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Foreign Investments’ Contribution to the Economic Development in China

Foreign investments have unquestionably made extremely large contributions to the economic development in China. Such contributions are the main focus of this paper, as it analyses two main areas of concern. Firstly, those many contributions foreign investments have made to China including the rapid and sound development of the national economy; the introduction of advanced and applicable technologies and managerial know how; and accelerating the readjustment of economic structure and the optimization of industrial structure; the acceleration of the integration of Chinese economy into the world economy and the creation of new employment opportunities will be discussed in detail. Secondly, those advantages and disadvantages of foreign investment for China shall be much closely examined. Following such discussions made, the paper will then conclude with a those findings made.

Foreign Investments’ Contribution to the Economic Development in China

Foreign investments have been extremely helpful for the economic development in China in the past, especially in the last five to ten years. In the late 1978 during the initial stages of development, China’s leadership have decided to move the economy away from a centrally planned system to one that was more market driven, while still maintaining the rigid political framework of Communist party control.

Starting from a tiny base, foreign investment surged to an annual average rate of $2.7 billion between 1985 and 1990 and then exploded to reach a record of $45.2 billion in 1997, making China the second biggest recipient of foreign direct investment inflows in the world after the United States.1 As a result of this inflow, 145,000 foreign-funded enterprises were established in the past 20 years, which realized capital investments of approximately $216 billion. According to some estimates, this investment might have provided 20 to 30 percent of China’s economics growth during the late 1980s and 1990s. By 1996, firms with foreign ownership accounted for 12 percent of industrial production, with manufacturing concentrated in toys, shoes, electrical appliances, and other labor-intensive sectors.2

During the years of China’s opening up to the rest of the world in terms of trade, foreign investment have contributed to the economic development in China in many different ways. China has made globally recognized achievements in attracting foreign investment since its reform and opening up. Since 1993, China has remained the number one destination for foreign investment among developing countries. Foreign investments have thus either directly or indirectly affected the development in China.

Rapid and Sound Development of the National Economy

From the period of 1996 to 2000, 104,621 foreign invested enterprises were approved by China with a total foreign commitment of US$279.984 billion, of which US$214.480 billion was utilized, accounting for 28.75 percent, 41.41 percent and 61.28 percent of their respective total for the past 20 years since China’s reform and opening up. The increased value of foreign-invested enterprises reached 1,336.9 billion yuan, accounting for 20.87 percent of China’s industrial increased value of the same period. The taxes derived from foreign-invested enterprises amounted to 683.6 billion yuan, thus accounting for 12.54 percent of China’s total industrial and commercial tax income, making these enterprises the fastest growing tax source since the early 1990s.3 Foreign invested enterprises have not only been able to contribute to the improvement of the balance of payments and the stabilization of China’s foreign reserve, but have also maintained as a whole a favourable exchange balance.

Foreign direct investment (FDI) flows to China have contributed to the growth in GDP in several ways. It has raised the GDP growth by adding capital formation. In the 1990s, FDI have contributed in adding about 0.4 percentage points to the annual GDP growth by adding to capital formation. It has also contributed to the higher GDP growth through its positive effects on total factor productivity. Similarly in the 1990s, empirical research has found that FDI help to raise the total factor productivity growth in China by about 2.5 percentage points annually.

Therefore, it contributes nearly 3 percentage points to potential GDP growth for China.4 FDI have contributed to the GDP growth directly through the establishment of foreign invested enterprises and thus will contribute indirectly by creating positive spillover effects to the domestic enterprises. Foreign invested enterprises now tend to be the most dynamic and productive firms in China’s economy. Domestic enterprises thus benefit from the presence of these enterprises both through increased sales and positive spillovers from the introduction of new technologies and management skills by the foreign invested enterprises. Therefore it can be seen that foreign invested enterprises have become a key component, and a driving force of China’s national economy.

Introduction of New Technological and Managerial Know-How

The advanced technologies, skills, equipment and products imported by foreign invested enterprises have advanced the technological innovation of Chinese industries, and speeded up the readjustment of China’s industrial structure. The absorbed foreign investment has helped upgrade the products and improve the technology and production technique of Chinese industries, including machinery, electronics, communications, automobile, chemistry, light industry, textile and many more. Some sectors have forged a number of new and hi-tech industries in a short period, and hence narrowing the gap between China and other advanced countries in terms of product and technology.5 This therefore would help the economic development of China because it narrowed the gap between China and other advanced countries, it would then make China more competitive against them with other advantages the domestic counterpart will have in the foreign invested enterprise. This will therefore create a greater competitive advantage over other countries, thus driving up the business volume leading to the contribution to the economic development in China.

