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35747

  1. 1. AN447 Page 1 of 61 35743 Candidate Number: 35747 MSc in China in Comparative Perspectives (Anthropology Department) 2007 Dissertation in partial fulfillment of the requirements of the degreeForeign Direct Investment in China and India: DevelopmentExperiences and Determinants in a Comparative Perspective Word Count: 9965
  2. 2. AN447 Page 2 of 61 35743 TABLE OF CONTENTSAcknowledgementAbstractList of Abbreviations and acronymsList of Tables1. INTRODUCTION 82. DETERMINANTS OF FDI: A THEORETICAL EXPOSITION 92.1 FOREIGN DIRECT INVESTMENT DEFINED 102.2 MAIN THEORIES OF FDI 122.2.1 INDUSTRIAL ORGANIZATION THEORY 132.2.2 INTERNALIZATION THEORY 142.2.3 PRODUCT LIFE-CYCLE THEORY 142.2.4 ECLECTIC THEORY OF INTERNATIONAL PRODUCTION 152.3 SUMMARY 173. FDI IN CHINA AND INDIA: AN OVERVIEW 183.1 TRENDS AND PATTERNS OF FDI 183.2 SOURCE-COUNTRY COMPOSITION 243.3 SECTORAL COMPOSITION 283.4 REGIONAL DISTRIBUTION 31
  3. 3. AN447 Page 3 of 61 357434. DETERMINANTS OF FDI 344.1 POLITICAL ENVIRONMENT AND FDI POLICY REGIME 354.2 ECONOMIC DEVELOPMENT 394.3 SOCIETY 414.4 TECHNOLOGY DEVELOPMENT 434.5 BUSINESS ENVIRONMENT 444.6 LEGAL SYSTEM 464.7 SUMMARY 485 SUMMARY AND CONCLUSIONS 485.1 FINDINGS 495.2 POLICY IMPLICATIONS 515.3 LIMITATION OF THE STUDY 535.4 FUTURE RESEARCH DIRECTIONS 53BIBLIOGRAPHY: 55
  4. 4. AN447 Page 4 of 61 35743 ACKNOWLEDGEMENTI express my deep sense of gratitude to Professor Stephan Feuchtwang forhis talented suggestions and intellectual stimulus on this dissertation. Iwould also like to thank Dr. Victor Teo and all other staff in theAnthropology Department for their tutoring and support throughout theyear. Special thanks go to the UK Foreign and Commonwealth Office andthe British Council for their generous financial help with my study in theLondon School of Economics and Political Science. I am deeply indebted to my daughter, Youyou Hu, for the immensesacrifice she has made for bearing my absence, when she needed me most.
  5. 5. AN447 Page 5 of 61 35743 ABSTRACT The analogies between Chinese and Indian economies draw obviouscomparison. This research seeks to understand the FDI inflows andexamines the main determinants in the two countries. Since the empiricalwork over the past decades has not produced consensus as to thedeterminants of FDI, Dunning’s O-L-I paradigm offers a unifiedframework of the various theories. To identify the differences ofdeterminants of FDI inflows in China and India, the changing patterns ofFDI are closely studied with special reference to the source countries ofFDI, the sectoral composition and regional distribution. Moreover, thisstudy develops a PESTEL framework for analyzing the recentexperiences and determinants of FDI inflows in China and India. Itconcludes that on the determinants of political and FDI policies,economic development, society and business environment, China doesbetter than India; whilst India is ahead of China in terms of technologyand legal system.
  6. 6. AN447 Page 6 of 61 35743List of Abbreviations and acronymsCJV Contractual Joint VentureEJV Equity Joint VentureEU European UnionFDI Foreign Direct InvestmentGBPC Global Business Policy CouncilIPA Investment Promotion AgencyIT Information TechnologyIPR Intellectual Property RightLDC Less Developed CountryMNC Multinational CorporationMNE Multinational EnterpriseNIE Newly Industrializing EconomiesOECD Organization for Economic Cooperation and DevelopmentSEZ Special Economic ZoneTNC Transnational CorporationUNCTAD United Nations Conference on Trade and DevelopmentWFOE Wholly Foreign-owned VentureWTO World Trade Organization
  7. 7. AN447 Page 7 of 61 35743List of tablesTABLE 3.1 FDI INFLOWS IN CHINA 1979-2005 18TABLE 3.2 FDI INFLOWS IN INDIA, AUGUST 1991-2005 22TABLE 3.3 COMPARISON OF FDI INFLOWS TO CHINA AND INDIA 23TABLE 3.4 TOP TEN SOURCE COUNTRIES (REGIONS) OF FDI INCHINA, 1979-2005 24TABLE 3.5 TOP TEN SOURCE COUNTRIES (REGIONS) OF FDI ININDIA, AUG. 1991-2005 26TABLE 3.6 SECTOR-WISE FDI INFLOWS IN CHINA, 2000-2005 28TABLE 3.7 SECTOR-WISE FDI INFLOWS IN INDIA, AUG. 1991-2005 30TABLE 3.8 PROVINCE-WISE FDI INFLOWS IN CHINA, 1979-2005 32TABLE 3.9 REGION-WISE FDI EQUITY INFLOWS IN INDIA, 2000-2006 33TABLE 4.1 COMPARISON OF SOFTWARE INDUSTRY IN CHINA ANDINDIA (YEAR 2005) 38TABLE 4.2 COMPARISON OF SELECTED ECONOMIC INDICATORS:CHINA AND INDIA 40
  8. 8. AN447 Page 8 of 61 35743 Foreign Direct Investment in China and India: Development Experiences and Determinants in a Comparative Perspective1. IntroductionChina and India enjoy a lot in common: long histories, giant markets,huge populations and soaring growth rates. Both countries have anancient and prestigious cultural heritage; both are under the influence ofthe Soviet model and have embraced economic reform and liberalization– China in the late 1970s and India in the early 1990s. Now both are inthe process of liberalizing their economies as they open up to foreigndirect investment (FDI), which is not at the same stage and we shall takea closer look at it below. FDI has increasingly been considered as a catalyst to market growthfor the developing countries, particularly in countries such as China andIndia. More importantly, besides supplementing capital, FDI, as aprincipal conduit of technology upgrade, know-how transfer andmanaging skills exchange, heralds the globalisation of host economies(United Nations Conference on Trade and Development. 2005; UNCTAD2006). The global competition for FDI among developing countries isincreasing and in this context, both China and India are aiming for a highshare of the FDI pot for they are now getting increasingly integrated withthe global economy as they open up their markets to international trade
  9. 9. AN447 Page 9 of 61 35743and investment inflows. The remaining sections of the paper are as follows. The theoreticaljustification for the research propositions is examined in Chapter 2. InChapter 3, a overview of FDI trends and patterns in both countries ispresented. The changing patterns of FDI are closely studied with specialreference to the source countries of FDI, the sectoral composition andregional distribution, which are used as the background information forfollowing chapters. Relevant determinants of FDI inflows into eachcountry are discussed and compared in Chapter 4 by using a PESTELanalysis format. Finally, the major findings of the paper are summarizedin Chapter 5. The policy implications are addressed and the limitations ofthe study are highlighted before presenting the future research directions.2. Determinants of FDI: A Theoretical ExpositionThe past three decades have witnessed the emergence of a sizable body ofliterature dealing with various dimensions of the determinants andmotives of FDI flow. A review of these studies is essential to know aboutthe different determinants of FDI and to see how far these determinantscan be applied in the following empirical study on China and India. Thefirst section of this chapter seeks to define FDI and the impact and effectsof FDI. The second section then reviews the existing discussion on FDIand shows that FDI is determined by different factors under differentmacro economic conditions.
