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Economics of Planning 31: 151–173, 1998. © 1998 Kluwer Academic Publishers. Printed in the Netherlands.

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Sino-Indian Liberalization: The Role of Trade and Foreign Investment A.S. BHALLA Sidney Sussex College, Cambridge, CB2 3HU, UK. E-mail: [email protected] Abstract. Two major factors account for a country’s growing integration with the global economy: trade and foreign investment; expansion of exports, and foreign direct investment (FDI). Growth of exports became a dominant source of industrial growth during the 1980s in most developing countries (see Helleiner, 1995). Most of these countries including China and India, have replaced the old import-substitution policy by an export promotion strategy. Both domestic and international factors played an important role in the shift of national policies to repay debts. The process of globalization already underway necessitated export orientation for improving technology, management practices, marketing and international competitiveness. This paper aims at exploring the contributions of exports and FDI to growth and economic liberalization in China and lndia. The first section briefly reviews similarities and differences in the two economies. The second section deals with growth, composition and direction of foreign trade. The third section examines the role of FDI, and its sources and composition by sector, industry, and by overseas ethnic Chinese and Indians. Trade and FDI linkages are examined in the fourth section which also contains a brief case study of Guangdong (China).

1. Chinese and Indian liberalization: Similarities and differences Despite the different political and economic systems, there are striking similarities in the development strategies adopted by China and India over the past four decades: heavy industrialization, regional/sectoral balance and economic liberalization. In the 1950s and 1960s, both countries adopted an unbalanced growth strategy for accumulation, import-substitution and self-reliance. In both countries restrictions were imposed on foreign capital in order to develop national capabilities and a solid domestic industrial base. In both cases foreign capital played an insignificant role in economic development and export growth (Bhalla, 1995a, 1995b; Kaplinsky, 1997). Both gave high priority to the public sector and state enterprises. In the late 1960s and 1970s, both countries focused on sectoral and regional balance and adopted similar measures to achieve this. They both adopted economic reforms although China began earlier in 1979, and India only in mid-1991; in the latter, limited liberalization was also introduced in the 1980s. In this paper we are concerned mainly with the 1991 phase of comprehensive liberalization which had many similar characteristics. The post-Mao economic liberalization differed significantly from the earlier goal of balanced development. Maoist egalitarian policies were reversed and the

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policy of local and national self-reliance was replaced by that of liberal imports of foreign investment, technology and know-how. In India, liberalization measures attempted half-heartedly in the 1980s, did not make much headway. It was only in July 1991 that major liberalization started seriously following a balance of payments crisis. The private sector is accorded a bigger role in core industries which were formerly reserved mainly for the public sector. China introduced similar measures: profit and foreign exchange retention from export proceeds by state enterprises, gradual shift from planned to market economy through the introduction of a ‘dual pricing’ system and a contract responsibility system which replaced annual plan targets and offered greater autonomy to enterprise managers. There are two further similarities. First, in both countries despite pronouncements, ownership reconfiguration of the state sector has not made much headway. Second, in both countries the process of liberalization has been gradual and incremental. Despite major efforts on price reforms in China, reform of the fiscal and banking and insurance systems still remains to be implemented (Gang, 1994). In India also many liberalization measures have not made much headway. They have been confined largely to the manufacturing and trade sectors. The convertibility of the rupee remains partial and reform of the banking and insurance industry has not yet been fully tackled (Sachs, 1994; Financial Times Survey on India, 17 November 1995). The recent Asian financial crisis may further deter China and India from introducing financial liberalization in the near future. The key indicators of openness in India and China on the eve of liberalization are presented in Table I which shows that China was less open than India on the eve of its liberalization. Its export structure was less diversified with much lower shares of manufactured exports. Also Chinese reforms began when the national and world economic environments were much more favourable. There are other differences also. Firstly, approaches to the restructuring of state enterprises have been different. While India explicitly promotes privatization, China did not envisage this solution until the Congress in September 1997 when this measure was adopted. Instead, China lay emphasis on raising the efficiency of state enterprises without changing their ownership. Rapid growth of urban collective enterprises and village and township enterprises is encouraged to provide competition to state enterprises (Jefferson and Rawski, 1994; Naughton, 1995; Rawski, 1994). Secondly, the Indian liberalization measures largely neglected agriculture. In contrast, in China liberalization was spearheaded by drastic rural economic and institutional restructuring. Thirdly, the political structure and constraints to reform implementation are more severe in India with a multi-party political system and weak coalition governments since 1996. The existence of freedom of press, popular democracy and electoral competition between different political parties can raise transaction costs significantly. For example, this last factor prevented reduction in public expenditure on subsidies (and thus fiscal deficits) which were an essential element of Indian liberalization (Chhibber, 1995). Can the poorer performance of

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Table I. Some key economic indicators on the eve of liberalization Indicator

India (1990-91)

China (1979)

GDP growth Inflation Fiscal deficit (% of GDP) Imports (% of GDP) Exports (% of GDP) Manufactured exports (% of total exports) Machinery exports (% of total exports) Debt ratio (FDI as % of GDP) FDI (as % of gross fixed capital formation)

5.2 12.1 8.5 20.3 15.3

7.6 2.0 5.1 6.1 6.0∗

72.9

49.7∗

11.9 0.5∗∗∗

4.4∗ -

0.3

-

Sources: China Statistical Yearbook; Government of India, Ministry of Finance: Economic Survey; World Bank, World Development Report. ∗ -1980 ∗∗ -1991. Ratio for 1990 was 27.5. ∗∗∗ 1990.

