Post on 06-May-2015
description
AN447 Page 1 of 61 35743
Candidate Number: 35747
MSc in China in Comparative Perspectives (Anthropology Department) 2007 Dissertation in partial fulfillment of the requirements of the degree
Foreign Direct Investment in China and India: Development
Experiences and Determinants in a Comparative Perspective
Word Count: 9965
AN447 Page 2 of 61 35743
TABLE OF CONTENTS
Acknowledgement
Abstract
List of Abbreviations and acronyms
List of Tables
1. INTRODUCTION 8
2. DETERMINANTS OF FDI: A THEORETICAL EXPOSITION 9
2.1 FOREIGN DIRECT INVESTMENT DEFINED 10
2.2 MAIN THEORIES OF FDI 12
2.2.1 INDUSTRIAL ORGANIZATION THEORY 13
2.2.2 INTERNALIZATION THEORY 14
2.2.3 PRODUCT LIFE-CYCLE THEORY 14
2.2.4 ECLECTIC THEORY OF INTERNATIONAL PRODUCTION 15
2.3 SUMMARY 17
3. FDI IN CHINA AND INDIA: AN OVERVIEW 18
3.1 TRENDS AND PATTERNS OF FDI 18
3.2 SOURCE-COUNTRY COMPOSITION 24
3.3 SECTORAL COMPOSITION 28
3.4 REGIONAL DISTRIBUTION 31
AN447 Page 3 of 61 35743
4. DETERMINANTS OF FDI 34
4.1 POLITICAL ENVIRONMENT AND FDI POLICY REGIME 35
4.2 ECONOMIC DEVELOPMENT 39
4.3 SOCIETY 41
4.4 TECHNOLOGY DEVELOPMENT 43
4.5 BUSINESS ENVIRONMENT 44
4.6 LEGAL SYSTEM 46
4.7 SUMMARY 48
5 SUMMARY AND CONCLUSIONS 48
5.1 FINDINGS 49
5.2 POLICY IMPLICATIONS 51
5.3 LIMITATION OF THE STUDY 53
5.4 FUTURE RESEARCH DIRECTIONS 53
BIBLIOGRAPHY: 55
AN447 Page 4 of 61 35743
ACKNOWLEDGEMENT
I express my deep sense of gratitude to Professor Stephan Feuchtwang for
his talented suggestions and intellectual stimulus on this dissertation. I
would also like to thank Dr. Victor Teo and all other staff in the
Anthropology Department for their tutoring and support throughout the
year. Special thanks go to the UK Foreign and Commonwealth Office and
the British Council for their generous financial help with my study in the
London School of Economics and Political Science.
I am deeply indebted to my daughter, Youyou Hu, for the immense
sacrifice she has made for bearing my absence, when she needed me most.
AN447 Page 5 of 61 35743
ABSTRACT
The analogies between Chinese and Indian economies draw obvious
comparison. This research seeks to understand the FDI inflows and
examines the main determinants in the two countries. Since the empirical
work over the past decades has not produced consensus as to the
determinants of FDI, Dunning’s O-L-I paradigm offers a unified
framework of the various theories. To identify the differences of
determinants of FDI inflows in China and India, the changing patterns of
FDI are closely studied with special reference to the source countries of
FDI, the sectoral composition and regional distribution. Moreover, this
study develops a PESTEL framework for analyzing the recent
experiences and determinants of FDI inflows in China and India. It
concludes that on the determinants of political and FDI policies,
economic development, society and business environment, China does
better than India; whilst India is ahead of China in terms of technology
and legal system.
AN447 Page 6 of 61 35743
List of Abbreviations and acronyms
CJV Contractual Joint Venture
EJV Equity Joint Venture
EU European Union
FDI Foreign Direct Investment
GBPC Global Business Policy Council
IPA Investment Promotion Agency
IT Information Technology
IPR Intellectual Property Right
LDC Less Developed Country
MNC Multinational Corporation
MNE Multinational Enterprise
NIE Newly Industrializing Economies
OECD Organization for Economic Cooperation and Development
SEZ Special Economic Zone
TNC Transnational Corporation
UNCTAD United Nations Conference on Trade and Development
WFOE Wholly Foreign-owned Venture
WTO World Trade Organization
AN447 Page 7 of 61 35743
List of tables
TABLE 3.1 FDI INFLOWS IN CHINA 1979-2005 18
TABLE 3.2 FDI INFLOWS IN INDIA, AUGUST 1991-2005 22
TABLE 3.3 COMPARISON OF FDI INFLOWS TO CHINA AND INDIA 23
TABLE 3.4 TOP TEN SOURCE COUNTRIES (REGIONS) OF FDI IN CHINA, 1979-2005 24
TABLE 3.5 TOP TEN SOURCE COUNTRIES (REGIONS) OF FDI IN INDIA, AUG. 1991-2005 26
TABLE 3.6 SECTOR-WISE FDI INFLOWS IN CHINA, 2000-2005 28
TABLE 3.7 SECTOR-WISE FDI INFLOWS IN INDIA, AUG. 1991-2005 30
TABLE 3.8 PROVINCE-WISE FDI INFLOWS IN CHINA, 1979-2005 32
TABLE 3.9 REGION-WISE FDI EQUITY INFLOWS IN INDIA, 2000-2006 33
TABLE 4.1 COMPARISON OF SOFTWARE INDUSTRY IN CHINA AND INDIA (YEAR 2005) 38
TABLE 4.2 COMPARISON OF SELECTED ECONOMIC INDICATORS: CHINA AND INDIA 40
AN447 Page 8 of 61 35743
Foreign Direct Investment in China and India: Development
Experiences and Determinants in a Comparative Perspective
1. Introduction
China and India enjoy a lot in common: long histories, giant markets,
huge populations and soaring growth rates. Both countries have an
ancient and prestigious cultural heritage; both are under the influence of
the Soviet model and have embraced economic reform and liberalization
– China in the late 1970s and India in the early 1990s. Now both are in
the process of liberalizing their economies as they open up to foreign
direct investment (FDI), which is not at the same stage and we shall take
a closer look at it below.
FDI has increasingly been considered as a catalyst to market growth
for the developing countries, particularly in countries such as China and
India. More importantly, besides supplementing capital, FDI, as a
principal conduit of technology upgrade, know-how transfer and
managing skills exchange, heralds the globalisation of host economies
(United Nations Conference on Trade and Development. 2005; UNCTAD
2006).
The global competition for FDI among developing countries is
increasing and in this context, both China and India are aiming for a high
share of the FDI pot for they are now getting increasingly integrated with
the global economy as they open up their markets to international trade
AN447 Page 9 of 61 35743
and investment inflows.
The remaining sections of the paper are as follows. The theoretical
justification for the research propositions is examined in Chapter 2. In
Chapter 3, a overview of FDI trends and patterns in both countries is
presented. The changing patterns of FDI are closely studied with special
reference to the source countries of FDI, the sectoral composition and
regional distribution, which are used as the background information for
following chapters. Relevant determinants of FDI inflows into each
country are discussed and compared in Chapter 4 by using a PESTEL
analysis format. Finally, the major findings of the paper are summarized
in Chapter 5. The policy implications are addressed and the limitations of
the study are highlighted before presenting the future research directions.
2. Determinants of FDI: A Theoretical Exposition
The past three decades have witnessed the emergence of a sizable body of
literature dealing with various dimensions of the determinants and
motives of FDI flow. A review of these studies is essential to know about
the different determinants of FDI and to see how far these determinants
can be applied in the following empirical study on China and India. The
first section of this chapter seeks to define FDI and the impact and effects
of FDI. The second section then reviews the existing discussion on FDI
and shows that FDI is determined by different factors under different
macro economic conditions.
AN447 Page 10 of 61 35743
2.1 Foreign Direct Investment Defined
FDI is an important instrument in the process of globalization and plays a
crucial role in the development of the economies of the developing
countries. As defined by the Organization for Economic Cooperation and
Development (OECD), it ‘reflects the objective of obtaining a lasting
interest by a resident entity in one country (‘direct investor’) in an entity
resident in an economy other than that of the investor (‘direct investment
enterprise’)’. Krugman and Obstfeld define FDI as ‘…international
capital flows in which a firm in one country creates or expands a
subsidiary in another’ (Krugman and Obstfeld 2000: p.159). They go on
to highlight that the distinct feature of FDI is that ‘it involves not only the
transfer of resources but also the acquisition of control’. Södersten and
Reed further point out that FDI ‘is in essence a bundle of capital,
technology and management skills transmitted by multinational
enterprises (MNEs) or transnational corporations (TNCs)’ (Södersten and
Reed 1994: p.489).
Unlike conventional definitions of FDI, the official Chinese
counterpart incorporates three forms of direct foreign-invested enterprises
1(sanzi qiye). They are equity joint venture (EJV) (hezi jingying qiye),
contractual joint venture (CJV) (hezuo jingying qiye) and wholly
foreign-owned venture (WFOE) (waishang duzi jingying qiye) (Huang
1 They are usually established through 1) mergers and acquisitions with another company; 2) a direct subsidiary (greenfield FDI); 3) an EJV; and 4) buying a controlling stake of the public listed company.