Acceleration of the Integration of Chinese Economy into the World Economy

Foreign investment has helped sharpen the edge of China’s import and export products in international competition, broaden the trade channels and speed up the growth of the import and export trade. Since 1998, the export volume of foreign invested enterprise accounted for above 44 percent of China’s total export value. For the period from 1996 to 2000 the import and export value of foreign invested enterprise stood at US$858.634 billion, therefore making up nearly 50 percent of China’s total foreign trade. The industrial output of foreign invested enterprises reached US$188 billion, accounting for 27 percent of China’s total industrial output.

The continuous increase of foreign invested enterprises’ import and export has much bearing on the improvement of China’s trade environment and balance between China’s import and export. Such contributions have an impact on the economic development in China because of the increasing of import and export drive to help the growth of GDP. This will also improve the economic development because with the increasing rate of exports, more employment opportunities will be available to fulfill the extra demands for the product that needs to be exported. That extra employment which has been created shall result in more spending by the consumers because they would have more money, and ultimately lead to higher GDP, thus contributing to the economic development in China.

Creation of New Employment Opportunities

An increase in GDP is not the only affect of foreign direct investment, but also the creation of many employment opportunities for the people in China. This creation of employment opportunities has been one of the most prominent impacts of FDI in China. Due to the establishments of foreign invested enterprises in urban areas, employment have quadrupled between 1991 and 1999, to a total of 6 million, accounting for about 3 percent of China’s urban employment. They also account for over 10 percent of urban employment in Guangdong, Fujian, Shanghai, and Tianjin in 1999.7 Currently, there are about 180,000 foreign invested enterprises in operation, employing around 20 million people, that is equivalent to about 10 percent of China’s non-agriculture labor force.8 It can then be seen that foreign investment played a positive role in promoting China’s economics development.

Advantages and Disadvantages of Foreign Investment For China

Advantage of Foreign Investment for China

Firstly, with the outside investment will come increasing flows of management skills, technology, market information and global production and distribution networks linking China to other economies. This therefore creates better opportunities for China to compete with other countries and thus increasing the economic status of the country contributing to the economic developments in China.

With foreign investments, many domestic manufacturers will learn that their products are or can become just as good as those made in foreign countries and that they will be able to compete with the world’s best. This confidence boost due to foreign investments may lead to great success by the domestic firms. The increased business competition will lead to large-scale restructuring and strengthening of the Chinese industries, resulting in greater efficiency and new opportunities, leading to contributing to the economic developments.

Due to increasing foreign investment, the Chinese government will be motivated to accelerate reforms, create greater administrative efficiency and legal transparency. As the rules are simplified and procedures standardized, greater potential for a better environment for business shall begin, as there will be more incentive for new investments by both the foreign and domestic investors because they know they will be protected legally. Having the legal transparency will allow both the foreign and domestic investors to know and understand their rights and obligations. The better transparency of rules and regulations such as the protection of intellectual property rights will inspire technological progress and economic growth for China.

The increasing foreign investment will lead to the creation of new employment opportunities as it has done so for the past decade. This rise in international business transactions will boost the demand for employment positions in areas of finance, accounting, legal and other services. Along with an increase in job opportunities, there will be an increase in the living standard of people in China. With the increase in the living standard, the quality standard of both the people and the society will also increase leading to a better environment thus contributing to the economic development in China.

Foreign investment will also help to open up the Chinese economy in ways of training the new labor market through positive spillovers, or from the transfer of technological and managerial know-how to line up to world standards and best case practices. Economic development shall be allowed to occur at a faster pace with help from the foreign investors in areas such as research and development, technological know-how, managerial know-how, incentive ideas and many more. With foreign investments, such as joint ventures or greenfield, there will be more reason to help train the Chinese for it will also benefit the foreign company as well resulting in a positive double edged sword. This would therefore help contribute the economic development in China.