India in trade and investment liberalization, discussed below, be attributed to higher agency or transaction costs?

2. Trade and investment liberalization policies We start with a critical analysis of liberalization policies, paying particular attention to FDI, export orientation and international competitiveness. In China, prior to liberalization, foreign trade was the exclusive preserve of 12 state-owned foreign trade corporations dealing with specific product lines and falling under the authority of the Ministry of Foreign Trade (later to become Ministry of Foreign Economic Relations and Trade). Local governments and provinces were allowed to establish their own trading corporations and domestic enterprises to enter directly into foreign trade (see IMF, 1991, 1994; Lardy, 1992,1995, 1996; World Bank, 1994).2 The central government introduced an agency system under which national and local foreign trade corporations offered their services to enterprises engaged in foreign trade. Compensation trade was introduced under which domestic enterprises could obtain technology and machinery from foreign firms in exchange for goods produced with that technology (a sort of deferred payment in kind). The development of export-processing zones in coastal areas was a further step towards opening of the Chinese economy to international competition and FDI inflows.

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In 1992, under pressure from the United States, and in order to enhance its chances to enter GATT (now WTO), China agreed to abolish the bulk of its importlicensing and quota controls over a five-year period, to reduce average tariffs on a large number of commodities, and to simplify its legal framework and regulatory practices (IMF, 1994; World Bank, 1994).3 Nevertheless, its legal framework remains weak and underdeveloped. Lack of intellectual property protection results in higher transaction costs for foreign firms (especially those involving non-ethnic Chinese investors) because they have to take decisions without a full knowledge about local customs and practices. Lack of legal protection and pirating of foreign software (especially from the US) led the US in May 1996 to threaten China with trade sanctions over issues of copyright while the latter threatened to retaliate. Such trade friction can, in future, dampen the trade and investment climate (Bhalla and Bhalla, 1997). However, it is ironic that despite lower transaction costs for India’s foreign firms, because of the existence of a legal framework, its performance in export and FDI growth is less impressive than China’s as we shall examine below. Could it be that the lower transaction costs on account of a well-developed legal system are offset by the higher transaction costs due to a multi-party political system in India? Parallel to trade liberalization, China also liberalized its investment regime in order to attract modern technology.4 In 1986, China issued draft regulations on direct investment providing for reduction in taxes and costs of certain inputs, and greater access to energy and transportation which are under state control. Approval and licensing procedures for foreign-owned enterprises were streamlined. Investment liberalization measures include special tax concessions, liberalized leasing of land to foreign enterprises in coastal cities, foreign participation in property development, port development, power generation and retailing. Corporate tax for special economic zones is much lower (15 per cent) than for other foreign-funded enterprises (33 per cent) and Chinese enterprises (55 per cent). Foreign enterprises also enjoy a tax holiday of two profit-making years and a 50 per cent reduction for a further two years. Besides these central government tax breaks, local authorities offer incentives to foreign enterprises in the form of lower taxes on land, utility and property. Many of these incentives were withdrawn in 1996 in an effort to reduce inequity between domestic and foreign enterprises. As a result of new guidelines issued in 1995, such sectors as transportation and communications, insurance and other service industries have also been opened up for FDI. Foreign-funded law and consultancy agencies are now being allowed to operate (see Broadman and Sun, 1997). In India quantitative restrictions and tariffs on imports were considerably reduced. Licensing restrictions on the imports of intermediate and capital goods have been largely abolished and those on consumer goods imports have been partially liberalized. The government aims at reducing the average import-weighted tariff level to 10-15 per cent, equivalent to the levels prevailing in East Asia and Latin America.

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The Indian investment regime too has been liberalized. Prior to liberalization in 1991, foreign companies investing in India were restricted to 40 per cent equity participation which has now been raised to 51 per cent. Indian firms of good standing are allowed to raise funds through equity and convertible bond issues in the Euromarkets, and foreign institutional investors can now (according to the 199697 budget) hold 10 per cent (instead of the former 5 per cent limit) of share capital subject to an overall limit of 24 per cent equity. Export-oriented Units and Export Processing Zones are allowed 100 per cent foreign equity. Wholly-owned foreign subsidiaries are also allowed in the power sector. Significant incentives to nonresident Indians (NRIs) are offered to encourage them to invest in India. NRIs can invest up to 100 per cent of equity capital in 35 high-priority industries, including ‘sick’ (with net negative worth) industrial companies. Restrictions on the use of foreign brands and trade marks have been removed and foreign investors are permitted to repatriate profits except in the case of some consumer goods industries. Foreign investors can invest in most sectors including telecommunications and power: the World Bank (1996) states that ‘in telecommunications, power and mining, it (India) is significantly more open than its East Asian neighbours’. It is also more open than China. China’s underdeveloped legal and regulatory system noted above and lack of assurances of performance obligations from Chinese counterparts may have deterred foreign investors. Although the World Bank (1997) notes that ‘the government wants to shift FDI toward infrastructure (especially in the interior) and away from manufacturing and real estate’, in the past China has been reluctant to accept FDI in these sectors presumably for fear of cultural invasion and weakening of central authority. The central government in India has liberalized foreign investment, but restrictions remain in many Indian states and FDI regulations are quite cumbersome.5 Even though many states do not openly oppose FDI, in practice they can (and do) create difficulties for foreign investors by stalling on location, clearances and approvals needed for acquiring land for factories, power and electricity and other infrastructure (Sen et al., 1997, p. 140). It is stated that ‘only 300 of the 2,171 cases approved between July 1991 and April 1994 had been able to acquire land for factories. Out of these, only 200 have been able to begin construction of factories’ (Khorakiwala, 1996).

