Is China’s rampant economy creating problems for the international system or presenting other nations with greater prospects for
economic and trading expansion?
Introduction
China’s emergence has been perhaps the single most important new development affecting the world economy at the outset of the 21st century. For the past ten years the Chinese economy has been among the fastest growing in the world. By some estimates it contributed more than a quarter of the growth of global GDP in this time. It is the world’s sixth larger trader, supplying more than 6 per cent of global exports. More recently, China became the principal beneficiary of the globe’s
foreign direct
investment (FDI).
Basically, this is a good
news story as China’s economic development has well-recognised secondary benefits for other
countries. Still, such a speedy economic progression has drawn it’s share of negative assessments: Amid concerns that rapid growth of foreign investment in China will make it more difficult for other
economies to win new investment, analysts are asking whether the risk is limited to emerging Asian economies, and in turn, what are the links between FDI
flows to China and FDI in the OECD countries?
The concerns are wide-ranging and most of them are in the form of simplistic blanket statements: Some Western economists and politicians, especially in the USA, claim the under-valuation of the renminbi as a major contributor to significant balance of trade deficits; Japanese concerns relate to expanding Chinese industry hurting their domestic manufacturing; emerging economies have protested increasing difficulties in attracting FDI due to competition with China; and the IMF acknowledges higher investment in China might be linked with the relocation of production away from Latin America.
FDI in China commenced rising sharply in 1993, when economic liberalisation accelerated and inflation stabilised. Yet the FDI attracted by other developing countries maintained their levels until 1996, only declining significantly after the Asian financial and currency crisis of 1997-98. Following the crisis, while FDI in China continued to rise, FDI to other developing economies dropped by as much as 26%. This encouraged the opinion that China was crowding out foreign investment towards other emerging economies.
Analysis
This paper addresses the question through an empirical analysis of FDI flows between 29 ‘source’ countries and around 60 ‘destination’ countries, using the gravity model, using both aggregated and disaggregated data. This paper defines FDI as investment by foreign residents with the aim of establishing a lasting interest in a local enterprise, mainly through mergers and acquisitions.
The gravity model explains bilateral FDI flows by three factors:
1. The economy size of both source and destination countries;
2. The distance between them (providing a theoretical stand-in for information and transportation costs); and
3. Any relevant geographical, historical and political features (e.g. incidence of a common language or a currency union; the existence of a post-colonial relationship; and an assessment of political risk).
On top of these three factors is China’s own FDI inflows. If the crowding out premise holds water, this should have a negative effect on the FDI receipts of other economies. A positive effect would support the alternative premise: that FDI into China encourages investment flows in other countries.
An aggregate analysis of 1988 to 2002 shows no significant negative effect on the FDI inflows of other countries from China’s inflows. However, the conclusion is less clear when this is broken down by region (i.e. Asia including Japan, Latin America, Central and Eastern Europe, and the OECD countries). This provides two interesting results:
1. Chinese FDI are positively related to inflows into other Asian (and, to a lesser extent, Central European) countries, and have no impact on FDI into Latin America. There is strong evidence of complementarities in foreign investment, possibly due to the fact that China and other Asian countries are integrated into global supply chains, and therefore attract direct investment flows from abroad together. This result can not be spuriously attributed to the fact that FDI in China and in other Asian countries are driven by the same positive trends due to the globalization process and to shifts in international investors’ sentiments.
2. China’s FDI does seem to divert investment flows from developed, OECD countries. There are two possible reasons: A) relatively lower Chinese production costs, and B) the desire to locate factories close to a fast-growing final.
Conclusion
The role of China in worldwide FDI patterns includes both a strong complementarity of foreign investment in China, Japan and other Asian countries. More surprisingly, the effect of FDI in China indicates a diversion of investment flows from the OECD developed economies.
From the perspective of FDI diversion, then, China’s rise is both good and bad news. It is good news for Asia, although it may not be such good news for individuals who depend for their livelihoods on the food-processing and chemicals industries, which are receiving less foreign investment as a result of Chinese competition. On the other hand, China’s rise may be bad news in this respect for OECD countries and their manufacturing sectors in particular.
In conclusion, China’s economic emergence is a mixed blessing requiring a nuanced analysis and not simplistic blanket statements.
This is an abstract of:
"Is China's FDI Coming at the Expense of Other Countries?", an NBER Working Paper by Barry Eichengreen (University of California, Berkeley) and Hui Tong (Bank of England).
WP Serial No.: 11335, Pages: 37, Released: May 2005.
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