AN447 Page 11 of 61 35743
1998).
In case of India, the earlier definition of FDI differed from that of the
IMF, as well as that of the World Investment Report compiled by the
United Nations Conference on Trade and Development (UNCTAD)2.
Since 2003, with the establishment of the Technical Monitoring Group on
Foreign Direct Investment, a new method of compilation of the FDI
statistics has been adopted in India, which makes the data internationally
comparable. The new system includes equity capital, reinvested earnings
and other capital, which are mainly intra-company loans (Tamuli 2006:
pp.2-5).
Much of the discussion on FDI in former years, particularly in the
extractive industries, MNCs were perceived as exploitative terms (Dos
Santos 1969: p.21; Cohen 1973), and indeed were seen to be the cause of
much of host economies’ problems (Caves 1982). In India, the takeover
by the British East India Company of control over the whole India had
created the East India Company syndrome (Gupta, Dahiya et al. 2005:
p.149). The ideological change came about during 1990s, when FDI
inflows had become the most important component of total capital flows
to developing countries, notably in East and South East Asia. FDI not
only adds to external financial resources for development, but is also
more stable than other types of flows. Kawai and Urata demonstrate how
2 IMF’s definition includes external commercial borrowings, reinvested earnings and subordinated debt, while the World Investment Report excludes external commercial borrowings.
AN447 Page 12 of 61 35743
FDI upgrades the technological capability of the recipient economies
(Urata and Kawai 2000) and Urata further notes the importance of FDI
for promoting trade (Urata 2001). OECD, Yusuf, Nabeshima and Altaf
identify the role of FDI in fostering recipients’ participation in global
production networks (OECD 2002; Nabeshima, Yusuf et al. 2004; Yusuf,
Altaf et al. 2004). Moran has done a research covering 183 projects
across 30 countries in 15 years and point out that FDI has a positive
impact on the national income of the host economy in the majority of
projects (Moran and Institute for International Economics (U.S.) 1999).
2.2 Main Theories of FDI
There have been a prolific number of empirical studies on the
determinants and motives of FDI. Some studies have concentrated upon
the ownership specific advantages of the foreign firms which are
necessary to outweigh the disadvantage of being foreign. These studies
have tried to find out the significance of various ownership advantages
arising due to propriety knowledge, financial assets, product
differentiation, plant economic of scale, size of the firm and multi-plant
operations etc. We hereby categorizes such theories as external
(supply-side) approaches. Other studies have focused on the locational
specific advantages as low cost of labor, reduced tariffs, fiscal incentives,
market size and characteristics of the host economy, favorable FDI
policies of the host government, political stability and other locational
AN447 Page 13 of 61 35743
factors. Here this study categorizes such theories as internal (demand-side)
approaches. In sum, the external factors include economic conditions
outside the host country, while internal factors include the economic
conditions of the host country.
Traditionally, most empirical papers have focused on the role of the
external factors in determining FDI flows into developing countries.
These theories so far mainly stress on the ownership specific advantages
of the firms and three of them are examined as follows.
2.2.1 Industrial Organization Theory
Hymer and Kindleberger argue that the ‘ownership advantages’
(including inventory, cost, financial or marketing advantages) motivate
them to establish subsidiaries in the host countries (Kindleberger 1969;
Hymer 1976). These advantages which they assume to be exclusive to the
firm owing them explain why American-type FDI is predominant in a
particular sector of industry but it may be unable to portray a general
pattern of FDI.
Another industrial organization approach, developed by Caves, is
based on models of ‘oligopolistic competition’. He treats a MNC as a
creature of market imperfections that lead a firm to possess specific
advantages over local firms in the host country (Caves 1982).
In fact, some Japanese scholars refute its limitation to explain
Japanese-type FDI, which is based on location factors rather than
AN447 Page 14 of 61 35743
technological superiority, economic scale and management skills (Ozawa
1979; Kojima 1996).
2.2.2 Internalization Theory
The internationalization theory, created by Buckley and Casson, and
developed by Rugman and Hennart, is primarily concerned with the
transactions cost approach (Rugman 1981; Hennart 1982; Casson and
Buckley 1983). The basic hypothesis of this theory is that MNEs emerge
when it is more beneficial to internalize the use of such intermediate
goods as technology than externalize them through the market. The core
prediction of the theory is that, given a particular distribution of factor
endowments, MNE activity will be positively related to the costs of
organizing cross-border markets in intermediate products.
2.2.3 Product Life-cycle Theory
In a classic article published in 1966, Vernon was the first to investigate
the relationship between FDI and technology. He uses a microeconomic
concept, ‘the product cycle’, to explain a macroeconomic phenomenon,
which is the foreign activities of US MNCs in the postwar period (Vernon
1966).
He argues that the product life-cycle can be divided into three stages as
new product stage, matured product stage and standardized product stage.
In the early new product stage, firms place factories in the home country
since the demand for a new product is too small elsewhere. As the
AN447 Page 15 of 61 35743
expansion of production in the home country becomes too expensive, the
mature oligopolist invests in a host country with high income elasticity of
demand and similar consumption patterns to the home country. Therefore
it develops into the second stage of matured product. As the product turns
into increasingly standardized and its competition is based on price, the
product is manufactured in less developed countries (LDCs) for export.
Although this theory considers changes in technology and implicitly
assumes that the MNCs would acquire the manufacturing plants in the
countries with abundant low-cost workers, it is not a dynamic theory for
the rate of change and the time-lag between product stages are not
considered. Chen rebuts that it is also unable to explain FDI in
non-standardized products and special products for overseas markets
(Chen 1983: pp.28-9).
The theories explained above mention only the home country
macro-economic, industry specific and firm specific external (supply-side)
factors. But it is necessary to bear in mind that the host country must
possess certain locational advantages to attract FDI. The O-L-I paradigm
developed by Dunning seeks to offer a comprehensive framework by
combining the company comparative advantages and host country
location endowments.
2.2.4 Eclectic Theory of International Production
The eclectic paradigm of international production, which postulates that
AN447 Page 16 of 61 35743
FDI is determined by three sets of factors, namely ownership
(firm-specific) advantage, internalization advantage and location
(country-specific) advantage, is developed by Dunning and modified by
his associate Narula (Dunning 1981; Dunning 1988; Dunning and Narula
1995; Narula 1996).
According to Dunning, the rationales of FDI can be well-defined by
O-L-I paradigm:
� Ownership (O) advantages: economies of scale, exclusive production
and technical expertise, managerial and marketing skills. These are
the prerequisite to ensure or enable the MNCs to recover the costs of
investing abroad. Itaki further argues that these O advantages largely
take the form of privileged possession of intangible assets and the use
made of them are assumed to increase the wealth-creating capacity of
a MNC, and hence the value of its assets (Itaki 1991).
� Location (L) factors: low labor costs, potential foreign market,
favorable investment incentives. These pull factors of host country
contribute to the MNCs’ decision to employ ownership advantages to
produce aboard.
� Internalization (I) factors: Comparing with licensing and exporting,
by using greater organizational efficiency or ability to exercise
monopoly power over the assets under the governance, an internal
market is created between parent-company and affiliates to control
AN447 Page 17 of 61 35743
key resources of competitiveness or to reduce the risk of selling them
as well as the right of use of them, to foreign firms.
Compared with the above theories, which were founded on ownership
advantages in the form of technology and finance, transaction costs and
differential factor endowments, the unique feature of Dunning’s O-L-I
paradigm is to unify and summarize the various theories, although it is
still a frame which synthesizes most FDI theories rather than a new
theory per se. It signified the ownership, locational and internalization
advantages of the firm and, by extension, the ownership and
internalization advantages of the home country, and locational advantages
of the host country of FDI, which Dunning stipulates that O-L-I is
applicable to ‘home country’ and ‘host country FDI’ (Dunning 1981).
According to this theory, FDI is chosen as a market entry strategy so that
a firm can exploit its ownership advantages through internalizing
transaction costs in a specific location, which possess locational
advantages.
2.3 Summary
To conclude, the relative significance of the motives and determinants as
contained in the above theories differs not only between firms and
regions but also from time to time for a particular firm or region. It is
very difficult to generalize about the determinants of FDI and it is true
that most firms are influenced in their behavior by more than one
AN447 Page 18 of 61 35743
objective and sometimes different values are placed on the same
objective.
The difference in the strength of the determinants is most marked
between China and India which differ radically with regard to economic
structure, development characteristics and socio-economic profiles.
Nevertheless, the above theories provide us with a rich collection of
motives and determinants that can support and guide the following study
of the explanatory variables of FDI flows into China and India.
3. FDI in China and India: an overview
This chapter examines and discusses the trends and patterns of FDI
inflows into China from year 1991 to 2005 and India from August 1991to
2005. Based on published official data, it provides a clear picture about
the longitudinal and latitudinal analysis of FDI inflows, the country of
origin, sectoral composition as well as regional distribution of FDI in
both countries.
