China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

Winners and Losers: FDI in China

September 4, 2013

In the last three decades, China has emerged from an isolated economy to the number one destination in foreign direct investment (FDI). How has FDI affected the Chinese economy? This essay summarizes the authors’ own research findings from the perspective of domestic firms in China.

The existing studies on FDI spillover effects in China have several drawbacks. First, most studies limit their research to total factor productivity (TFP) or labor productivity. Second, even for studies on TFP, different papers have produced very different results, leading to confusing conclusions. In particular, among studies that find positive FDI spillovers on TFP, many suffer from methodological flaws that lead to an upward bias in the estimates or downward-biased standard errors. Finally, there is little research studying the specific conditions under which positive spillovers actually occur. In our recently published book (with the same title, together with Galina Hale, by World Scientific), we attempt to address these issues, relying on multiple large-scale disaggregated data sets.

Using data from China’s National Bureau of Statistics Manufacturing Census (2000-2006) and the World Bank firm surveys of 2001 and 2004, we show in Chapter 2 that foreign-invested firms in China do tend to be more productive, with firms invested by regions from outside the greater China area (FRN firms) having a greater advantage. All foreign-invested firms pay higher wages to their engineers and managers, but not necessarily to their production workers. Furthermore, firms with investment from Hong Kong, Macao, and Taiwan (HMT firms) also tend to export more of their outputs. Finally, firms with foreign investment are not more likely to have introduced new products, regardless of the country origin of foreign investment.

Chapter 3 is the first chapter to explore spillover effects of FDI presence, where TFP is the performance measure of interest. We find that there is no overall significant horizontal spillover effects of FDI on TFP of domestic firms. However, significant positive horizontal spillovers are observed for private firms as a whole, and there are more significant positive horizontal spillovers of FDI from outside the greater China area than of that from within the HMT region. We also study two kinds of vertical spillovers, spillover effects of downstream FDI (or backward linkages), and those of upstream FDI (or forward linkages). For backward linkages, we find no significant overall effects for the full sample of firms. Yet positive effects are found for private firms of downstream FDI both from within and outside the greater China area. In particular, these positive effects are larger in size than the horizontal spillovers. In contrast, SOEs suffer significant negative effects of presence of FDI from outside the greater China area in downstream industries. The patterns observed for forward linkages are very similar. We view these findings as evidence that private firms are more efficient and more competitive than SOEs.

In Chapter 4 we explore the spillover effects of FDI on wages and labor quality and find that the spillover effects vary along two dimensions. First of all, FDI presence significantly drives up the wages for managers and engineers in domestic firms located nearby, but not the wages for production workers. In addition, private domestic firms raise their wages for managers and engineers at the presence of foreign invested firms, while SOEs are not significantly affected in these wages. We also find that FDI presence affects labor quality: managers hired by private domestic firms tend to have more foreign experience when FDI is presence, yet there is some evidence of quality deterioration for managers employed by SOEs. Put together, these findings suggest that foreign invested firms pose real competition with Chinese domestic firms in the labor market of skilled workers, thus driving up their wages. Furthermore, the constraints faced by Chinese SOEs may have hampered their ability to compete with foreign firms in the labor market.

The spillover effects of FDI on exports are studied in Chapter 5. While HMT investment is found to have no overall significant effects on same-industry domestic firms’ exporting behaviors, FRN investment is shown to have negative and significant effects on the ratio between exports and total sales in domestic firms in the same industry, in particular for private firms. Very similar results are obtained for vertical spillover effects, be they through backward linkages or forward linkages. We interpret these results as reflecting the combined effects of the following mechanisms through which FDI impacts domestic firms: (1) the technological and managerial spillovers that increases the competitiveness of domestic firms’ output on the international market; (2) the competition between foreign invested firms and domestic firms on the export market that pushes domestic firms’ output away from exports; and, (3) the supplier and client relationships established between foreign and domestic firms that pull domestic firms’ output toward domestic market. The evidence suggests that FDI from regions outside the greater China area are more likely to engage domestic firms in their supply chains within China.

