What do the foreign investors look for in China?

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What do the foreign investors look for in China?

--Evidence from provincial data and Western European companies

Rong Wei S2513889

University of Groningen Faculty of Economics and Business

Research Paper for MSc IFM

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ABSTRACT

This paper examines the determination of FDI decisions in China. Many factors can influence the foreign investor decisions. This paper analyzes the potential factors using the province-level data of China. The openness and GDP level are viewed as a reflection of the acceptance for foreign assets and economic level. Education background, infrastructure, labor cost, and consumption capability are also taken into account in the analysis. A questionnaire survey is conducted for better explaining the results. The economic level, labor cost and market size are considered by foreign investors when making FDI decisions in China. We find that the results are more consistent with the market-oriented FDIs.

Key words: FDI, China’s FDI, FDI determinations, Western Europe companies,

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1．Introduction

China, as a developing country, has become the world's third-biggest economy in recent years. Along with China’s rapid economic growth, China is becoming a potential market for many international corporations, thus attracting these enterprises to do overseas business or investments. In year 2013, Chinese government announced to open up the financial sector, which would be the boldest change in decades. Under this circumstance, this is the time for multinational enterprises to have more investments in China.

China’s FDI in flow grow by 5.25 per cent in 2013. The year-end figures released for capital inflows and foreign direct investment showed a stronger sentiment than in 2012 suggest and businesses and investors still see China as a growth market. Although the most investment into China comes from a group of 10 Asian countries, investments from the EU into China jumped 18.1 per cent to $7.2 billion in 2013, regardless the fact that investment in the EU fell 13.6 per cent at a time when the two sides are embroiled in trade disputes including on Chinese solar panels and European wine.

The main aim of this paper is to first analyze the factors that determine FDI inflows in China. Numerous studies have identified major determinants of FDI, including differences in capital return, market size of host country, openness, exchange rates, tax policy, et cetera. One of the prime topics among scholars researching on the Chinese economy is how to explain the country’s FDI boom; as consequence, a plethora of literature has emerged. For instance, Branstetter and Feenstra (2002) show that FDI inflows reflect openness level in China, while Cheng and Kwan (2000) find that large market purchasing power and good infrastructure are important determinants of FDI in China.Lardy (1995), Henley, Kirkpatrick, and Wilde (1999) identify potential market size, low labor cost, tax policy, openness, geographic proximity, and political stability as primary factors attracting FDI. Xing (2004) related the FDI inflow amount with the exchange rate volatility.

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5 the FDI assessment of several Western Europe companies about their business in China. The questionnaires were sent to several companies that may have a business relationship with China. The questions could provide information on their foreign investment level, especially in China. Focuses, motivations of these firms as well as the risks they may face are included in the questionnaire. This paper is one of the very few studies about the FDI assessment method in another country, choosing a developing country as targeted area and having a multi layered research structure. In the following pages, section 2 provides the information of China’s FDI inflow. The amount of FDIs has been increasing since 1980s. The structure and sources of FDI inflow are also included. Literature review of previous studies on determination of FDI decisions is also introduced in this section. Section 3 discusses the research methodology and it gives the reasons why some variables are chosen for analysis. Section 4 has the analysis and the results. FDI assessment methods are discussed in section 5. The last section is the conclusion and suggestion.

2．FDI in China and Literature review

2.1 FDI in China

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6 Figure1

Most of the FDI inflows in China come from Asian countries or regions. Hong Kong is the largest source of the nation’s FDI, accounting for more than 50 per cent of the total FDI inflow in 2012, followed by the British Virgin Islands, Japan, Singapore, Korea, Taiwan and America. In recent years, the pool of FDI in China has been diversified. The direct investment from EU kept above 5 per cent in recent years. Figure 3 shows that slight decline happened in 2007, the reason could be a diversified FDI inflow pool and the more attractive FDI destination such as central and Eastern Europe. Figure 2 0 20000 40000 60000 80000 100000 120000 140000 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10 20 12