3.1 Trends and Patterns of FDI
China
During the period 1979-2005, China has approved a total number of
552,942 foreign-invested companies with a cumulative foreign capital
investment (contract value) of US $1285.7 billion, of which US $622.4
billion was effectively invested.
Table 3.1 FDI Inflows in China 1979-2005 (US $billions)
AN447 Page 19 of 61 35743
Year Contracted FDI3 Paid-in FDI4 1979-1991 52.669 13.018
1992 58.124 11.008 1993 111.36 27.515 1994 82.680 33.767 1995 91.282 37.521 1996 73.276 41.726 1997 51.003 45.257 1998 52.102 45.462 1999 41.223 40.318 2000 62.380 40.715 2001 69.192 46.878 2002 82.768 52.7 2003 115.07 53.505 2004 153.479 60.63 2005 189.065 72.406 Total 1285.673 622.426
Sources: Bureau of Foreign Capital, the Ministry of Foreign Trade and Economic Cooperation (the Ministry of Commerce since March, 2003)
Analyzing Table 3.1 reveals the FDI development in China can be
divided into three stages: 1979 to 1991, 1992 to 2001, and 2002, the year
after the China’s entry into the World Trade Organization (WTO) to
present.
From late 1978, China cast off its self-reliance policy and adopted the
policy of reform and open-up. FDI in China grew rapidly during the first
half of the 1980s. Entering the second half of the 1980s, the growth rate
in China leveled off and turned negative in the aftermath of the
Tiananmen massacre (Chai and Roy 2006: p.133). According to Chen, the
annually growth rate reached 20 percent at that period. Moreover, the
paid-in FDI soared to US $4.36 billion in 1991, making it the largest FDI 3 Contracted FDI based on signed contracts, but not always actual inflow. It’s better for gauging the intention to invest. 4 Paid-in FDI was actually invested in host country. It’s a better measure of the actual size of the investment flow.
AN447 Page 20 of 61 35743
recipient among developing countries. (Chen 2002).
In 1992, after Deng Xiaoping’s tour in the Southern provinces, China’s
reform and opening up policy was further intensified. Besides 11 open
coastal provinces, part of the interior regions was open up for FDI.
Furthermore, two new investment categories were created, namely, the
export-oriented and technology-advanced projects, which were entitled to
additional incentives regardless of their location. From US $4.3 billion
(paid-in FDI) and US $11.97 billion (contracted FDI) respectively in
1991, the FDI volume increased dramatically to US $11 billion and US
$58.1 billion, a jump of more than 150% and 380%. Only since the
outbreak of the Asian financial crisis in 1997, the growth momentum has
slowed down (Zhang 2006).
The WTO accession in November 2001 provided another impetus to
FDI and China received US $52.7 billion in 2002, which made China the
Asia’s and the developing world’s largest recipient of FDI. As noted in
World Investment Report 2003, in year 2002, for the first time, China
surpassed the United States to become the largest global recipient of FDI,
accounting for 9.88 percent of the global flows of FDI (Wu 1999).
India
In accordance with the requirements of the economic development in
different phases, the Indian government’s policy toward FDI has evolved
over time (Kumar 1998). In the 1950s, soon after the independence, the
AN447 Page 21 of 61 35743
anti-FDI environment in India was largely based on two factors. The first
was the strong nationalistic sentiments in the wake of independence.
Second, whatever narrow industrial base the country had at that time, an
overwhelming part of it, almost three-fourths, was British-owned.
Political and business leaders wished for the day when such a large
foreign ownership of industries could be contained and Indian industry
and market became a place for Indian entrepreneurs (Das 2006).
Therefore, FDI was discouraged by a) imposing severe limits on equity
holdings by foreign investors and b) restricting FDI to the production of
only a few reserved items (Gakhar 2006).
In the 1980s the attitude toward FDI began to change, adopting the
policies of liberalization of industrial approval rules, a host of incentives
and exemption from foreign equity restriction. In the middle of 1991, a
package of economic reforms was introduced by the government, which
had greatly affected the magnitude and pattern of FDI inflows received
by India (Gupta, Dahiya et al. 2005).
The average for 1985-90 was less than US $2 million per annum. To
put the lack of significant FDI in the Indian economy in perspective, one
should take note of the two following statistics. First, the stock of the FDI
in 1990 was less than US $2 billion, while the inflow was US $100
million (Kapur and S.Athreye 2001: p.130). These statistics are enough to
bring home that India was a minor player in global FDI flows before
AN447 Page 22 of 61 35743
1991.
After the macroeconomic reform process began in 1991, the economy
was gradually opened up to FDI and policy endeavors were made to
attract it. This becomes clear from Table 3.2 that India is fast emerging as
an attractive destination of foreign investors.
Table 3.2 FDI Inflows in India, August 1991-2005 (US $millions)
Financial Year (April-March) Amount of Paid-in FDI5 August 1991-March 2000 15,483
2000-2001 4,029 2001-2002 6,130 2002-2003 5,035 2003-2004 4,673 2004-2005 5,535
2005-2006(up to Dec.2005) 4,719 Total 45,604
Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India
The above table presents the first high point of FDI inflows was
reached in 2001, when it topped at US $4 billion. In 2004, with a total
amount of US $4.6 billion FDI inflows, India was the fifth largest
recipient of FDI in the developing world. China, Hong Kong SAR,
Singapore and Korea were larger recipients than India.
Compared to China, India appears to remain an underperformer in the
global competition for FDI. However, conclusions based solely on those
figures in Table 3.1 and 3.2 need to be interpreted carefully, as the above
indexes have used FDI data provided by official sources in each country
5 The Indian data on inflows do not cover the approval amount of FDI. It is estimated that on an average just 35.8% of approved amount has flown in India from 1991-2000.
AN447 Page 23 of 61 35743
whose definition and measurement methods vary significantly. The
following Table 3.3, using the data from World Investment Report,
elucidates a relatively accurate comparison based on international
standards.
Table 3.3 Comparison of FDI inflows to China and India
(Amount in US $millions)
1990-2000 (annual average)
2002 2003 2004 2005
China 30104 52743 53505 60630 72406 India 1705 5627 4585 5474 6598
Developing economies
134670 163583 175138 275032 334285
World 495391 617732 557869 710755 916277
Source: UNCTAD, World Investment Report 2006 (www.unctad.org/wir)
India’s share of global flows to developing countries appears to be very
small, especially compared with those received by China. The reported
inflows of US $6.6 billion in 2005 represented a mere 1.9 percent of total
inflows to developing economies, in contrast to US $72.4 billion inflows
to china with a share of 21 percent (Ray 2005).
However, as noted by Pfefferman, an IMF 2002 paper asked whether
something was wrong with India’s FDI numbers. The IMF found out that
the India’s FDI statistics exclude reinvested earnings, subordinated debt
and overseas commercial borrowing, which are included in FDI of other
countries (Pfeffermann 2002). On the other hand, the Chinese statistics
are believed to be overestimating the real FDI flows in view of
round-tripping of Chinese capital to take advantage of more favorable tax
AN447 Page 24 of 61 35743
treatment of FDI. According to the World Bank, round tripping accounts
for 20%-30% of FDI in China (World Bank. 2002). This argument is
supported by Song’s research, which shows that the Mainland’s inward
FDI from Hong Kong is overstated by the amount of non-Hong-Kong
(Mainland, Taiwanese and others) capital channeled via Hong Kong, as
Hong Kong’s investment in the Mainland appears to be too larger for the
size of the Hong Kong economy (Song 2005: p.30)
In summary, China and India have pursued radically different FDI
development strategies. So far the absolute amount of FDI going to China
is still much larger than India, but the gap in growth rates is narrowing.
3.2 Source-country Composition
China
Since 1979, more than 200 countries and regions have invested in China.
In the past, most of China’s FDI came from Hong Kong or Macau,
following by those from USA and Japan. More recently, with
normalization of political and economic relation between China, South
Korea and Taiwan, the latter two regions have become important sources
of FDI in China.
Table 3.4 Top ten source countries (regions) of FDI in China, 1979-2005
(Amount in US $billions)
Rank Sector Paid-in FDI %age of total china FDI
1 Hong Kong 288.948 46.62% 2 Taiwan 62.119 9.98%
AN447 Page 25 of 61 35743
3 United States 54.385 8.74% 4 Japan 53.445 8.59% 5 South Korea 31.318 5.03% 6 Singapore 28.956 4.65% 7 United Kingdom 13.287 2.13% 8 Germany 11.517 1.85% 9 France 7.47 1.2% 10 Netherlands 6.967 1.12%
Sources: China Foreign Investment Report 2006, Ministry of Commerce
As Table 3.4 shows, Newly Industrializing Economies (NIEs),
including Hong Kong, Taiwan, Singapore and South Korea, have been the
major investors in China, accounting for 66.28% of the total accumulated
FDI inflows. They represent mainly small and medium-sized businesses
that are export-oriented and involved in assembly and processing
operation. Among them, Hong Kong is keeping as the most important
player. However, its share has dropped from 70% in 1992 to 46.6% in
2005. It is estimated, with the China’s success in industrial upgrading and
greater openness to the outside world, the role of Hong Kong in providing
and intermediating FDI inflows into China will be further reduced in the
future. It should also be stressed here that published FDI figures of Hong
Kong are overstated for the large proportion of round tripping capital,
although no reliable estimates of such part are available.
