Foreign direct investment – Supporting China’s leapfrog development

Wang Xiaohong, deputy minister of information at the China International Economic and Exchange Centre, believes that foreign direct investment has been integral to China’s development, allowing it to become a major trading power and promote independent innovation and technological progress

IFF China Report 2018 10
Litchi Park Bridge, Shenzhen Special Economic Zone
IFF China Report 2018
This article is part of The IFF China Report 2018

Foreign direct investment (FDI) is a fundamental national policy critical to China’s ‘opening‑up’ and boosting the open economy. Since the start of the period of reform and the introduction of the policy of opening‑up, China has persisted in making active use of foreign capital, constantly innovating its foreign investment policy and management system. It has optimised the foreign investment environment and has become a leading country in terms of absorbing foreign investment. By 2016, 864,000 foreign-invested enterprises (FIEs) had been set up, with FDI amounting to US$1.77 trillion. In practice, FDI has been proven to be the best way to effectively combine the elements of global production, service and innovation, promote upgrading of the industrial structure and achieve economic ‘leapfrog’ development. Although the number of FIEs in China accounts for fewer than 3% of all businesses, their import and export quantities account for about one-half of the total. With the profits of industrial enterprises – above state-designated scale – making up around one-quarter of the total, their tax revenue one-fifth and their employment opportunities around one-tenth, it is clear that FIEs are now a vital part of China’s economy. 

FDI in China – Four main stages

IFF China Report 2018 Wang Xiaohong
Wang Xiaohong

Stage one – 1978–1991  

During this period, in order to solve the ‘dual gap’ of capital and foreign exchange, China took the first step of introducing foreign capital. In addition to using foreign loans, the government protected the rights and interests of foreign investors, and attracted FDI through exemptions from import duties, export tax rebates, the implementation of preferential policies on tax relief, and tax exemptions for foreign-funded enterprises. In the early 1980s, special economic zones were set up in Shenzhen, Xiamen and Hainan, among others, taking the lead in opening up exploration. Between 1979 and 1982, 920 FIEs were established, and foreign investment totalled US$1.769 billion. From 1983 to 1991, the number of FIEs rose to 12,978, and FDI increased to US$4.366 billion. In this period, most FDI introduced was small and medium-sized investment, and processing trade enterprises from Hong Kong and Taiwan. But it laid a solid policy foundation for attracting large-scale investments to the manufacturing industries of multinational corporations.


Stage two – 1992–2000 

This period for FDI was one of rapid growth. In November 1993, at the Third Plenary Session of the 14th Central Committee of the Communist Party of China (CCCPC), the Decision of the CCCPC on some issues concerning the establishment of a socialist market economic structure was published, and proposed to “improve the investment environment and management measures, expand the scale of foreign investment, extend FDI to more fields and deepen the opening‑up of the domestic market”, and “fully develop the comparative advantages of our country’s resources and markets, attract foreign funds and technologies, and promote economic development”. The implementation of the ‘market-for-technology’ strategy was implemented and aimed to boost the technological innovation and management of domestic enterprises. 

In 1992, 48,764 FIEs had FDI of US$11.08 billion. In 2000, the manufacturing industry absorbed 64% of total foreign investment. Large-scale FDI effectively alleviated the capital bottleneck in China’s development. The average amount of foreign investment in China at this time accounted for around 12% of the annual total national investment in fixed assets. The manufacturing structure was constantly upgraded: labour-intensive industries such as textile and home appliances maintained their advantages, but capital-intensive industries such as the automobile, equipment, electronic information, machinery and chemical industries also rapidly developed. From 2000 to 2004, more than 100 projects – in electronics, automobiles and household appliances – received foreign investment from 30 multinational German and Japanese corporations. The remainder of investment flowed into four major industries: communications equipment, machinery, electrical appliances and chemicals.


Stage three – 2001–2011 

During this period, FDI entered the stage of structural readjustment and comprehensive development. China joined the World Trade Organization, and a new round of international industrial transfer dominated by multinational corporations in the service industry commenced. The combined effect was to expand China’s utilisation of foreign capital structure from the manufacturing industry to the service industry. 

In 2002, 34,171 FIEs were established in China, with FDI of US$52.743 billion. One hundred service trade sectors – including banking, insurance, securities, telecoms and distribution – opened to foreign investors, accounting for 62.5% of the total service industry. This influx of foreign capital continuously promoted domestic financial services, logistics, commerce and trade, software and IT services, as well as services such as research and development (R&D), design and professional consulting expanded rapidly. By 2010, 27,406 FIEs had been set up, and FDI broke through the US$100-billion mark for the first time. Another first was that the proportion of the service industry’s utilisation of FDI exceeded that of manufacturing, making it the industry with the largest foreign funding in 2011. During this period, the proportion of FIEs in the export of high-tech products increased from 80% in 2001 to 84.5% in 2009. Foreign-owned enterprises accounted for 68.6% of China’s high-tech exports in 2006, and played an important role in their export. 