FDI inflow China

78% 1%

6% 9%

4% 2%

FDI inflow in China,2012

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7 Figure 3

FDI is recognized as a means of better utilizing China’s resources in the absence of domestic capital and providing the Chinese with valuable experience of modern economic management skills. Although the Chinese leadership admitted that FDI is an effective way to acquire and master advanced technology and equipment from foreign countries, FDI was allowed only in a small number of industries. The government feared the dominance of foreign capital in many industries in the early time of the open policy. Later on, after President Deng’s southern tour in 1992, many more industries became open to foreign investors. Foreign investments mainly enter the industries such as manufacturing, retailing, real estate, transportation, and banking in recent years. FDI in China started to shift from labor-intensive and capital-intensive to mainly technology based manufacturing with an increasing share towards service sectors. 0% 2% 4% 6% 8% 10% 12% 14%

China's FDI inflow from EU

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8 Figure 4

2.2 Literature review

Generally, foreign direct investment is defined as foreign investments in which the investor owns more than 10% of the stock that is invested in. This usually refers to the investments by multinationals in foreign controlled affiliates or subsidiaries. FDI flows consist of two broad categories, one is the direct net transfers from the parent company to a foreign affiliate, either through equity or debt, and the other is reinvested earnings by a foreign affiliate.

Usually, the assessment of FDI decisions could be cataloged into internal or firm-level factors and external factors such as exchange rate, tax level and trade protection. Many of the recent works is trying to develop the theory and an estimation model for the behavior of MNEs.

Testing internal factors is difficult because the firm-specific factors are not public. This kind of information is unobservable and hard to measure because the FDI decisions are made by the managements or stockholders. R&D intensity, measured as the ratio of advertising and research expenses to intangible assets, can be used to measure internationalization of firms. The firms have to be innovative enough to join the foreign market. This variable has been generally accepted for the firm-level analysis of FDI decisions.

Manufactu ring Real Estate Wholesale and Retail Trades Leasing and Business Services Transport, Storage and Post others Percentage 44% 22% 8% 7% 3% 16% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% p e rc e n tage

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9 A large body of literature examining external determinants of FDI begins with financial motivation. These studies basically examine how the macro-economic factors influence the firms’ FDI decisions. The structure variables such as market size, growth rate, and tax policy can determine the FDI trend, or the long run equilibrium. However, variables such as preferential tax rates and rising GDP could not explain the short-term fluctuation of FDI inflows, in particular the downturn of FDI. The time-variant exchange rate may be the most appropriate exogenous variable for interpreting the fluctuation.

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10 variability discourages international investment.MNEs face tax rates at a variety of levels in consideration of double taxation: both the host and parent country and policies can affect the taxes on a MNEs incentive to invest.

A series of papers also underline the impact of double-taxation rules, in line with the initial theoretical studies by Hamada (1966) and Musgrave (1969). One may assume that enhanced FDI outflows to low-tax countries, because repatriated profits are then excluded from taxation. However, FDI flowing from countries operating credit schemes should be less sensitive to tax incentives because repatriated profits are subject to home-country tax rate. Since the mid 1980s, many empirical research addresses the issue of the desirability and feasibility of corporate income taxation in a context of globalization and perfect capital mobility. Devereux et al. (2004) shows that the loosened capital controls stimulate tax competition and thus reduce effective tax rates. Slemrod (2002) comes to a similar conclusion by providing consistent evidence of international competitive pressure, with the degree of capital market openness being negatively associated with corporate tax rates, although not with average corporate tax rates. Garretsen and Peeters (2007) concluded that increased volume of FDI generates a downward pressure on effective average tax rates.

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11 concluded that free trade agreements have positive impact on FDI inflows for this group of countries.

The labor cost is also a consideration of FDI. One may use either unit labor cost gross wages or total labor cost. Resmini (2000) considers gross wages and uses monthly earnings in the manufacturing sector for Europe countries. In contrast, Holland and Pain (1998) consider “relative” gross wages by dividing host country wages with GDP-weighted wages of all other host countries. Wunnava and Janicki (2004) use the differences between the home and host country’s labour costs by adopting the average labour costs per employee in the manufacturing sector from 1995 to 1999. It is commonly accepted that lower cost of capital could be attractive for FDI.

