The Extent to Which FDI Inflows have Influenced GDP Growth in China Essay

Abstract

This paper examines the relationship between Foreign Direct Investment and Gross Domestic Product or economic growth of China. To establish the relationship between the two variables, the paper analysed concluded research works, carefully examined the country’s FDI trends and linked them to the country’s GDP growth over the last 15 years extending from 1990 to 2004.

It also explored the country’s trade volume for the same period, both inflows and outflows. The conclusions of the analysis show a direct relationship between FDI and GDP growth of the country.

Introduction

Foreign Direct Investments are the instruments of inflows, both cash and non-cash, into a country from trading and cooperating partners. The role of Foreign Direct Investments to a country’s growth is vital. Even though all countries benefit from Foreign Direct Investments, developing nations benefit the most.

Foreign Direct Investments fulfill a nation’s short-term capital deficiency and contributes to the host nation’s capital as well. According to Hossain and Mohammad (2012, p. 9), Foreign Direct Investment “…is not only about investment, but also about transfer of technology, training, skills and other relevant materials.”

Foreign Direct Investment (FDI) has accelerated employment in host countries, raised level of productivity, introduced advanced technological knowhow to the host countries, and boosted the countries’ export and import. Multinational corporations operating in the host countries propel most FDI activities.

The spillover effects of these large companies commanding huge sums of money benefit the host nation’s population and economy in many ways. The benefits of FDI to a nation cannot be denied. Just as other nations struggle to boost their level of FDI, China has not been left behind. In fact, over the last few years, China’s reputation as a global business hotspot has greatly increased.

Large and medium businesses have expanded their capital involvement in China to have a share of its lucrative market. This rush for China’s market can be attributed to steady economic growth, favorable business environment, relatively low production costs, and sound economic policies. The country’s GDP has also grown tremendously.

According to Neelankavil and Rai (2009, p. 142), “recent studies overwhelmingly show a positive relationship between FDI and trade,” which calls for a careful analysis of trade trends if FDI patterns are to be accurately established. Additionally, the growth in the country’s FDI has been accompanied by a significant growth in its GDP. This calls for the analysis of the existing relationship between FDI and GDP growth.

Literature Review

The growth of FDI has been growing steadily over the last few decades (Rotberg 2008). Considering the numerous accepted effects of FDI on the economies of host countries, a more detailed analysis of its effect on the GDP of the countries’ is essential. There have been numerous research works attempting to link FDI with the rate of economic growth (GDP) of a country.

Using different methods, different procedures, different data analysis techniques, different time span, different countries, and different research variables, these concluded works have shown a close relation in terms of results. The researches have established a substantial positive relation between GDP and FDI. Some of the most credible researches in this field and their conclusions are discussed below.

First in this category is the study by Mortaza and Das (2007). The two researchers attempted to link the relationship between selected Asian nations’ FDI and GPD with much success. There study was based on a 24 year period spanning from 1980-2004. The study also explored, extensively, trade liberation and growth trends in the nations and derived its conclusions based on the data collected from 1980-2004.

For Bangladesh and Pakistan, their research concluded that FDI had a significant impact on economic growth. FDI resulted in an upward growth in these countries (Mortaza and Das 2007). These results were a reflection of earlier findings of a research conducted in 2005 by Li and Liu in attempts to establish the relationship between FDI and human capital to GDP growth of a country.

The two researchers used data from 84 countries to draw the conclusion of their study and to establish existing research gaps. In their view, FDI contributed directly to the GDP of the countries in question (Li and Liu 2005).

Of the many researches on the relationship between GDP and FDI, the researchers’ work can pass any credibility test considering its extensive scope, effective data analysis techniques employed, and credible data collection methods used. The researchers used data sets for 29 continuous years beginning 1970 and ending 1999.

A research by Rudra and E. Pradhan on this subject is equally resourceful to this study. Their research was focused on the period of 1970-2007. The researchers used co-integration at individual and panel data levels to derive the relationship between the variables.

There output suggested that GDP and FDI re co-integrated. In their conclusion, the two researchers claimed that FDI is undeniably the force driving the economies of developing nations.