  10. 10. AN447 Page 10 of 61 357432.1 Foreign Direct Investment DefinedFDI is an important instrument in the process of globalization and plays acrucial role in the development of the economies of the developingcountries. As defined by the Organization for Economic Cooperation andDevelopment (OECD), it ‘reflects the objective of obtaining a lastinginterest by a resident entity in one country (‘direct investor’) in an entityresident in an economy other than that of the investor (‘direct investmententerprise’)’. Krugman and Obstfeld define FDI as ‘…internationalcapital flows in which a firm in one country creates or expands asubsidiary in another’ (Krugman and Obstfeld 2000: p.159). They go onto highlight that the distinct feature of FDI is that ‘it involves not only thetransfer of resources but also the acquisition of control’. Södersten andReed further point out that FDI ‘is in essence a bundle of capital,technology and management skills transmitted by multinationalenterprises (MNEs) or transnational corporations (TNCs)’ (Södersten andReed 1994: p.489). Unlike conventional definitions of FDI, the official Chinesecounterpart incorporates three forms of direct foreign-invested enterprises1 (sanzi qiye). They are equity joint venture (EJV) (hezi jingying qiye),contractual joint venture (CJV) (hezuo jingying qiye) and whollyforeign-owned venture (WFOE) (waishang duzi jingying qiye) (Huang1 They are usually established through 1) mergers and acquisitions with another company; 2) a direct subsidiary(greenfield FDI); 3) an EJV; and 4) buying a controlling stake of the public listed company.
  11. 11. AN447 Page 11 of 61 357431998). In case of India, the earlier definition of FDI differed from that of theIMF, as well as that of the World Investment Report compiled by theUnited Nations Conference on Trade and Development (UNCTAD) 2 .Since 2003, with the establishment of the Technical Monitoring Group onForeign Direct Investment, a new method of compilation of the FDIstatistics has been adopted in India, which makes the data internationallycomparable. The new system includes equity capital, reinvested earningsand other capital, which are mainly intra-company loans (Tamuli 2006:pp.2-5). Much of the discussion on FDI in former years, particularly in theextractive industries, MNCs were perceived as exploitative terms (DosSantos 1969: p.21; Cohen 1973), and indeed were seen to be the cause ofmuch of host economies’ problems (Caves 1982). In India, the takeoverby the British East India Company of control over the whole India hadcreated the East India Company syndrome (Gupta, Dahiya et al. 2005:p.149). The ideological change came about during 1990s, when FDIinflows had become the most important component of total capital flowsto developing countries, notably in East and South East Asia. FDI notonly adds to external financial resources for development, but is alsomore stable than other types of flows. Kawai and Urata demonstrate how2 IMF’s definition includes external commercial borrowings, reinvested earnings and subordinated debt, while theWorld Investment Report excludes external commercial borrowings.
  12. 12. AN447 Page 12 of 61 35743FDI upgrades the technological capability of the recipient economies(Urata and Kawai 2000) and Urata further notes the importance of FDIfor promoting trade (Urata 2001). OECD, Yusuf, Nabeshima and Altafidentify the role of FDI in fostering recipients’ participation in globalproduction networks (OECD 2002; Nabeshima, Yusuf et al. 2004; Yusuf,Altaf et al. 2004). Moran has done a research covering 183 projectsacross 30 countries in 15 years and point out that FDI has a positiveimpact on the national income of the host economy in the majority ofprojects (Moran and Institute for International Economics (U.S.) 1999).2.2 Main Theories of FDIThere have been a prolific number of empirical studies on thedeterminants and motives of FDI. Some studies have concentrated uponthe ownership specific advantages of the foreign firms which arenecessary to outweigh the disadvantage of being foreign. These studieshave tried to find out the significance of various ownership advantagesarising due to propriety knowledge, financial assets, productdifferentiation, plant economic of scale, size of the firm and multi-plantoperations etc. We hereby categorizes such theories as external(supply-side) approaches. Other studies have focused on the locationalspecific advantages as low cost of labor, reduced tariffs, fiscal incentives,market size and characteristics of the host economy, favorable FDIpolicies of the host government, political stability and other locational
  13. 13. AN447 Page 13 of 61 35743factors. Here this study categorizes such theories as internal (demand-side)approaches. In sum, the external factors include economic conditionsoutside the host country, while internal factors include the economicconditions of the host country. Traditionally, most empirical papers have focused on the role of theexternal factors in determining FDI flows into developing countries.These theories so far mainly stress on the ownership specific advantagesof the firms and three of them are examined as follows.2.2.1 Industrial Organization TheoryHymer and Kindleberger argue that the ‘ownership advantages’(including inventory, cost, financial or marketing advantages) motivatethem to establish subsidiaries in the host countries (Kindleberger 1969;Hymer 1976). These advantages which they assume to be exclusive to thefirm owing them explain why American-type FDI is predominant in aparticular sector of industry but it may be unable to portray a generalpattern of FDI. Another industrial organization approach, developed by Caves, isbased on models of ‘oligopolistic competition’. He treats a MNC as acreature of market imperfections that lead a firm to possess specificadvantages over local firms in the host country (Caves 1982). In fact, some Japanese scholars refute its limitation to explainJapanese-type FDI, which is based on location factors rather than
  14. 14. AN447 Page 14 of 61 35743technological superiority, economic scale and management skills (Ozawa1979; Kojima 1996).2.2.2 Internalization TheoryThe internationalization theory, created by Buckley and Casson, anddeveloped by Rugman and Hennart, is primarily concerned with thetransactions cost approach (Rugman 1981; Hennart 1982; Casson andBuckley 1983). The basic hypothesis of this theory is that MNEs emergewhen it is more beneficial to internalize the use of such intermediategoods as technology than externalize them through the market. The coreprediction of the theory is that, given a particular distribution of factorendowments, MNE activity will be positively related to the costs oforganizing cross-border markets in intermediate products.2.2.3 Product Life-cycle TheoryIn a classic article published in 1966, Vernon was the first to investigatethe relationship between FDI and technology. He uses a microeconomicconcept, ‘the product cycle’, to explain a macroeconomic phenomenon,which is the foreign activities of US MNCs in the postwar period (Vernon1966). He argues that the product life-cycle can be divided into three stages asnew product stage, matured product stage and standardized product stage.In the early new product stage, firms place factories in the home countrysince the demand for a new product is too small elsewhere. As the
  15. 15. AN447 Page 15 of 61 35743expansion of production in the home country becomes too expensive, themature oligopolist invests in a host country with high income elasticity ofdemand and similar consumption patterns to the home country. Thereforeit develops into the second stage of matured product. As the product turnsinto increasingly standardized and its competition is based on price, theproduct is manufactured in less developed countries (LDCs) for export. Although this theory considers changes in technology and implicitlyassumes that the MNCs would acquire the manufacturing plants in thecountries with abundant low-cost workers, it is not a dynamic theory forthe rate of change and the time-lag between product stages are notconsidered. Chen rebuts that it is also unable to explain FDI innon-standardized products and special products for overseas markets(Chen 1983: pp.28-9). The theories explained above mention only the home countrymacro-economic, industry specific and firm specific external (supply-side)factors. But it is necessary to bear in mind that the host country mustpossess certain locational advantages to attract FDI. The O-L-I paradigmdeveloped by Dunning seeks to offer a comprehensive framework bycombining the company comparative advantages and host countrylocation endowments.2.2.4 Eclectic Theory of International ProductionThe eclectic paradigm of international production, which postulates that