In terms of the infrastructure, the quality and availability of infrastructure facilities are quite important for foreign market operations. In a study on Romania, Hunya and Iara (2006) reported that the one of the unavoidable problem faced by investors is the underdeveloped infrastructures, especially transportation situation via highways and railroads. The transportation cost would reduce FDI since a foreign subsidiary has to import material or semi-finished goods from its parent economy (Zhang & Markusen, 1999). Furthermore, the construction with telephone mainlines, was used as proxy for the endowment with and quality of a country’s infrastructure (Kinoshita and Campos, 2006).

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3．Research methods

Given the purpose of examining factors determining of FDI inflow determination in China, a model is constructed by regressing China’s FDI on a set of domestic characteristics. The data used in our model are a panel spanning the period from 2001 to 2012 for all the 31 provinces in China. Thus, the number of observations in the panel is 372 (12×31). We start from 2001 because we believe the FDI attraction mechanism in China had been well established and thus the model helps us gain through combining the time trend and growth pattern of FDI inflows in China. The empirical model is

FDIt,i= a0+ a1FDIt−1,i+ a2opent,i+ a3gpc + a5roadt,i+ a6telet,i+ a7edut,i+ a8labct,i

+ a9csmt,i+ ut,i

, where subscript “i” and ”t” stand for province i in year t.

The dependent variable is FDI inflows. Foreign investment could be achieved through direct investment and indirect investment, normally. In the past, the classic definition of FDI has changed constantly. However, the core definition of FDI has remained. Traditionally, direct foreign FDI is made from fixed assets like machines, equipments or estates. With the development of technology, facilitated transportation, loosening of direct investment restrictions in many markets and decreasing communication costs, non-traditional forms of investment will play an important role in the future. The definition has been broadened to include merger and acquisition enterprise outside the investing firm’s home country. This form of FDI can be a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property. Our data of province-level FDI inflows are drawn from the national statistic yearbook (http://www.stats.gov.cn/english/). The independent variables included in the model are predicted to have influence on the FDI inflows through the economic channel and environmental differences such as infrastructure.

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13 The clusters also construct network for attracting the investors. Mucchielli (1998,2008) attributed the benefits into market potential, cost efficiency and flexible official rules. Foreign investors believe they can be benefit from the agglomeration with the supplier network and also can sufficient labor force; both are crucial for long-term earnings. Also, the investment herding could exert a positive influence on the preponderance of the local FDI environment and thus attract more potential investors.

Usually, there are two types of the FDI activities, based on their motivation. Market-seeking or horizontal FDI, which focuses on the market in host country, chooses local production to avoid the associated costs of trade, such as transportation and traffic. This is the type that dominated the FDI flows for the earlier decades and it still plays important role in today’s global economy. Apart from that is the so called cost-efficiency or vertical FDI where investors pick up different locations for each link of production chain to reduce the overall costs. Hanson, Mataloni and Slaughter (2001) indicate that recent surge of FDI inflows, especially to the South, is mainly of the vertical form. A similar conclusion is also found in Markusen and Maskus (1999), who conclude the differences of the type of FDI will have different implications on location determinants, e.g. market size, trade restrictions.

We consider host country’s per capita real GDP as a good indicator of its economic growth and average annual consumption for the market size. The real GDP per capita is calculated by the GDP level divide the regional population. In our regression model, the market size is measured by the average personal consumption. The acceptance to foreign investment is indicated by the open rate, which is the total amount of import/export to the real GDP. The average consumption is calculated as the totally annual consumption to the population.

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14 of cost considerations, even though it is not the first consideration when making the investment decisions. However, it still possible that, in some cases, a positive correlation will show up, because the labor cost can as a proxy for the purchasing power or income level. We use the wage rate in manufacturing as a proxy for the labor cost. The national statistic yearbook provides the data for individual province manufacturing wages. We convert the wage rates to US dollars using official average exchange rates drawn also from the year book annual exchange rate. As for the labor quality, the ratio of the graduates from universities and technical schools to the total local population is used.