Chapter 6 studies the spillover effects of FDI on the innovation behaviors of domestic firms, arguably the most important long term impact of FDI on the Chinese economy. The patterns observed, however, suggest a rather grim view of FDI’s influence on the innovation activities of Chinese indigenous firms. Findings based on the NBS census show that FDI presence significantly lowers the probability of having new product sales in domestic firms, whether the FDI is made in the same industry, in downstream industries, or in upstream industries. In addition, the negative effects hold regardless of where the foreign capital comes from. Results from the World Bank data analysis give a somewhat positive picture, where some domestic private firms increase their likelihood of new product introduction. However, these results also indicate that the new products that are introduced tend to be imitations rather than authentic innovations.

With continued growth in FDI inflow projected for the foreseeable future, China needs to recalibrate its policies and the above research findings may inform policy making.

 

 

 

 

 

 

Cheryl Long
Associate Professor, Director of the Asian Studies Program, Colgate University and Xiamen University

 

 

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China – Strong Impact on Commodity Prices Despite Slower Growth

China will show a slower growth of around 7.5 per cent in 2013. This is a slight reduction of the growth rate in relation to the previous year. But even with this more moderate growth the country still dominates the global commodity markets.

In the current year, China’s share of global crude steel production will equal nearly fifty per cent. While global crude steel production expanded by only two per cent until the end of July, the Chinese production grew by around seven per cent. For the whole year we expect a growth rate of around six per cent.  As a result of an only slightly higher domestic steel demand, the exports mainly to other Asian countries and North America expanded. And in addition to the strong increase in Chinese crude steel production, the prices for iron ore came up after a decline in the first quarter of 2013.

The worldwide production of primary aluminum in the first half of 2013 shows a similar picture: high growth of nearly 11 per cent in China and a reduced generation in Europe let Chinas market share rise to nearly 43 per cent.  For 2013 in total, we forecast a growth rate of around 10 per cent. But the global market share for recycling aluminum is below the Chinese market share for primary aluminum. The main reasons for this phenomenon are underdeveloped collecting and scrap treatment activities.

On the other hand, China reduces the inventories of commodities. A good example is the development in the copper market. Chinese apparent usage of copper declined by around three per cent until the end of May 2013 caused by a reduction of net imports of refined copper. Market participants explain this reduction with a decline of unreported inventories in Chines warehouses. China had built up its copper inventories during a period of lower copper prices after the global economic crisis of 2009. We forecast that the reduction of inventories will come to an end during the third quarter of the current year. A stable or slightly increasing Chinese copper usage in the fourth quarter of 2013 will stimulate the global copper prices.

These three examples show the new role of the Chinese economy in the global commodity markets. Small changes in the domestic Chinese demand influence the worldwide price level and lead to a higher volatility in the global markets. Stagnating domestic consumption of metals or other commodities induces higher exports and pressure on production levels in other countries, mainly in Asia and America but more and more – see e.g. some flat steel products – on the Middle Eastern and European markets.

The Chinese government emphasizes its new role in the global commodity markets alternatively by a system of import taxes, export subsidies or sometimes regulation of markets (see e.g. the markets for rare earths).  On the one hand, this behavior secures the resource base of the Chinese economy. On the other hand, Chinese producers of metal products have a competitive advantage on the global markets as a result of higher metal production volumes in relation to smaller economies.

In the long run, this will lead to a reduction of production levels in some European countries and in America, because China will hold its production on a high level even in times of a lower domestic demand. Chinese overproduction will than go into export markets.

In total, China has defined its role in the world economy as follows:

a)      securing its own resource base by different kinds of protection,

b)      stimulating the exports in times of lower domestic usage of commodities
         with an crowding-out effect on foreign production

c)       which will result in a further increase in market shares.

