EMPIRICAL LITERATURE REVIEW
Overview of the poverty in world
DEFINITIONS AND MEASUREMENT OF POVERTY:
CAUSES OF POVERTY:
WAYS OUT OF POVERTY:
International trade AND POVERTY REDUCTION:
CHAPTER 2: LITERATURE REVIEW
Generally speaking, more studies are being conducted concerning developing countries to
ensure that they have the tools and knowledge necessary to make the most proficient use of FDI
that is, focusing efforts on increasing economic development and growth. In this chapter, there is
a brief consideration of some empirical studies regarding FDI. The hope therein is to understand
better how China was able to best capitalize on these new funds for faster economic growth.
EMPIRICAL LITERATURE REVIEW:
Paraphrasing from a definition set by Branstetter and Fritz (514-515), FDI refers to an
investment by a foreign entity (governmental or business in nature) within a country to establish a
presence for profit or diplomacy. In this respect, FDI has the power to both allow China to grow
by foreign example as well as influence the development efforts of other countries, over time
(Williams, 2016). Most of the previous studies reviewed for this thesis focused primarily on the
positive side of FDI in economic growth. Given this leaning, I wanted my review to exhibit greater
balance betwixt the positive and negative effects of FDI on an economy. Once this
accomplishment, I could devise an empirical methodology and analysis that could have real
implications for entities interested in FDI. It is also in this chapter where the discussion of the
prevailing theories and the purported relationships between FDI and growth takes place.
Overview of the Development of FDI in China:
Until 1978, China was an isolated economy that never emphasized multinational business
operation, or, frankly, any permanent negotiations outside its local markets. Of course, China, as
a self-proclaimed “communist” nation, is still rather isolated and antiquated in much of its thinking
as a political body (Williams, 2006). However, after 1978, with the introduction of the now famous
“open-door” strategies of Deng Xiaoping, the Chinese government began to make changes in some
of its policies regarding isolationism; and, it was the impact of these policies that initiated both a
new era of a more liberated Chinese economy and the subsequent lessening of Chinese
underdevelopment (Ebrey, 2010). As one strand to these new policies, the Chinese government
provided incentives to encourage foreign markets to consider China as a destination for FDI dollars
(so to speak). According to China’s Ministry of Commerce, back in 2011, it was precisely the
inclusion of overseas markets that made China’s exports and imports rise by more than half to
record $262 billion in the year 2007 (Dehghani et al., 2016). For better management of the
tremendous inflows, the Chinese leaders decided to permit the introduction of capitalist elements
into its economy. From this, China leaders were able to free some efforts from micromanaging the
economy and redirect those efforts into maintaining political stability across the country.
As per the OECD (2000), as well as Ren and Pentecost (2007), the distribution of China’s
open-door strategies was across three periods to accomplish their primary objective, financial
stability for the country. In the first, time frame, 1978-1983, regulations on joint ventures sought
to pull in investors from different nations and teach them all that China had to offer as human
capital and resource-rich country. Additionally, amidst that period, particularly in 1980, the
country's political-economic administration set-up four special economic zones (SEZs). The
consequences of this approach were quite positive, and they were grounded in the idea that freeing
FDI inflows would permit greater dissemination of technologies and know-how into China. At this
time, there was FDI restriction to just these four areas (SEZs) but, the administration’s plan was a
start in creating a more internationally competitive China.
From this initial experimentation with the first, four SEZs (namely, Shenzhen, the city of
Zhuhai, Shantou in Guangdong and Xiamen in the Fujian region), the observed successes
established a positive precedent and causation between the freeing of FDI and economic growth.
The establishment of causation in the positive ramifications of the program occurred when it was
definitive that only those SEZs were shown to grow disproportionately to the other regions of the
economy. Of course, upon further examination, it is, perhaps, no surprise that freed FDI in those
highly trade-sensitive coastal regions would lead to growth. After all, the Shenzhen region is near
the British-enhanced city-state of Hong Kong, and the other FDI-freed areas of Zhuhai and Xiamen
are close to the democratic and US-backed Taiwan and the historically affluent Macao,
respectively. Moreover, these urban areas are situated in regions of cultural and linguistic
homogeneity, which has shown to improve economic efficiency. However, despite these geoeconomic circumstances, the reality remained that these regions were still highly underutilized
until FDI was, firstly, permitted to enter those regions and, secondly, freed from the direct
oversight of China’s government. The move ultimately established success for the program.