  16. 16. AN447 Page 16 of 61 35743FDI is determined by three sets of factors, namely ownership(firm-specific) advantage, internalization advantage and location(country-specific) advantage, is developed by Dunning and modified byhis associate Narula (Dunning 1981; Dunning 1988; Dunning and Narula1995; Narula 1996). According to Dunning, the rationales of FDI can be well-defined byO-L-I paradigm: Ownership (O) advantages: economies of scale, exclusive production and technical expertise, managerial and marketing skills. These are the prerequisite to ensure or enable the MNCs to recover the costs of investing abroad. Itaki further argues that these O advantages largely take the form of privileged possession of intangible assets and the use made of them are assumed to increase the wealth-creating capacity of a MNC, and hence the value of its assets (Itaki 1991). Location (L) factors: low labor costs, potential foreign market, favorable investment incentives. These pull factors of host country contribute to the MNCs’ decision to employ ownership advantages to produce aboard. Internalization (I) factors: Comparing with licensing and exporting, by using greater organizational efficiency or ability to exercise monopoly power over the assets under the governance, an internal market is created between parent-company and affiliates to control
  17. 17. AN447 Page 17 of 61 35743 key resources of competitiveness or to reduce the risk of selling them as well as the right of use of them, to foreign firms. Compared with the above theories, which were founded on ownershipadvantages in the form of technology and finance, transaction costs anddifferential factor endowments, the unique feature of Dunning’s O-L-Iparadigm is to unify and summarize the various theories, although it isstill a frame which synthesizes most FDI theories rather than a newtheory per se. It signified the ownership, locational and internalizationadvantages of the firm and, by extension, the ownership andinternalization advantages of the home country, and locational advantagesof the host country of FDI, which Dunning stipulates that O-L-I isapplicable to ‘home country’ and ‘host country FDI’ (Dunning 1981).According to this theory, FDI is chosen as a market entry strategy so thata firm can exploit its ownership advantages through internalizingtransaction costs in a specific location, which possess locationaladvantages.2.3 SummaryTo conclude, the relative significance of the motives and determinants ascontained in the above theories differs not only between firms andregions but also from time to time for a particular firm or region. It isvery difficult to generalize about the determinants of FDI and it is truethat most firms are influenced in their behavior by more than one
  18. 18. AN447 Page 18 of 61 35743objective and sometimes different values are placed on the sameobjective. The difference in the strength of the determinants is most markedbetween China and India which differ radically with regard to economicstructure, development characteristics and socio-economic profiles.Nevertheless, the above theories provide us with a rich collection ofmotives and determinants that can support and guide the following studyof the explanatory variables of FDI flows into China and India.3. FDI in China and India: an overview This chapter examines and discusses the trends and patterns of FDIinflows into China from year 1991 to 2005 and India from August 1991to2005. Based on published official data, it provides a clear picture aboutthe longitudinal and latitudinal analysis of FDI inflows, the country oforigin, sectoral composition as well as regional distribution of FDI inboth countries.3.1 Trends and Patterns of FDIChinaDuring the period 1979-2005, China has approved a total number of552,942 foreign-invested companies with a cumulative foreign capitalinvestment (contract value) of US $1285.7 billion, of which US $622.4billion was effectively invested.Table 3.1 FDI Inflows in China 1979-2005 (US $billions)
  19. 19. AN447 Page 19 of 61 35743 Year Contracted FDI3 Paid-in FDI4 1979-1991 52.669 13.018 1992 58.124 11.008 1993 111.36 27.515 1994 82.680 33.767 1995 91.282 37.521 1996 73.276 41.726 1997 51.003 45.257 1998 52.102 45.462 1999 41.223 40.318 2000 62.380 40.715 2001 69.192 46.878 2002 82.768 52.7 2003 115.07 53.505 2004 153.479 60.63 2005 189.065 72.406 Total 1285.673 622.426 Sources: Bureau of Foreign Capital, the Ministry of Foreign Trade and Economic Cooperation (the Ministry of Commerce since March, 2003) Analyzing Table 3.1 reveals the FDI development in China can bedivided into three stages: 1979 to 1991, 1992 to 2001, and 2002, the yearafter the China’s entry into the World Trade Organization (WTO) topresent. From late 1978, China cast off its self-reliance policy and adopted thepolicy of reform and open-up. FDI in China grew rapidly during the firsthalf of the 1980s. Entering the second half of the 1980s, the growth ratein China leveled off and turned negative in the aftermath of theTiananmen massacre (Chai and Roy 2006: p.133). According to Chen, theannually growth rate reached 20 percent at that period. Moreover, thepaid-in FDI soared to US $4.36 billion in 1991, making it the largest FDI3 Contracted FDI based on signed contracts, but not always actual inflow. It’s better for gauging the intention toinvest.4 Paid-in FDI was actually invested in host country. It’s a better measure of the actual size of the investment flow.
  20. 20. AN447 Page 20 of 61 35743recipient among developing countries. (Chen 2002). In 1992, after Deng Xiaoping’s tour in the Southern provinces, China’sreform and opening up policy was further intensified. Besides 11 opencoastal provinces, part of the interior regions was open up for FDI.Furthermore, two new investment categories were created, namely, theexport-oriented and technology-advanced projects, which were entitled toadditional incentives regardless of their location. From US $4.3 billion(paid-in FDI) and US $11.97 billion (contracted FDI) respectively in1991, the FDI volume increased dramatically to US $11 billion and US$58.1 billion, a jump of more than 150% and 380%. Only since theoutbreak of the Asian financial crisis in 1997, the growth momentum hasslowed down (Zhang 2006). The WTO accession in November 2001 provided another impetus toFDI and China received US $52.7 billion in 2002, which made China theAsia’s and the developing world’s largest recipient of FDI. As noted inWorld Investment Report 2003, in year 2002, for the first time, Chinasurpassed the United States to become the largest global recipient of FDI,accounting for 9.88 percent of the global flows of FDI (Wu 1999).IndiaIn accordance with the requirements of the economic development indifferent phases, the Indian government’s policy toward FDI has evolvedover time (Kumar 1998). In the 1950s, soon after the independence, the
  21. 21. AN447 Page 21 of 61 35743anti-FDI environment in India was largely based on two factors. The firstwas the strong nationalistic sentiments in the wake of independence.Second, whatever narrow industrial base the country had at that time, anoverwhelming part of it, almost three-fourths, was British-owned.Political and business leaders wished for the day when such a largeforeign ownership of industries could be contained and Indian industryand market became a place for Indian entrepreneurs (Das 2006).Therefore, FDI was discouraged by a) imposing severe limits on equityholdings by foreign investors and b) restricting FDI to the production ofonly a few reserved items (Gakhar 2006). In the 1980s the attitude toward FDI began to change, adopting thepolicies of liberalization of industrial approval rules, a host of incentivesand exemption from foreign equity restriction. In the middle of 1991, apackage of economic reforms was introduced by the government, whichhad greatly affected the magnitude and pattern of FDI inflows receivedby India (Gupta, Dahiya et al. 2005). The average for 1985-90 was less than US $2 million per annum. Toput the lack of significant FDI in the Indian economy in perspective, oneshould take note of the two following statistics. First, the stock of the FDIin 1990 was less than US $2 billion, while the inflow was US $100million (Kapur and S.Athreye 2001: p.130). These statistics are enough tobring home that India was a minor player in global FDI flows before
  22. 22. AN447 Page 22 of 61 357431991. After the macroeconomic reform process began in 1991, the economywas gradually opened up to FDI and policy endeavors were made toattract it. This becomes clear from Table 3.2 that India is fast emerging asan attractive destination of foreign investors. Table 3.2 FDI Inflows in India, August 1991-2005 (US $millions) Financial Year (April-March) Amount of Paid-in FDI5 August 1991-March 2000 15,483 2000-2001 4,029 2001-2002 6,130 2002-2003 5,035 2003-2004 4,673 2004-2005 5,535 2005-2006(up to Dec.2005) 4,719 Total 45,604 Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India The above table presents the first high point of FDI inflows wasreached in 2001, when it topped at US $4 billion. In 2004, with a totalamount of US $4.6 billion FDI inflows, India was the fifth largestrecipient of FDI in the developing world. China, Hong Kong SAR,Singapore and Korea were larger recipients than India. Compared to China, India appears to remain an underperformer in theglobal competition for FDI. However, conclusions based solely on thosefigures in Table 3.1 and 3.2 need to be interpreted carefully, as the aboveindexes have used FDI data provided by official sources in each country5 The Indian data on inflows do not cover the approval amount of FDI. It is estimated that on an average just35.8% of approved amount has flown in India from 1991-2000.
