What Attracts Foreign Multinational Corporations to China?

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KEVIN HONGLIN ZHANG [*]

After adopting the open-door policy, China experienced a boom of inward foreign direct investment (FDI) by multinational corporations. This article attempts to assess effects of location characteristics and government policies on FDI flows during the period 1987-98. A model of FDI determinants is specified and estimated with cross-section and panel data. The estimates indicate that China's huge market size, liberalized EDI regime, and improving infrastructure are attractive to multinationals. The regional distribution of FDI within China is influenced largely by EDI incentives and historical-cultural links with foreign investors, along with other location factors. (JEL F21, F23, O53)

Over the past decade, few developments in international economics have been more important than the sudden emergence of China as a dominant recipient of foreign direct investment (FDI) in the world. From an almost isolated economy in 1979, China has become the largest recipient of FDI in the developing world and globally the second only next to the United States since 1993. Accumulated FDI flows into China in 1992-97 was $196 billion, constituting over 30% of total FDI into all developing countries (UNCTAD, 1998). It should be stressed that the FDI boom is not unprecedented, but in fact conforms rather closely to Latin America in the 1970s and Southeast Asia in the 1980s. China's real distinction is its huge size and enormous population. The combination of the FDI boom and the huge size raises questions such as how China formed its FDI regime to attract multinational corporations and what differences China's market size made to the FDI boom.

Though there has been a lot of work done in examining determinants of FDI in China (e.g., Lardy [1995]; Chen [1996]; Head and Ries [1996]; Henley et al. [1999]; Zhang [2000a]), an empirical assessment of roles of China's FDI regime and location characteristics with the latest data has been limited. The purpose of this study is to close the gap in the literature by estimating a model of FDI determinants with both cross-section and panel data in 1987-98. Estimations with the cross-section data are also conducted in three subperiods to investigate dynamic features of location advantages and policy instruments.

The study should be of importance in policy implications for developing countries. FDI has been viewed to play a positive role in a host country's capital formation, export promotion, employment augmentation, and, more important, technology transfers (UNCTAD, 1992). From a host country's point of view, it thus is desirable to assess what policy instruments should be adopted to attract FDI and to identify the locational factors through which the host country may to some extent influence the magnitude and the direction of FDI.

I. THE PATTERN OF FDI IN CHINA

FDI in China has experienced dramatic changes since 1979, when China promulgated the "Law of Sino-Foreign Joint Venture." The pattern of FDI may be described by its time trend, sources, sectoral structure, and regional distribution. First, the most impressive feature of the time trend is the sharp FDI boom in 1990s in contrast with steady but small amount of inflows in the 1980s (see Table 1). In fact, the seven-year (1992-98) inflows amounted to $233.9 billion, constituting 91% of total FDI ($257 billion) over the entire period of 1979-98 (SSB, 1999). The factors that caused the FDI boom included further liberalization of China's FDI regime and the explosive growth of domestic economy, along with the worldwide rise in FDI outflows in the first half of the 1990s and China's political stability (Lardy, 1995).

Second, most of the FDI received by China did not come from the world's major investors (the US, Japan, and West Europe) but from Hong Kong, Taiwan, and other Asian developing countries. Table 1 shows origins of FDI into China over the period 1979-98. During the boom period (1992-98), the Asian FDI sources that contribute over 70% of total FDI in that period include Hong Kong (53. …