Many research works that have attempted to establish the factors influencing the FDI of a country. These researches have also contributed positively to the research on the influence of FDI on GDP growth of given countries. The foreign Direct Investment (FDI) of any country is influenced by many factors. According to Arjun, Joerg and Beamish (2007), the culture of a nation plays a significant role in influencing its FDI.

They argue that “host country cultural variables: uncertainty avoidance and trust influence the location choices of foreign firms…” (Arjun, Joerg & Beamish 2007, p. 29). In their view, the low levels of uncertainty in a market or nation is a boost for that region’s ability to attract foreign investment. Therefore, countries that are seen to have a high rate of uncertainty can hardly attract significant investment.

Corruption is another factor considered as a major impediment to FDI. Economic theory points to two kinds of corruption effects on FDI. The two effects include helping and grabbing hand. Whereas the helping hand effects influence FDI positively, grabbing hand influence FDI negatively. Egger and Winner (2006, p. 459) claim that there exist “a negative relationship between corruption and FDI.”

Therefore, despite the positive aspects of corruption on FDI as put forward by economic theories, in reality, the negative aspects of corruption outweigh the positive effects. Every country has its own trade policies governing foreign ventures. Actually, international trade cannot flourish without regulation. However, some countries are known for stringent trade measures that discourage foreign investments.

Still, other countries are notorious for policies that thwart foreign investments while boosting local investments. Whereas emerging and small local firms cannot match competition from multinationals and large foreign companies, the playing filed should be level for all the players; in some cases, this is never so.

Analysis

The period 1990-2004 marked a significant improvement in China’s FDI. As shown in figure 1 below, the country’s FDI has increased significantly from US $3 billion in 1990 to US $ 61 billion in 2004.

China’s FDI growth 1989-2004

Figure 1: China’s FDI growth 1989-2004

Source: http://www.china-profile.com/data/fig_fdi_3.htm

The increment represents a 1933% growth in FDI in only 15 years. From the detailed year on year results, provided in Appendix 1, for the given period, the country’s FDI has been fluctuating but mostly upwards. In fact, it is only in 1999 and 2000 where the county’s FDI growth retarded. The two periods recorded a decline of 12.5% and 10% respectively. The figures represent investments in all parts of the country.

However, different parts of China have experienced varying investments. This is attributed to investors’ unique mix, which makes them prefer other regions to others. According to the Chinese Bureau of Commerce (2009), the FDI inflows from different regions and countries were in the given ratios, during the same period.

Figure 2: Leading Sources of FDI for China

Leading Sources of FDI for China

Source: http://www.china-profile.com/data/overview_economy.htm

The tremendous growth of China’s FDI can be attributed to various factors. China’s economic reform process has concentrated on promotion of Foreign Direct Investment. The process has changed the way many countries and investors view China as an investment destination. In fact, in the recent years, China has become “the main destination for Foreign Direct Investment” (Swaine 2011, p.186).

Today, of the 500 World’s leading companies, 450 operate in China. The Chinese Foreign Direct Investment policies started changing in the late 1970s. In 1983, for example, the government made a new policy that allowed joint ventures in which foreign capital was involved (Swaine 2011). The government also set up Special Economic Zones in Shenzhen, Shantou, Zhuhai, and Xiamen to aid trade.

The biggest stride was yet to come when the People’s Republic of China passed a law that legalized Foreign Direct Investment. The legalization of Foreign Direct Investment led to a tremendous increase in number of firms operating in China. Despite a high influx of foreign investors against a declining market, “…most of these firms are highly profitable” (Jolly 2009, p. 45).

In 2006, business environment eased further when the Chinese National Development and Reform Commission formulated a plan for better management of Foreign Direct Investment. The plan proposed a significant reduction on restrictions on holding of domestic firms by foreign investors. This encouraged even more investors in the country.

If the growth in FDI is to be linked in any way to the country’s GDP growth, then we must establish the country’s GDP growth during the same period.

Figure 3: China’s GDP 1970-2001

China’s GDP 1970-2001

Source: International Monetary Fund (IMF)

Using the graph above, we realize from the outset that China’s GDP growth has been steady just like its FDI growth. The adapted figure shows China’s GDP to be US $200 billion in 1990. During the same period, the country’s FDI recorded US $3 billion. In 1994, the country’s GDP increased to US $250 billion. Its FDI also showed the same trend by posting $34 billion.