Firms that are in a joint venture with a foreign enterprise will receive preferential policies. It is offered to the sectors and regions where investment in encourages by the state.9 In many sectors, the income tax for example for enterprises with foreign investment are much lower than the original rate therefore making it an advantage for the firm to be able to reduce income tax paid and therefore having a higher relative profit. China also benefits because with the higher profit from the lower income tax, there will be better conditions for the employees of the firm allowing them to improve their conditions will see to the contribution of economic development. It can be said that in general cases, firms with foreign investment especially in sectors and regions where investment is encouraged by the state will be able to benefit from the preferential policies. This does not only include income reduction but also include other tax reductions and exemptions. With these benefits, the joint venture firms will be able to retain more revenue as profits thus able to invest more into employment welfare or research and development for new products. Either way, the result will lead to the contribution of economic development in China.

Disadvantages of Foreign Investment for China

One of the fundamental problems and disadvantages for China with the still increasing foreign investment is related to the many state owned enterprises and the relatively smaller domestic firms. With the increasing foreign investments entering China, as well as the increase in products brought into China from the home countries of those enterprises, there becomes a decrease in the demand for domestic products dramatically. Currently, the state owned enterprise takes only about one third of China’s production but employs about 60 percent of the entire workforce.10 This places extra burden on to the state owned enterprises for they are continuously making losses but cannot consolidate due to their social responsibility to keep the unemployment rate low. Therefore the government would have to support those enterprises that are still in operation with extra funding annually. For those state owned enterprises that have ceased operations, they would still receive funding from the government to pay for the minimum wages to its former employees. This extra funding worsens the balance of payments for the government slowing down China’s economic development thus making foreign investments a disadvantage for China.

Furthermore, the increasing foreign investments also possess enormous threat to the smaller domestic firms in China. With the Chinese population favoring foreign products over the domestic product the demand and supply will ultimately move to the left where the lower demand will be met with the decrease in supply. Over the long run, those small domestic firms will be forced to cease operation due to their inability to meet their production costs, thus resulting in an increase in the unemployment rate. Although the increase in foreign invested enterprises will bring employment opportunities, the number employed by those enterprises will be unable to compensate for the large number of unemployment caused by the consolidation and the cease of operation for those domestic firms. As a result, this will prevent the sound future economic development in China creating a disadvantage in foreign investment for China.

Balance of payment issues has an adverse impact upon the economic development of China. Although it may seem that foreign investment has a positive impact in the form of injections being provided into the economy to stimulate growth, the end result is one in which the money that is accrued does not stay within China in its entirety. As a result, it is a disadvantage to China in the sense that the revenue generated from foreign investment does not help to contribute to the economic developments in China. Instead, the revenues generated from the enterprises is transferred back to their own headquarters in their home countries and thus helping the economic development of their own country instead of the economic development for China.

The driving force behind all businesses is money; such self-interests pose as a disadvantage for the Chinese economy. This may be shown by the fact that a foreign company may choose to invest in another market if they believe that the labor costs for example, are lower within that other market as opposed to the one that they are currently in. What this may mean, is that the economy may suffer from instability as foreign companies have the ability to withdraw from competition in the Chinese economy on the whim that there are better places to invest.

This will then ultimately result in a crash and a recession for the Chinese economy when foreign invested enterprises start to leave the Chinese market to seek for cheaper and more efficient markets. As a result, it will have an inverse effect on the economic developments in china.

Conclusion

In summation, it may be realized that through the explored issues, foreign investments bring both advantages and disadvantages, and those advantages outweigh those disadvantages brought upon by the foreign investments made. Furthermore, many of the disadvantages that exist can be diversified or eliminated with careful planning and evaluation. With all the advantages that foreign investments bring to China, including better technology know-how; managerial know-how; greater administrative efficiency and legal transparency; creation of new employment opportunities and many other benefits will all lead to a better overall environment both for investors dealing in China and the society as a whole. The rapid and sound development of the national economy over the years is explicitly shown in terms of GDP increases; the introduction of new technological and managerial know-how; the acceleration of the integration of Chinese economy into the world economy by the still increasing volumes in imports and exports and the creation of new employment opportunities which currently accounts for about 10 percent of China’s non-agriculture labor force. Thus those better conditions will help to develop the economic conditions and developments in China.

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