The following reform period commenced in 1984 and ended in 1991. In 1986, entirely
foreign-owned companies were formally recognized as licensed operators within the Chinese
market only in the determined SEZs. Additionally, organizations with progressive technologies
enjoyed special incentives to penetrate the Chinese market. At around the same time, new legal
measures were instituted to provide some oversights and investor insurance programs (particularly
special interest safeguards). These new programs continued to bring growth to the regions
mentioned above, which then spurred new interests to develop more zones. It was then, at the early
1990s, that the foundation of Free Trade Areas and High Technology Development Zones took
place. Ultimately, to accommodate the growing socio-economic status of the Chinese workers and
households of those regions, many of those zones opened to international organizations that
operated in retail as well as wholesale markets, banking industries, insurance, and consultancy
administrations. It bolstered an economically virtuous cycle of spending and production, which
reinforced the FDI programs.
Peak Stage (1992 – 1993) during this stage, Shanghai rose into an economic center of China and
also opening of Pudong New area occurred since the Chinese government resolved to develop
Shanghai into a an international hub for finance, economy and trade. The rise of Shanghai
become as a luck since the government opted to test its newly found policies from this place and
also varied successful policies were applied from this place and the rest of the world. Southern
China had been captured by FDI leaving out the Southeastern part, therefore, the government
opted to shift the FDI to Shanghai so that its concentration should not only be witnessed in one
region but it should occupy the other parts.
During this period, income generating entities such as high-tech enterprises, established
manufactures, and the financial companies were advised to conduct their operations at Pudong
where the central and local government could offer them different preferred treatments (Zhang,
2002). Through implementation of new framework, the Chinese government encouraged the
exports-oriented and Foreign Invested Enterprises with help of the advanced economy. Through
this, the new sectors opened for foreign investors were wholesaling and retailing, accounting and
information consultancy, banking and insurance.
The government procedures were made simple in terms of FDI, there was a need to direct
FDI into the country’s inner regions which were less developed and less industrialized.
Remarkable growth in FDI was witnessed in 1992 and the government announced its intention of
adopting the socialist market economy strategy. Between 1992 and 1993,the laws and regulations
attached to the market operations was passed which include’ adoption of trade union law, the
company law, and Provision regulations of value-added tax, consumption tax, business tax and
enterprise income tax.
Adjustment Stage (1994 – 2000) a new stage in economic reforms was seen in 1994, this is
because the growth rate which use to be very high in two previous years slowed down to stable
level, therefore, in order to realize the economic development goal by the government, guiding
of the FDI became a priority (Yuan, 2006). The guiding directory categorized FDI into the
following categories; encouraged, restricted, prohibited and permitted, in the first category we
had projects min infrastructure or underdeveloped agriculture with the advanced technology, the
second category involved those whose production exceeded domestic demand and those who
engaged in the exploration of rare and valuable resources were treated as restricted. In the third
category we had projects that tend to interfere with the national security or the public interest the
other remaining projects felt under permitted.
Post-WTO Stage (2001 – present) after a long-term negation, which lasted for 15 years, China
officially, got the chance to be a member of the World Trade Organization (WTO) on November
11th 2011. Since then, China adopted a way of making true its objective, which were basic
principles of non-discrimination, pro-trade, and pro-competition. This action made China to
realize an impact on the FDI, an access to the WTO made China’s export market become larger
and more predictable (Zebregs, 2001). China’s domestic market attracts FDI in industries where
there is large market potential this enables China’s export to get protection from competitors.
Becoming a WTO member grants China the chance to further its economic reforms and
streamline its legal framework. This, in importance, improves China’s business environment and
assist in attracting more foreign investment.
