Patterns of PRC's FDI and their Relations to Round Tripping

The rapid FDI inflows into PRC, following its economic opening and reform, are essentially driven by two factors: PRC’s large surplus labour and PRC's declining barriers for cross-borer mobility of capital and capitalistic institutions. In 2001, Japan, with its half a century long rapid economic growth and development, attracted only $49 per capita in FDI inflows and $395 per capita in FDI stock, compared to the world average of $120 in flow and $1118 in stock and PRC's $37 in flow and $309 in stock. Japan may be a capital-rich economy but many other capital-rich OECD economies such as U.S. recorded large FDI inflows. Also, at official exchange rates, PRC's foreign trade is more than 40% of GDP while Japan’s is about 20% at the current official exchange rates. The gap may be exaggerated because of under-valued RMB and over-valued JPY according to purchasing power parity exchange rates. Nevertheless these numbers seems to indicate that the Chinese economy is more open than the Japanese economy.

Moreover, PRC allows a large amount of processing trade, which requires large amount of imported components. Large scale processing trade is only possible for very open economies with close to zero transaction costs, tariffs and other taxes. PRC has committed to this close to zero transaction costs and taxes for processing trade since early 1980s, drawing lessons from its successful neighbours of newly industrialized Asian economies. The processing trade is important in creating jobs for some unskilled labour in PRC and in creating new capital or profits for the foreign investors. The later is a key condition for attracting both real FDI and round tripping FDI.

PRC's importing of capitalistic economic institutions is also unprecedented in scale, scope, depth, and speed, ranging from central banks, modern public corporations, labour markets, stock markets, and social security systems. The transfer of capitalistic institutions and practices is facilitated greatly by the existence of mature market economies in Hong Kong, China and Taipei,China as well as large amount of returning overseas students and overseas Chinese business communities. In a way, the overseas Chinese human capital could also be regarded as a kind of round tripping human capital as it went aboard first and then came back to PRC with experiences and knowledge about the global economy.

However, in the near future, PRC's financial and legal systems are under great pressure to price the risks and returns for millions of large and small projects, which would challenge even the best bankers in the world. The legal system, in spite of great achievements in legislation, is still weak in the enforcement of property rights and contracts. This weakness affects directly the robustness and efficiency of the Chinese economy and is one of the key factors behind the sustained capital flight and round tripping FDI.

PRC's competitiveness in labour intensive manufactures is well recognized and attracted 60% of PRC's total FDI as shown in Table 2 [ PDF 62.3KB | 1 page ]. However, FDI is also significant in non-labour-intensive real estate sector that has about 12% of PRC's FDI and is ranked the second in the amount of FDI inflows among all major sectors. There are more than 20,000 real estate developers in PRC, 10% of which are FIEs. Many of them are likely to use round-tripping FDI to enjoy preferential policies on land use rights or to access external and domestic financial services. The services sector also attracted substantial FDI. Foreign invested enterprises have penetrated into virtually all kind of manufacturing and service industries. This is at least partly due to some round tripping FDI by disguised private enterprises, which attempts to take advantage of the preferential policies for FDI.

The concentration of PRC's FDI in a few clusters of coastal super cities have created a critical mass for global scale production, distribution and financing. This is one of the key factors behind PRC's rising capacity to create new capital. It is primarily these coastal regions that are attracting both real and round tripping FDI inflows into PRC. Table 3 [ PDF 78.8KB | 1 page ] ranks PRC's 31 provincial level regions by their average FDI inflows in 2001-2002 and provides a number of indicators for the provincial economies. The provinces and cities are then cut into three groups by their ranking in FDI inflows: the top-9, the middle-12, and the bottom-10. The top 9 includes, in descending order of the share of average FDI during 2000-2001, Guangdong (25.7%), Jiangsu (14.9%), Shanghai (9.3%), Fujian (8.5%), Shandong (7.6%), Liaoning (5.4%), Zhejiang (4.8%), Tianjin (4.6%), and Beijing (3.8%). Many foreign visitors are impressed by the physical changes in the cities such as Shanghai and Beijing but the real stars of productive investment and manufacturing capacity in PRC is Guangdong and Jiangsu, where land prices have not been driven up to international levels as in Hong Kong, China, Shanghai and Beijing while access to finance, research and other services provided by the big cities is still convenient. The concentration of FDI in the top-9 is impressive if not surprising. This group has about one third of PRC's population but produced half of PRC’s GDP and attracted three quarters of PRC's FDI and generated 90% of PRC's foreign trade. This is entirely consistent with the main theme of this paper: FDI inflows, real or round tripping, are attracted by the hosting economies' capacity to create profits and new capital.

FDI has dominated PRC’s use of foreign capital. Foreign loans and other forms of foreign capital have declined to about 10% in recent years from about 70% before 1990. This is partly due to PRC’s weak domestic banks and capital markets which have not yet been able to intermediate cross-border financial transactions. PRC's FDI on the other hand does not need to rely much on domestic financial system. The existence of round tripping FDI and rising importance of FDI provides an alternative for equity and debt financing for PRC's growing private enterprises (McCauley etc 2002).