  23. 23. AN447 Page 23 of 61 35743whose definition and measurement methods vary significantly. Thefollowing Table 3.3, using the data from World Investment Report,elucidates a relatively accurate comparison based on internationalstandards. Table 3.3 Comparison of FDI inflows to China and India (Amount in US $millions) 1990-2000 2002 2003 2004 2005 (annual average) China 30104 52743 53505 60630 72406 India 1705 5627 4585 5474 6598 Developing 134670 163583 175138 275032 334285 economies World 495391 617732 557869 710755 916277 Source: UNCTAD, World Investment Report 2006 (www.unctad.org/wir) India’s share of global flows to developing countries appears to be verysmall, especially compared with those received by China. The reportedinflows of US $6.6 billion in 2005 represented a mere 1.9 percent of totalinflows to developing economies, in contrast to US $72.4 billion inflowsto china with a share of 21 percent (Ray 2005). However, as noted by Pfefferman, an IMF 2002 paper asked whethersomething was wrong with India’s FDI numbers. The IMF found out thatthe India’s FDI statistics exclude reinvested earnings, subordinated debtand overseas commercial borrowing, which are included in FDI of othercountries (Pfeffermann 2002). On the other hand, the Chinese statisticsare believed to be overestimating the real FDI flows in view ofround-tripping of Chinese capital to take advantage of more favorable tax
  24. 24. AN447 Page 24 of 61 35743treatment of FDI. According to the World Bank, round tripping accountsfor 20%-30% of FDI in China (World Bank. 2002). This argument issupported by Song’s research, which shows that the Mainland’s inwardFDI from Hong Kong is overstated by the amount of non-Hong-Kong(Mainland, Taiwanese and others) capital channeled via Hong Kong, asHong Kong’s investment in the Mainland appears to be too larger for thesize of the Hong Kong economy (Song 2005: p.30) In summary, China and India have pursued radically different FDIdevelopment strategies. So far the absolute amount of FDI going to Chinais still much larger than India, but the gap in growth rates is narrowing.3.2 Source-country CompositionChinaSince 1979, more than 200 countries and regions have invested in China.In the past, most of China’s FDI came from Hong Kong or Macau,following by those from USA and Japan. More recently, withnormalization of political and economic relation between China, SouthKorea and Taiwan, the latter two regions have become important sourcesof FDI in China. Table 3.4 Top ten source countries (regions) of FDI in China, 1979-2005 (Amount in US $billions) Rank Sector Paid-in FDI %age of total china FDI 1 Hong Kong 288.948 46.62% 2 Taiwan 62.119 9.98%
  25. 25. AN447 Page 25 of 61 35743 3 United States 54.385 8.74% 4 Japan 53.445 8.59% 5 South Korea 31.318 5.03% 6 Singapore 28.956 4.65% 7 United Kingdom 13.287 2.13% 8 Germany 11.517 1.85% 9 France 7.47 1.2% 10 Netherlands 6.967 1.12% Sources: China Foreign Investment Report 2006, Ministry of Commerce As Table 3.4 shows, Newly Industrializing Economies (NIEs),including Hong Kong, Taiwan, Singapore and South Korea, have been themajor investors in China, accounting for 66.28% of the total accumulatedFDI inflows. They represent mainly small and medium-sized businessesthat are export-oriented and involved in assembly and processingoperation. Among them, Hong Kong is keeping as the most importantplayer. However, its share has dropped from 70% in 1992 to 46.6% in2005. It is estimated, with the China’s success in industrial upgrading andgreater openness to the outside world, the role of Hong Kong in providingand intermediating FDI inflows into China will be further reduced in thefuture. It should also be stressed here that published FDI figures of HongKong are overstated for the large proportion of round tripping capital,although no reliable estimates of such part are available. The USA and Japan have been by far the largest foreign investorsamong developed countries investing in China, representing 17.33% ofthe total China FDI. The United Kingdom, Germany, France and theNetherlands constitute the main sources of European Union (EU) in
  26. 26. AN447 Page 26 of 61 35743China, as together they account for 6.3%, which was quite weak.IndiaTable 3.5 Top ten source countries (regions) of FDI in India, Aug.1991-2005 (Amount in US $millions) Rank Sector Paid-in FDI %age of total India FDI 1 Mauritius 11,115.47 37.25% 2 United States 4,912.75 15.8% 3 Japan 2,059.33 6.79% 4 Netherlands 1,987.18 6.65% 5 United Kingdom. 1,911.77 6.26% 6 Germany 1,338.88 4.27% 7 Singapore 962.41 3.14% 8 France 772.99 2.55% 9 South Korea 748.98 2.28% 10 Switzerland 613.58 1.98% Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Foreign Direct Investment Policy, April 2006 Table 3.5 gives percentage share of major country sources in the actualinflow of FDI in India during 1991-2005. Mauritius, as the top-placecontributor, account for 37.25% of total FDI inflows. It is estimated thatDouble Tax Avoidance Treaty entered into with Mauritius, exemptingcapital gains from Indian Income Tax, 1961 and benefiting foreigninvestors, could be only one of the reasons of spurt in FDI inflows fromMauritius (Chopra 2003: p.158). Hence, investors from other countries,principally the United States, route their investments through Mauritius totake advantage of the tax treaty. The United States occupies the second position with a share of 15.8%
  27. 27. AN447 Page 27 of 61 35743and Japan stands at the third rank having a share of 6.79%. The share ofmajor EU source countries, including the United Kingdom, Germany,France, Switzerland and the Netherlands, is approximately 21.7%. In reviewing the source countries of FDI inflows to China and India,two conclusions can be drawn. First, in China there is a clear pattern ofconcentration of FDI inflows. A large part of Chinese FDI comes fromChinese-owned or overseas Chinese owned companies located in HongKong, Taiwan, Singapore and other NIEs. This proportion to a certainextent forms the basis for the economic integration of the region, which issometimes referred to as Greater China. The plausible explanation here isthat the relative geographical and cultural proximity of China and otherEast Asian countries with major sources of capital such as Japan andSingapore may have put India a disadvantage. However, projects fromsuch countries are mainly in labor-intensive ones, small in scale, with alow level of capitalization and little technology transfer. By contrast,source-country composition in India is more diversified. Kumar studiedthe changing sources of FDI in India and indicated that the Europeancountries were the major sources of FDI inflows to India until 1990.However, they had declined steadily from 66% in 1990 to 31% by 1997,while US emerged as the biggest player over this period with a share of13.75% in 1997 (Kumar 2003). Second, India boasts a relatively larger share of FDI from developed
  28. 28. AN447 Page 28 of 61 35743countries (including US, Japan and EU), which accounts for 44.3%. Incomparison, China only holds a share of 23.63%. Although the EUconstitutes the world’s largest home base for FDI, it is relativelyunderrepresented in the Chinese FDI, at least as compared to its overallFDI position in the global economy. As Bulcke and Zhang point out, theweak FDI position of the European Union in China has directly affectedthe competitiveness of the EU companies in the Asian emerging markets(Bulcke, Zhang et al. 2003: p.3).3.3 Sectoral CompositionChina Table 3.6 Sector-wise FDI inflows in China, 2000-2005 (Amount in US $millions) 2000 2001 2002 2003 2004 2005 National total 4071481 4687759 5274286 5350467 6062998 6032469 Agriculture 67594 89873 102764 100084 111434 71826 Mining and 58328 81102 58106 33635 53800 35495 quarrying Manufacturing 2584417 3090747 3679998 3693570 4301724 4245291 Electric Power, gas and water 224212 227276 137508 129538 113624 139437 production and supply Construction 90542 80670 70877 61176 77158 49020 Transportation,storage, postal, and 101188 90890 91346 86737 127285 181230telecommunications services Wholesale and retail trade and 85781 116877 93264 111604 158053 159871 catering services Banking and 7629 3527 10665 23199 25248 21969 insurance
