Chinese success with FDI: lessons for India.
|Publication:||Name: China: An International Journal Publisher: East Asian Institute, National University of Singapore Audience: Academic Format: Magazine/Journal Subject: Social sciences Copyright: COPYRIGHT 2008 East Asian Institute, National University of Singapore ISSN: 0219-7472|
|Issue:||Date: Sept, 2008 Source Volume: 6 Source Issue: 2|
In 1947, China and India were on the same footing in terms of main
economic indicators such as per capita income. But today, the picture of
the two countries is very different. For instance, China's GDP
growth rate reached 10.7 per cent in 2006, while India's was 9.2
per cent. (1) It was estimated that China would grow by 10 per cent in
2007 and 9.5 per cent in 2008, while India's growth for these two
years would be 8.4 and 7.8 per cent, respectively. In 2005, China's
GDP, at about USD2.2 trillion, was roughly thrice that of India; its
trade amounted to 7.4 per cent of world trade, as against one per cent
in India's case. The other key parameters of both economies suggest
that the Chinese dragon is flying ahead of the Indian elephant. (2)
Clearly, both countries are the star growth performers among the
world's major economies, though a major difference in scale between
the two countries exists (see Table 1). China's economy is three
times larger than India's and contributes significantly more to
global economic growth. It has emerged as a production hub and export
market for the region. These are the key factors in boosting
intra-regional trade and investment in China. Meanwhile, India has also
grown rapidly following reforms in the early 1990s and more recently,
has become a global leader in service exports, even though its impact on
the regional and global economies has so far been more or less limited.
(3) Both the Asian giants are on their way to becoming economic super
powers, but both have different strength and weaknesses. They also
follow different economic models and political systems. (4) While China
is a closed society run by a tightly knit communist party, India is an
open democratic society, with an independent judiciary and free press.
Despite their differences, there are many lessons these countries can learn from each other. Chinese success in attracting foreign direct investment (FDI) may prove very useful to other countries, especially India which aims to become a global economic power by 2020. Hence, the main objective of this article is to examine the lessons which India can learn from China's success in attracting FDI on a large scale.
China is continuing to grow rapidly. GDP growth was over 10 per cent in 2005 and 2006, and was projected to grow more or less at that level in 2007 and 2008. Net exports and investment continue to expand rapidly. Strong world demand and China's increasing role in global processing trade have propelled the export growth. A slowdown in import growth resulted in a current account surplus of more than 7 per cent of GDP, up from 3.5 per cent in 2004 (see Table 2). China's economy continues to rely heavily on fixed asset investment. However, excess liquidity is a problem. It is fast becoming a market economy.
India's GDP growth exceeded 8 per cent during the past few years, reaching over 9 per cent in 2006 despite several weaknesses in policy and institutions. Its industrial production has grown over 10 per cent in the same period and the country accumulated a foreign exchange reserve of more than USD175 billion. Over the past three years, the ratio of exports of goods and services to GDP shot up from 14.6 per cent to 20.5 per cent, India's share in global merchandise exports doubled from 0.5 per cent in 1990-1 to one per cent in 2006, and its share of global services exports also doubled in recent years to 2.5 per cent. The growth in the various sectors of the economy has, in turn, made India a very attractive destination for international investors. The flow of investments has been on the increase and this is reflected in a sharp rise in the benchmark stock indices like the Bombay Stock Exchange (BSE) Sensex. The overall economic scenario is quite bright and provides ample scope for optimism. Its expansion is primarily led by domestic demand.
China, whose growth has been driven by manufacturing, has tapped into domestic savings and foreign investment to build impressive infrastructure, whereas India's strength is its service industry. India is now also gaining ground in manufacturing. (6) Although China currently seems to have the advantage over India in terms of the size of its economy and speed of growth, this difference can be attributed, in part, to China's 13-year head start in economic reforms. As India begins to capitalise on improving its workforce skills and advantages in age distribution (35 per cent of its population is under the age of 15), the gap will probably narrow in the near future. (7) In China, following Deng Xiaoping's push towards a market-oriented economy in the past two decades, FDI increased from USD3 billion in 1990 to USD63 billion a year in 2006. Similarly--although on a different scale--after India launched economic reforms in 1991, its FDI increased from USD133 million in 1991-2 to USD15 billion in 2006.