3. Pattern and direction of trade The nature, pattern and growth of Chinese and Indian trade can be illustrated by exports as a share of GDP, share of manufactured exports and machinery exports in total exports. These ratios are sensitive to the type of data sources used and the exchange rates. If one uses the World Bank data in dollar terms and unadjusted exchange rate-based GDP, between 1980 and 1994, the export ratio increased much more significantly in China than in India. At the beginning of the 1980s exports to GDP ratios were low for both countries. However, the gap in this ratio started

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widening consistently till 1994. This is also true if one calculates the ratio by using local currency, suggesting that changes in exchange rate movements do not have much effect on trend. Figure 1 shows the divergence quite clearly. However, if we use the GDP adjusted for purchasing power parity (PPP), the gap between the two countries, which started widening since 1985, is much narrower. The official estimates of China’s exports and FDI in GDP are excessively high, much higher than the ratios for Japan and the US. These estimates are exaggerated because China’s exchange-rate based GDP (the denominator) is underestimated. The purchasing-power parity measure of GDP is much higher (as estimated by the World Bank and Lardy, 1994; cited in Wei, 1995), and correspondingly the export ratios as shown in Figure 1. Let us now turn to the composition of trade which is illustrated by the shares of manufactured exports and machinery (including transport equipment) exports. These two shares are presented in Figure 2. In 1984 the share of India’s manufactured exports was only a little lower than that of China. However, China’s share has been higher than the Indian since then. Indian manufactured export shares have been rising consistently since 1984, that is, long before the 1991 economic reforms. In fact, these shares rose much faster between 1984 and 1991 than between 1991 and l995. (Estimates based on the World Bank data in US dollars are generally lower than the official estimates reported in Figure 2). This suggests that post1991 trade liberalization did not have any particularly favourable impact on export shares. In China, economic reforms and trade liberalization had a bigger impact on exports. During the first phase (1980-85) the export ratio did not increase significantly; however, during the second phase (1986-95) it increased appreciably in response to special trade liberalization measures introduced in the mid-1980s. Shares of machinery exports (electrical and non-electrical equipment, locomotives and trucks) for both China and India have remained low throughout the 1984-1993 period. However, here again, since 1989 the Chinese share has risen substantially and is higher than the Indian share. The Indian shares of machinery exports based on national data are much higher than the World Bank estimates suggesting the influence of movements in the exchange rate. Turning now to the direction of trade, we find that developing countries and Japan were the most important destinations for Chinese exports in 1995. However, between 1985 and 1995, the importance of the European Union and the United States as destinations for Chinese exports improved significantly whereas that of Japan declined. For Indian exports during 1985-95, Japan has been a less important destination than the United States. The share of India’s exports to the European Union rose significantly during this period (see Table II). Since 1990 Asia has become a significant trading region for India.

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Figure 1. Trends in Exports as percentage of GDP

Figure 2. Trends in Composition of Exports (India and China) in percentages

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Table II. Destination of exports (share of total exports) (Percentages) Destination

European Union Japan United States Asia Developing countries

1985

China 1990

1995

1985

India 1990

1995

8.1 22.3 8.9 39.2 52.5

9.5 14.6 8.4 53.4 63.3

12.8 19.1 16.6 40.0 48.3

18.3 11.1 18.9 9.3 24.8

26.4 9.3 15.1 21.8 39.8

26.9 7.0 17.4 40.0 41.2

Source: IMF (1992,1996). Table III. GDP-weighted index of inward flows of FDI Country/Region

China Indonesia Malaysia Thailand East & Southeast Asia India South Asia

(1986)

Year (1990)

(1995)

1.3 0.6 3.3 1.1 1.9 0.1 0.2

1.1 1.1 6.0 3.4 2.0 0.1 0.1

5.5 1.9 4.3 1.0 2.6 0.6 0.5

Source: Our estimates based on investment data from UNCTC/UNCTAD, World Investment Reports, and GDP data (exchange rate based) from World Bank, World Development Reports.

4. Foreign direct investment (FDI) The attractiveness of FDI to a particular country or region can be assessed on the basis of an FDI index weighted by GDP so that: (FDIi /FDIw ) / (GDPi /GDPw ), where i refers to a particular country or region and w to world. An FDI index of value 1 implies that the investment flow as a proportion of world FDI is proportional to a country’s or region’s GDP share in world GDP. When the index exceeds unity, it shows the country’s relative attractiveness of FDI inflows; when it is lower than unity, it shows the opposite. Trends in the FDI index for India and China are shown in Table III. These indices are compared respectively with indices for South Asia and East and Southeast Asia including individual countries known to have attracted substantial FDI lately (e.g. Malaysia, Indonesia and Thailand). The index for Malaysia for example, is well above the average for East and Southeast Asia for all the three years considered. That for India is much lower than

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Table IV. FDI stocks and flows: China and India (1985-96)

A.

