Does FDI provide spoils, or does it just spoil?

Working out who gains what in overseas investment is a complex matter

Since China's strategy of going global began in the late 1990s, its foreign direct investment has increased rapidly, attracting considerable attention from policymakers, academics and the public.

Obviously, certain aspects of this investment raise questions. For example, what impact does it have on the countries where the investment is made, especially developing ones? Is the FDI's impact on growth different to that of conventional foreign direct investment?

The answer to that question remains elusive. On the one hand, to the host developing countries, the emergence of FDI from the South provides a new source of capital, technology and skills so it is welcome. On the other, it is sometimes argued that the main aim of Chinese FDI in developing countries is to find markets and resources. Further, it drives the African and Latin American countries to resource-based economies and crowds out local industries. A third stream of argument is that Southern multinational companies, including Chinese ones, are not an obviously superior option to conventional multinational companies in the way they affect development.

Theoretically there are substantial benefits for a country that attracts FDI. These include: development financing; direct and indirect job creation; knowledge transfer and spillovers through the demonstration effect, the mobility of trained labor, and the transfer of knowledge within supply chains; the effect of competition when foreign entry forces local firms to improve efficiency so as to survive and compete with foreign invested firms.

Of course FDI is not an unalloyed blessing. There may also be negative effects on the host economy. These include the ramifications of affiliates of multinational companies crowding out domestic firms from the local market. There are also opportunity costs of resources such as land and labor as well as costs due to environmental damage. Moreover, foreign invested firms may remain as enclaves in the host economy, leading to sharpened dualism in the economies of the host country. Therefore, the strength of the FDI's effect on growth depends on its characteristics and on the host country. In other words, the type of FDI, its source, and the sector to which it flows in the host country also matter.

What impact does Chinese FDI have on the growth of host economies? Is it different to that of traditional FDI? The answer depends on the characteristics of the investment and of the host economies and how these differ to those of traditional FDI. This is because these characteristics determine the linkages between the foreign and domestic invested firms, the nature and strength of the transmission mechanisms, the absorptive capacity of the host country firms, and the propensity of knowledge spillover and adoption. Moreover, the compatibility between the host and investing countries is of crucial importance in determining the direction and strength of the growth impact of FDI on the host economy.

In general, the development financing effect of Chinese FDI is similar to that of traditional FDI. However, it is argued that the opportunity cost of accepting Chinese FDI is very low because it often goes to sectors to which other investment normally does not.

As for how much FDI affects job creation, that depends on the labor intensity of the production technology and the way the FDI comes in. Research has consistently found that developing countries' multinational companies use more labor-intensive technology in production. Moreover, technologies used by firms are different even in the same sector. Chinese firms use more labor-intensive technology than is the case in conventional multinational companies. For example, in mining, agriculture, construction, and apparel and furniture manufacturing, Chinese firms use more labor than conventional multinational companies do.

The different ways that multinational companies go about FDI also affect job creation in different ways. Greenfield projects will generate more job opportunities than mergers and acquisitions. In the period 2003-10 some 93 percent of large Chinese FDI projects in least developed countries were greenfield projects, the United National Conference on Trade and Development says. It is often argued that Chinese FDI firms prefer using Chinese workers and suppliers to local workers and suppliers, but the Danish academic Peter Kragelund suggests this is exaggerated, and evidence in this respect is sparse.

Another matter is the appropriateness of the foreign technology and management style in relation to local economic, physical and technical conditions. Theories about appropriate technology and directed technical change theories all suggest that technology created in the North may be inappropriate for countries in the South. Therefore, technology created in China embedded in Chinese FDI may be more appropriate in labor-abundant countries; and technologies produced in the developed countries are more likely to be skilled labor and capital intensive.

The appropriateness of technologies used by multinational companies matters. For labor-abundant countries, technology in Chinese FDI may be more appropriate; for resource-rich or land-rich countries, technology in Chinese FDI may not be optimal.

Industry distribution of China's outward FDI also matters. It is often argued that Chinese outward FDI mainly seeks resources and goes into mining. However, the most recent data show that mining accounted for only 14 percent of its total outward FDI, and 6 percent of the total number of overseas firms from China. In fact, in terms of the number of overseas firms, manufacturing is the largest sector.

A firm-level survey in Guangdong province jointly carried out by Oxford University and Guangdong University of Foreign Studies shed interesting light on the sector and ownership distribution of China's outward FDI in regions that are more open and more marketized. Of all of China's provinces, Guangdong has the largest outward FDI stock. Its outward FDI stock accounted for 20 percent of the country's total in 2010. It is often argued that Chinese outward FDI is mainly carried out by state-owned enterprises. But for outward FDI from Guangdong, non-state owned firms accounted for 70 percent. Their behavior and motivation are more similar to what happens with traditional FDI.

The impact of Chinese FDI on the host economy is also to a great extent determined by the motives behind it. Seeking resources has been regarded as Chinese enterprises' main game. But the Guangdong survey suggests that reasons for investing in developing countries are very diverse. The only factor that more than 60 percent of firms regard as important is "market expansion". Other factors are regarded as important for about half of the firms, including exploiting local preferential policies, improving the allocation of resources, using local brand resources and having access to strategic resources such as local technology.

So it is not surprising that a study I carried out based on national data found that Chinese investment in developing countries appears to have a positive and significant impact on their long-run economic growth. However, its association with short-run growth in these countries is negative. Chinese direct investment is more likely to go to countries with low per capita income growth.

Second, Chinese outward FDI appears to have contributed positively to economic growth not only in Africa but also in Europe and North America. However, its contribution in Asia and Latin America is insignificant. This is perhaps related to less developed institutions in these countries as well as the weaker compatibility between Chinese enterprises and local economies there in comparison with what prevails in Africa, Europe and the US.

Third, Chinese outward FDI has had a significant effect in creating jobs in host developing economies. Compared with FDI from industrialized countries, Chinese FDI often goes to labor-intensive sectors. Even in the same sector, Chinese FDI uses more labor-intensive technologies than FDI from industrialized countries.

Finally, the depiction that Chinese outward FDI is mainly resource-seeking is exaggerated.

Further research is no doubt needed to better understand the mechanisms through which Chinese outbound FDI affects the host economies and what complementary policies and measures are needed to enable them to fully deliver their development promise.

The author is professor of technology and international development, Oxford University. The views do not necessarily reflect those of China Daily.

(China Daily 01/25/2013 page8)