China's share in world merchandise exports increased to 7.4 per cent in 2005 with the country exporting goods worth USD762 billion during the year. Thus, the Chinese economy has become an inseparable part of the world economy. (8) On the other hand, India's merchandise exports were worth USD99.5 billion in 2005, or approximately one per cent of total global exports worth USD10,355.3 billion. These facts and figures indicate that China is ahead of India.
A considerable part of the buoyancy of China's industrial growth over the last three decades has come from considerable inflows of FDI. Such investments were authorised in China in 1979 as part of the economic reform and opening up policy launched in December 1978. China's policy for opening up its economy aimed, on the one hand, at promoting exports and, on the other, at protecting the domestic market. It has achieved remarkable growth in the manufacturing sector, turning the country into a global hub for multinational corporations (MNCs).
A key driver of the trade dynamics in China has been FDI by MNCs. FDI flows have been channelled into manufacturing which has fed exports. Economists estimate that FDI flows and exports growth have accounted for more than half of the growth in China's GDP since 1981. Around 50 per cent of China's exporting companies are either owned by foreigners or are partly foreign owned. (9) China is one of the largest recipients of FDI in the world, while India, as mentioned above, has attracted less than one-fourth of what China has. However, there are certain key problems in China such as foreign investors still having to obtain approval from Chinese bureaucrats and the non-availability of skilled manpower. MNCs enter China to take the advantage of cheap labour, especially in the manufacturing sector. Thus, products are manufactured and exported to the rest of the world to gain price advantages. The Chinese government also provides huge incentives to foreign companies in the form of tax concessions. (10)
In terms of outward FDI flows, it is estimated that Indian firms had, by 2003, invested USD5.1 billion abroad, putting India at number 14 in the developing country rankings in this regard. Hong Kong (USD336 billion invested till 2003) was at the top, followed by Singapore (USD90.9 billion) and China (USD65.2 billion). (13) Recently, India's overseas FDI has emerged as one of the fastest growing components of the country's international investment. From USD10.03 million in March 2005, cumulative outward FDI rose to USD14.44 billion by September 2006. This is primarily due to overseas mergers and acquisitions (M&As) by Indian entities. In fact, Indian companies want to be part of the global action and opt for acquisitions of greenfield projects since it gives them a head start with an existing brand or production facility. In the case of China, on the other hand, such M&As have become a part of national policy. For instance, in the five-year period from 2001, Chinese companies engaged in over 110 outbound M&A deals valued at close to USD14 billion. Indian companies over the same period made over 200 outbound deals valued at about USD8 billion. The most glaring difference is in the type of companies that are engaging in outbound M&As. In the case of China, most outbound M&As have been carried out by state-owned companies. In the case of India, on the other hand, most overseas M&As are dominated by private companies. (14)
Reasons for Success
A number of reasons have been given for China's success in attracting FDI inflows and for India's lower success:
China cautiously opened up and reformed its economy. China adopted economic reforms for the sake of fast development in 1978. Most of the country was involved in this process. The first reforms focussed on poverty in rural areas. These involved a comprehensive set of land reforms. In the next phase of reforms initiated in 1994, some of the next steps were the overhauling of the tax and fiscal systems, monetary centralisation and financial reforms, downsizing and reform of government institutions, privatisation of state-owned enterprises (SOEs), the laying off of state workers, unification of foreign exchange rates and conversion of the current account. China's procedural clearances for setting up manufacturing units are easy and very quick. The government provides infrastructure at affordable rates and foreign investment approvals are cleared by the local administration in a short time. These reforms have facilitated a higher volume of FDI inflows into China. However, there are still many internal and external problems, especially the former, such as the high costs of economic growth, large disparity between east and west, inefficiency of state-owned enterprises, large number of unemployed and laid-off workers, delayed political system reform, environmental problems, energy shortages, etc. (15) A number of areas--notably the banking system, the enterprise sector, the social safety net, the labour market and income inequalities--still pose major challenges and all need reforms. (16)
As for India, it has become a little simpler to start a business there. Easier registration, cross-border trading and relaxed tax payment norms are some of the measures introduced to facilitate company start-ups. Despite these reforms, India is still one of the most difficult places to do business. Therefore, India is still considered a less investor-friendly country. The following problems in doing business in India have been identified: (17)
* Starting a business in India is an 11-stage process that takes 35 days. By contrast, it takes just two days and two formalities in Australia.
