Evaluation of China’s Open Door Policies

Categories: ChinaMercantilism

Summary:

Lawrence and Cheng in their book of U.S. Direct Investment in China examine a very significant point in analyzing China’s open door policies, which is China’s institutional and legal framework of Foreign Direct Investment (FDI). This shows the trend of continuous reform and implementation of new incentivizing policy and protectionist regulations forming a zigzag towards the goal of the industrialized and liberated Chinese market. A significant policy outlined in their book for FDI attraction is the reduction of tax and land use cost depending on the area such as Special Economic Zones (SEZ), Open Cities, and Open Coastal Areas as well as foreign exchange policy to facilitate operation of FDI and flow of current account.

The author identifies that these policies have attracted 5 types of FDI inflow in China, with the permission from the government to form legal contract to set up those types of FDI actions which includes; wholly foreign-owned Enterprise, Sino- Foreign Equity Joint Venture (EJV), Joint development (JD), Sino- Foreign Contractual Joint Venture, and Foreign-funded Joint Stock Company.

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This concept is illustrated by the authors to show that depending on the type of FDI, the industry and the area of operation, the cost-benefit would differ for foreign enterprise and the Chinese economy. For instance, the authors present an example of legislation that gives responsibility for wholly foreign-owned enterprise’s investor to deal with the cost of employing advanced technology and equipment for domestic regional development. In return, the investor may get more autonomy from bureaucracy avoiding some tax requirement and pursue its own interest Joint Ventures, the most popular type of FDI, are formed by foreign investor entering the domestic market by cooperating with local companies.

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These are mutually beneficial to both parties as cheap raw materials and labor as well as local market knowledge can be inputted by local enterprise while advanced capital and investments can be contributed by foreign enterprises. Depending on the zones which the Joint Venture would form, whether Special Economic Zones, Open Coastal Area or others, they would be able to enjoy varying reduction of tax and land use fees. As a result, the authors reveal the fact that for US firms, they were generally granted high rate of return while China is granted more government revenue, technologies, and land development, establishing a positive mutual relationship between U.S and China in terms of trade.

There have been criticisms by scholars such as Wei and Prasad that the Chinese government may have been discriminatory to domestic firms to encourage cooperation with foreign investors in order to raise FDI. Moreover, the rise of foreign shares brings up the problem of overbidding as stated by Huang. However, Lawrence and Cheng give evidence that the Chinese government has been utilizing protectionist regulations in order to balance out too much market liberalization, including National guideline in 1997 to restrict foreign market share in certain industries.

The overall point of Lawrence and Cheng is that the institutional and legal framework of FDI in China is used selectively depending on what industry Chinese government wants to develop jointly with Foreign, specifically U.S investors, and what industrial sector domestic firms need to grow in through protection from foreign competition.

Evaluation:

The authors’ perspectives in the book are mainly focused on U.S firm’s entrance to the Chinese economy not so much on the detailed impact on the Chinese economy and society. Direct Investment to China may be significant to the U.S since China is the monopoly for FDI among Asian economies for the U.S, the majority of FDI source in China is developed Asian economies, which the authors do not discuss. However, this book provides a compelling insight about how institutional and legal framework in China has developed into a more transparent, and liberalizing one while advising some possible reforms needed to facilitate the improvement of U.S and China trade relations.

The article addresses the ongoing current trade dispute between the U.S and China, analyzing each party’s trade balance and position in international trade, to predict the outcome of increasing tariff on Chinese imports and rising tensions from the dispute. Martin Wolf argued that Trump could not overthrow Chinese economy by imposing augmented tariff on Chinese imports because the position of China in relations to the U.S is not “bilateral mercantilism, or asymmetric balance of pain”, unlike the relations of Mexico with the U.S where Mexico was dependent on the U.S for export and had asymmetric balance of pain, giving the U.S a superior position for negotiation.

The author gave analysis by graphical representation to support this data showing that China’s dependence on the US in terms of trade fell, a reduction from 2006 where current account balance surplus was 10.2% of GDP to 3.1% of GDP currently, with China’s export to the U.S as a share of GDP of 4.1%. Wolf Martin expects from this data that, if the U.S were to impose a prohibitive tariff on all Chinese imports, the Chinese economy would suffer less than 2% shock of their GDP which they can cover in few months since Chinese imports value is added in other parts in the world as well. While this means that the damage on the Chinese economy is less than expected, it also leads to the assumptions that the dispute would also affect the global economy. We could draw out from his article that the foreign investors involved in the production process of Chinese goods would deteriorate, including the U.S and other investors contributing to China’s FDI in a form of Joint Venture.