  29. 29. AN447 Page 29 of 61 35743 Real estate 465751 513655 566277 523560 595015 541807 Other sectors 386039 393142 463481 587364 499657 586523Sources: China Foreign Investment Report 2006, Ministry of Commerce; ChinaStatistical Yearbook, National Bureau of StatisticsTable 3.6 examines the distribution of FDI inflows by industry from 2000through 2005. It shows that nearly 65-70 percent concentrated primarilyin the manufacturing sector. The next highest share, approximately 9-11percent, is in real estate. Beyond those two sectors, FDI in China isscattered across various sectors with single-digit or lower percentageshares. On the whole, the industry concentration of FDI in China is notvery high compared with the industry concentration in other countries(IMF 2002). Regarding manufacturing sector, it is observed that FDI has beenconcentrated in the various fields, in particular the electric and electronicequipment sector, the textile sector, and the chemical and pharmaceuticalsector. However, a shift of FDI away from manufacturing towardsservices sector is forecasted because the significant liberalizationfollowing China’s membership in the WTO. The greatest liberalizationwill be in financial services, telecommunications, and distribution. Thesesub-sectors in the service sector are expected to see rapid increase in FDI.IndiaThe sectoral distribution of FDI in India between August 1991 andDecember 2005 is given in the following Table 3.7. Table 3.7 Sector-wise FDI inflows in India, Aug. 1991-2005
  30. 30. AN447 Page 30 of 61 35743 (Amount in US $millions) Rank Sector Amount of FDI %age of total India inflows FDI 1 Electrical Equipment6 4,885.88 16.5% 2 Transportation Industry 3,143.09 10.34% 3 Service Sector 2,971.66 9.64% 4 Telecommunications 2,890.12 9.58% 5 Fuels7 2,521.49 8.41% 6 Chemicals (Other than 1,899.51 5.86% Fertilizers) 7 Food Processing Industry 1,173.18 3.67% 8 Drugs and Pharmaceuticals 948.54 3.18% 9 Cement and Gypsum 746.79 2.54% Products 10 Metallurgical Industries 627.32 2.12% 11 Consultancy Services 444.48 1.59% 12 Miscellaneous Mechanical 435.45 1.51% & Engineering 13 Textiles 430.07 1.32% 14 Trading 374.23 1.16% 15 Paper and Pulp 363.46 1.1% Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Foreign Direct Investment Policy, April 2006 The table 3.7 shows the electrical equipment is the largest beneficiaryof FDI inflows, which represents one of the most spectacularachievements for the Indian economy. Transportation, service sector andtelecommunications, which can be categorized as the tertiary industry,emerge as significant recipients with a share of 30 percent. Comparedwith the old pattern of FDI stock before liberalization, the relativeimportance of manufacturing sector has declined with the opening up ofinfrastructure and service sectors. Furthermore, within the manufacturingitself, the preference pattern of FDI is shifting away from heavy6 Computer software and electronics are included7 Power and oil refinery are included
  31. 31. AN447 Page 31 of 61 35743industries to light industries. To sum up the foregoing discussion on sectoral distribution of FDI inChina and India, we note that both countries witness that the opening upof new industries has led to increased investments in service sector, thusbringing down the share received by manufacturing. Within themanufacturing sector, both countries saw a steady upgrading of FDIinflows from labor intensive industries to capital and technologicalintensive industries and from traditional manufacturing industries toinformation technology (IT) related industries. Therefore, in the comingyears, China and India will still present a David and Goliath image inattracting FDI inflows.3.4 Regional DistributionChinaThe geographical distribution of FDI in China is highly uneven andreflects the history of liberalization, deregulation and government policy,as noted in section 3.1. In the early period of reform and opening up, thereformers targeted China’s coastal areas as the leading regions for theeconomic development and established four Special Economic Zones8(SEZs) in Guangdong and Fujian Province. The analysis of Table 3.8reveals that the coastal areas, particularly Guangdong and Jiangsu, are themajor locations for FDI inflows. The other main locations for FDI were8 The four SEZs are located in Shenzhen, Zhuhai, Shantou and Xiamen.
  32. 32. AN447 Page 32 of 61 35743Shanghai, Shandong and Fujian.Table 3.8 Province-wise FDI inflows in China, 1979-2005 (Amount in US $billions) Rank Province Amount of FDI %age of total inflows India FDI 1 Guangdong 151.657 24.36% 2 Jiangsu 89.848 14.44% 3 Shanghai 55.394 8.90% 4 Shandong 52.932 8.50% 5 Fujian 47.851 7.68% Sources: China Foreign Investment Report 2006, Ministry of Commerce Using China’s provincial and municipal data, Hsiao and Shen foundout that the development of cities and infrastructure and easy access tomarkets are two of the primary factors often determining MNCs’ choiceof where to invest (Hsiao and Shen 2003). Another point is that the closegeographical proximity and tight cultural and linguistic links betweensouthern China and the overseas Chinese communities in Hong Kong,Taiwan and Macau have also contributed to the observed geographicalpattern of FDI inflows in China.IndiaThe major portion of the FDI in India is found to be flowing into theeconomically richer states. The five richer Indian states, Maharashtra,Delhi, Tamil Nadu, Karnataka and Andhra Pradesh accounted for morethan 66.65% of the FDI inflows into India. This trend in FDI inflowsshows the economic inequality that already exists among the Indian states.Tamuli asserted that FDI inflows to these states seemed to respond to
  33. 33. AN447 Page 33 of 61 35743infrastructure availability, business managers’ perception of investmentclimate, educational qualification of manufacturing workers andproductivity level of manufacturing industries (Tamuli 2006). Table 3.9 Region-wise FDI Equity inflows9 in India, 2000-2006 (Amount in US $millions) Rank Regional office State covered Amount of %age of FDI inflows total India FDI Maharashtra, Darda 1 Mumbai &Nagar Haveli, Daman & 7,486.6 24.91% Diu Delhi, Part of Up and 2 New Delhi 7,045 23.42% Haryana 3 Chennai Tamil Nadu, Pondicheery 2,295 7.64% 4 Bangalore Karnataka 2,052 6.82% 5 Hyderabad Andhra Pradesh 1,157 3.86% 6 Ahmedabad Gujarat 970 3.26% Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Fact Sheet on FDI, from Aug.1991-Dec.2006 To summarize, locational benefits appear to be a prime considerationfor foreign investors contemplating participation in any FDI projects bothin China and India. Especially in China, the selective economic policycreates uneven regional economic development, which strongly affectsthe inflow and location of FDI. The study also finds out that the forces ofconvergence are very weak in two countries and the provinces (states) areshowing a tendency of divergence rather than convergence. Thegeographical distribution of FDI in two countries today also is the resultof local government’s efforts to create a favorable investment, especially9 Includes ‘equity capital components’ only
  34. 34. AN447 Page 34 of 61 35743in fostering industrial clusters in their jurisdictions. The Indian economistKurian notes that ‘the better-off states are able to attract considerableamounts of private investment, both domestic and foreign, to improvetheir development potential because of the existing favorable investmentclimate including better socio-economic infrastructure’(Kurian 2000:p.12). It seems both China and India express the concern that a growingpolarization of the country can have an extremely damaging effect onnational unity and harmony. A wider geographic spread of capital acrossthe country are actively pursued by each country. In China, to narrow thegap, it introduced The West Development Strategy in 1998. In contrast,the India’s 10th five-year plan explicitly addresses the need to ensureequity and social justice and ‘particular attention must be paid to theimportance of ensuring a balanced development for all States’ (India.Planning Commission. 2003: p.8).4. Determinants of FDIFollowing the analysis and literature review on determinants of FDI inChapter 2 and the discussion on trends and patterns of FDI inflows toChina and India in Chapter 3, this chapter in turn examines the variousdeterminants of FDI and to see how far these determinants can be appliedin both countries. Since the external (supply-side) factors explain theoutward investment by different countries while the internal(demand-side) factors explain the uneven distribution of FDI among the