Supported by Wei (2000), the host country’s infrastructure quality is another determination for attracting the foreign investments. An inadequate supply of infrastructure is rated by business as the biggest obstacle to operate in foreign affiliates, and improving basic infrastructure would drive up FDI. Fung, Iizaka and Parker (2002) and Fung, Iizaka and Siu (2003) find positive evidence that Chinese provinces with better infrastructure are more likely to become an FDI destination. The proxies for the host country’s infrastructure quality are the construction of transportation and the amount of business volume of post and telecommunication services. The transportation situation is measured as the total length of railway and highways.

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15 only 103 of the addresses are available on the companies’ websites page. Some of the companies are registered in China and some are not enterprises. They can be an international organization or schools. Moreover, the financial and service companies are excluded from the list. Only 103 emails were sent, among which 67 were sent through the Surveymonkey and 36 were from the direct emails.

Only ten useful replies were collected in the end. The low reply rate could be attributed to many factors. For instance, the one who fill in the questionnaire must be quite familiar about the company’s overall management. Questions like their foreign investment motivations and parts of their financial methods were asked in the survey. These questions are professional and need precision. The main aim of the questionnaire survey is to analysis the FDI assessment method in reality, and the further explain the findings of the regression model.

4. Empirical results

4.1Results for 31 provinces

Table 1

Mean Median Maximum Minimum Std. Dev.

FDI 102.4649 47.56466 1034.762 0.402201 146.2525 LFDI 89.96497 38.45066 963.5439 0.007634 130.6519 OPEN 33.39728 13.02738 174.9719 3.57267 42.14648 GPC 3174.768 2337.07 14454.2 345.067 2648.821 ROAD 53.63293 41.95121 205.1557 0.585803 42.24875 TELE 170.7148 131.8751 924.1265 15.43244 139.0086 EDU 0.675728 0.62481 3.155048 0.097401 0.428407 LABC 3027.285 2444.424 10302.1 805.1226 1846.964 CSM 1544.833 1170.92 8157.003 265.2236 1233.848

Statistical description of the variables

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16 Dependent Variable: FDI Method: Panel Least Squares

Ⅰ Ⅰ Ⅰ Ⅰ Ⅰ LFDI 0.961815 (0)*** OPEN -0.236387 -0.820774 -0.61827 -0.373119 -0.371878 (0.19) (0.0148)** （0.0556）* -0.2757 (0.2636) GPC 0.007636 0.029014 0.051316 0.057779 0.065582 (0.075)* (0)*** （0）*** (0)*** (0)*** ROAD -0.052529 0.05222 0.161548 0.03644 0.133232 (0.6592) -0.821 -0.4652 -0.8712 (0.5438) TELE -0.037731 -0.033922 -0.050914 0.003427 -0.024645 (0.0607)* -0.3672 -0.158 -0.9273 (0.5057) EDU 19.65439 6.391675 11.61141 -7.786503 1.846804 (0.0013)*** -0.563 -0.273 -0.4881 (0.868) LABC -0.001381 -0.028722 -0.023881 (0.6388) (0)*** (0)*** CSM -0.0057 -0.061685 -0.038655 (0.4735) (0)*** (0.008)*** R-squared 0.968134 0.877651 0.888851 0.88436 0.891167 Adjusted R-squared 0.964498 0.864907 0.876906 0.871933 0.879111 Durbin-Watson stat 2.19232 0.344283 0.37927 0.373415 0.388467 F-statistic 266.2384 68.86425 74.41569 71.16438 73.91679 Prob(F-statistic) 0 0 0 0 0

Outcomes of the panel least squares

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17 As shown in Table 1, large gaps are between the minimum and maximum in almost every variable. The uneven regional development has been a serious problem in China and the pillar industries are different provinces. For instance, the western China rely on the livestock industry and energy industrial while the eastern China has more foreign investments.

