Promoting Foreign Direct
Investment
China’s Experience
Qimiao Fan, the World Bank
Presentation Outline
• Why Worry About Foreign Direct Investment
(FDI)
• What Matters to Foreign Investors
• Is China Relevant for Madagascar
• China’s Experience in Attracting FDI
• Some Possible Lessons
Why Worry About FDI?
4 % of GDP (inflows)
32% of GDP (stock)
11% of total domestic
investment
FDI Inflows and Stock, Developing Countries
2500
35.0%
30.0%
2000
Bn US$
• FDI is an important
source of capital for
developing countries.
In 2000, FDI amounted
to
25.0%
Inflows
1500
20.0%
Stock
1000
15.0%
Inflows, % of GDP
10.0%
Stock, % of GDP
500
5.0%
0
0.0%
1980 1985 1990 1995 2000
• FDI Transfers Knowledge and Diffusion of
Ideas Drives Growth
Foreign firms bring in new technology or upgrade
existing technology
Technical and managerial skills and ways of doing
business are transferred directly to local employees
Foreign firms introduce best practices to local firms
that enable them to compete as suppliers to the foreign
firms
• FDI Contributes to Better
Integration of Developing
Countries into the World
Economy:
Investment by foreign firms can
bring about convergence in
environment, labour, product,
safety and technology to
international standards
FDI increases imports and
exports
Developing Countries
0.35
0.3
0.25
0.2
Imports, % of GDP
0.15
Exports, % of GDP
0.1
0.05
0
1997
1998
1999
2000
2001
What Matters to Foreign Investors
• The Investment Climate
Macroeconomic or country-level environment
 Political and economic stability (inflation and interest rates)
 Policy towards FDI and trade including foreign exchange rate
policy
Regulatory framework and governance
 Entry and exit regulations
 Taxation
 Environmental, health, labour and safety regulations
The quality and quantity of infrastructure
 Physical infrastructure (e.g. power, telecommunications and
transport)
 Financial infrastructure (banking system, capital market)
 Human capital (e.g. skills and education level)
Share of
developing
Country FDI
Percentile
Rank Above
50
1999
Political
Stability
China
16.3%
Yes
Brazil
11.5%
Hong Kong
9.9%
Argentina
9.7%
Mexico
 Countries with better
investment climate tend to
attract more FDI
 Studies have shown that the
investment climate matters
for FDI and for firm
productivity
 Most of the top ten
countries with the largest
share of FDI ranked in the top
fifty percent in both political
stability and regulatory
quality.
Regulatory
Quality
Yes
Yes
Yes
5.1%
Yes
Yes
Singapore
4.8%
Yes
Yes
Bermuda
3.8%
Yes
Yes
S. Korea
3.8%
Yes
Chile
3.7%
Yes
Yes
Poland
2.9%
Yes
Yes
Is China Relevant for Madagascar?
China and Madagascar
Value Added by Sectors, % of GDP
100%
100%
90%
90%
80%
80%
70%
70%
60%
60%
Services
50%
50%
Industry
40%
40%
Agriculture
30%
30%
20%
20%
10%
10%
0%
0%
China, 1980
China, 2001
Madagascar, 1980
Madagascar, 2001
China and Madagascar
Employment by Sectors, % of Total
100%
100%
90%
90%
80%
80%
70%
70%
60%
60%
Services
50%
50%
Industry
40%
40%
Agriculture
30%
30%
20%
20%
10%
10%
0%
0%
China, 1978
China, 1999
Madagascar, 1980
Madagascar, 2000
China and Madagascar
GDP per capita in US$
1,000
900
800
700
600
1980
500
2001
400
300
200
100
0
China GDP
Madagascar GDP
China and Madagascar
• By Most Measures, China Has Been Successful in
Attracting FDI
• In 1980, Total FDI was US$57 million in China and US$
million in Madagascar.