B.

Inward FDI stock China ($million) As % of GDP India ($million) As % of GDP FDI inflows China ($million) As % of gross fixed capital formation India ($million) As % of gross fixed capital formation

1985

1990

1995

l996a

3444 1.2 1075 0.5 (1985-90) (Annual average) 2654

14135 3.6 1667 0.5

126808 18.2 5871 1.9

169108 8458 -

3487

35849

42300

14.5 169

162

25.7 1929

2587

1.2

-

3.6

-

Source: UNCTAD, World Investment Report. - = not available; a - estimates.

the one for East and Southeast Asia and is very close to that for South Asia. In contrast, the index for China for 1995 is higher than that for India, for South Asia and for East and Southeast Asia.? It shows a dramatic increase between 1990 and 1995. China has attracted much more FDI than has India (see Tables IV and V). While India had hoped to attract substantial amounts of FDI since its liberalization policies began in 1991, so far it has failed to do so. However, since the 1991 reforms FDI has risen rapidly from a very small base. As Table IV shows, FDI inflows into India as recently as 1995 were a very small fraction of FDI flows to China. Shares of FDI stock in GDP tell the same story. However, the Chinese FDI figures may be overstated. In order to take advantage of special incentives, Chinese firms send money offshore and then recycle it back as FDI (so-called ‘round tripping’). Such recycling has been estimated at about 25 per cent of gross investment inflows (Harrold and Lall, 1993) but may be on the decline since the policy changes introduced in 1996 to unify the tax system and abolish preferential import duties granted to foreign investors.6 Furthermore, the World Bank estimates of round tripping may be exaggerated since they do not distinguish between recycling and reinvestments into China by the Chinese companies in Hong Kong established in the 1960s and 1970s. Chinese affiliates raise funds in Hong Kong financial market and loans from international banks. Export earnings and investment returns of these affiliates are reinvested in China besides being used for local business expansion (see Zhan, ? East & Southeast Asia includes Hong Kong, but not Taiwan.

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1995). Even if one discounts recycling, China still receives far greater amounts of FDI than India or any other developing country. 4.1.

FDI DISPERSAL

The Chinese government opened inland cities and provinces to FDI in 1992. Have this and related measures encouraged any decentralisation of FDI in recent years? Zhang and Bulcke (1996) note that ‘an increasing number of foreign subsidiaries actually moved their production units from the coastal to the inland region to benefit from lower labour costs, cheaper raw materials, less competition (of both imports and local products), larger market size, more tax incentives’ (p.401). Is this a case of a ‘flying goose model’ operating within China? As the coastal provinces are becoming more expensive (especialy in terms of higher labour costs), FDI is assumed to be gradually shifting towards the lower-cost hinterland. Wide variations in the level of the annual urban wage noted across provinces and regions should a priori support this assumption. For example, in 1993, the Special Economic Zones (SEZs) like Shenzhen and Zhuhai recorded urban wage level at over 8,000 yuan per annum compared to only around 3,000 yuan in such provinces and cities as Harbin, Hainan, Shenyang and Xian (see Tang and Lu, 1996). Initially, China benefited as foreign investors shifted labour-intensive production there from Hong Kong and Taiwan among other regions within East Asia where labour costs had risen following growing labour scarcity. Now the hinterland, especially those regions with rich natural and mineral resources but low labour costs, may command comparative advantage over coastal regions. However, actual FDI inflows into noncoastal provinces in the 1990s show no clearcut and consistent decentralizing trend. While in some non-coastal provinces (e.g. Henan, Hunan and Heilongjiang) FDI shares have risen, in others they have either flattened out or declined (see Figure 3). In the case of coastal provinces, a decline or flattening out of FDI shares is more consistent as in the cases of Guangdong and Fujian. Too much should not, therefore, be made of dispersion of FDI as a consequence of the state policy and inequalities in urban wage. These are only some of the factors entering a decision of foreign investors to move to the hinterland. Generally infrastructure is much less developed in the interior of China which discourages foreign investors from moving there. 4.2.

SOURCES , COMPOSITION AND CONCENTRATION

The composition of capital inflows shows an interesting contrast between China and India. While the bulk of such capital inflows into China were in productive sectors, the capital inflows into India were largely in the form of portfolio investments of a short-term speculative nature. Table V shows that India is in the league of Latin American countries with significant portfolio investments, whereas China stands apart from the rest with relatively much more significant direct investment.

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Figure 3. FDI Shares by Coastal and Non-coastal Provinces

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Table V. Capital inflows in selected developing countries (1993-94) Country

Net direct investment

Net portfolio Investment

Total

Total relative to: GDP

($billion) China India Brazil Mexico Korea Thailand

35.11 1.38 0.30 10.48 -0.91 2.22

6.68 7.09 91.44 17.73 17.72 4.94

41.79 8.47 91.14 28.20 16.81 7.16

4.9 1.6 7.9 3.9 2.4 2.7

Exports

Investment

(Percentages) 20.7 14.2 114.6 38.0 9.8 9.0

11.2 7.9 39.6 16.9 6.6 7.0

Source: Collyns (1995).

