China Research

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 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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