Stage four – 2012 onwards 

Since 2012, FDI in China has entered a new phase of transformation – from emphasising rapid growth to high-quality development. In 2013, the inflow of FDI to China was the second-highest in the world at US$123.9 billion. In 2016, China’s service industry consumed 70% of its total foreign investment. IT, integrated technical services, construction and finance have become the most attractive areas for foreign investment. FDI in high-end service industries such as multinational headquarters, R&D and logistics centres and clearing houses is increasing; no longer are essential productive factors and preferential policies needed to entice this investment. 

The focus of attracting foreign investment has gradually shifted from adopting the scale of funds to introducing high-end elements of technology, knowledge, personnel, management and service. In the past five years, the quality of foreign investment in China has been continuously improving and the structure continuously optimised, playing an active role in promoting the development of new industries, new formats and new models. In 2017, the absorption of foreign capital in high-tech industries increased by 61.7%, up 9.5 percentage points from the previous year, accounting for 28.6% of the market. Foreign capital use in high-tech manufacturing and service sectors was CNY66.59 billion and CNY184.65 billion, respectively, an increase of 11.3% and 93.2% compared with the same period in 2016. 

FDI in China has entered a new phase of transformation – from emphasising rapid growth to high-quality development

Industrial development goals and foreign investment

Since 1995, China has continually refined the Catalogue of industries for guiding foreign investment according to national industrial development goals by placing foreign investment projects into four categories: encouraging, permitting, restricting and prohibiting. In 2017, the revised Catalogue and the Measures for the administration of foreign investment admission in free-trade zones – known as the ‘Negative List’ – was reduced by 30 and 27 restrictive measures, respectively.

This continual adjustment and improvement of foreign investment policies has been integral to China’s economic development in five ways:

1. Advancing China towards becoming a global trading power. At the beginning of the period of reform and the introduction of the policy of opening‑up, the processing trade model – driven by foreign capital – became dominant. At this stage, processing trade was characterised by the ‘3+1’ trading scheme: ‘3’ refers to the types of processing supplied by foreign enterprises – materials, designs or samples – and ‘1’ refers to compensation trade. Its production process was also situated abroad – both raw materials and the market destination of the final product market were overseas. This not only solved the dual-gap problem of capital and foreign exchange, but also laid a foundation for the major trading nations and foreign exchange reserve. In 1987, the import and export of FIEs accounted for only about 5% of the country’s total. After 1995, it exceeded 39%; in 2005 it reached its apogee at greater than 64%. In 2016, FIEs constituted 46% of the country’s total imports and exports.

2.Transforming China from an agricultural power to an industrialised and service power. China has accomplished rapid industrialisation and urbanisation by undertaking the manufacturing industry transfer of multinational corporations to become the world’s leading manufacturer. By introducing new types of industries such as foreign retail chains and supermarkets, the revolution in the distribution industry has been sparked, and traditional formats such as department stores have metamorphosed into new ones. 

Since the turn of the century, with the finessing of R&D, software and IT, and supply-chain management of multinational corporations, service industries such as consulting and finance have continued to flow into China, enhancing international competitiveness by boosting the overall level of the domestic service industry and the growth of emerging service industries. 

3.Cultivating a large, experienced and skilled labour force. Multinational corporations have made extensive use of professionally trained domestic senior management and technical personnel. In 2008, more than 70% of Motorola’s management in China was Chinese, nearly 80% of managers were locals, and the number of Chinese employees reached 14,000. Many people with experience working for multinational companies started business ventures of their own afterwards, including former executives, technicians, researchers, designers and developers from Volkswagen, General Motors, Microsoft and IBM. Some rural migrant workers were inspired by their experience in the processing trade and returned to their hometowns to start up their own businesses.

4.Promoting independent innovation and technological progress. The number of Chinese enterprises owning independent intellectual property rights and their own brands is growing, and their technological innovation capabilities have attained an international level of advancement. Increasing numbers of multinational corporations are establishing R&D centres in China – in 2017 more than 300 of these centres for foreign capital were set up. FDI has been an important bridge to introducing technology since reform and opening‑up. For example, in 2001, China signed a total of US$9.09 billion in technology import contracts, of which US$4.95 billion was technical fees, accounting for 48.3% of the total contract value. In 2013, China signed US$43.36 billion of contracts for technology imports, almost 10 times greater than in 2001. The technical cost was US$41.09 billion, or 94.8% of the total contract amount.

5. Foreign investment policies promoting the construction of a number of open platforms. These platforms – in China’s economic and technological development zones (ETZs), high-tech zones (HTZs) and pilot free-trade zones (FTZs) – serve not only to attract foreign investment, but to encourage technological innovation and pioneering institutional innovations to help create an open economy. Currently, China has 219 state-level ETZs, 156 HTZs and 16 border economic co-operation zones. Following the establishment of the FTZ in Shanghai, seven FTZs such as Liaoning and three pilot FTZs in Guangdong, Tianjin and Fujian were set up to form a ‘1+3+7’ development pattern covering the eastern, central and western regions. Between January and September 2017, the gross output value of industrial output and the total volume of imports and exports – above state-designated scale – in the state’s economic open area increased by 7.7% and 16.7%, respectively, than the same period in 2016, forming more than 20 ‘billion-plus-billion’ industrial clusters.


This article is part of The IFF China Report 2018, which draws mainly on content provided by China-headquartered think tank, the International Finance Forum, and is published in association with Central Banking.

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