  35. 35. AN447 Page 35 of 61 35743recipient countries. Therefore the focus of this chapter will be on internal(demand-side) factors, although the separation of the two kinds of factorssometimes is impossible. It will present the PESTEL (political, economic,social, technological, environmental and legal) analysis of variables thathave directly or indirectly determined the FDI inflows to both countries.4.1 Political Environment and FDI policy regimeChina is still regarded as a communist regime and one of the mostimportant characteristics of Chinese political system is the one party rule,while India is the world’s largest democracy. Therefore, the simplestlanguage to describe the difference between the two countries is ‘theworld’s largest democracy’ versus ‘the world’s largest autocracy’.Although this metaphor indeed reflects some truth, the reality is muchmore complex. Both countries, despite enjoying different politicalsystems, have actually come from the same place – Soviet style plannedeconomies and massive state-owned enterprises. Both countriesundertook significant reforms in the 1980’s and 1990’s. As Chinamodernizes, it increasingly encourages free trade and capitalist-basedeconomic model which allows more democracy; whilst as Indiamodernizes, it’s getting it’s democracy under control for the good ofnation. The first reason for the FDI gap between two countries is that India isat least twelve years behind China in terms of launching reforms. As
  36. 36. AN447 Page 36 of 61 35743discussed in Chapter 3, China opened its doors to FDI in 1979 and hasbeen progressively liberalizing its policy regime, while the reforms inIndia were introduced in June 1991, which ‘aimed at reducing the extentof government controls over various aspects of domestic economy,increasing the role of the private sector, redirecting scarce public sectorresources to areas where the private sector is unlikely to enter, andopening up the economy to trade and foreign investment’ (Cassen andJoshi 1995: P.13). In addition to the late start, Franda asserts that failure to effectfar-reaching economic reform in the 1990s could be attributed as animmediate cause to the enormous factionalism characterizing Indianpolitical life. For example, the BJP-led coalition formed in 1999 consistedof almost two dozen political parties with widely divergent platforms andinterests (Franda 2002: pp24-27). Vardarajan also declares that India isperhaps the only democracy where businessmen don’t become politiciansand political system is dominated by political leaders who base theirappeal on “castemanship, regional factionalism and personal cults”(Cable and Royal institute of international affairs. Internationaleconomics programme. 1995). Therefore, a major consequence of thefragmentation of Indian political party life is the near-impossibility ofconducting meaningful national FDI promotion campaigns. In thisatmosphere, it is little wonder that FDI volume in India was only
  37. 37. AN447 Page 37 of 61 35743one-tenth of China from 2000 through 2005 (see above table 3.1 and 3.2).Additionally, during a debate in the Rajya Sabha on 20 August 2001, thethen planning minister, Arun Shourie, was asked why India had receivedonly $17 billion in FDI in a decade when China had attracted $323 billion.Shourie stated that the reason was that the Chinese government is ‘marketsavvy, quick in decision-making and better still in executing decisions’(The Statesman, 21 August 2001). Another essential reason for China’s unparallel success is its strategy ofcreating Special Economic Zones (SEZs) and coastal economic zones,which has been discussed in section 3.4. Decision-makers in the publicpolicy community proactively create an enabling environment for theinflows of FDI in the domestic economy, which are essentially located inthe coastal areas of the eastern and the southern provinces of China (Das2005). Therefore, the ability of China to attract FDI inflows is largely theresult of special economic zones that give foreign enterprises better andspecialized infrastructure and flexibility in domestic regulations.Compared with China, India’s SEZs scheme was launched in 2000, again15 years later than China (Gakhar 2006: p.85). Furthermore, unlike China,India has not employed fiscal incentives such as tax concessions to attractFDI. Only in December 2004, the Indian government initiated the reformof the Foreign Investment Promotion Board, and has established theIndian Investment Commission to enhance and facilitate FDI in India,
  38. 38. AN447 Page 38 of 61 35743which acts as a one-stop shop between the investor and the bureaucracy. The one bright spot for India in its FDI competition with China hasbeen the ability to invite more foreign software investors. The mosttelling demonstration of India’s superiority in software technology is inFDI inflows and trade statistics (see table 4.1).Table 4.1 Comparison of software industry in China and India (Year2005) (Amount in US $millions) Software industry FDI Software industry inflows Exports China 932 3590 India 1451 10000 Source: China Foreign Investment Report 2006, Ministry of Commerce; NASSCOM, India10 Software development in China is at the opposite end of the spectrumfrom that in India. Beijing’s effort to build sophisticated softwareproduction capabilities did not get started until the mid-1990s and theChinese government provided little state support to this effort until thelate 1990s. While India’s lead in software technology can be traced to1984, when Rajiv Gandhi began to adopt the first liberal economicpolicies designed to develop this sector (McManus, Li et al. 2007). Compared to the above reform and FDI policies, it is worth noting thatthe government need to understand ‘how their policies and behaviorsshape the opportunities and incentives facing firms’(WorldBank 2005:10 NASSCOM is the apex software industry body in India. Useful information on the Indian software industry aswell as doing business in India is available at its website, http://www.nasscom.in
  39. 39. AN447 Page 39 of 61 35743p.12). In brief, the government policies can play an important role inattracting FDI inflows. It is desirable to give some specific policydirection to foreign investors, as the cases of China’s SEZ success andIndia’s software development demonstrate.4.2 Economic DevelopmentChinese gross domestic product (GDP), adjusted for purchasing powerparity, ranked number 2 after USA, whereas Indian adjusted GDP rankednumber 4 after Japan. Over the past two decades, China’s average annualgrowth rate was above 9 percent, and the average annual inflation ratewas kept below 3 percent. The Chinese economy continues its robustdevelopment, total growth in 2005 exceeded expectations at nearly 10percent. In contrast, the Indian rate also jumped from about 3 percent ayear during 1950-79 to between 5-6 percent a year during 1980-2004(Chai and Roy 2006). According to the research on the contribution ofGDP growth to FDI by Hsiao and Shen, the elasticity of a 1 percentincrease in GDP raises FDI by 2.117 percent (Hsiao and Shen 2003).Therefore, if both countries could sustain their present growth in thefuture, they are likely to attract more FDI. Table 4.2 compares the current stage of China’s macroeconomicperformance and economic structure with that of India in terms of somekey economic indicators. Table 4.2 Comparison of selected economic indicators: China and India
  40. 40. AN447 Page 40 of 61 35743 China/India Indicator Unit Year China India ratio GDP per capita at PPP US $ 2002 4580 2670 1.71 Gross national income US $ 2003 1,100 540 2.0 (per capita) Rank 2003 134th 159th Share of manufactured Percent 2002 90 75 1.2 products in exports Share of high-tech Percent 2002 23 5 4.6 products in exports Electricity production Billion kwh 2002 1,640 597 2.7 Share in multilateral Percent 2004 8.9 1.1 trade Rank 2004 3rd 20th Position in the WTO 2004 3rd 30th league table of exporters Position in the WTO 2004 3rd 37th league table of importers Foreign exchange US $ billion 2005 711 144 4.97 reserves Rate of poverty Percent 2002 17 35 0.5 Adult literacy rate Percent 2002 91 61 1.49 Per million Researchers in R&D 2002 584 157 3.71 people Share of IT industry in Percent 2002 3 NA GDP Sources: (1) World Development Indicators 2005, (2) International Trade Statistics 2005, (3) China Statistical Yearbook, National Bureau of Statistics The comprehensive comparison of the above economic indicatorsreveals that India currently is at the level that China had reached in theearly 1990s. Hence, there is roughly a ten-year gap between China’s andIndian’s economic development. These again prove that China’seconomic reforms, including those related to attracting FDI, wereinitiated so much earlier than India’s and proceeded at such a faster paceover the past three decades. However, in certain field, such as IT industry,India is ahead of China.