This may presumably be due to the recent and incipient growth of the stock market in China. Sources of FDI inflows (approvals) for China and India during 1985-1995 also show some interesting contrasts. First, while India relied mainly on developed countries for FDI inflows, China’s inflows came primarily from Asia. For example, in 1995 China obtained nearly 68 per cent of total FDI inflows from within Asia; the bulk (51 per cent) came from Hong Kong and Taiwan. In the case of India on the other hand, in 1994, Asia accounted for only 8 per cent, the rest originating mainly in industrialized countries. Secondly, Japan is a far more significant source of FDI for China than for India where the relative importance of the United States has increased. Thirdly, the bulk of FDI to China from within Asia is accounted for by the overseas Chinese investors from Malaysia, Singapore and Taiwan. In the case of India, although the NRI investments have started growing since economic reforms, they remain considerably less important (about 30 per cent of actual FDI inflows- see Table VI). The overseas Chinese are estimated to be over 55 million (nearly 5 per cent of the total Chinese population) scattered around the world particularly in Asia: Taiwan (21 million), Indonesia (7.2 million), Hong Kong (6 million), Thailand (5.8 million), Malaysia (5.2 million) and Singapore (2 million) (Overseas Chinese Economy Yearbook, cited in Guha, 1993). The size of the Indian NRIs is much smaller, about 15 million. Sectoral composition of FDI inflows into China and India is quite different. While in the case of China, the relative importance of the tertiary sector has grown at the expense of the secondary sector, in India the secondary sector continues to account for the bulk of FDI inflows. Between August 1991 and July 1996, infrastructure (roads, ports, telecommunications, energy and fuels) accounted for 48 per cent of the total FDI proposals (see Ganesh, 1997). In China on the other hand, less than 10 per cent of FDI inflows went to infrastructure and basic industries (Zhang,

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Table VI. India: FDI by non-resident Indians (NRIs) Pre-liberalization Period (1986-90)

Post-liberalization Period (1991-95)

No. of foreign collaboration contracts (Share in total) (%)

96 2.4

462 6.1

Approved FDI (Rs. million) (share in total) (%)

1230 9.5

35000 10

n.a.

10000 32

Actual FDI inflow (Rs. million) (Share in total) (%) Annual FDI inflow (Rs. million)

(1991) 1600

(1992) 1500

(1993) 5600

(1994) 11080

(1995) 18800

Source: Centre for the Monitoring of Indian Economy (CMIE), Annual Report 1994-95, Mumbai.

1997, p 41). FDI inflows have substantially risen for real estate including both owned and leased property. There are further differences in the nature of FDI. In China, the main and growing form of FDI is in joint ventures, with wholly foreign-owned enterprises as a more recent phenomenon (see below). The Provisions for the Encouragement of Foreign Investors (1986) encourage the latter and requires a 25 per cent minimum level of equity of not less than $20 million. On the other hand, India did not welcome joint ventures, long-term equity arrangements or wholly foreign-owned enterprises. During the pre-1991 period, it relied mainly on technical collaborations and industrial licensing. It preferred shorter commitments and lump sum payments under arrangements with foreign investors (for an analysis of this issue, see Pant, 1995). However this situation has changed since 1991; liberalization of FDI is leading to a shift towards joint ventures and majority ownership. In principle even 100 per cent ownership of subsidiaries by multinationals is allowed (Kumar, 1995; Sen et al., 1997). However, Sen et al. note that the existing Indian joint ventures with foreign partners are reported to have run into difficulties over management and control. In both China and India multinationals are increasingly inclined to set up wholly-owned subsidiaries which allows them proprietary control over both technology and products. In both China and India, FDI is concentrated in a very few provinces (states). In China, four provinces/regions (viz. Fujian, Guangdong, Jiangsu, Shanghai) account

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Table VII. FDI approvals for the Rs. 10,000 million-plus states in India State

FDI approved (Aug. 91–May 95) (Rs. million)

Share in total (%)

Maharashtra West Bengal New Delhi (E) Tamil Nadu Gujarat Orissa Andhra Pradesh

57,350 37,000 34,500 24,420 24,140 17,430 12,820

16.5 10.5 10.0 7.0 7.0 5.0 3.7

Total (of 7 states) Grand Total

207,660 348,500

60.0 100.0

Source: Statistical Outline of India, 1995-96, Tata Services, Mumbai. E- estimated.

for over 60 per cent of total FDI inflows. In India, FDI is highly concentrated in a few coastal states, such as Gujarat and Maharashtra, which account for nearly 40 per cent of the total FDI proposals for industry. Only seven states account for 60 per cent of FDI (see Table VII). This concentration in both China and India is bound to have serious implications for both income and spatial inequalities (see below). The above FDI comparisons need to be interpreted with some caution because available data are often not comparable across countries. Apart from differences in definitions of FDI, the national data by host countries of FDI are often at variance with that from the IMF balance of payments statistics. Furthermore, it is difficult to estimate ‘real’ against ‘nominal’ FDI on account of exchange rate fluctuations and changes in price levels. Serious price distortions in the Chinese economy are well known. The coverage of FDI in the two countries is different, which makes comparisons difflcult. The Indian data, for example, only occasionally include investment by NRIs, whereas the Chinese data are bound to include all FDI from the overseas Chinese which is the most significant. 4.3.