• In 2002
 FDI was over US$50 billion in China compared with US$ in
Madagascar
 FDI was equivalent to 4% of GDP in China compared with 2% for
Madagascar
 FDI per capita was US$37 in China compared with US$7 in
Madagascar
 FDI accounted for 10.1% of total fixed investment in China
compared with 1.6% for Madagascar
• Both China and Madagascar are low-income
developing countries
• Similar initial conditions in late 1970s and early
1980s with economy dominated by agriculture
and state-owned enterprises
• Despite similarities in initial conditions,
performance differed significantly in the past
two decades in the two countries
• Policies do matter
China’s Experience in Attracting FDI
• The National “Open-door Policy” With the
Encouragement of FDI as a Key Component
• Ensuring a Stable Political and Economic
Environment for FDI
• Investing Heavily in Infrastructure
• The Special Economic Zones (SEZs)
• The Role of Local Governments
• The Role of Overseas Chinese
• The National “Open-door Policy” With the
Encouragement of FDI as a Key Component
The open-door policy, the encouragement of FDI and
commitment to a market economy have been enshrined
in the Communist Party Charter and the country’s
Constitution
Even in the face of crises, China has maintained its
commitment to opening up and encouraging FDI
Commitments are reaffirmed whenever there is doubt and
uncertainty (e.g., when a new leadership comes in or
after major political events)
Officials are trained and educated about the national
policy to ensure implementation at all levels
Although initially only a small number of regions and
sectors were allowed for FDI, the number of regions and
sectors have been rapidly expanded
 Foreign investors are
allowed to invest in most
industries including
infrastructure
 The majority of FDI went to
the manufacturing sector,
half of it to labor-intensive
manufacturing and half to
technology-intensive and
capital-intensive
manufacturing.
Sectoral Distribution of FDI, in % of total contracted
value, 1998
10%
6%
Manufacturing
Real Estate
24%
60%
Distribution
Others
• Ensuring a Stable
Political and
Economic
Environment
 China has been able to
maintain relatively low
inflation rates since the start
of reforms
 Average annual inflation was
5.8% between 1980-90 and
7.1% between 1990-2000. In
2000, inflation was 0.9%.
 The political environment
has also been relatively
stable
Average Annual Growth Rates
0.12
0.1
0.08
1980-90
0.06
1990-2000
0.04
0.02
0
GDP
GDP Deflator
• Investing Heavily in Infrastructure
 Both central and local governments have withdrawn from
investing in competitive assets and redirected public investment to
infrastructure
 FDI and domestic private investment are also allowed into
infrastructure
1990
2000
Electric Power Consumption (kwh per capita)
471
759
Electric Power Transmission and Distribution Losses (in
percent of output)
7.5
7.0
Air Transport, freight (million tons – km)
818
3900
Roads, Goods Transported (billion tons –km)
336
613
Telephone Mainlines (per 1,000 people)
5.9
112
0.02
66
Mobile Phones (per 1,000 people)
• The Special Economic Zones (SEZs)
Important part of the open-door policy
Set up in the coastal provinces to experiment with
various reforms, to attract FDI and to promote exports
The key policies are liberalization allowing both foreign
and domestic private investors to invest in most sectors,
enjoying fewer regulatory barriers and preferential tax
treatment
Local governments in the SEZs have significant
autonomy over policies, regulations and investment
approval
The SEZs were “economic laboratories for the market
economy” and “a bridge to outside world”
Most reform policies were first implemented in the SEZs
But successful policies, experiences, best practices and
managerial and technical know-how quickly extended to
the rest of the economy
The SEZs attracted some of the most innovative and
entrepreneurial managers, workers and civil servants, but
many managers and workers returned to their home
region to start their own business – knowledge transfer
The SEZs set the standards and provide competition to
the rest of the enterprise sector including the SOEs
• The Role of Local Governments
Despite a uniform macroeconomic environment and
national policy, FDI performance differs significantly
across regions and SEZs
Local governments in both the SEZs and other regions
are allowed significant autonomy and initiative
The coastal regions attracted over 90% of total
cumulative FDI as well as large amount of domestic
investment
The regional differences in FDI are largely a result of
differences in the quality of the legal and regulatory
environment and infrastructure
Almost half of all fixed asset investment came from local
governments primarily in infrastructure
• The Role of Overseas Chinese
 FDI from Hong Kong and
Macao and Taiwan
accounts for the majority of
total FDI into China
 Overseas Chinese played
an important role in early
FDI due to the language
and culture
 But their share is declining
as FDI from the US, EU
and other Asian countries
increases
Sources of FDI, % of Total
100%
Other
80%
EU
60%
US
40%
Taiwan
Japan
20%
Hong Kong and Macao
0%
1991
1995
1999
Some Lessons from China
• Maintaining a Stable Economic and Political Environment Through
Prudent Macroeconomic Management and Careful Sequencing of
Reforms
• Maintaining a Consistent and Credible National Policy and Ensuring
Its Implementation Through Imbedding Key Policy Elements into
Laws and Training of Officials
• Investing in Infrastructure Through Redirecting Public Expenditures
and Private Sector Participation
• Extending Rapidly the Reforms and Successful Policies from SEZs to
the Rest of the Economy and Maximize the Role of SEZs in
Knowledge Transfer
• Making Use of the Bridging Role of the Diaspora But Ensuring Equal
Treatment for Investors
• Creating a Good Regulatory Environment and Infrastructure More
Important Than Fiscal Incentives
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FDI and Investment Promotion