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?

• FDI is an important source of capital for developing countries. In 2000, FDI amounted to4 % of GDP (inflows)32% of GDP (stock)11% of total domestic

investment

FDI Inflows and Stock, Developing Countries

0

500

1000

1500

2000

2500

1980 1985 1990 1995 2000

Bn U

S$

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Inflows

Stock

Inflows, % of GDP

Stock, % of GDP

• 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

0.05

0.1

0.15

0.2

0.25

0.3

0.35

1997 1998 1999 2000 2001

Imports, % of GDP

Exports, % of GDP

What Matters to Foreign Investors

• The Investment ClimateMacroeconomic 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

Regulatory Quality

China 16.3% Yes

Brazil 11.5% Yes

Hong Kong 9.9% Yes Yes

Argentina 9.7%

Mexico 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

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.

China and Madagascar

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

China, 1980 China, 2001

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Madagascar, 1980 Madagascar, 2001

Services

Industry

Agriculture

Value Added by Sectors, % of GDP

Is China Relevant for Madagascar?

China and Madagascar

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Madagascar, 1980 Madagascar, 2000

Services

Industry

Agriculture

Employment by Sectors, % of Total

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

China, 1978 China, 1999

China and Madagascar

GDP per capita in US$

0

100

200

300

400

500

600

700

800

900

1,000

China GDP Madagascar GDP

1980

2001

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 2002FDI was over US$50 billion in China compared with US$ in

MadagascarFDI was equivalent to 4% of GDP in China compared with 2% for

MadagascarFDI per capita was US$37 in China compared with US$7 in

MadagascarFDI 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 ComponentThe 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

60%24%

6%

10%

Manufacturing

Real Estate

Distribution

Others

• Ensuring a Stable Political and Economic EnvironmentChina 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

0.02

0.04

0.06

0.08

0.1

0.12

GDP GDP Deflator

1980-90

1990-2000

• Investing Heavily in InfrastructureBoth 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 2000Electric 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

Mobile Phones (per 1,000 people) 0.02 66

• The Special Economic Zones (SEZs)Important part of the open-door policySet up in the coastal provinces to experiment with

various reforms, to attract FDI and to promote exportsThe 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 SEZsBut 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 GovernmentsDespite 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

0%

20%

40%

60%

80%

100%

1991 1995 1999

Sources of FDI, % of Total

Other

EU

US

Taiwan

Japan

Hong Kong and Macao

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

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