  41. 41. AN447 Page 41 of 61 35743 To sum up, on the basic economic determinants, China does better thanIndia. China’s total and per capita GDP are higher, making it moreattractive for market-seeking FDI. Its higher literacy and education ratessuggest that its labor is more skilled, making it more attractive toefficiency-seeking investors.4.3 SocietyThe Dunning’s O-L-I framework and other mainstream FDI theoriesdiscussed in the Chapter 2 do not take social factors explicitly intoconsideration. Undeniably, social factors are considered by MNCs andthey have a tremendous impact on the causes and effects of FDI inflows. Firstly, the FDI gap between two countries is partly a tale of twoDiasporas. China has a large and wealthy Diaspora that has long investedits money. During the 1990s, more than half of China’s FDI came fromoverseas Chinese sources (Friedman and Gilley 2005). Yeung revealedthat a large proportion of foreign investment in Dongguan, GuangdongProvince was stemmed from overseas Chinese entrepreneurs (includingthe overseas-based subsidiaries of enterprises originating in China). Thecompetitive advantage for overseas Chinese-funded enterprises inDongguan was their ethnic or close relationship with local governmentofficials (Yeung 2001). The discussions at section 3.1 and 3.2 alsosupport Hong Kong and Taiwan’s ethnic relationship with China is aunique advantage, which enables investors to conduct negotiations and
  42. 42. AN447 Page 42 of 61 35743operations much easier. By contrast, the Indian diaspora was, at least until recently, resented forits success and much less willing to invest back home. Until now, theIndian diaspora has accounted for less than 10 percent of the foreigncapital flowing to India. Recently, the Indian government has noticed thisproblem and organizations, such as The Indus Entrepreneurs (TiE) , wereestablished to provide platforms for formation of social networks(McManus, Li et al. 2007: p.48). Besides the ethnic networks, the personal relationship (Guanxi)cultivated with local officials is also considered by foreign investors,especially those from Hong Kong and Taiwan. As Yeung indicates thatsome open-minded local government officials have establishedcommunication channels exclusively for foreign investors (Yeung 2001:p.131). It is regarded as an internalization advantage for foreign investorsas it reduces the information costs for clarifying and understanding newpolicies. In contrast, feedbacks received from potential foreign investorsindicate that India’s vast market-place and skilled workforce do notcompensate for poor infrastructure and a corrupt bureaucracy (FortuneIndia 31 December 2003: p.8). The American congressman, Frank Pallowonce complained that ‘India is not a difficult place to invest, but India hasto contend with the reality that its bureaucratic maze makes it moredifficult to handle than the stringent bur clearer norms of more autocratic
  43. 43. AN447 Page 43 of 61 35743countries like China’ (Gakhar 2006: p.118). Hence, the FDIdecision-makers are now acutely conscious of India’s corrupt andinefficient bureaucracy, which could turn into a veritable and bothersomehurdle.4.4 Technology development Much has been made of the implications over China and India’spolitical systems, economic reforms and social relations, which maintainthe accepted truth that China is 12 years ahead of India. While this maybe true of the infrastructure development of China, it is not true foranother important determinant of FDI, which India is ahead. With betterEnglish language skills, India may have an advantage in technicalmanpower, particular in information technology. Some of the differences in competitive advantage of the two countriesare illustrated by the sectoral composition of their FDI inflows, which hasbeen explained in section 3.3. For example, in information andcommunication technology, China has become a key center for hardwaredesign and manufacturing while India specializes in IT services, callcenters, business back-office operations and R&D (Winters and Yusuf2007). Therefore, foreign investors perceive China and India as distinctlydifferent markets. While China is well regarded by them as the leadingglobal manufacturer and the fastest growing consumer market, India isviewed as a world-class services provider in business processes and
  44. 44. AN447 Page 44 of 61 35743ICT-enabled services. Therefore, the Times of India claims that India isthe most preferred outsourcing destination in the world (Times of IndiaOnline. 15 February 2005). There is awareness in the global investmentcommunity that India’s service-oriented development over the last twodecades has made it possible for it to bypass some of its glaring economicweaknesses, like a poor quality physical infrastructure. Moreover, as we have discussed at the above section 4.3, although withthe help of its diaspora, China has won the race to be world’s factory.India could become the world’s office with the help of its diaspora ontechnological field. The development of Indian software industrydiscussed at section 4.1 shows the fact that ‘India’s soft skill andtechnology are creating a tortoise that will ultimately overturn the hardChinese hare’ (Smith 2007: p.176). Kiran Karnik, president of Nasscomcomments that China has ‘great potential but is far from being a seriouscompetitor’ and lags three to five years behind India’s software industry,quoted by FT reporter (Yee 2007).4.5 Business EnvironmentAs discussed at section 4.1, liberalization of FDI policy is a necessaryvariable for FDI, especially in the kick-off stage, but it’s not sufficient forexpanding FDI inflows. The overall business environment continues toexercise a major influence on the magnitude of FDI inflows, for it signalsto potential investors the growth prospects of host country. Hence, paying
  45. 45. AN447 Page 45 of 61 35743attention to the overall business climate and creating a stable andenvironment will crowd-in FDI. A survey of global executives was conducted by the Global Business 11Policy Council (GBPC) in 2005 and published as FDI ConfidenceIndex. Both China (2.19) and India (1.95) are at the center of the FDIradar screen for they are considered as the 1st and 2nd most attractive FDIlocations globally. This is the forth year in a row that China held the topspot and India rose from 3rd to 2nd place, surpassing the United States(GBPC 2005). In Year 2004, this extensive opinion-survey put China atthe top with a score of 2.03 for having the best investment environment,the US second with a score of 1.45 followed by India with a score of 1.40(GBPC 2004). A noteworthy observation here is that the gap in the valueof the confidence index between China and India is getting tiny. The result of the GBPC opinion survey coincided with that of a 2005opinion survey conducted by the World Investment Report team of theUNCTAD. This team conducted a larger sample survey of the globalinvesting community, MNCs, FDI experts and investment promotionagencies (IPAs). Their results revealed that those who were surveyedregarded China as the most attractive location with 55% of the CEOsurveyed were willing to invest the most in China, followed by India11 This survey has a wide coverage in terms of sample size. It covers top decision-makers in the 1,000 largestMNCs of the world on their opinions of various FDI destinations and their investment intentions. These 1,000MNCs contribute over 70% of total FDI flows and represent all major regions and sectors. The survey tracks theimpact of political, economic and regulatory changes in the host economies by the global investing community andpreferences of decision-makers in these MNCs. The confidence index ranges between zero and three.
  46. 46. AN447 Page 46 of 61 35743(36%). Again, both countries are considered as the most favoredinvestment destination (United Nations Conference on Trade andDevelopment. 2005). The World Development Report 2005 emphasizes that ‘forgovernments at all levels, a top priority should be to improve theinvestment climates of their societies. To do so, they need to understandhow their policies and behaviors shape the opportunities and incentivesfacing firms’(WorldBank 2005: p.12). From the above surveys, we cansee that a virtual sea change has taken place in the business environmentof India and it is catching up China very quickly. Therefore, in terms ofoverall business environment, India does not rank much below China.4.6 Legal SystemAlthough the FDI literature focuses essentially on political and economicdevelopment, business environment and technology, to some extent, thelegal system and barriers need to be taken into account as well for acomprehensive analysis. The lack of a well-structured and transparent legal system in Chinaposes serious problems for foreign investors. A clear and stricthierarchical system of norms does not really exist yet. Moreover, differentministries and departments of the central and local governments haveissued many diverse regulations, which result in the failure of the foreigncompanies to find out which regulations exactly apply to them. In
  47. 47. AN447 Page 47 of 61 35743contrast, India enjoys a strong British-based legal and accounting system,which helps it to attract more capital from Western countries. Therefore,the absence of reliable legal and secure property rights and vastdifferences in culture help to explain China’s below par performance inattracting FDI from Western countries, compared with the performance ofIndia which has been demonstrated in section 3.2. Meanwhile, India’slong history of private property, democracy and similar law system withWestern countries should prove attractive for potential foreign investors.In other words, even if economic policy is great and politics stable, ifthere are no property rights and contract enforcement in a country, theresno way anyone can do business. One of the key issues on legal affairs is the protection of intellectualproperty rights (IPR). The most significant change in the Chinesebusiness regulations for foreign-invested companies was the introductionand improvement of IPR during the 1990s. The introduction of patent lawhas removed a major obstacle to lure FDI in high-tech industries.However, the full implementation of IPR protection regulations remainsweak in China. For example, according to the Software Piracy Study ofBusiness Software Alliance12, China has a very high software piracy ratewith 82 percent in 2006. In contrast, India’s rate is a littler lower thanChina, which stands at 71% (BSA 2006). Additionally, the Patent Law in12 The Business Software Alliance (www.bsa.org) is the organization dedicated to promoting a safe and legaldigital world. An important mission of BSA’s research portfolio is the BSA/IDC Global Software Piracy Study,which tracks the state of software piracy across more than 100 countries.