* Getting 20 licenses in India takes 270 days. In Denmark, getting 7 licenses takes 70 days.
* Hiring and firing are both difficult. The rigidity of employment is estimated in India at 41, compared with 23 in East Asia and the Pacific.
* An investor must typically spend 7.85 per cent of the cost of a property to register it in India, as against 0.1 per cent in New Zealand and the Slovak Republic; and 62 days are spent in registering a property in India compared to just 2 days in New Zealand and Thailand.
The Indian Finance Ministry's mid-year review of the Indian economy rightly calls for reforms in labour laws, deregulation of mining, improvement in infrastructure facilities, steps to boost agriculture, etc.
The countries' different investment environments greatly affect FDI. China began its phenomenal growth in the early eighties along with its high savings rate, an untapped large consumer market, investor-friendly environments including world-class infrastructure, low labour costs, a depreciated renminbi, etc. These have been primary determinants of China's external competitiveness. (18) According to one estimate, lying between 7-10 per cent, China has much lower rates of protection for domestic manufacturers of white goods and consumer appliances. In India, however, the effective rate of protection on car makers is as high as 27 per cent, while manufactures of washing machines, refrigerators and microwaves enjoy 11 per cent protection. These have resulted in strong inflows of FDI into China. India has a low savings rate, small market size, poor infrastructure and a weak regulatory framework.
The Hong Kong and Taiwan Factors
A substantial volume of FDI into China is routed through Hong Kong and Taiwan which arguably have the best business conditions in the world. Hong Kong is now part of China. Taiwan has become one of China's closest economic partners and investors. (19) Much of the FDI from Hong Kong is said to represent "round-tripping" money coming in from the mainland and going out as FDI to take advantage of the benefits given to FDI. India does not have any such opportunity. (20)
Non-resident Chinese have played an important role in investing in China, while Non-resident Indians (NRIs) have been quite hesitant to invest back home. This is changing gradually however. Analysis of FDI data from 1991 to 2004 indicates that investment by NRIs in India was only USD329.9 million. But due to changes in the definition of FDI in 2000, NRIs can use money already existing in the country to make market purchases of equity. According to the revised figures, FDI inflows into India have increased sharply in recent years. The Reserve Bank of India (RBI) estimates that 47 per cent or USD7.8 billion of the USD16.44 billion FDI in financial year 2006-7 was contributed by NRIs.
A key to China's success in attracting FDI in the manufacturing sector has been its infrastructure development. From 1997 to 2002, the Chinese government invested over USD30 billion in building infrastructure. Before 1985, China did not have a single highway. It is now building world-class expressways everywhere. Low wages, cheap power and cheap capital are additional incentives to invest in China. Its low labour costs supported by a large pool of unskilled as well as skilled labour, have strengthened its external competitiveness. A number of hidden and explicit subsidies such as an artificially low interest rate, cheap electricity, etc. have also provided impetus to its competitiveness, whereas India's weakest link in its growth model is lack of infrastructure, a major deterrent to FDI.
One of the lesser known aspects of China's emergence as a global manufacturing hub is the manner in which it completely revamped its tax system in the early 1990s. The modernisation of the tax system was in place by 1993 and was an integral part of the Chinese strategy for export-driven and manufacturing-driven growth. In addition, in recent years, China's Central Bank has taken a number of monetary measures including raising the lending bank rate and revaluing of its currency, namely pegging it to a basket of currencies. (21) These reforms have provided impetus for the washing out of market distortions and have increased the incentive to invest in China.
It has been highlighted that the following three factors stand out in China's management of labour. (22) First, after the labour law reforms of the mid-1980s, all new companies in China have had the flexibility to retrench workers and apply productivity-based wages. These policies began with the units that were set up in the Special Economic Zones (SEZs) and now cover all new investment in China. Second, together with labour law reform, the government strengthened social security (e.g. provided assistance of USD35 per unemployed person per month in Beijing and USD10 per month in the hinterland for up to three years after the loss of a job) and eased previously stringent restrictions on labour mobility (imposed through the residence permit system). Third, employees are often provided a variety of facilities by the government or by companies, e.g., accommodation close to the place of work.