The USA and Japan have been by far the largest foreign investors
among developed countries investing in China, representing 17.33% of
the total China FDI. The United Kingdom, Germany, France and the
Netherlands constitute the main sources of European Union (EU) in
AN447 Page 26 of 61 35743
China, as together they account for 6.3%, which was quite weak.
India
Table 3.5 Top ten source countries (regions) of FDI in India, Aug.
1991-2005
(Amount in US $millions)
Rank Sector Paid-in FDI %age of total India FDI
1 Mauritius 11,115.47 37.25% 2 United States 4,912.75 15.8% 3 Japan 2,059.33 6.79% 4 Netherlands 1,987.18 6.65% 5 United Kingdom. 1,911.77 6.26% 6 Germany 1,338.88 4.27% 7 Singapore 962.41 3.14% 8 France 772.99 2.55% 9 South Korea 748.98 2.28% 10 Switzerland 613.58 1.98%
Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Foreign Direct Investment Policy, April 2006
Table 3.5 gives percentage share of major country sources in the actual
inflow of FDI in India during 1991-2005. Mauritius, as the top-place
contributor, account for 37.25% of total FDI inflows. It is estimated that
Double Tax Avoidance Treaty entered into with Mauritius, exempting
capital gains from Indian Income Tax, 1961 and benefiting foreign
investors, could be only one of the reasons of spurt in FDI inflows from
Mauritius (Chopra 2003: p.158). Hence, investors from other countries,
principally the United States, route their investments through Mauritius to
take advantage of the tax treaty.
The United States occupies the second position with a share of 15.8%
AN447 Page 27 of 61 35743
and Japan stands at the third rank having a share of 6.79%. The share of
major EU source countries, including the United Kingdom, Germany,
France, Switzerland and the Netherlands, is approximately 21.7%.
In reviewing the source countries of FDI inflows to China and India,
two conclusions can be drawn. First, in China there is a clear pattern of
concentration of FDI inflows. A large part of Chinese FDI comes from
Chinese-owned or overseas Chinese owned companies located in Hong
Kong, Taiwan, Singapore and other NIEs. This proportion to a certain
extent forms the basis for the economic integration of the region, which is
sometimes referred to as Greater China. The plausible explanation here is
that the relative geographical and cultural proximity of China and other
East Asian countries with major sources of capital such as Japan and
Singapore may have put India a disadvantage. However, projects from
such countries are mainly in labor-intensive ones, small in scale, with a
low level of capitalization and little technology transfer. By contrast,
source-country composition in India is more diversified. Kumar studied
the changing sources of FDI in India and indicated that the European
countries were the major sources of FDI inflows to India until 1990.
However, they had declined steadily from 66% in 1990 to 31% by 1997,
while US emerged as the biggest player over this period with a share of
13.75% in 1997 (Kumar 2003).
Second, India boasts a relatively larger share of FDI from developed
AN447 Page 28 of 61 35743
countries (including US, Japan and EU), which accounts for 44.3%. In
comparison, China only holds a share of 23.63%. Although the EU
constitutes the world’s largest home base for FDI, it is relatively
underrepresented in the Chinese FDI, at least as compared to its overall
FDI position in the global economy. As Bulcke and Zhang point out, the
weak FDI position of the European Union in China has directly affected
the competitiveness of the EU companies in the Asian emerging markets
(Bulcke, Zhang et al. 2003: p.3).
3.3 Sectoral Composition
China
Table 3.6 Sector-wise FDI inflows in China, 2000-2005
(Amount in US $millions)
2000 2001 2002 2003 2004 2005 National total 4071481 4687759 5274286 5350467 6062998 6032469 Agriculture 67594 89873 102764 100084 111434 71826 Mining and quarrying
58328 81102 58106 33635 53800 35495
Manufacturing 2584417 3090747 3679998 3693570 4301724 4245291 Electric Power, gas
and water production and
supply
224212 227276 137508 129538 113624 139437
Construction 90542 80670 70877 61176 77158 49020 Transportation,
storage, postal, and telecommunications
services
101188 90890 91346 86737 127285 181230
Wholesale and retail trade and catering services
85781 116877 93264 111604 158053 159871
Banking and insurance
7629 3527 10665 23199 25248 21969
AN447 Page 29 of 61 35743
Real estate 465751 513655 566277 523560 595015 541807 Other sectors 386039 393142 463481 587364 499657 586523
Sources: China Foreign Investment Report 2006, Ministry of Commerce; China Statistical Yearbook, National Bureau of Statistics
Table 3.6 examines the distribution of FDI inflows by industry from 2000
through 2005. It shows that nearly 65-70 percent concentrated primarily
in the manufacturing sector. The next highest share, approximately 9-11
percent, is in real estate. Beyond those two sectors, FDI in China is
scattered across various sectors with single-digit or lower percentage
shares. On the whole, the industry concentration of FDI in China is not
very high compared with the industry concentration in other countries
(IMF 2002).
Regarding manufacturing sector, it is observed that FDI has been
concentrated in the various fields, in particular the electric and electronic
equipment sector, the textile sector, and the chemical and pharmaceutical
sector. However, a shift of FDI away from manufacturing towards
services sector is forecasted because the significant liberalization
following China’s membership in the WTO. The greatest liberalization
will be in financial services, telecommunications, and distribution. These
sub-sectors in the service sector are expected to see rapid increase in FDI.
India
The sectoral distribution of FDI in India between August 1991 and
December 2005 is given in the following Table 3.7.
Table 3.7 Sector-wise FDI inflows in India, Aug. 1991-2005
AN447 Page 30 of 61 35743
(Amount in US $millions)
Rank Sector Amount of FDI inflows
%age of total India FDI
1 Electrical Equipment6 4,885.88 16.5% 2 Transportation Industry 3,143.09 10.34% 3 Service Sector 2,971.66 9.64% 4 Telecommunications 2,890.12 9.58% 5 Fuels7 2,521.49 8.41% 6 Chemicals (Other than
Fertilizers) 1,899.51 5.86%
7 Food Processing Industry 1,173.18 3.67% 8 Drugs and Pharmaceuticals 948.54 3.18% 9 Cement and Gypsum
Products 746.79 2.54%
10 Metallurgical Industries 627.32 2.12% 11 Consultancy Services 444.48 1.59% 12 Miscellaneous Mechanical
& Engineering 435.45 1.51%
13 Textiles 430.07 1.32% 14 Trading 374.23 1.16% 15 Paper and Pulp 363.46 1.1%
Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Foreign Direct Investment Policy, April 2006
The table 3.7 shows the electrical equipment is the largest beneficiary
of FDI inflows, which represents one of the most spectacular
achievements for the Indian economy. Transportation, service sector and
telecommunications, which can be categorized as the tertiary industry,
emerge as significant recipients with a share of 30 percent. Compared
with the old pattern of FDI stock before liberalization, the relative
importance of manufacturing sector has declined with the opening up of
infrastructure and service sectors. Furthermore, within the manufacturing
itself, the preference pattern of FDI is shifting away from heavy 6 Computer software and electronics are included 7 Power and oil refinery are included
AN447 Page 31 of 61 35743
industries to light industries.
To sum up the foregoing discussion on sectoral distribution of FDI in
China and India, we note that both countries witness that the opening up
of new industries has led to increased investments in service sector, thus
bringing down the share received by manufacturing. Within the
manufacturing sector, both countries saw a steady upgrading of FDI
inflows from labor intensive industries to capital and technological
intensive industries and from traditional manufacturing industries to
information technology (IT) related industries. Therefore, in the coming
years, China and India will still present a David and Goliath image in
attracting FDI inflows.
3.4 Regional Distribution
China
The geographical distribution of FDI in China is highly uneven and
reflects the history of liberalization, deregulation and government policy,
as noted in section 3.1. In the early period of reform and opening up, the
reformers targeted China’s coastal areas as the leading regions for the
economic development and established four Special Economic Zones8
(SEZs) in Guangdong and Fujian Province. The analysis of Table 3.8
reveals that the coastal areas, particularly Guangdong and Jiangsu, are the
major locations for FDI inflows. The other main locations for FDI were
8 The four SEZs are located in Shenzhen, Zhuhai, Shantou and Xiamen.
AN447 Page 32 of 61 35743
Shanghai, Shandong and Fujian.