The number of foreign invested enterprises in PRC is huge. By 2003 PRC has approved establishment of about 432,820 Foreign Invested Enterprises (FIEs) with a cumulated realized FDI as much as USD461 billion. Some of these FIEs are really disguised Chinese private enterprises through round tripping FDI. The FIEs have played very important role in the Special Economic Zones (SEZs). In Shenzhen, one of the SEZs next to Hong Kong, China, in 2002, the FIEs have generated two thirds of the city's gross industrial output. Although it is impossible to verify directly, it was understood well among practitioners that the FDI statistics are inflated by many FIEs. It is not surprising to see FDI reported by PRC is usually higher than those reported by Hong Kong, China and other source regions. The operational life of FIEs in PRC is short for many. As of the end of 2002 the number of FIEs approved in PRC was 424,196 but more than 200,000 of them, or 48%, have closed and only about 220,000 (among which about 160,000 industrial enterprises) are still in operation. Many FIEs have wound up purposely in order starting new FIEs as the preferential tax policies are given to new FIEs over their first 5 years. It is common for these new FIEs to use round tripping FDI for their registered capital (Huang 2003c).

Table 4 [ PDF 64.7KB | 1 page ] shows PRC's inward FDI flows over the years from 1994 to 2001 and grouped by four major regions and selected economies which have close trade and investment relations with PRC. The share of total FDI by each of the four major regions in 2001 is respectively 36.3% for Hong Kong, China and Macau, 16.7% for offshore financial centres, 17.9% for Asia Pacific economies, and 27.6% for developed countries. Each of these four regions is likely to have different rate of round tripping FDI into PRC. We will examine their patterns separately in Section 6.

It was noted that round tripping FDI is less likely to happen for large investment projects originated from developed economies such as US, Germany and Japan. This may be true but the problem is that there are also many small investment projects associated with overseas Chinese who is likely to be involved in the round tripping FDI because of their close relations with the local people in PRC. Table 5 [ PDF 63.3KB | 1 page ] shows PRC's top 15 suppliers of FDI in 2002. Hong Kong, China ranked the first with $20.5 billion utilized investment, followed by U.S. ($4 bn), Japan ($3.6 bn), Taipei,China Province ($3.3 bn), British Virgin Islands ($2.4 bn) and Singapore ($2.1 bn). The interesting issue here is the size of the investment per project. Are FDI projects from USA on average much larger than from Hong Kong, China or British Virgin Islands? Table 5 shows that the FDI per project has little correlation with the size or importance of the source economies. It turns out that Cayman Islands has the largest average size of FDI per project at $556,000, followed by Netherlands at $407,000, British Virgin Islands at $366,000. Eight out of the fifteen countries/regions have average size of their FDI per project below $110,000, including U.S. and Hong Kong, China. The average FDI per project from Canada and Taipei,China province was below $60,000, the smallest among the group. If small size projects are more likely to be associated with round tripping FDI, then both developed economies such USA and Canada and Asia Pacific economies such as Singapore and Republic of Korea are equally likely to have significant round tripping FDI in PRC.

Table 6 [ PDF 56KB | 1 page ] examines the average size of utilized FDI in foreign invested enterprises with different legal types. Except for the joint exploration type, all the other types, including joint ventures, contractual joint ventures, and wholly foreign owned enterprises, have low levels of average utilized value of FDI ranging from $85,000 to $157,000 per enterprise. The joint exploration type has only 183 foreign invested enterprises with average size of realized FDI at $4 million per enterprise.

Table 7 [ PDF 59.5KB | 1 page ] shows the average size of the foreign invested enterprises by selected regions over the period from 1994 to 2001 in terms of utilized FDI per enterprise and per project. Although there is a tendency for the size to increase for all selected regions, the pattern that offshore financial centres have much larger FDI per project and per enterprise remain. This is largely due to the fact that many large Chinese enterprises have used these offshore financial centres to facilitate their listing in Hong Kong, China and other overseas stock markets.

Table 8 [ PDF 62.3KB | 1 page ] provides a few indicators showing the impact of FDI on the Chinese economy over the period from 1985 to 2002. In recent years, total utilized value of FDI is about 4% to 5% of PRC’s GDP at official exchange rate, comparable to similar ratio for Canada (4%), Mexico (4%), New Zealand (6.4%), France (4%), Hungary (4.6%), Poland (3.9%), and UK (3.8%) but much high than the ratio in U.S. (1.3%) and Japan (0.4%). The contribution of foreign invested enterprises to PRC’s gross industrial output has increased from 11.3% in 1994 to 33.4% in 2002. The contribution of FIEs to PRC's exports has increased from 28.7% in 1994 to 41% in 1997 and 52.2% in 2002. The contribution to employment by FIEs reached 3% of total urban employment. The most impressive achievements by FIEs are their contribution to PRC's industrial and commercial taxes, which increased from 4.25% in 1992 to 14.4% in 1998 and 20.5% in 2002. Clearly FDI in PRC are making large amount of profits. This means that a lot of new capital has been created in PRC. This forms the base for sustained capital flight from PRC as well as sustained round tripping FDI back to PRC.

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1. kundan singh
   (posted 04 September 2006 / 10:10:07 AM)
   
   
   
   Thank you for this paper on round tripping. I am currently writing my masters thesis on the reasons for growth of fdi in China and India. Round tripping plays a part in the limitations of this research. The information has been useful in my thesis.
   
   Thank you
   
   Kundan Singh