In addition, Chinese workers are quick to learn and are highly disciplined. Productivity is at its highest ever. Wages are relatively low and absentee rates are also low. The rights of management to discipline recalcitrant labourers are fully recognised by the government. This gives comparative advantage to Chinese products on world markets. To make use of this opportunity, a large number of MNCs have reallocated their manufacturing bases to China. However, rising labour costs and high attrition rates among skilled labourers in recent months are slowly causing foreign investors in the leather goods industry to turn towards India.
For enforcement of contract, which is fundamental to business, India ranks 173rd. Enforcement requires 56 procedures over 1,420 days in India, as opposed to 31 procedures over 292 days in China. Indian exporters must produce 10 documents over 27 days, against six documents over 18 days in China. The import cost per container shipped is USD1,244 in India compared to USD375 in China. Starting a business takes 35 days in India, the same in China. But winding up a business takes a phenomenal 10 years in India, 2.42 years in China. Debtors recover just 13 per cent of their claims in India, versus 31.5 per cent in China. Despite industrial de-licencing, Indian businesses still need 270 days to complete 20 procedures for various permits and licenses. Here, China is worse: 367 days for 29 procedures. (23)
Lessons for India
FDI inflows into China can provide benchmarks for India and other developing countries. Its success is clear in terms of benefits gained from FDI inflows. A number of key lessons for India vis-a-vis China would be useful, while taking into account India's differences, namely its political system and strength in the service industry.
Improve FDI Policies: The four major constraints which appear to play a prominent role in influencing FDI inflows into India are: (a) lack of policy initiatives, (b) inadequate infrastructure, (c) rigidities in labour laws, and (d) high fiscal deficit. A strong surge of FDI inflows into India may come about if these bottlenecks are removed. It is often said that while China is unconstrained by democracy and this has helped its leaders take bold policy decisions, India's democracy has often been unstable making it difficult for the government to launch bold economic policy decisions. However, this argument does not have much substance. Indeed, many bold and major economic decisions have been taken in India during the tenures of coalition/thin majority-based governments since 1991.
The Chinese experience in FDI--it has attracted more FDI than the US, making it the largest FDI recipient in the world--is of great interest to Indian policy-makers. China's FDI procedures are easier and decisions are taken quickly. The procedural clearances for setting up manufacturing units in China are quick and easy. The government provides infrastructure at affordable rates and foreign investment approvals are quickly cleared by local administrations. (24)
Create Best Business Conditions: A large part of FDI inflows into China is routed through Hong Kong. China has its SEZs which are free from most procedural hassles. The first ones were located on the coastline near Hong Kong and Taiwan. Many distinctive features have contributed to the success of Chinese SEZs, including FDI from non-resident Chinese, attractive incentives, low indirect taxes, other tax benefits, flexible labour laws, liberal customs procedures, decentralisation of power to local authorities etc.
China's success in attracting FDI and becoming one of the top exporting countries of the world hinged on the careful implementation of reforms on an experimental basis in the SEZs, and then using their demonstrated success to make them deeper and wider. This is an example worth emulating. In India's case, the key reforms should be taken with respect to bureaucratic hurdles, labour laws, rules, procedures, and policy and regulatory systems for private infrastructure investment. Ideally, all of these areas should be addressed in the Indian SEZs law. (25)
Attract Investment in Labour-intensive Industries: Part of China's success can be attributed to investment in export-oriented sectors. Huge investments have been made in labour-intensive industries such as textiles and toys. FDI has increased productivity across these industries. The Chinese government provides financial incentives such as tax rebates in the form of lower duties. This, coupled with the huge domestic economy, has resulted in low-cost products. As a result, China has become the world's manufacturing destination and its products and brands have started to acquire increasing brand equity in the minds of global customers. (26) In India's case, there is much scope for attracting FDI into small scale industries (SSIs). The process of economic liberalisation and market reforms should be accelerated to enable the Indian SSIs to face increasing levels of domestic and global competition. Improved manufacturing techniques and management processes can enhance the competitiveness of Indian SSIs which will attract more FDI.