Table 3.8 Province-wise FDI inflows in China, 1979-2005
(Amount in US $billions)
Rank Province Amount of FDI inflows
%age of total India FDI
1 Guangdong 151.657 24.36% 2 Jiangsu 89.848 14.44% 3 Shanghai 55.394 8.90% 4 Shandong 52.932 8.50% 5 Fujian 47.851 7.68%
Sources: China Foreign Investment Report 2006, Ministry of Commerce
Using China’s provincial and municipal data, Hsiao and Shen found
out that the development of cities and infrastructure and easy access to
markets are two of the primary factors often determining MNCs’ choice
of where to invest (Hsiao and Shen 2003). Another point is that the close
geographical proximity and tight cultural and linguistic links between
southern China and the overseas Chinese communities in Hong Kong,
Taiwan and Macau have also contributed to the observed geographical
pattern of FDI inflows in China.
India
The major portion of the FDI in India is found to be flowing into the
economically richer states. The five richer Indian states, Maharashtra,
Delhi, Tamil Nadu, Karnataka and Andhra Pradesh accounted for more
than 66.65% of the FDI inflows into India. This trend in FDI inflows
shows the economic inequality that already exists among the Indian states.
Tamuli asserted that FDI inflows to these states seemed to respond to
AN447 Page 33 of 61 35743
infrastructure availability, business managers’ perception of investment
climate, educational qualification of manufacturing workers and
productivity level of manufacturing industries (Tamuli 2006).
Table 3.9 Region-wise FDI Equity inflows9 in India, 2000-2006
(Amount in US $millions)
Rank Regional office State covered Amount of FDI inflows
%age of total India
FDI
1 Mumbai Maharashtra, Darda
&Nagar Haveli, Daman & Diu
7,486.6 24.91%
2 New Delhi Delhi, Part of Up and
Haryana 7,045 23.42%
3 Chennai Tamil Nadu, Pondicheery 2,295 7.64% 4 Bangalore Karnataka 2,052 6.82% 5 Hyderabad Andhra Pradesh 1,157 3.86% 6 Ahmedabad Gujarat 970 3.26%
Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Fact Sheet on FDI, from Aug.1991-Dec.2006
To summarize, locational benefits appear to be a prime consideration
for foreign investors contemplating participation in any FDI projects both
in China and India. Especially in China, the selective economic policy
creates uneven regional economic development, which strongly affects
the inflow and location of FDI. The study also finds out that the forces of
convergence are very weak in two countries and the provinces (states) are
showing a tendency of divergence rather than convergence. The
geographical distribution of FDI in two countries today also is the result
of local government’s efforts to create a favorable investment, especially
9 Includes ‘equity capital components’ only
AN447 Page 34 of 61 35743
in fostering industrial clusters in their jurisdictions. The Indian economist
Kurian notes that ‘the better-off states are able to attract considerable
amounts of private investment, both domestic and foreign, to improve
their development potential because of the existing favorable investment
climate including better socio-economic infrastructure’(Kurian 2000:
p.12). It seems both China and India express the concern that a growing
polarization of the country can have an extremely damaging effect on
national unity and harmony. A wider geographic spread of capital across
the country are actively pursued by each country. In China, to narrow the
gap, it introduced The West Development Strategy in 1998. In contrast,
the India’s 10th five-year plan explicitly addresses the need to ensure
equity and social justice and ‘particular attention must be paid to the
importance of ensuring a balanced development for all States’ (India.
Planning Commission. 2003: p.8).
4. Determinants of FDI
Following the analysis and literature review on determinants of FDI in
Chapter 2 and the discussion on trends and patterns of FDI inflows to
China and India in Chapter 3, this chapter in turn examines the various
determinants of FDI and to see how far these determinants can be applied
in both countries. Since the external (supply-side) factors explain the
outward investment by different countries while the internal
(demand-side) factors explain the uneven distribution of FDI among the
AN447 Page 35 of 61 35743
recipient countries. Therefore the focus of this chapter will be on internal
(demand-side) factors, although the separation of the two kinds of factors
sometimes is impossible. It will present the PESTEL (political, economic,
social, technological, environmental and legal) analysis of variables that
have directly or indirectly determined the FDI inflows to both countries.
4.1 Political Environment and FDI policy regime
China is still regarded as a communist regime and one of the most
important characteristics of Chinese political system is the one party rule,
while India is the world’s largest democracy. Therefore, the simplest
language to describe the difference between the two countries is ‘the
world’s largest democracy’ versus ‘the world’s largest autocracy’.
Although this metaphor indeed reflects some truth, the reality is much
more complex. Both countries, despite enjoying different political
systems, have actually come from the same place – Soviet style planned
economies and massive state-owned enterprises. Both countries
undertook significant reforms in the 1980’s and 1990’s. As China
modernizes, it increasingly encourages free trade and capitalist-based
economic model which allows more democracy; whilst as India
modernizes, it’s getting it’s democracy under control for the good of
nation.
The first reason for the FDI gap between two countries is that India is
at least twelve years behind China in terms of launching reforms. As
AN447 Page 36 of 61 35743
discussed in Chapter 3, China opened its doors to FDI in 1979 and has
been progressively liberalizing its policy regime, while the reforms in
India were introduced in June 1991, which ‘aimed at reducing the extent
of government controls over various aspects of domestic economy,
increasing the role of the private sector, redirecting scarce public sector
resources to areas where the private sector is unlikely to enter, and
opening up the economy to trade and foreign investment’ (Cassen and
Joshi 1995: P.13).
In addition to the late start, Franda asserts that failure to effect
far-reaching economic reform in the 1990s could be attributed as an
immediate cause to the enormous factionalism characterizing Indian
political life. For example, the BJP-led coalition formed in 1999 consisted
of almost two dozen political parties with widely divergent platforms and
interests (Franda 2002: pp24-27). Vardarajan also declares that India is
perhaps the only democracy where businessmen don’t become politicians
and political system is dominated by political leaders who base their
appeal on “castemanship, regional factionalism and personal cults”
(Cable and Royal institute of international affairs. International
economics programme. 1995). Therefore, a major consequence of the
fragmentation of Indian political party life is the near-impossibility of
conducting meaningful national FDI promotion campaigns. In this
atmosphere, it is little wonder that FDI volume in India was only
AN447 Page 37 of 61 35743
one-tenth of China from 2000 through 2005 (see above table 3.1 and 3.2).
Additionally, during a debate in the Rajya Sabha on 20 August 2001, the
then planning minister, Arun Shourie, was asked why India had received
only $17 billion in FDI in a decade when China had attracted $323 billion.
Shourie stated that the reason was that the Chinese government is ‘market
savvy, quick in decision-making and better still in executing decisions’
(The Statesman, 21 August 2001).
Another essential reason for China’s unparallel success is its strategy of
creating Special Economic Zones (SEZs) and coastal economic zones,
which has been discussed in section 3.4. Decision-makers in the public
policy community proactively create an enabling environment for the
inflows of FDI in the domestic economy, which are essentially located in
the coastal areas of the eastern and the southern provinces of China (Das
2005). Therefore, the ability of China to attract FDI inflows is largely the
result of special economic zones that give foreign enterprises better and
specialized infrastructure and flexibility in domestic regulations.
Compared with China, India’s SEZs scheme was launched in 2000, again
15 years later than China (Gakhar 2006: p.85). Furthermore, unlike China,
India has not employed fiscal incentives such as tax concessions to attract
FDI. Only in December 2004, the Indian government initiated the reform
of the Foreign Investment Promotion Board, and has established the
Indian Investment Commission to enhance and facilitate FDI in India,
AN447 Page 38 of 61 35743
which acts as a one-stop shop between the investor and the bureaucracy.
The one bright spot for India in its FDI competition with China has
been the ability to invite more foreign software investors. The most
telling demonstration of India’s superiority in software technology is in
FDI inflows and trade statistics (see table 4.1).
Table 4.1 Comparison of software industry in China and India (Year
2005)
(Amount in US $millions)
Software industry FDI inflows
Software industry Exports
China 932 3590 India 1451 10000
Source: China Foreign Investment Report 2006, Ministry of Commerce; NASSCOM, India10
Software development in China is at the opposite end of the spectrum
from that in India. Beijing’s effort to build sophisticated software
production capabilities did not get started until the mid-1990s and the
Chinese government provided little state support to this effort until the
late 1990s. While India’s lead in software technology can be traced to
1984, when Rajiv Gandhi began to adopt the first liberal economic
policies designed to develop this sector (McManus, Li et al. 2007).
Compared to the above reform and FDI policies, it is worth noting that
the government need to understand ‘how their policies and behaviors
shape the opportunities and incentives facing firms’(WorldBank 2005:
10 NASSCOM is the apex software industry body in India. Useful information on the Indian software industry as well as doing business in India is available at its website, http://www.nasscom.in
AN447 Page 39 of 61 35743
p.12). In brief, the government policies can play an important role in
attracting FDI inflows. It is desirable to give some specific policy
direction to foreign investors, as the cases of China’s SEZ success and
India’s software development demonstrate.
