explored under the three main categories.

Market Size
It is believed by some analysts that China has a huge size of host market which can reduce the cost of supplying the market, encourage horizontal FDI, because of economics scales and lower fixed cost per unit of output.(Tseng and Zebreg,2003) Although it appears to be common sense that the largest population in China has granted it as a large market, it is the increasing aggregate purchasing power that matters.

During the past 20 years of reform and opening up, the national economy has been keeping a high-speed development with an average increase speed of two digits, topped the countries all over the world. The Gross Domestic Product in 1997 was RMB7, 446.3 billion Yuan and climbed to RMB10.2398 trillion Yuan in 2002 and become the sixth largest economic entity of the world. (GheeLim,2003) The graph below demonstrated the continued growth of GDP clearly. (ibid)

Corresponding with the steady growth of economy, the total volume of export and import amounts US$620.8 billion in 2002, and foreign investment deposit amounts for more than US430 billion, covering about 1/3 of the GDP of the whole year; and an annual foreign investment of about US$50 billion has been absorbed, covering about 4% of the GDP. (ibid)

The above factors indicated that China's favorable market environment offers realistic conditions for FDI and meanwhile reveals a broad prospect for foreign investment. It is also reconfirmed in the empirical studies carried out by Sun, Tong et al (2002) and Zheng(2001) However, it is not necessary to conclude here that market...

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