  48. 48. AN447 Page 48 of 61 35743India is being revised in conformity with the required standards of theWTO in 2002 (Chopra 2003: p.132). Concisely, there is a growing patent culture in both countries. TheIndian companies are striving to move up the value chain and areincreasingly approaching their competitive positioning withintellectual-property-based differentiation. At the same time, underdomestic and international pressure, the Chinese government hastightened its enforcement of IPR protection and will improve judicialperformance of contracts and other business codes, including thosegoverning IPR and counterfeiting.4.7 SummaryFrom the above PESTEL analysis, we may find that the FDI favors Chinaover India in the following significant areas: pro-business government,overall business environment, incentives provided by the hostgovernment, quality of infrastructure and macroeconomic management.All these add up to create a superior investment environment in Chinathan in India. The same set of decision-makers has favorable opinions onIndia’s English-speaking workforce, software talents, rule of law, culturalaffinity and regularity environment. As we have seen, the relativeattractions are now becoming better balanced. Given a choice, someinvestors have switched to prefer India.5 Summary and Conclusions
  49. 49. AN447 Page 49 of 61 357435.1 FindingsResearch on the characteristics and determinants of FDI in China andIndia is still at the developmental stage. The existing literature on FDI isappraised in chapter 2. However, most of the traditional studies of FDIexplain only the company advantages, transaction costs and differentialfactor endowments, while Dunning’s O-L-I paradigm unifies the varioustheories. According to this theory, FDI is chosen as a market entrystrategy so that a firm can exploit its ownership advantages throughinternalizing transaction costs in a specific location, which possesseslocational advantages for FDI. The third chapter details overall trends andpatterns of FDI inflows in China and India, including its developmentstages, sources, regional and sectoral distributions, along with thegovernment’s policy changes towards FDI. Since the host country’sinternal factors play an important role in influencing the magnitude,importance, pattern, form and impact of FDI in the economy, the Chapter4 deals with and compares the main determinants by adopting thePESTEL analysis format. Hence, this research has proved to be a useful experiment in theanalysis of the FDI development experiences and determinants strategiesof both countries. The main conclusions of the present study are givenbelow: One important finding is that multiple factors, rather than a single
  50. 50. AN447 Page 50 of 61 35743factor, influence the volume and pattern of FDI inflows, which includepolitical and social stability, sound macro-economic environment,well-developed soft and hard infrastructure, competitive supportingindustries, the availability of skilled labor, and open trade and FDIregimes. Indeed, these factors are considered “fundamental”; they createan environment that enables foreign firms to enter an economy andcontribute to its growth and development. Through the PESTEL analysis,this study finds out that in terms of political and FDI policies, economicdevelopment, society and business environment, China does better thanIndia; whilst India is ahead of China in terms of technology and legalsystem. A second major conclusion of the study is that changes in a country’sFDI policy regime are not enough to ensure the desired inflow of FDI.Actually, the policy coherence, consistency, transparency, and effectiveimplementation matter. In the forefront of effective implementation ofFDI policies is the speedy processing and approval of FDI applications.This means that both countries shall streamline its bureaucracy, simplifyapproval and remove restrictions on foreign ownership, therefore create aclimate of certainty and friendly policies towards FDI. A third major conclusion of the study is about the question whether therecent improvement in the image of India in the global investingcommunity will affect FDI flows to China. It can be answered by saying
  51. 51. AN447 Page 51 of 61 35743that it will have little impact. This relates only to the part of FDI thatoriginates from MNCs, which is a small proportion of total FDI going toChina. Regional FDI flows that originate from the Chinese Diaspora willnot change its pattern of FDI. Besides, the sectors that are going to attractthe global FDI in the immediate future in the two economies are verydifferent. Coupled with the economic impact of the 2008 BeijingOlympic Games and the 2010 Shanghai World Expo, rising FDI inservices and high-tech manufacturing might contribute to a new round ofFDI growth in China. As for India, in spite of the opportunities availablefor attracting FDI, several challenges remain to be met in order for theeconomy to sustain a higher growth path, and enhance competitiveness inorder to position itself favorably in the global competition for FDI.5.2 Policy ImplicationsIn addition to the general policy implications that have been drawn above,studies of determinants of FDI inflows conducted in the framework of anextended model of location of foreign production (Kumar 2002) havefound that a country’s ability to attract FDI is affected by structuralfactors such as market size (income levels and population), extent ofurbanization, quality of infrastructure, geographical and culturalproximity with major sources of capital, and policy factors (namely taxrates, investment incentives, performance requirements). Based on theabove discussions, India is at the verge of an FDI take-off. Whether this
  52. 52. AN447 Page 52 of 61 35743potential materializes or not will necessarily depend on how thegovernment manages and upgrades its business policy environment in theforeseeable future. At the same time, to maintain sustainable growth,China needs to improve its ability to attract and use FDI, especially on theissues of establishing a rule-of-law society and encouraging humancapital enrichment. As a guideline to both policymakers, it seemsreasonable to suggest that the encouragement of FDI should take formsthat bring long-term benefits to the host country’s economy. These mayinclude the upgrading and extension of infrastructure and publicexpenditure on education and training. Another important implication for both countries and economicanalysts is that we shall stop treating India and China as simple,one-dimensional entities weighable on a single scale to judge which is thesuccess and which the failure. Indeed, each, as revealed above,increasingly sees the other better in some ways and worse in others. Forexample, two policies that China can learn from India are: humanresource development and the development of local supporting industries.Human resource development not only ensures an adequate supply ofskilled labor for foreign investors, but helps a country achieve overalleconomic efficiency and move up the economic development ladder.Moreover, the competitive supporting local industries will promotetechnology spillover, one of the positive effects for host country.
  53. 53. AN447 Page 53 of 61 357435.3 Limitation of the StudyAn important limitation of this study is its use of secondary data andinformation which may sometimes be problematic. For example, as notedin chapter 3, the FDI inflows in China is reported to be overestimatedthus the gap between China and India can be exaggerated. Anotherlimitation is that we cannot compare the determinants of FDI by differentinvestors. FDI from different countries contains different levels oftechnology and would have different motives to invest. However, theexisting data are very aggregate and this study has to examine thedeterminants of FDI as a whole, whether they come from the UnitedStates, Europe, Japan and other countries or regions.5.4 Future Research DirectionsThis research has proved to be a starting point in the comparison of theFDI trends, patterns and determinants between China and India. Drawingon the PESTEL analysis of the Chinese and Indian FDI inflows presentedin the preceding chapters, the further research will perform a strengths,weaknesses, opportunities and threats (SWOT) analysis on both countryas well as compare and contrast them in relation to each. Furthermore,comparative analyses in regard to U.S. foreign investment in China andIndia are needed since it is now the major investor country source to bothcountries. In addition, as China and India continue to utilize FDI as anintegral part of its economic development strategy, it will be interesting to
  54. 54. AN447 Page 54 of 61 35743do increased research on changing provincial or state environment forFDI in both countries, particularly with reference to the interior orbackward provinces (states).
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