4.2 Economic Development
Chinese gross domestic product (GDP), adjusted for purchasing power
parity, ranked number 2 after USA, whereas Indian adjusted GDP ranked
number 4 after Japan. Over the past two decades, China’s average annual
growth rate was above 9 percent, and the average annual inflation rate
was kept below 3 percent. The Chinese economy continues its robust
development, total growth in 2005 exceeded expectations at nearly 10
percent. In contrast, the Indian rate also jumped from about 3 percent a
year during 1950-79 to between 5-6 percent a year during 1980-2004
(Chai and Roy 2006). According to the research on the contribution of
GDP growth to FDI by Hsiao and Shen, the elasticity of a 1 percent
increase in GDP raises FDI by 2.117 percent (Hsiao and Shen 2003).
Therefore, if both countries could sustain their present growth in the
future, they are likely to attract more FDI.
Table 4.2 compares the current stage of China’s macroeconomic
performance and economic structure with that of India in terms of some
key economic indicators.
Table 4.2 Comparison of selected economic indicators: China and India
AN447 Page 40 of 61 35743
Indicator Unit Year China India China/India
ratio GDP per capita at PPP US $ 2002 4580 2670 1.71 Gross national income
(per capita) US $ 2003 1,100 540 2.0
Rank 2003 134th 159th Share of manufactured
products in exports Percent 2002 90 75 1.2
Share of high-tech products in exports
Percent 2002 23 5 4.6
Electricity production Billion kwh 2002 1,640 597 2.7 Share in multilateral
trade Percent 2004 8.9 1.1
Rank 2004 3rd 20th Position in the WTO
league table of exporters 2004 3rd 30th
Position in the WTO league table of importers
2004 3rd 37th
Foreign exchange reserves
US $ billion 2005 711 144 4.97
Rate of poverty Percent 2002 17 35 0.5 Adult literacy rate Percent 2002 91 61 1.49
Researchers in R&D Per million
people 2002 584 157 3.71
Share of IT industry in GDP
Percent 2002 3 NA
Sources: (1) World Development Indicators 2005, (2) International Trade Statistics 2005, (3) China Statistical Yearbook, National Bureau of Statistics
The comprehensive comparison of the above economic indicators
reveals that India currently is at the level that China had reached in the
early 1990s. Hence, there is roughly a ten-year gap between China’s and
Indian’s economic development. These again prove that China’s
economic reforms, including those related to attracting FDI, were
initiated so much earlier than India’s and proceeded at such a faster pace
over the past three decades. However, in certain field, such as IT industry,
India is ahead of China.
AN447 Page 41 of 61 35743
To sum up, on the basic economic determinants, China does better than
India. China’s total and per capita GDP are higher, making it more
attractive for market-seeking FDI. Its higher literacy and education rates
suggest that its labor is more skilled, making it more attractive to
efficiency-seeking investors.
4.3 Society
The Dunning’s O-L-I framework and other mainstream FDI theories
discussed in the Chapter 2 do not take social factors explicitly into
consideration. Undeniably, social factors are considered by MNCs and
they have a tremendous impact on the causes and effects of FDI inflows.
Firstly, the FDI gap between two countries is partly a tale of two
Diasporas. China has a large and wealthy Diaspora that has long invested
its money. During the 1990s, more than half of China’s FDI came from
overseas Chinese sources (Friedman and Gilley 2005). Yeung revealed
that a large proportion of foreign investment in Dongguan, Guangdong
Province was stemmed from overseas Chinese entrepreneurs (including
the overseas-based subsidiaries of enterprises originating in China). The
competitive advantage for overseas Chinese-funded enterprises in
Dongguan was their ethnic or close relationship with local government
officials (Yeung 2001). The discussions at section 3.1 and 3.2 also
support Hong Kong and Taiwan’s ethnic relationship with China is a
unique advantage, which enables investors to conduct negotiations and
AN447 Page 42 of 61 35743
operations much easier.
By contrast, the Indian diaspora was, at least until recently, resented for
its success and much less willing to invest back home. Until now, the
Indian diaspora has accounted for less than 10 percent of the foreign
capital flowing to India. Recently, the Indian government has noticed this
problem and organizations, such as The Indus Entrepreneurs (TiE) , were
established to provide platforms for formation of social networks
(McManus, Li et al. 2007: p.48).
Besides the ethnic networks, the personal relationship (Guanxi)
cultivated with local officials is also considered by foreign investors,
especially those from Hong Kong and Taiwan. As Yeung indicates that
some open-minded local government officials have established
communication channels exclusively for foreign investors (Yeung 2001:
p.131). It is regarded as an internalization advantage for foreign investors
as it reduces the information costs for clarifying and understanding new
policies. In contrast, feedbacks received from potential foreign investors
indicate that India’s vast market-place and skilled workforce do not
compensate for poor infrastructure and a corrupt bureaucracy (Fortune
India 31 December 2003: p.8). The American congressman, Frank Pallow
once complained that ‘India is not a difficult place to invest, but India has
to contend with the reality that its bureaucratic maze makes it more
difficult to handle than the stringent bur clearer norms of more autocratic
AN447 Page 43 of 61 35743
countries like China’ (Gakhar 2006: p.118). Hence, the FDI
decision-makers are now acutely conscious of India’s corrupt and
inefficient bureaucracy, which could turn into a veritable and bothersome
hurdle.
4.4 Technology development
Much has been made of the implications over China and India’s
political systems, economic reforms and social relations, which maintain
the accepted truth that China is 12 years ahead of India. While this may
be true of the infrastructure development of China, it is not true for
another important determinant of FDI, which India is ahead. With better
English language skills, India may have an advantage in technical
manpower, particular in information technology.
Some of the differences in competitive advantage of the two countries
are illustrated by the sectoral composition of their FDI inflows, which has
been explained in section 3.3. For example, in information and
communication technology, China has become a key center for hardware
design and manufacturing while India specializes in IT services, call
centers, business back-office operations and R&D (Winters and Yusuf
2007). Therefore, foreign investors perceive China and India as distinctly
different markets. While China is well regarded by them as the leading
global manufacturer and the fastest growing consumer market, India is
viewed as a world-class services provider in business processes and
AN447 Page 44 of 61 35743
ICT-enabled services. Therefore, the Times of India claims that India is
the most preferred outsourcing destination in the world (Times of India
Online. 15 February 2005). There is awareness in the global investment
community that India’s service-oriented development over the last two
decades has made it possible for it to bypass some of its glaring economic
weaknesses, like a poor quality physical infrastructure.
Moreover, as we have discussed at the above section 4.3, although with
the help of its diaspora, China has won the race to be world’s factory.
India could become the world’s office with the help of its diaspora on
technological field. The development of Indian software industry
discussed at section 4.1 shows the fact that ‘India’s soft skill and
technology are creating a tortoise that will ultimately overturn the hard
Chinese hare’ (Smith 2007: p.176). Kiran Karnik, president of Nasscom
comments that China has ‘great potential but is far from being a serious
competitor’ and lags three to five years behind India’s software industry,
quoted by FT reporter (Yee 2007).
4.5 Business Environment
As discussed at section 4.1, liberalization of FDI policy is a necessary
variable for FDI, especially in the kick-off stage, but it’s not sufficient for
expanding FDI inflows. The overall business environment continues to
exercise a major influence on the magnitude of FDI inflows, for it signals
to potential investors the growth prospects of host country. Hence, paying
AN447 Page 45 of 61 35743
attention to the overall business climate and creating a stable and
environment will crowd-in FDI.
A survey of global executives was conducted by the Global Business
Policy Council (GBPC) 11 in 2005 and published as FDI Confidence
Index. Both China (2.19) and India (1.95) are at the center of the FDI
radar screen for they are considered as the 1st and 2nd most attractive FDI
locations globally. This is the forth year in a row that China held the top
spot and India rose from 3rd to 2nd place, surpassing the United States
(GBPC 2005). In Year 2004, this extensive opinion-survey put China at
the top with a score of 2.03 for having the best investment environment,
the US second with a score of 1.45 followed by India with a score of 1.40
(GBPC 2004). A noteworthy observation here is that the gap in the value
of the confidence index between China and India is getting tiny.
The result of the GBPC opinion survey coincided with that of a 2005
opinion survey conducted by the World Investment Report team of the
UNCTAD. This team conducted a larger sample survey of the global
investing community, MNCs, FDI experts and investment promotion
agencies (IPAs). Their results revealed that those who were surveyed
regarded China as the most attractive location with 55% of the CEO
surveyed were willing to invest the most in China, followed by India
11 This survey has a wide coverage in terms of sample size. It covers top decision-makers in the 1,000 largest MNCs of the world on their opinions of various FDI destinations and their investment intentions. These 1,000 MNCs contribute over 70% of total FDI flows and represent all major regions and sectors. The survey tracks the impact of political, economic and regulatory changes in the host economies by the global investing community and preferences of decision-makers in these MNCs. The confidence index ranges between zero and three.
AN447 Page 46 of 61 35743
(36%). Again, both countries are considered as the most favored
investment destination (United Nations Conference on Trade and
Development. 2005).