Table 2 provindes the parameter estimate for determinations of FDI inflows in China using the fixed-effects or the so called panel least squares method. ColumnⅠand Ⅴ compares the results for various specifications. The descriptions of each variable are shown in the appendix.

In column Ⅰ, which includes a regression on all the variables, the lagged FDI is strongly significant and positive, indicating a strong self-reinforcing effect of the dependent variable’s past value on its current value. Since FDI is considered a long-term capital investment that is irreversible in a short run, foreign investors are more cautious of their location choice. As mentioned above, the agglomeration of foreign investment will ensure these investors sufficient labor force and a qualified supply chain. When locations successfully attract members of foreign investors, this is usually considered by potential investors as the signal of a sound investment environment. To them, such an established environment will always be associated with positive externalities such as technology spillovers, skilled labors and productivity. The studies on U.S. (Wheeler and Mody, 1992) and Japanese FDI (Head, Ries, and Swenson 1995) about the agglomeration effects are in line with our finding. And this partly explains why the relatively advanced economies area, which began to absorb FDI much earlier than the others, continues to attract much larger share of FDI inflows. In China, the effect of agglomeration might be more obvious than other countries because of the openness policy. In the 90’s of 20th century, the government tried to have more worldwide businesses and several cities are appointed for the first trials. These pioneers are mostly located in the east coast, which are convenient for the shipping and logistics.

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18 the differences of R-squares in these columns. Apart from that, most of our variables have the expected signs. The economic level is indicated by GPC, real GDP per capita. As the literature suggested, the GPC level is attractive for new investment. Market-horizontal FDI mainly considers the market size by the economic develop level. Considering China’s national condition, a significant and positive sign of GPC is expected. When talking about the foreign FDI, the east coast will be the first choice for a potential investor. Apart from the agglomeration effect, the national policy encourages FDI destination though projects of industrial estate and tax preference, or even free tax zones. These projects were originally aimed at attracting FDI inflows in order to facilitate the economic growth. However, there are interactions or mutual effects between FDI inflows and economic development.

Our results show that the openness to trade is mainly positive but not strongly correlated with FDI inflows. The ratios of the provinces’ trade turnover to its GDP, known as the indicator of liberal trade environment in the specific region, is estimated positive. Openness here implies less trade barriers and restrictions for international business and FDI activities. However, the coefficient of openness is negative. In the empirical literature on FDI, a negative impact of openness to trade on FDI has also been found. One explanation is that more open economies tend to attract proportionally more foreign capital while the share of FDI in capital flows does not increase in economies that are more open (Hausmann, 2000). In our case, the biggest reason could be the measurement of openness. The openness for each single province could be better indicated not only by its import or expert amount. Through the domestic supply chain and logistic, materials and goods can flow across the country but the final products would be exported. In our calculation, the intermediate link of the final exported products is ignored.

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19 determined by the labor quality, and the higher payment is deserved by those having demanding jobs. That is why we introduce the variable of education. The education is the ratio of annual totally graduates from institutions of higher education and community college to the population. Thus, a lower level of skilled labor as indicated by a low education rates tend to deter FDI inflows. The labor quality is reflected though the acceptance of the new technology, the spillovers, the qualified rate of products. In the outcomes of column Ⅲ and Ⅴ, when exclude the huge influence of lagged FDI, the coefficient of labor cost is negatively related with FDI inflows. However, the education situation seems to have no influence in most outcomes. In China, the foreign investors are mainly focus on the labor-intensive industries, which are almost routine jobs and are not require the high level education. Another explanation is the mobility of the higher-educated employees. They are not bounded by geographic restriction. They are easier to find a job in other cities or provinces compared with the lower educated labor force.