Start Reforms in Infrastructure Construction: The Chinese performance in the infrastructure sector has been remarkable. Its success in the manufacturing sector through FDI is in large part due to its world-class infrastructure facilities. The main hurdle in India's economic development is the lack of infrastructure such as power, roads, railways, oil and gas, aviation, telecommunications, etc. There is also a need to improve transport between the metro- and port cities. The outlook for new infrastructure development will depend on how the investment is handled. Such investment requires long-term funds with long pay back periods, for example, from insurance and pension funds. Success can be facilitated by the development of a vibrant bond market and pension and insurance reforms. A single, unified exchange-traded market for corporate bonds should be created for financing infrastructure. (27)
When opening a Conference of the International Project Management Association, Indian Finance Minister P. Chidambaram said that India can replicate China in project management to speed up infrastructure development. Time and cost over-runs have become endemic in India. There are around 620 projects with a total investment of USD100 billion which are suffering from time and cost over-runs due to a shortage of project managers. Therefore, there is an urgent need to create new institutions for training project managers. Although a beginning has been made at both policy and operational levels to iron out bottlenecks in the infrastructure sector, many initiatives are still required.
Open up FDI in the Retail Sector: China opened up FDI in the retail sector in 1992 through the joint venture route. Its success in retailing can be replicated in India. For political reasons, however, the Government of India is taking a very cautious approach on this issue. In fact, opening up the sector would pave the way for Indian goods, especially farm goods, to get better access to global markets. Since these global retailers would stock Indian products at their outlets in the country, the products would also be increasingly sourced for sales in other countries. But, in India, a consensus has not yet been reached at the political level for opening up the retail sector for FDI. In this situation, liberalisation of the retail sector should be made in phases, incorporating a number of restrictions including a cap on the number of outlets in relation to the population of a region.
Start Reform of Labour Laws to Increase Investment: All new companies in China have the flexibility to retrench workers and pay productivity-based wages. In India, entrepreneurs are forced to choose labour-saving techniques due to the archaic labour laws. Clearly, rigidities in labour laws affect the domestic job market and raise the costs of companies, especially in the manufacturing sector. India cannot afford a "hire and fire system" without developing a proper social security network. It should amend its laws to favour flexible labour reforms. As a first step, short-term employment contracts and outsourcing of peripheral activities should be allowed.
Initiate Bold Tax Reforms: China has low to zero duties on industrial inputs and capital goods. On the other hand, India has to fulfil its stated objective of aligning its import tariffs with those of the Association of Southeast Asian Nations (ASEAN). A menu of options should be looked at to achieve this goal. India is still considered by foreign investors as a high cost and un-competitive manufacturer. Therefore, bold steps towards a modern and efficient tax system in India that incorporate the international best practices should be taken up.
With different national conditions, respective advantages and disadvantages, the two countries have adopted different ways and different models. (28) India's strength is its service industry, while China is the undisputed world-leader of manufacturing. The remarkable Chinese success in manufacturing and exports is closely associated with FDI inflows. For instance, in China, FDI accounts for over 90 per cent of exports of electronic circuits and mobile phones. Around 50 per cent of China's exporting companies are either foreign-owned or are partly foreign-owned. In India, merely 10 per cent of manufactured exports come from FDI. China is one of the biggest recipients of FDI amounting to USD63 billion in 2006, while FDI inflows into India were estimated at USD15 billion in the same year. A variety of reasons such as the early implementation of economic reforms with bold initiatives, world-class infrastructure, etc., are cited as reasons for large FDI inflows into China. Very clearly, China's heavy investment in infrastructure in the 1980s has given the country a head-start over India. India must recognise its infrastructure deficit and invest heavily in infrastructure to attract FDI on a large scale. A long-term policy perspective, willingness to get things done fast, perseverance and the importance given to infrastructure have given China its winning edge. India has many lessons to learn from the Chinese success in attracting FDI.
(1) IMF, World Economic Outlook, Apr. 2007.
(2) R.K. Srivastava, "China's Economic Performance: Lessons for India", Southern Economist (Feb. 2006): 23.
(3) David Burton et al., "Asia's Winds of Change", Finance and Development (June 2006): 11.