The World Development Report 2005 emphasizes that ‘for
governments at all levels, a top priority should be to improve the
investment climates of their societies. To do so, they need to understand
how their policies and behaviors shape the opportunities and incentives
facing firms’(WorldBank 2005: p.12). From the above surveys, we can
see that a virtual sea change has taken place in the business environment
of India and it is catching up China very quickly. Therefore, in terms of
overall business environment, India does not rank much below China.
4.6 Legal System
Although the FDI literature focuses essentially on political and economic
development, business environment and technology, to some extent, the
legal system and barriers need to be taken into account as well for a
comprehensive analysis.
The lack of a well-structured and transparent legal system in China
poses serious problems for foreign investors. A clear and strict
hierarchical system of norms does not really exist yet. Moreover, different
ministries and departments of the central and local governments have
issued many diverse regulations, which result in the failure of the foreign
companies to find out which regulations exactly apply to them. In
AN447 Page 47 of 61 35743
contrast, India enjoys a strong British-based legal and accounting system,
which helps it to attract more capital from Western countries. Therefore,
the absence of reliable legal and secure property rights and vast
differences in culture help to explain China’s below par performance in
attracting FDI from Western countries, compared with the performance of
India which has been demonstrated in section 3.2. Meanwhile, India’s
long history of private property, democracy and similar law system with
Western countries should prove attractive for potential foreign investors.
In other words, even if economic policy is great and politics stable, if
there are no property rights and contract enforcement in a country, there's
no way anyone can do business.
One of the key issues on legal affairs is the protection of intellectual
property rights (IPR). The most significant change in the Chinese
business regulations for foreign-invested companies was the introduction
and improvement of IPR during the 1990s. The introduction of patent law
has removed a major obstacle to lure FDI in high-tech industries.
However, the full implementation of IPR protection regulations remains
weak in China. For example, according to the Software Piracy Study of
Business Software Alliance12, China has a very high software piracy rate
with 82 percent in 2006. In contrast, India’s rate is a littler lower than
China, which stands at 71% (BSA 2006). Additionally, the Patent Law in 12 The Business Software Alliance (www.bsa.org) is the organization dedicated to promoting a safe and legal digital world. An important mission of BSA’s research portfolio is the BSA/IDC Global Software Piracy Study, which tracks the state of software piracy across more than 100 countries.
AN447 Page 48 of 61 35743
India is being revised in conformity with the required standards of the
WTO in 2002 (Chopra 2003: p.132).
Concisely, there is a growing patent culture in both countries. The
Indian companies are striving to move up the value chain and are
increasingly approaching their competitive positioning with
intellectual-property-based differentiation. At the same time, under
domestic and international pressure, the Chinese government has
tightened its enforcement of IPR protection and will improve judicial
performance of contracts and other business codes, including those
governing IPR and counterfeiting.
4.7 Summary
From the above PESTEL analysis, we may find that the FDI favors China
over India in the following significant areas: pro-business government,
overall business environment, incentives provided by the host
government, quality of infrastructure and macroeconomic management.
All these add up to create a superior investment environment in China
than in India. The same set of decision-makers has favorable opinions on
India’s English-speaking workforce, software talents, rule of law, cultural
affinity and regularity environment. As we have seen, the relative
attractions are now becoming better balanced. Given a choice, some
investors have switched to prefer India.
5 Summary and Conclusions
AN447 Page 49 of 61 35743
5.1 Findings
Research on the characteristics and determinants of FDI in China and
India is still at the developmental stage. The existing literature on FDI is
appraised in chapter 2. However, most of the traditional studies of FDI
explain only the company advantages, transaction costs and differential
factor endowments, while Dunning’s O-L-I paradigm unifies the various
theories. According to this theory, FDI is chosen as a market entry
strategy so that a firm can exploit its ownership advantages through
internalizing transaction costs in a specific location, which possesses
locational advantages for FDI. The third chapter details overall trends and
patterns of FDI inflows in China and India, including its development
stages, sources, regional and sectoral distributions, along with the
government’s policy changes towards FDI. Since the host country’s
internal factors play an important role in influencing the magnitude,
importance, pattern, form and impact of FDI in the economy, the Chapter
4 deals with and compares the main determinants by adopting the
PESTEL analysis format.
Hence, this research has proved to be a useful experiment in the
analysis of the FDI development experiences and determinants strategies
of both countries. The main conclusions of the present study are given
below:
One important finding is that multiple factors, rather than a single
AN447 Page 50 of 61 35743
factor, influence the volume and pattern of FDI inflows, which include
political and social stability, sound macro-economic environment,
well-developed soft and hard infrastructure, competitive supporting
industries, the availability of skilled labor, and open trade and FDI
regimes. Indeed, these factors are considered “fundamental”; they create
an environment that enables foreign firms to enter an economy and
contribute to its growth and development. Through the PESTEL analysis,
this study finds out that in terms of political and FDI policies, economic
development, society and business environment, China does better than
India; whilst India is ahead of China in terms of technology and legal
system.
A second major conclusion of the study is that changes in a country’s
FDI policy regime are not enough to ensure the desired inflow of FDI.
Actually, the policy coherence, consistency, transparency, and effective
implementation matter. In the forefront of effective implementation of
FDI policies is the speedy processing and approval of FDI applications.
This means that both countries shall streamline its bureaucracy, simplify
approval and remove restrictions on foreign ownership, therefore create a
climate of certainty and friendly policies towards FDI.
A third major conclusion of the study is about the question whether the
recent improvement in the image of India in the global investing
community will affect FDI flows to China. It can be answered by saying
AN447 Page 51 of 61 35743
that it will have little impact. This relates only to the part of FDI that
originates from MNCs, which is a small proportion of total FDI going to
China. Regional FDI flows that originate from the Chinese Diaspora will
not change its pattern of FDI. Besides, the sectors that are going to attract
the global FDI in the immediate future in the two economies are very
different. Coupled with the economic impact of the 2008 Beijing
Olympic Games and the 2010 Shanghai World Expo, rising FDI in
services and high-tech manufacturing might contribute to a new round of
FDI growth in China. As for India, in spite of the opportunities available
for attracting FDI, several challenges remain to be met in order for the
economy to sustain a higher growth path, and enhance competitiveness in
order to position itself favorably in the global competition for FDI.
5.2 Policy Implications
In addition to the general policy implications that have been drawn above,
studies of determinants of FDI inflows conducted in the framework of an
extended model of location of foreign production (Kumar 2002) have
found that a country’s ability to attract FDI is affected by structural
factors such as market size (income levels and population), extent of
urbanization, quality of infrastructure, geographical and cultural
proximity with major sources of capital, and policy factors (namely tax
rates, investment incentives, performance requirements). Based on the
above discussions, India is at the verge of an FDI take-off. Whether this
AN447 Page 52 of 61 35743
potential materializes or not will necessarily depend on how the
government manages and upgrades its business policy environment in the
foreseeable future. At the same time, to maintain sustainable growth,
China needs to improve its ability to attract and use FDI, especially on the
issues of establishing a rule-of-law society and encouraging human
capital enrichment. As a guideline to both policymakers, it seems
reasonable to suggest that the encouragement of FDI should take forms
that bring long-term benefits to the host country’s economy. These may
include the upgrading and extension of infrastructure and public
expenditure on education and training.
Another important implication for both countries and economic
analysts is that we shall stop treating India and China as simple,
one-dimensional entities weighable on a single scale to judge which is the
success and which the failure. Indeed, each, as revealed above,
increasingly sees the other better in some ways and worse in others. For
example, two policies that China can learn from India are: human
resource development and the development of local supporting industries.
Human resource development not only ensures an adequate supply of
skilled labor for foreign investors, but helps a country achieve overall
economic efficiency and move up the economic development ladder.
Moreover, the competitive supporting local industries will promote
technology spillover, one of the positive effects for host country.
AN447 Page 53 of 61 35743
5.3 Limitation of the Study
An important limitation of this study is its use of secondary data and
information which may sometimes be problematic. For example, as noted
in chapter 3, the FDI inflows in China is reported to be overestimated
thus the gap between China and India can be exaggerated. Another
limitation is that we cannot compare the determinants of FDI by different
investors. FDI from different countries contains different levels of
technology and would have different motives to invest. However, the
existing data are very aggregate and this study has to examine the
determinants of FDI as a whole, whether they come from the United
States, Europe, Japan and other countries or regions.
5.4 Future Research Directions
This research has proved to be a starting point in the comparison of the
FDI trends, patterns and determinants between China and India. Drawing
on the PESTEL analysis of the Chinese and Indian FDI inflows presented
in the preceding chapters, the further research will perform a strengths,
weaknesses, opportunities and threats (SWOT) analysis on both country
as well as compare and contrast them in relation to each. Furthermore,
comparative analyses in regard to U.S. foreign investment in China and
India are needed since it is now the major investor country source to both
countries. In addition, as China and India continue to utilize FDI as an
integral part of its economic development strategy, it will be interesting to
AN447 Page 54 of 61 35743
do increased research on changing provincial or state environment for
FDI in both countries, particularly with reference to the interior or
backward provinces (states).
