China’s Changing Pattern of FDI

By+JOHN+ROSS

INWARD investment into China continues to be the highest of any developing economy， at US $101 billion in 2013， according to UN fi gures， but its pattern is changing signifi cantly as the country develops， and this trend will inevitably deepen.

In the first decades after the start of Chinas economic reforms in 1978， foreign direct investment was primarily undertaken by foreign companies to create a base for exports. This was helpful in Chinas early stage of reform and opening-up， but was frequently very low added-value. For example， a 2009 study found that China received only two percent of worldwide earnings for iPod production， despite every iPod， which had been the worlds most successful consumer product， being manufactured in China.

As recently as 2010， the majority of Chinas exports came from companies with foreign ownership. Among large exporters the role of foreign investment was even greater – of the top 200 exporting companies in 2009， 153 were foreign funded. Chinese-owned companies were dominant among small and medium-sized exporters. For example， Alibabas original success was due to creating the Internet systems that connected these Chinese companies to their foreign markets.

But as Chinas economy developed the reason for its attractiveness to foreign companies radically changed. In comparative international terms， China is no longer a low wage economy. Only 30 percent of the worlds population now lives in countries with a higher per capita GDP than China– and wages will be approximately proportional to this. In Southeast and South Asia， every developing country except Malaysia now has a per capita GDP lower than China.

For many exporters Chinas unrivalled skill in major manufacturing fields has become its main attraction. The U.S. study， with the self-explanatory title， “Why Apple Builds IPhones （and Everything Else） in China” spelt it out clearly. Based on research for the New York Times， this posed the question “What does China have that America lacks？” The conclusion was： Quite a lot. China has more mid-level engineers， a more fl exible workforce， and gigantic factories that can ramp up production at the drop of a hat. China also offers tech fi rms a one-stop solution.

“The entire supply chain is in China now，” a former highranking Apple executive told The Times. “You need 1，000 rubber gaskets？ Thats the factory next door. You need a million screws？ That factory is a block away. You need that screw made a little bit different？ It will take three hours.”

Indeed， the example of the iPhone， now the worlds most successful consumer product， graphically shows how Chinas manufacturing capability saved what is now a triumph from a potential PR disaster. As the New York Times noted：“A little over a month before the iPhone was scheduled to appear in stores， Mr. Jobs beckoned a handful of lieutenants into an offi ce. For weeks， he had been carrying a prototype of the device in his pocket.”

“Mr. Jobs angrily held up his iPhone， angling it so everyone could see the dozens of tiny scratches marring its plastic screen… ‘People will carry this phone in their pocket… I wont sell a product that gets scratched， he said. The only solution was using unscratchable glass. ‘I want a glass screen， and I want it perfect in six weeks， Jobs said.”

“After one executive left that meeting， he booked a fl ight to Shenzhen， China. If Mr. Jobs wanted perfect， there was nowhere else to go.”

The result was that when the screens arrived： “The workers were assembling 10，000 iPhones a day within 96 hours. Another example： Apple had originally estimated that it would take nine months to hire the 8，700 qualifi ed industrial engineers needed for oversee production of the iPhone； in China， it took 15 days.”

Low wages are therefore no longer Chinas key attraction for such foreign investors.

“Wages actually arent that big a part of the cost of making consumer electronics… Paying American wages to build iPhones would add only about US $65 to the retail price of each handset， according to analysts estimates. Thats an amount Apple could likely afford. And in fact， China no longer offers rock-bottom wages. But when it did， it used that window “to innovate the entire way supply chains work，”said Sarah Lacy at Pando Daily. China is now “a place other countries can beat on sheer cost， but not on speed， fl exibility， and know-how.”

The second fundamental feature of the new situation for inward FDI is that since 2007 China is not only an export base but also the worlds most rapidly growing market in dollar， as well as percentage， terms – and this will continue. This results from the fact that although the U.S. remains the worlds largest economy， at market exchange rates， Chinas growth rate is almost three times that of the U.S. Consequently， as shown in the chart， in 2013 Chinas increase in GDP was US $1，038 billion compared to US $555 billion for the US – i.e. Chinas dollar GDP increased by almost twice as much as the U.S.s.

Chinas unparalleled market expansion presents decisive advantages for potential company growth. In stagnant or slowly growing markets， such as the U.S. and Europe， to achieve rapid growth most companies have to increase market share. In China， in contrast， rapid growth can be achieved without gaining market share but simply through ongoing market expansion – an easier prospect. FDI is therefore increasingly to take advantage of Chinas domestic market， not for exports. A further result， consequently， is that FDI increasingly flows into the service sector， which primarily serves Chinas domestic market and not exports. In 2013 52 percent of inward FDI went into Chinas service sector.

But if Chinas market expansion is the worlds fastest， there is no doubt that competition among companies engaged in FDI is becoming tougher in certain respects. In its earlier stages of development China so badly needed FDI that it offered formal tax concessions and regulatory enforcement was sometimes lax. Tax concessions are already largely abolished， and lax enforcement is being tightened.

The latter includes dealing with criminality – in 2010 RTZ employees in China admitted taking kickbacks and recently GlaxoSmithKline was fi ned US $490 million after it was found to have bribed doctors to increase sales of its pharmaceuticals. Anti-competitive behaviour is also being clamped down on. This year six infant milk formula companies were convicted of price fi xing， and fi ned US $110 million， while 12 Japanese auto parts makers were also fined US $200 million for the same offence.

Foreign companies investing in China continue to enjoy clear advantages in key sectors. These include advanced technology industries， apart from defense – for example highend computer services and civil aircraft production； highly concentrated global industries dominated by global producers such as automobiles， and non-fi nancial services in general – for example supermarkets and fastfood chains. But in medium technology， or many rapidly growing industries， Chinese companies are increasingly tough competitors. Lenovo not only dominates Chinas domestic computer market but has become the number one PC producer globally， while Chinas smartphone manufacturers， such as Xiaomi， Lenovo and Huawei， are increasingly effective in domestic competition with Apple and Samsung.

Given the size and growth of Chinas market， inward FDI will remain at very high levels. But the days of China as a cheap labor export base are ended， and Chinas domestic market is increasingly the main attraction for foreign companies. Foreign companies have to get into what is already the worlds most rapidly growing market， which within a decade will also be the worlds largest， but the full range of their competitive skills are increasingly required for this.