An analysis of China's economic development policies and prospects

Business Economics, July, 1998 by Roger Chen

Foreign Investment in China

In the past few years, China has been the second largest country in the world in attracting foreign investment. Foreign invested enterprises (FIEs) not only provided China with development capital but also brought to China new technologies and management knowledge. More importantly, foreign enterprises are a major source of the rapid growth for China's exports, which created new employment opportunities. These growing job opportunities greatly alleviate the unemployment burden caused by SOE reform. Thus, the growth of foreign investment becomes an important factor affecting the success of SOE reform.

As more foreign capital and firms pour into China, the country also starts to face problems in dealing with FIEs. The first is complaints from domestic firms, especially the SOEs. Many Chinese firms believed that incentive policies favoring foreign companies have unfairly put domestic firms at a competitive disadvantage. These domestic firms require that the government give them equal treatment in terms of tax and other benefits. Second, as more foreign firms enter China, some of them have become major and even dominant players in some markets. For example, in the camera manufacturing sector, domestic manufacturers have decreased from more than thirty to less than ten in the past few years. Similarly, in the markets for fax machines, video cameras, mobile phones, electronic components, camera film, and soft drinks, foreign companies account for more than 60 percent of the market. This situation has made the Chinese government very concerned about losing its domestic industries. In 1997, the State Planning Commission issued a foreign investment guideline, which indicated that China needs to monitor the impact of foreign investments on the country's economic security.

The Chinese government has become very sensitive in defending and promoting Chinese brand-name products. The government has also removed some favorable policies given to foreign firms. For example, in 1996, it cut foreign firms' value-added tax rebate for exports from 17 to 9 percent. It has also planned to withdraw the privilege enjoyed by FIEs to import capital equipment tax and duty free, although the government has recently modified this plan. In short, the Chinese government has become more selective and careful in attracting foreign investments.

Being selective does not mean that the Chinese government no longer welcomes foreign investments. In December 1997, government officials repeatedly indicated that China still needs foreign capital to help its economic development. The only change is that the government wants to be more effective in steering foreign investments to the country's most needed sectors, in order to boost its economic growth and develop and upgrade its domestic industries.

Foreign companies, for their part, are becoming more cautious in investing in China. From January to November 1997, actual foreign investment in China reached $43 billion, an increase of 3 percent from 1996 (some of these investments were contracted in 1996 or earlier). Newly contracted foreign investment reached $48.7 billion, down 28 percent from the previous year, demonstrating that less foreign capital is flowing into China. There are many reasons for the decline, but the recent change of government policies, especially the removal of tax- and duty-free policies for importing equipment and materials by FIEs, is partly responsible for the decline. Considering the recent Asia financial crisis and its domestic economic problems, the Chinese government is very concerned about the further loss of foreign capital. Under this situation, the government has resumed the policy of import capital equipment tax and duty free to many FIEs.