AN447 Page 55 of 61 35743
Bibliography:
BSA (2006). The Fourth Annual BSA and IDC Global Software Piracy
Study. Washington, D.C.
Bulcke, D. v. d., H. Zhang, et al. (2003). European Union direct
investment in China: characteristics, challenges, and perspectives.
London, Routledge.
Cable, V. and Royal institute of international affairs. International
economics programme. (1995). China and India: economic reform
and global integration. London, Royal Institute of International
Affairs, International Economics Programme.
Cassen, R. and V. Joshi (1995). India, the future of economic reform.
Delhi, Oxford University Press.
Casson, M. and P. J. Buckley (1983). The Growth of international
business. London, Allen & Unwin.
Caves, R. E. (1982). Multinational enterprise and economic analysis.
Cambridge; New York, Cambridge University Press.
Chai, C. H. and K. C. Roy (2006). Economic reform in China and India:
development experience in a comparative perspective. Cheltenham,
UK; Northampton, MA, Edward Elgar.
Chen, C. (2002). Foreign Direct Investment: Prospects and Policies.
China in the World Economy. Paris, OECD-China Program.
Chen, E. K. Y. (1983). Multinational corporations, technology and
AN447 Page 56 of 61 35743
employment. London, Macmillan.
Chopra, C. (2003). Foreign investment in India: liberalisation and WTO :
the emerging scenario. New Delhi, Deep & Deep.
Cohen, B. J. (1973). The question of imperialism: the political economy
of dominance and dependence. New York, Basic Books.
Das, D. K. (2005). Asian economy and finance : a post-crisis perspective.
New York, Springer.
Das, D. K. (2006). China and India: a tale of two economies. London ;
New York, Routledge.
Dos Santos, T. (1969). The Crisis of Development Theory and the
Problem of Dependency in Latin America, Siglo.
Dunning, J. H. (1981). International production and the multinational
enterprise. London, Allen & Unwin.
Dunning, J. H. (1988). Explaining international production. London,
Unwin Hyman.
Dunning, J. H. and R. Narula (1995). Foreign direct investment and
governments: catalysts for economic restructuring. London; New
York, Routledge.
Franda, M. F. (2002). China and India online: information technology
politics and diplomacy in the world's two largest nations. Lanham,
Md., Rowman & Littlefield.
Friedman, E. and B. Gilley (2005). Asia's giants: comparing China and
AN447 Page 57 of 61 35743
India. New York, Palgrave Macmillan.
Gakhar, K. (2006). Foreign direct investment in India, 1947-2007:
policies, trends and outlook : incorporating also foreign direct
investment policy, April 2006. New Delhi, New Century
Publications.
GBPC (2004). FDI Confidence Index. Alexandria, VA, A.T.Kearney, Inc.
GBPC (2005). FDI Confidence Index. Alexandria, VA, A.T.Kearney, Inc.
Gupta, D., B. Dahiya, et al. (2005). India in a globalising world. Gurgaon,
Hope India Publications.
Hennart, J.-F. (1982). A theory of multinational enterprise. Ann Arbor,
University of Michigan Press.
Hsiao, C. and Y. Shen (2003). "Foreign Direct Investment and Economic
Growth: The Importance of Institutions and Urbanization."
Economic Development and Cultural Change 51(July): pp.883-96.
Huang, Y. (1998). FDI in China : an Asian perspective. Hong Kong
Singapore, Chinese University Press ; Institute of Southeast Asian
Studies.
Hymer, S. H. (1976). The international operations of national firms : a
study of direct foreign investment. Cambridge, Mass. ; London,
M.I.T. Press.
IMF (2002). Foreign Direct Investment in China: What Do We Need to
Know? Economic Forum. Washington, D.C.
AN447 Page 58 of 61 35743
India. Planning Commission. (2003). Tenth five year plan, 2002-2007.
New Delhi, Planning Commission, Govt. of India.
Itaki, M. (1991). "A Critical Assessment of the Eclectic Theory of the
Multinational Enterprises." Journal of Ineternational Business
Studies Vol. 22: pp.445-460.
Kapur, S. and S.Athreye (2001). "Foreign Direct Investment in India:
Pain or Panacea?" World Economy Vol.3 (No.2): pp.126-57.
Kindleberger, C. P. (1969). American business abroad: six lectures on
direct investment. New Haven; London, Yale U.P.
Kojima, K. (1996). Trade, investment and Pacific economic integration:
selecte essays of Kiyoshi Kojima. Tokyo, Binshindo.
Krugman, P. R. and M. Obstfeld (2000). International economics: theory
and policy. Reading Mass., Addison-Wesley.
Kumar, N. (1998). "Liberalization and Changing Patterns of Foreign
Direct Investment: Has India's Relative Attractiveness as a Host of
FDI Improved?" Economic and Political Weekly Vol. 33(No. 22).
Kumar, N. (2002). Globalization and the quality of foreign direct
investment. New Delhi, Oxford, Oxford University Press.
Kumar, N. (2003). "Liberalization, Foreign Direct Investment Flows and
Economic Development: The Indian Experience in the 1990s."
RIS-Discussion Paper (No. 65/2003).
Kurian, N. J. (2000). "Widening Regional Disparities in India." Economic
AN447 Page 59 of 61 35743
and Political Weekly(February).
McManus, J., M. Li, et al. (2007). China and India: opportunities and
threats for the global software industry. Oxford, Chandos.
Moran, T. H. and Institute for International Economics (U.S.) (1999).
Foreign direct investment and development: the new policy agenda
for developing countries and economies-in-transition. Washington,
DC, Institute for International Economics.
Nabeshima, K., S. Yusuf, et al. (2004). Global production networking and
technological change in East Asia. Washington, D.C., World Bank.
Narula, R. (1996). Multinational investment and economic structure:
globalisation and competitiveness. London ; New York, Routledge.
OECD (2002). Foreign Direct Investment for Development: Maximising
Benefits, Minimising Costs. Paris.
Ozawa, T. (1979). Multinationalism Japanese style : the political
economy of outward dependency. Princeton N.J., Princeton
University Press.
Pfeffermann, G. (2002). Business Environment and Surveys, Paradoxes:
China vs India. Presentation made at the 2002 PSD Forum on
Investment Climate Assessment Methodology: The Investment
Climate in India and China: Which is Better?
Ray, P. (2005). FDI and industrial organization in developing countries :
the challenge of globalization in India. Aldershot, UK ; Burlington,
AN447 Page 60 of 61 35743
VT, Ashgate.
Rugman, A. M. (1981). Inside the multinationals : the economics of
internal markets. London, Croom Helm.
Södersten, B. and G. Reed (1994). International economics. Basingstoke,
Macmillan.
Smith, D. (2007). The dragon and the elephant : China, India and the new
world order. London, Profile.
Song, E. (2005). The emergence of Greater China : the economic
integration of mainland China, Taiwan and Hong Kong.
Basingstoke, Palgrave.
Tamuli, M. K. (2006). Foreign direct investment in India: an analytical
overview. New Delhi, Akansha Pub. House.
UNCTAD (2006). World Investment Report 2006. New York, United
Nations.
United Nations Conference on Trade and Development. (2005). World
Investment Report 2005. New York, United Nations.
Urata, S. (2001). "Emergence of an FDI-Trade Nexus and Economic
Growth in East Asia". Rethinking the East Asia miracle
J. E. Stiglitz and S. Yusuf. Washington, D.C.
New York, World Bank ;
Oxford University Press: x, 526 p.
Urata, S. and H. Kawai (2000). "The Determinants of the Location of
AN447 Page 61 of 61 35743
Foreign Direct Investment by Japanese Small and Medium-sized
Enterprises." Small Business Economics 15: pp 79-103.
Vernon, R. (1966). "International Investment and International Trade in
the Product Cycle." Quarterly Journal of Economics No. 88:
pp.190-207.
Winters, L. A. and S. Yusuf (2007). Dancing with giants: China, India,
and the global economy. Washington, DC, World Bank : Institute
of Policy Studies.
World Bank. (2002). "Global development finance." from Available in
electronic format via ESDS http://esds.mcc.ac.uk/wds_wb/
World Bank (2005). World Development Report 2005. Washington DC,
World Bank
Wu, Y. (1999). Foreign direct investment and economic growth in China.
Cheltenham, UK ; Northampton, MA, E. Elgar.
Yee, A. (2007). India Lobby Group Touts IT Industry Potential. Financial
Times. London.
Yeung, G. (2001). Foreign investment and socio-economic development
in China : the case of Dongguan. Basingstoke, Palgrave.
Yusuf, S., M. A. Altaf, et al. (2004). Global production networking and
technological change in East Asia. Washington, D.C., World Bank.
Zhang, K. H. (2006). China as the world factory. London, Routledge.