To sum up the main points of the author’s demonstrations, the current trade dispute between U.S and China is not a zero-sum game or successful negotiation. Regardless of the damage to different economies, it would hurt everyone. While this article provides a reasonable clarification of China’s international position to estimate the effect on Chinese economy due to the trade dispute, it is clearly shown that the author had simplified the dimensions of this dispute by neglecting the capital account side and trade imbalances caused by prohibitive tariffs.

The vast augmentation of China’s economic growth followed by swift accumulation of foreign direct investment (FDI) was explained as a result of institutional framework increasing the demand of FDI and the supply-side policies meeting the increasing demand recognized by Huang in the book. The author provided suitable perspective in an Asian economies’ perspectives as the majority of FDI source were from developed Asian economies, especially Taiwan and South Korea, and its increase results in fundamental changes in the location of Asian manufacturing sites, and the relations between East Asia and the United States.

The author explores that the reasons for this phenomenon is China’s advantageous economic fundamentals, such as large wage differentials to other East Asian nations as well as having a large pool of labor. Huang also argued that aside from the nature of its labor factor in the market, there was a demand-side factor resulting in excess demand for investment such as having informational asymmetry with high sunk cost, meaning that there are exit barriers for foreign firms to relocate their business to other sites once they have been attracted, government policies such as import-substitution strategy and decentralized economic management to enable easier tax avoidance, production autonomy, and less bureaucracy. These institutional characteristics not only clarifies why foreign investors are drawn to China, but may also imply that the environment has induced more of local enterprises to cooperate with foreign investors to establish foreign-invested enterprises so they would enjoy more autonomy in production and managerial process and have more bargaining power.

Nevertheless, Huang had provided some controversies of macroeconomic factors that deters FDI attraction such as high inflation and lacking transparency in legislation contrastingly to her formal statement of advantageous economic fundamentals. The author also added that the developed Asian economies’ investors were not seeking wage differences or labor-intensive production. The author argues that despite this economical deterrence, the rise in the supply of FDI including mobility of equity capital and exchange rate changes as well as other demand factors such as large domestic market and political stability after the 1990s have contributed to the escalation of FDI.

To evaluate and apply the Huang’s assumption, the author had mentioned that the institutional framework, especially the import-substitution strategy (home-biased) promoted the increase of export and current account balance surplus. This is an important point since my essay deals with current dispute with China and the U.S by current account balance, which can also be shaped by FDI and existing institutional framework by China, by applying the author’s assumptions we can uncover the fact that the environment in China is solid enough to maintain existing foreign enterprises and investment by various means such as established barrier to exit, thus sustain some amount of its exports through building reliance of Chinese import by other economies. While talking about positive effects associated with an excess demand of FDI, the book also outlines costs of it such as overbidding for FDI and loss of domestic bargaining power, which is a useful source in evaluating the open door policy in my essay.

The author also draws out the comparison of other Asian countries’ regulations in order to illustrate the difference in FDI accumulation. This, however, only focuses on locational and relative advantages, political changes and supply-side policies neglecting the historical event of Asian economic crisis which contributed to shifting manufacturing site to China from other Asian economies. Hence, this signifies that the author’s focus is mostly limited to the regulatory and institutional framework not viewing the phenomenon as a whole, combined with historical and economic causes.

Reference:

  • Fung, Lau, Li, Lau, Lawrence J., and Li, Cheng. U.S. Direct Investment in China. Washington, D.C.: AEI Press, 2004.
  • Wolf, Martin. ‘Donald Trump Is Wrong: China Is Not Mexico.’ Financial Times. October 02, 2018. Accessed October 21, 2018. https://www.ft.com/content/155f0ab0-c558-11e8-8670-c5353379f7c2.
  • Huang, Yasheng. FDI in China : An Asian Perspective. [ISEAS Series on China and the Asia-Pacific], 1. Hong Kong : Singapore: Chinese University Press ; Institute of Southeast Asian Studies, 1998.

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Evaluation of China’s Open Door Policies. (2021, Aug 18). Retrieved from https://studymoose.com/evaluation-of-china-s-open-door-policies-essay

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