WHY IS CHINA MORE SUCCESSFUL IN ATTRACTING FDI ?

What explains China’s success and India’s failure in attracting FDI? Is it because of the political instability and stock market scandals in India, and frequent balance of payments crises? As we discussed above, several factors have accounted for a dramatic increase in FDI inflows into China during 1990-95, namely, significant overall increase of FDI to developing countries, impressive growth of the economy since 1992, and liberalization of foreign investment through special tax incentives and concessions (Lardy, 1995). One wonders however, why India did not share the

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significant increase in overall FDI flows to developing countries. Two plausible reasons seem to be its late start with liberalization of the foreign investment regime and the rather unimpressive growth of the Indian economy until 1995. FDI tends to follow high growth rather than the reverse. In China, unprecedented growth rates may be an important factor in explaining high FDI inflows. Also in India during years of higher growth (1995, 1996) FDI inflows were substantially greater (see Table IV). Another factor explaining China’s success in attracting FDI may be an offer of greater ‘credibility of policy reforms’ to foreign investors (Rodrik, 1989). While the Chinese government wooed FDI by offering special incentives in order to upgrade its management and technology capabilities, for a long time the Indian tax system did not offer any special incentives for FDI.7 The institutional structure for FDI approvals also seems more cumbersome in India. There are several institutions dealing with the subject, namely, the Foreign Investment Promotion Board, Empowered Committee on FDI, Secretariat for Industrial Approval in the Ministry of Industry, and the Cabinet Committee. Red tape and bureaucratic delays in approvals are still common despite efforts to expedite. No wonder then that there is a wide gap between FDI approvals and their actual realization. On the other hand, in China the main approvals are undertaken by the Ministry of Foreign Economic Relations and Trade. The administrative committees in the export-processing zones are also authorized to approve projects. Thirdly, China’s geographical proximity to Hong Kong and Taiwan has enabled it to benefit from the dynamic management and marketing expertise of the overseas Chinese. Similar opportunities are not available to India. Many of the Indian NRIs are working in the Middle East as semi-skilled workers at low per capita incomes which may partly explain their lower capacity to invest. While the Chinese overseas investors consist mainly of traders and small businessmen (particularly in Hong Kong and Taiwan), the NRIs are engaged much more in professional, managerial and related occupations. Although there are traders and businessmen among the NRIs also, their size is much smaller and most of them are not wealthy enough to be significant investors in India. Fourthly, the NRIs lack informal trading networks (guanxi) enjoyed by the overseas Chinese. Perkins (1994) notes how family ties helped the Hong Kong and Taiwanese Chinese to invest in China compared to American and Japanese corporations. To quote: ‘the latter might have better connections at the top of the Chinese pyramid, but nothing comparable to the Hong Kong-Guangdong connections that really counted in day-to-day operations’ (p. 35). The above factors may raise transaction costs for the NRIs relative to the Chinese overseas investors.

5. Trade-FDI linkages Having discussed trade and FDI our next task is to examine the relationship between the two. Under the old import-substitution policies adopted by China and India

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Figure 4. China: Export Shares of Foreign-funded Enterprises

Figure 5. China: FDI Shares of Foreign-funded Enterprises

and most other developing countries, FDI acted as a substitute for trade. Increased restrictions on commodity trade tended to eliminate trade but led to movements of capital. Faced with high tariff barriers, industrialized countries invested in developing countries to produce for the domestic sheltered markets (so-called “tariff jumping”). Bhagwati (1978) argued that a country adopting an export promotion strategy would attract more growth-inducing FDI catering for larger international markets. The theoretical validity of this hypothesis rests on the inefficiencies of the import-substitution model, neutrality of the export promotion strategy between export and import sectors and an efficient allocation of resources based on comparative advantage. On the basis of cross-section data from 46 developing countries, Balasubramanyam et al. (1996) test the validity of the Bhagwati hypothesis and suggest some support for it. However, such analyses may not be very reliable. International comparisons of FDI data are fraught with serious conceptual, definitional and measurement poblems.

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Figure 6. Guangdong: FDI Shares of Foreign-funded Enterprises