The Purpose of Attracting FDI:
The primary goal of attracting FDI is to increase the productivity of an economy, either in
pertinent areas or as a whole. It is a valid goal since FDI inflow is diverse as it targets different
sectors of the economy; talk of insurance or banking, thereby enhancing volumes as every industry
is in a position to produce quality. Technology is another reason to attract FDI; the entities come
with advanced machines for efficiency, and these, in the end, would help trigger the quality and
quantity of productions within the domestic economy. Its significance follows by ensuring a
competitive market environment in the host country where local firms would ensure quality in
their output, and in the end customers would enjoy the very best at affordable prices. Through
technological investment as well as various fresh inflows from different economies, FDI is
significant in capital formation to the host country (Dehghani et al., 2016). When a country is
experiencing low human capital concerning managerial skills, FDI inflow becomes the best
solution. Such enterprises would bring the best to manage their investment and in the domestic
economy would learn via experience and training. In consideration to the employment
opportunities that the FDIs bring along, they help in solving the unemployment dilemma, which
by a more significant margin counteracts the poverty level hence resulting in improved living
standards. In conclusion, based on the above, FDI enhances economic growth and development of
every economy and that defines the primary purpose of its acceptance. The GDP levels shall
change while infrastructure, living standards and income per head improve as poverty level
declines in the recipient country.
Different Forms of FDI in China’s Economy:
The research describes various kinds of FDI in China’s economy. The primary two forms
of FDI discussed are the export and domestic-oriented types. The study also describes other types
of FDI such as Joint Exploration, Wholly Foreign-Owned Enterprises, Contractual Joint Ventures
and Equity Joint Ventures (Fung 2002, OECD 2000 and Ali & Guo 2005).
Contractual Joint Ventures (CJVs): This group entails investments by the cooperation of
Chinese and foreign enterprises.
Equity Joint Ventures (EJVs): This category includes joint enterprises by foreign and
Chinese companies. Apart from sharing the losses and profits, the risk is lower. This type
of FDI took place with absolute success in the 90s.
Joint Exploration: The category entailed market exploration, and it was carried out in the
early phases of the Chinese’s adoption of FDI programs.
Wholly Foreign-Owned Enterprises (WFOs): It is the kind of FDI where foreign investors
establish affiliates. WFOs showed a significant upward trend since 1986 in China.
In general, EJVs performed well in the early phase of the reform. However, WFOs has
flourished since in the middle of the 80s.
The Impact of FDI in China’s Economy graphs:
It is a necessity to examine and comment on the underlying trends concerning a country’s
GDP, FDI, and exports. Embracing open-door policies in 1978, the gross domestic product of
China began to achieve extraordinary growth and development. Statistical evidence provided by
the world bank shows that the country’s GDP rose steeply to about $6.101 trillion in 2010 from
205.09$ billion in the year 1982.
GDP upto 2010
GDP IN billions
Moreover, the information from fig 2.6.2 illustrates a rising trend of Foreign Direct
Investments. In the 1980s, the country’s FDI remained at an expressively low level at
approximately $1,070 million. In the midst of 1980s, FDI sustained a remarkable growth and
attained about $6,060 million because of tax incentives as well as many benefits that the Chinese
government allotted for foreign investments. Among most of the developing nations, China has
been in the in the forefront regarding FDI, as explained by Ren and Pentecost (1991).
Fig 2.6.2: Foreign Direct Investments inflows in China measured in United States dollars at the
current price and existing exchange rates in millions. (1978-2010)
Source: United Nations, Unctad
Figure 2.6.3 exhibits the standing of exports in 2010. The information is available on the
official World Bank site. China is leading in exportation across the world with an approximated
amount of $516.493 billion, followed by Germany which has $141.044 billion. Then France,
Japan, and the U.S follow with their exports in 2010 reaching $ 93.548, 116.658 and 132.789
billion, respectively. In 2004, China was in the third place after the USA and Germany. Therefore,
the progress of the country in the six years that followed has been immense and encouraging for
China’s export sectors.
Figure 3: Exports of products and services in 2010(in billion US dollars).