 

 

 

 

 

 

 

Heinz-Jürgen Büchner
Vice President Economics and Research, IKB Deutsche Industriebank

 

 

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The BRICS Turmoil: Reality or Overshooting?

During summer, we have seen – and still see – quite some nervousness about the so-called BRIC countries in the emerging world – and some contagion to a couple of emerging market countries that also try to catch up, like Indonesia and Turkey. Three questions seem to be particularly interesting:

¤ Is the current nervousness about BRIC countries really motivated?

¤ Why do we have these contagion effects to several countries – to some extent similar to developments during the Asian crisis of 1997-98?

¤ Do we currently see the beginning of a real BRIC crisis which may turn much worse and which will also mean a notable downsizing of BRICS countries’ potential (trend) growth?

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BRIC is a term that has been coined in the beginning of the past decade by an economist from Goldman Sachs, a major American investment bank. BRIC –nowadays BRICS since South Africa joined the “club” a few years ago – are the initial letters of Brazil, Russia, India and China. I always considered the BRIC(S) thing mainly as a marketing instrument for asset allocation. In reality, these countries did not have enough in common to put all four eggs in one basket. Relatively good economic growth during a couple of years and a large population were simply not enough to “harmonize” analysis and investment strategies for these countries.

By the way, similar simplifications could be recognized already in the latter part of the 1990s when Eastern Europe Equity Funds and Asia Equity Funds were launched as attractive alternatives for investors. At that time, countries with different structural and institutional conditions were put in the same investment baskets, too. This proved to be wrong after some time. BRIC supporters from all over the world could have learnt from these examples.

Many experts see the main reason for the current “BRICS problems” in the expectations of – right or wrong – forthcoming cautiously rising interest rates in the traditional industrial world, especially in the U.S. Such a development could (probably) lead to (further) substantial capital outflows from BRIC countries to North America (the U.S.) and (parts of) Europe, according to the BRICS pessimists.

This explanation, however, is too fluffy. A deeper analysis of the BRICS problems is urgently needed. Are there fundamental reasons for the contagion? Or have we got a new example of overreacting financial markets?    

Let’s first look at possible common characteristics of the four BRIC countries – South Africa is excluded in this context – that may have caused negative feelings about the BRICs as a group.

¤  Portfolio shifts?  More financial inflows to the traditional OECD countries – at the expense of portfolio investments in emerging markets because of expected gradual, cautious monetary tightening by mainly the Fed  (with the assumption that the four above-mentioned, leading emerging markets are running the highest outflow risks)
–> could partly serve as an explanation because the four above-mentioned BRIC countries represent the economically four most important emerging economies.

¤  Substantial slowdown in GDP growth?   A rapid weakening of GDP could actually been noted in only two BRIC countries during the past year – in Russia and in India. Brazil even stands for growth improvements four quarters in a row after a couple of growth stimuli.

The last GDP-growth numbers for the BRIC countries look as follows:

Brazil:    2013, q2: 3.3%;    2012, q2: 0.5%         –> coming down from around 9% in early 2010

Russia:  2013, q2: 1.2%;     2012, q2: 4.3%        –> coming down from roughly 5% in early 2010

India:    2013, q2:  4.4%;    2012, q2: 5.3%         –> compared with about
9% in early 2010

China:   2013, q2:  7.5%;    2012, q2: 7.6           –> compared with about 10% in early 2010

Obviously, GDP growth has not developed simultaneously in all BRIC countries in the past few quarters – but more visibly on trend during the past 3-4 years. This is indeed true for all BRIC countries.  This development strengthens the view that more positive growth signals that currently come from the U.S., Japan and some European countries to a high extent more strongly triggered the worsening cyclical view of financial investors on BRIC countries than any other single factor. But looking at GDP-growth developments since 2010 gives also certain reasons to find structural components in the now more dampened growth outlook for BRIC. Thus, we have
–>  an obvious  cyclical BRIC phenomenon combined with certain negative structural components (like, for example, demand from Southern Europe) – and not a pure structural problem.