Foreign-owned enterprises have played a more important role in the Chinese success in export promotion than its domestic enterprises (unlike Hong Kong, Japan or Korea). The Chinese spectacular growth in exports is linked directly to massive inflows of FDI. This is shown by the rapidly growing share of foreignowned enterprises in Chinese exports (Figure 4) and rising FDI in wholly-owned foreign enterprises since 1994 (Figure 5). The Chinese FDI strategy is aimed at export promotion by the foreign-funded enterprises which are required to balance their foreign exchange requirements. They have to generate foreign exchange to pay for their imports which induces export expansion. During the 1990s export shares of wholly foreign-owned enterprises rose steadily whereas those of joint ventures stagnated before starting to rise in 1995. Both exports and FDI shares of contractual joint ventures have been stagnating. FDI in wholly-owned enterprises has been increasing at the expense of contractual joint ventures suggesting the willingness of foreign investors to make longer-term commitments and acceptance by the government of full foreign ownership. In contrast, during the 1980s, FDI in foreign-funded enterprises was rather small and their number did not increase rapidly (see Okamoto, 1996). It is difficult to determine FDI-export linkages for India for lack of detailed and disaggregated firm-level data. However, on the basis of balance sheet data for foreign and domestic firms in the chemicals and electrical and non-electrical industries, Pant (1995) shows that export intensities of both types of firms are very low, ranging between 1 to 8 per cent of sales. This confirms the generally held view that the organized industrial sector in India has not contributed much to Indian exports. This and other empirical tests (Subramanian and Pillai, 1979; Lall and Mohammad, 1983; Kumar, 1994, 1995) relate mainly to the pre-liberalization period. The only empirical study for the post-liberalization period (Subramanian et al., 1996) also comes to a similar conclusion, viz, that foreign firms are not neces-

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sarily more export-oriented than domestic firms and that there is no significantly positive correlation between FDI and exports.

5.1.

THE CASE OF GUANGDONG

Guangdong ranks at the top of China’s provinces in terms of exports and FDI. It is, therefore, a particularly interesting case for studying trade-FDI linkages. The foreign-funded enterprises – equity joint ventures, contractual joint ventures, and wholly foreign-owned enterprises – are significantly represented in the province. Out of the 233,564 registered foreign-funded enterprises in China by the end of 1995, Guangdong accounted for 59,582 or over 25 per cent, of which over 30,000 were in operation. The total investment of the registered enterprises in Guangdong amounted to $204,627 million (32 per cent of total investment for China as a whole) of which $92,948 million was the share of foreign partners, or over 45 per cent (Statistical Yearbook of China 1996). Nearly 2,000 of these enterprises are located in the capital city of Guangzhou (Almanac, 1996-97, p. 422). Joint ventures are the most common form of foreign collaboration in Guangdong. However, since 1990, FDI in wholly foreign-owned enterprises has been steadily rising as in Figure 6, which shows FDI shares of equity joint ventures, contractual joint ventures and wholly foreign-owned enterprises as proportions of the provincial total. The figure suggests that since 1994 FDI in wholly foreign-owned enterprises has gained at the expense of equity joint ventures. This may be explained by the government’s more liberal policy towards full foreign ownership and transnationals (TNCs) preference for it. Before 1990, these enterprises were not so important, but the TNCs involved in high technology prefer full ownership; they are reluctant to share it with Chinese nationals under joint ventures. Guangdong benefited considerably from several Special Economic Zones (SEZs) in the province which attracted the bulk of FDI mainly from Hong Kong. Significant FDI inflows could explain the spectacular growth in the province (over 13 per cent per annum between 1979 and 1992) surpassing that of China as a whole (about 9 per cent per annum during the same period) (Kueh and Ash, 1996, p. 156). However, Guangdong’s share of national FDI has declined from nearly 42 per cent in 1990 to 28 per cent in 1996, suggesting FDI dispersal to other coastal and noncoastal provinces. It is interesting to note that despite a decline in FDI in wholly foreign-owned enterprises till 1994, their export shares continued to rise steadily (see Figure 7). We noticed in Figure 3B that Guangdong’s FDI share in the national total declined consistently between 1991 to 1993 and then flattened out. FDI shares of such other coastal provinces as Fujian and Liaoning remained almost constant, with the shares of Jiangsu showing wide fluctuations. Does this suggest that FDI has shifted to the hinterland? Does this picture change if we consider separately joint ventures and wholly foreign-owned enterprises? Below we shall attempt a comparison of Guangdong with (a) China, (b) other coastal provinces, including Spe-

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Figure 7. Guangdong: Export shares of foreign-funded enterprises

cial Economic Zones (SEZs) and Open Coastal Cities (OCCs)and (c) non-coastal provinces. A comparison between Figures 4 and 7 shows some deviation of Guangdong from the national average: export shares of foreign-funded enterprises in Guangdong rose at the expense of those of joint ventures, whereas in China both have been rising since 1995. In China the importance of equity joint ventures declined somewhat whereas in Guangdong FDI in both joint ventures and wholly foreign-owned enterprises has been rising since 1995. Data on FDI in joint ventures in selected coastal and non-coastal provinces as a proportion of the Chinese national total show that with the exceptions of Jiangsu, Hunan and Guangxi (which show peaks and troughs), FDI shares declined in Guangdong and remained fairly constant in Fujian and Shandong. Export shares of joint ventures show a decline in Guangdong paralleled by a decline in SEZs but an increase in OCCs and in Shandong. The picture of wholly foreign-owned enterprises is somewhat different from that of joint ventures. While Guangdong’s shares of FDI and exports declined, Jiangsu’s and Shandong’s FDI shares increased from a negligible base in 1990. Hunan’s FDI share started rising since 1994 (see Bhalla, 1998). The above comparison between FDI and exports of joint ventures in Guangdong and selected coastal and non-coastal provinces shows no clearcut or consistent shift towards the latter. It is, therefore, more likely that FDI has shifted to the 14 Open Coastal Cities (OCCs) and Special Economic Zones (SEZs). We do not have recent FDI data to determine the validity of this hypothesis. However, data for the 1980s show that the FDI share of OCCs rose from 14 per cent in 1985 to 18 per cent in 1991, whereas the FDI share of SEZs declined from 21 per cent in 1986 to 16 per cent in 1991 (see Kueh, 1996). In view of China’s policy of accepting wholly foreign-owned enterprises mainly for export promotion (rather than opening its domestic market to them), we can argue in favour of an export-FDI complementarity in the OCCs.