(4) V. Chinniah and A. Velonganni Joseph, "FDI in India and China: An Appraisal", Third Concept (July 2006): 45.
(5) Alok Sheel, "Tweedledee and Tweedledum?", Economic Times, 19 May 2005, p. 14.
(6) Charles Kramer, "Booming India at Risk of Overheating", IMF Survey (11 Apr. 2007): 96.
(7) Raymond Lim, "Creating a Globally Connected Asian Community", Finance and Development (June 2006): 30.
(8) Yao Chaocheng and Hu Yinping, "Studies on China and the Process of Asian Economic Unification", China Report 41, no. 2 (Apr./June 2005): 156.
(9) Ruchir Sharma, "China Does it Again", Economic Times, 27 July 2002, p. 4.
(10) V. Chinniah and A. Velonganni Joseph, "FDI in India and China: An Appraisal", p. 47.
(11) Government of India, Ministry of Commerce, FDI Data Cell.
(12) UNCTAD, World Investment Report 2006.
(13) UNCTAD, Trade and Development Report 2006.
(14) Harhe Vardhan, "Outbound M&A from India and China", Economic Times, 29 Dec. 2006, p. 14.
(15) Yao Chaocheng and Hu Yinping, "Studies on China and the Process of Asian Economic Unification", p. 156.
(16) "China's Dynamic Economy Needs Structural Reforms to Sustain its Rapid Growth", IMF Survey, 1 Dec. 2003, p. 353.
(17) World Bank, Doing Business Report 2007.
(18) Eswar Prasad et al., "Beyond the Great Wall", Finance and Development (Dec. 2003): 46.
(19) G. Anandalingam, "China Expands its Influence", Economic Times, 25 Apr. 2003, p. 6.
(20) T. T. Ram Mohan, "Much Ado about Outward FDI", Economic Times, 2 Nov. 2006, p. 14.
(21) R.K. Srivastava, "Chinese Currency Revaluations: Some Implications", Third Concept (Oct. 2005): 17.
(22) Confederation of Indian Industry (CII) and McKinsey, Improving Indias Competitiveness vis-a-vis China (2003).
(23) World Bank, Doing Business Report 2007.
(24) R.K. Srivastava, "FDI Inflows into India: Pitfalls and Outlooks", Southern Economist, 15 Aug. 2005, pp. 8-9.
(25) Arvind Virmani, "Changing the Face of SEZs", The Economic Times, 2 Feb. 2005, p. 140.
(26) V. Chinniah and A. Velonganni Joseph, "FDI in India and China: An Appraisal", p. 47.
(27) Government of India, Economic Survey 2006-07.
(28) Zhang Guihong, "China's Peaceful Rise and Sino-Indian Relations", China Report 41, no. 2 (Apr./June 2005): 167.
R.K. Srivastava (firstname.lastname@example.org) is a Reader of Economics at HNB Garhwal University, Badshahi Thaul Campus, Tehri Garhwal, India. He received his PhD from the University of Roorkee (now IIT) in economics. His main research interests are current international economic problems.
Table l. Comparing China and India China India GDP (1) USD2.2 trillion USD700 billion Foreign trade (1) USD1.4 trillion USD230 billion Foreign exchange services (1) USD820 billion USD147 billion Contribution to global growth (2) 15% 5% National savings (3) 47% 25% Adult female literacy (3) 87% 48% Investment in infrastructe (3) 7 % of GDP 3.5% of GDP Foreign Direct investment (1) USD60 billion USD5 billion Notes: (1) Figures are for 2005. (2) Figures are for 2000-4. (3) Figures are for 2004. Source: Chinese and Indian authorities; Economist Intelligence Unit; Goldman Sachs and UNESCO Institute of Statistics. Table 2. China's Booming Economy 2003 2004 2005 2006 * (% of GDP) Real GDP 10.00 10.1 10.2 10.00 Consumer prices (1) 1.20 3.9 1.8 1.5 (billion USD) Exports 438 593 762 937 Current account Balance 46 69 161 179 Gross official reserves (2) 412 619 826 1046 Notes: * Projected. (1) Period average. (2) Includes gold, SDR holdings and reserve positions in the IMF Source: Chinese and IMF estimated projections.
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