Between the four years period, the country’s GDP grew by 25%, while its FDI grew by 1033%. In both cases, there was a significant increase. The country then witnessed a continuous growth in its FDI until1999 when its growth dropped and stayed so in 2000. After recording a peak of 45 billion in 1998, the country’s FDI dropped to 40 billion in 1999 and 41 billion in 2000.

The drop from the 1998 figure of 45 billion to the 1999 value of 40 billion represented a 12.5% decline. During the same period, the country’s GDP showed an increase, though it was in a decreasing rate. This can be justified because the country’s GDP growth from 1995 to 1998, the same period for which FDI is calculated, showed a sharp increase. The GDP increased from 255 billion to 505billion, which represents a 98.03% increase.

Between 1998 and 2000, however, the increase in GDP was minimal. GDP posted US $505 billion in 1998 and US$ 510 in 2000, which represents an increase of 0.99%. Considering that during this same period FDI dropped by 12.5% it is only probable that it contributed significantly in the slow growth of the country’s GDP.

This claim is further strengthened by the fact that when FDI started picking up again and continued to grow in the following years, the GDP of the country also showed an increasing trend.

Conclusion

Numerous research works have been carried out to establish the relationship between Foreign Direct Investment and Gross Domestic Product or economic growth of a nation. Despite the level of professionalism involved and the amount of data used, the results have been varied. Whereas some nations’ growth is hardly influenced by FDI, others show a strong relationship between FDI growth and GDP growth.

In this paper, however, it has been established that China’s FDI and GDP for the period 1990 to 2004 have been related. Periods characterised by a fall in FDI have also witnessed a slow growth in GDP, and periods with steady FDI have posted significant GDP growth. By adopting sound economic programs aimed at encouraging FDI, China placed itself in on track to achieving self-sufficience and economic success.

By allowing joint ventures in which foreign capital is involved, setting up Special Economic Zones in Shenzhen, Shantou, Zhuhai, and Xiamen to aid trade, and passing a law that legalized Foreign Direct Investment, China made a big step towards stable FDI and economic success.

Appendices

Appendix 1: Year on Year FDI for China 2001-2006

Year on Year FDI for China 2001-2006

References

Arjun, B, Joerg, D & Beamish, P 2007, ‘Host country cultural influences on foreign direct investment: Host Country; Culture; Location Choices; Foreign Direct Investment; FDI’, Management International Review, vol. 47 no. 1, pp. 29-50.

Chinese Bureau of Commerce, 2009, FDI and GDP Growth, Chinese Bureau of Commerce, Beijing.

Egger, P & Winner, H 2006, ‘How Corruption Influences Foreign Direct Investment: A Panel Data Study,’ University of Chicago Press, Economic Development and Cultural Change, vol. 54, no. 2, pp. 459-486.

Hossain, A & Mohammad, H 2012, ‘Empirical Relationship between Foreign Direct Investment and Economic Output in South Asian Countries: A Study on Bangladesh, Pakistan and India’, International Business Research, vol. 5, no. 1, pp. 9-21.

Jolly, A, 2009, Business insights, Europe a practical guide to company formation, employment law and taxation across the EU, Kogan Page, London.

Li, X & Liu, X 2005, ‘Foreign Direct Investment and Economic Growth: An Increasingly Endogenous Relationship’, Journal of World Development, vol.33, no. 3, pp. 393-407.

Mortaza, G & Das, 2007, Trade Liberalization and Economic Growth: Empirical Evidence from South Asia and Implications for Bangladesh. Retrieved from web.

Neelankavil, J & Rai, A 2009, Basics of international business, M.E. Sharpe, Armonk, N.Y.

Rotberg, R 2008, China into Africa: trade, aid, and influence, Brookings Institution Press, Washington, D.C.

Rudra, P & Pradhan, E 2009, ‘The FDI led-growth hypothesis in ASEAN-5 countries: Evidence from co-integration panel analysis’, International Journal of Business and Management, vol. 4, no. 12, pp. 7-32.

Swaine, M 2011, America’s challenge: engaging a rising China in the twenty-first century, Carnegie Endowment for International Peace, Washington, DC.

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