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Joint ventures and wholly foreign-owned enterprises differ in respect of ownership, control and decision making. Strictly speaking wholly foreign-owned enterprises with full ownership should be more free than joint ventures to locate in the hinterland to take advantage of lower labour costs (which, however, need to be offset by the availability of raw materials and adequate infrastructure). In the 1980s, due to lack of confidence in the Chinese economy foreign investors were more inclined to prefer short-term contractual joint ventures than equity joint ventures (Kueh and Howe, 1984).

6. Concluding remarks This paper has attempted a China-India comparison in respect of the roles of trade and foreign investment. We have shown that China has been more successful than India in integrating into the global economy, promoting exports and attracting FDI. But it is important to remember that the Chinese started liberalizing trade and foreign investment much earlier and during a more favourable period of the world economic environment. There are two types of FDI into China and India, by transnational companies from the industrialized countries and by overseas Chinese and non-resident Indians. While the bulk of Chinese FDI comes from the overseas Chinese, much of Indian FDI is channelled through transnationals. While both exports and FDI, besides domestic factors, have made important contributions to China’s growth, in India until recently FDI inflows were small and thus may not have contributed as much to its growth. Furthermore, limited empirical evidence suggests no clearcut positive correlation between FDI and exports in India whereas such correlation exists in China. Evidence on exports and FDI in China’s coastal and non-coastal provinces and in SEZs and OCCs suggests that some shift of FDI and exports has occurred away from the pioneer province of Guangdong. Such a shift can be explained by a number of factors: (a) foreign investors’ desire to avail of lower labour costs, (b) saturation of FDI in Guangdong, growing labour shortages and, consequently, rising labour costs, and government’s policy to promote industrialization of the hinterland in order to reduce spatial inequalities. Secondly, a shift has occurred more towards the OCCs than to the non-coastal provinces as such. Thirdly, there is a clear decline in the shares of SEZs which depict a picture similar to that of Guangdong.

Notes 1. I am grateful to Dr Christopher Bramall of Sidney Sussex College, Cambridge, and Dr Shujie Yao of the Economics Department, University of Portsmouth for useful comments. Thanks are also due to Eshete Hailu of IDRC, Ottawa, for the preparation of figures and tables. This paper is based on a keynote address delivered at the Chinese Economic Association Annual Conference held at the London School of Economics, 16-17 December 1997.

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2. In 1991, China abolished mandatory planning for exports and budgetary subsidies to foreign trade corporations for exports. By 1992, import planning covered only 11 broad product groups accounting for about 18 per cent of total imports. In 1993, import planning was further reduced, to only about five product groups. About 5,000 domestic enterprises and nearly 9,000 foreign trade corporations and about 80,000 foreign-funded enterprises were allowed to engage directly in foreign trade (IMF, 1994). 3. At the end of December 1993, tariffs were lowered on nearly 3,000 commodities covering mostly raw materials and equipment in short supply in China. As a result China’s average tariff rate was reduced from 39.9 per cent to 36.4 per cent (see IMF, 1994, pp. 10-11). 4. Since domestic savings and investment rates are very high by international standards, FDI was not considered a necessity for raising total investment. International competitiveness, and expansion of exports seem to be the major motivations for encouraging FDI. Besides, FDI was seen as a cushion against a heavy debt burden. 5. In August 1995, the newly elected BJP government in the state of Maharashtra cancelled a US$ 2.8 billion contract with Enron, an American energy company for building a major power station. The earlier Congress government had signed the contract. Having cancelled the contract, the BJP government started renegotiating it presumably to extract a better deal and terms and conditions. This stalling tactic by the state government ruled by the opposition party could also have been to embarrass the Central Congress Government. Since then the Congress Government at the Centre has been replaced by a coalition of 13 regional parties which find it often difficult to agree on a firmly positive approach towards FDI. Different political parties governing states have for a long time had an ambivalent attitude towards FDI. For example, in 1995 the Bharatya Janata party (BJP), the main opposition party opposed the free entry of multinational and FDI in Indian manufacturing on the grounds that Indian industry would suffer a severe blow. The BJP forms the largest single party in the current (April 1998) coalition government. This government is in favour of FDI in infrastructure rather than in consumer goods. 6. In April 1996, China abolished exemptions for foreign investors of value-added tax and customs duties on imported capital equipment (Broadman and Sun, 1997). 7. At a seminar in New Delhi in December 1993, German delegates noted the following main barriers to FDI in India: (i) administrative constraints such as bureaucratic delays in decision making, (ii) political instability, (iii) labour market constraints including rigid labour laws, and (iv) infrastructural bottlenecks (Chawla, 1995).

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