¤  Current account problems?   Current account deficits are frequently used explanations for the problems of the BRICs – and the need for foreign capital inflows for financing these deficits. But only India has a (somewhat) too high deficit ratio in relation to GDP (around -4.5-5% in 2013).  Brazil’s predicted deficit in the range of 3 ¼ – 3 ¾ % for 2013 is a little bit high but should not be as scaring as markets consider the entire BRIC situation. China and – probably – Russia should even continuously manage current account surpluses which takes us to the conclusion
–-> that current account problems should not really be considered as a major common problem for all the four major BRICS countries. From this point of view, the contagion effects that have been created by global financial markets, seem to be overdone. But they exist!

¤  Insufficient fiscal stability?  Public debt – annual and total – is, of course, an economic indicator that all country analysts watch very carefully. In this respect, Russia and – probably – Brazil seem to have their structural fiscal conditions roughly under control. China seems to be on the safe side for the time being – at least when official numbers are analyzed (about which, unfortunately, one may have serious doubts). India finally has been affected by negative fiscal developments since a long time ago. Thus, the question is
–> why well-known fiscal conditions – which are not really bad in all four BRIC countries – suddenly should lead to general worries on global financial markets. We probably can find psychological explanations in this respect. This urges for deeper analysis.

¤  Lagging structural reforms?  Sure, all emerging countries have more or less burdening structural or fundamental shortcomings. What concerns Brazil, one may mention, for example, insufficient productivity gains and declining international competitiveness, lagging education and pension systems, etc. Furthermore, Brazil is nowadays increasingly competing with – currently – a more reform-minded and economically improving Mexico. Russia suffers from a significant number of institutional deficits – the financial system and support of entrepreneurship included – a too large role for the government/state in the economy and a too high dependence on the energy sector.

India, on the other hand, has more obvious fiscal problems than Brazil, Russia and China and more growth-impeding infrastructural shortcomings which are – also according to my own micro experience from these countries – much more serious than in the three other large emerging countries. The same conclusion can be made about the Indian current account deficit. Last but not least China. Nobody questions that China’s economy has proceeded substantially in the past two decades or so. But we know also that China despite all economic progress still suffers from lots of structural shortcomings particularly when it comes to microeconomic and institutional conditions – unfortunately combined with worrying transparency shortcomings.

Putting together the reflections of the above-mentioned structural thoughts means that structural shortcomings exist in all four  BRIC countries  
–> but without strong logical correlation for motivating sudden distortions and disappointment for the BRIC region as a whole as we have seen in the past months.    

Conclusions                                                                 

In my opinion, the recent negative pressure from global financial markets on the artificial BRIC group – South Africa is excluded in this analysis – should not be considered as the result of a completely consistent and logical approach. Several factors point also at psychological overshooting. Common issues for all four BRIC countries are the insufficient demand for their exports, mainly caused by weak global demand – an issue that probably is characterized by both cyclical and structural dimensions – and the expected future monetary tightening in the U.S.

I have also found that several negative macroeconomic indicators do not point at the same degree of imbalance in all four BRIC countries (if at all).Consequently, it can be singled out that certain psychological overreactions are/were in place.

For this reason, I would argue that current developments have re-set the previously overdone BRIC enthusiasm – to some extent the result of artificial financial marketing – to a more justified stance of growth expectations (without considering the issue of the middle-income trap). This should induce some reduction of previously exaggerated expectations of BRIC countries’ potential GDP growth – but probably less dramatically than described in many recent analytical pieces. Again: Almost all countries have their own characteristics. This makes it most doubtful to put several “(emerging) country eggs” in one single analytical basket.

However, occasional negative contagion effects from one country to another will most probably be inevitable in the future as well. Here we have another example that clarifies the need for more research in behavioral finance.

Hubert Fromlet
Visiting Professor of International Economics, Linnaeus University
Editorial board

 

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