Economic Engine? Foreign Trade and Investment in China

By Lardy, Nicholas R. | Brookings Review, Winter 1996 | Go to article overview

Economic Engine? Foreign Trade and Investment in China


Lardy, Nicholas R., Brookings Review


Since the late 1970s, when economic reform began in China, the role of the foreign sector has burgeoned in ways that no one anticipated. Today China is one of the world's largest trading nations and a major participant in international financial markets. It attracts more foreign direct investment than any other country in the world. It is the World Bank's largest borrower and a major borrower as well from national development banks, national export-import banks, and commercial banks worldwide. It also sells both debt and equity issues on international markets.

The immensely increased presence of foreign capital and foreign trade in China has certainly put China prominently on the world business map. But the economic dynamism generated by foreign capital and trade has largely bypassed China's state-owned industries, which remain inefficient and overprotected. Unless reform begins soon to extend to industrial restructuring, the phenomenal growth of trade and investment is likely to slow, leaving China to lag behind the high-performing economies of East Asia.

Investment and Borrowing from Abroad

Foreign direct investment in China grew from only a few hundred million dollars a year in the late 1970s and early 1980s to almost $4 billion in the late 1980s [ILLUSTRATION FOR FIGURE 1 OMITTED]. In the aftermath of the Tiananmen Square crisis of 1989, actual investment growth slowed, but, beginning in 1991, it surged, more than doubling in both 1992 and 1993 and climbing a further one-fifth in 1994 to reach almost $34 billion.

Four developments spurred the foreign direct investment boom. First, aggregate foreign direct investment in developing countries grew rapidly in the 1990s. Average annual flows in 1990-93 were double those of 1987-89. Second, China's seeming political stability in the wake of Tiananmen, combined with double-digit growth of the domestic economy after 1992, led foreign firms to conclude that it was safe to invest. In fact, many multinationals decided that they could not afford not to invest in the world's fastest-growing emerging market. Third, China systematically liberalized its foreign investment regime. Special tax concessions, liberalized land leasing, and other inducements once confined to four zones in South China were made available in a growing number of open coastal cities, economic development areas, and high-tech development zones. Retailing, power generation, port development, and property development were also opened to foreign investors. And fourth, Chinese firms, taking advantage of the incentives provided to foreign invested enterprises, moved money off-shore and recycled it back into China disguised as "foreign investment." That flow, the World Bank has guessed, might have been as much as 25 percent of foreign investment in 1992.

China's second largest source of foreign capital, after foreign direct investment, has been borrowing [ILLUSTRATION FOR FIGURE 2 OMITTED]. China's gross external debt, well under $1 billion in 1978 as reform was getting under way, rose to $93 billion by the end of 1994. Only Indonesia among low- and lower-middle-income economies has a larger outstanding debt. Mexico and Brazil, the most heavily indebted upper-middle-income economies, barely exceed China's debt.

China's debt burden, however, remains modest, in part because its exports are so large relative to its outstanding debt. On average in 1991-93, China's total external debt relative to earnings from the export of goods and services was less than half that of Mexico and less than a third that of Brazil.

In addition, much of China's external debt is concessionary, with grace periods of up to 10 years before repayments of principal must begin or with below-market interest rates. And even its nonconcessionary debt carries favorable interest rates since China enjoys an investment-grade rating on its external sovereign debt, allowing it to sell its bonds internationally with a lower interest rate than the market would otherwise demand. …

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