China: 1, Germany: 2, USA: 3, Japan: 4, France: 5
Source: World Bank Indicator.
Reviews on FDI, Exports and Economic Growth:
The relationship between FDI, Exports and the Economic growth has been a fundamental issue for
economists and researchers who tend to study in the field on international economics. FDI occurs
when an investor from a home country acquires an asset in another country with an intention of
managing that asset, on the other hand, economic growth is the increase in a country’s real output
per capita, and export as well is the recorded surplus by the host country sold to other countries.
(Gay, 2016). According to ‘Brussels Declaration and Programmed of Action for the LDCs’ (BPoA), FDI
inflows is basic in supporting economic growth and development in LDCs, also, the foreign demand for
exports is essential for economic growth than the domestic demand.
Graham and Wada (2001) also supported the notion that FDI depicts a significant
correlation to the Chinese economic growth. Their findings showed that China’s exports had
increased dramatically due to investments by multinationals enterprises. Additionally, wages and
income per capita also went up in provinces where FDI was freed and encouraged (Whalley, Xin,
& Lardy 2007, January). The same trend is also supported by Chen, Chang, and Zhang (1995) who
argue that FDI has shown a positive correlation with the augmentation of total fixed asset
investments in China.
Reviews on the Productivity Gains and Spillover Effects of FDI:
Several kinds of literature emphasized the importance of FDI’s spillover impacts on the
Chinese economy; and given this, it becomes necessary to point out at least a few. First, Cheung
and Ping (2004) established that FDI has positive and significant impacts on native patent
applications in China. According to Buckley, Clegg, and Wang (2003), FDI has both negative and
positive effects on the productivity of Chinese firms. Moreover, the authors use 41 sub-sectors of
China’s electronics companies between the years 1996 and 2001 to illustrate that the benefits from
spillover effects to Chinese industries diminish over time. As such, China’s domestic productivity
has a life cycle.
Wang and Lo (2007) assessed the correlation of FDI with China’s domestic industry
productivity at the provincial level. The results prove that even though FDI improves economic
development by increasing allocative efficiency in the short and medium-run, it also has negative
impacts that can worsen the ability of productivity, over time. In conclusion, he argues that FDI
has more negative than positive consequences. Given the fact that related types of research are
limited, it is imperative also to review Hu and Jefferson’s study on FDI Impact and Spillover
(2001). Hu and Jefferson have data on both large and medium-sized Chinese enterprises with
which to test the impact of FDI and its spillover in manufacturing firms in China between 1995
and 1999. The authors ultimately illustrated that FDI Inflows have a more positive effect on
China’s economy since they introduce advanced products in the marketplace that would have
otherwise never existed within the borders.
Hale and Long (2007) also conducted similar studies on FDI Impact and Spillover. In spite
the evidence that they applied a great number of disclaimers to test the influence of FDI spillovers
on the output of local firms in China (firm-level data), they established varied results with many
optimistic conclusions. It was mostly the case because of aggregation bias and a failure to control
the FDI types. In citing another example, in the work of Nicole Madariaga and Poncet (2007), their
dataset consisted 180 Chinese cities over the period 1990-2002. Their study concluded that
Chinese cities not only benefited from the influxes but also from FDI received by their immediate
Reviews on Different Regions:
FDI and GDP growth have a positive correlation in most provinces in China. According to
Gen and Cheng (2000), FDI also stimulates less growth in the GDP within the western areas than
in the coastal regions. Economic growth and FDI in the eastern sector have an increasing and an
apparent, positive correlation, as noted by Hou- Kai (2002). Studies conducted by Hull et al.,
(2006, October) point out that the income growth of China is significantly affected by FDI inflows.
China’s income growth is, therefore, positively associated with FDI. He also reinforces the notion
mentioned above that the income growth is smaller in inland than in coastal provinces, over time.
Regional disparities in China have been argued to correlate with FDI and exports in each
region, Fu and Balasubramanyam, (2003). Fu discovered that migration effects and spillover of
the commodities and FDI markets affect the income in ...
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