There is evidence that a well-established infrastructure will facilitate the businesses for foreign investors. Transportation and Tele-services are proxies for infrastructure. Transportation is calculated as the ratio of the length of the railway and highway in net work over the total province area. Tele-service is measured as the business volume of post and telecommunication services of one province dividing the total population. In our regression outcomes, these two variables are not significant. One possible reason is the innovation of communication technology has threatened the traditional communication techniques. As explained above, the FDI are always attracted to large potential markets and the local market makes the transportation or logistic cost meaningless. The agglomeration of FDI establishments can also bring down the importance of transportation.

4.2 Hausman test

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20 province has its own individual characteristics that may or may not influence the FDI inflows. Another important assumption is that those time-invariant characteristics are unique to the individual and should not be correlated with other individual characteristics. However, the rationale behind the random effects model is that, unlike the fixed effects model, the variation across provinces is assumed to be random and uncorrelated with the FDI inflows. The crucial distinction between fixed and random effects is whether the unobserved individual effect embodies elements that are correlated with the China’s FDI inflows in the model, not whether these effects are stochastic or not.

In our regression model, the number of time series is 12 and the cross-sections is 31. This model includes all the 31 provinces in China. This means the chosen provinces have covered all the areas in China. Our goal is to compute the common effect size for China, and not to generalize to other countries. In random-effect model, the studies used an identical, narrowly defined region in China. Considering the special conditions of China, the outcomes may not be applied to other countries. In conclusion, the use of fixed-effect model is appropriate for our regression model. A Hausman test has been run here to decide between fixed or random effects and the null hypothesis is that the preferred model is a random-effects model. The significant p-value (0.0012) supports the use of fixed-effect model.

4.3 Regression results for the greater administration areas

Greater administrative areas were early top-level administrative divisions of the People's Republic of China that directly governed provinces and municipalities. These six divisions are separated based on the geographic locations, and they have local autonomy for their internal transactions. These divisions have the rights on policy-makings. The financial markets like banks are also divided in the same form of administration.

Table 3

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21 Statistical description of the variables

Table 4

Mean Median Maximum Minimum Std. Dev.

FDI 85.40539 63.53238 294.7414 4.825101 70.86474

LFDI 73.44901 51.59222 264.4553 4.280856 62.36991

OPEN 36.9813 34.53829 75.9808 6.702976 23.1065

Method: Panel Least Squares Periods included: 12

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22 GPC 1723.766 1250.656 6640.67 256.5298 1446.035 ROAD 35.01807 26.41855 110.5372 5.538828 28.20225 TELE 157.9774 140.2879 393.0057 24.89196 97.67059 EDU 67.40445 70.50909 174.3062 15.23916 36.28199 LABC 3014.498 2474.22 7416.333 1069.711 1731.069 CSM 1421.514 1139.651 3747.99 382.4676 877.4868

Outcomes of the panel least squares

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23 the vast section of the countryside is overlooked. The government has to appeal the world markets in order to rescue the ragged and faltering state-owned industries (Mehmet & Taube, 2002).

It is well recognized that agglomeration facilitates flow of labor force, spillovers, and supply chain. Urban and regional economics have provided explanations for the agglomeration of economic activity. For instance, the precision of the knowledge transmitting from one place to other decreases as geographic distance increases. The closer a firm is located to another in an FDI concentrated area, the more likely their employees will interact with each other, and the labor force would shift more frequently within these two companies. Moreover, the agglomeration is also important for supply chain or transportation between FDI firms and their local suppliers, which often are located close to one another (Cheung & Lin, 2003).

In conclusion, quite some factors could influence the determination of foreign investors. The chosen variables in the regression model are mainly deal with the external circumstance without consolidating with the firms’ internal aspect. In the following section, the results of questionnaire survey will be discussed related to the motivation and risks of FDI in China from the firms’ level.

5. FDI assessment method

5.1 Description of results

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24 risk when doing business in China? 2) How do you calculate the return of investment/cost of capital/cost of equity? The results of the questionnaire will serve as to assess the regression model results.

In the ten collective responses, five of them have annual turnover for no more than 25 million. The other five have the annual turnover range from 25 million to more than one billion. Most of the ten companies have more than 50 per cent of foreign sales, but there is no evidence showing the relationship between firm size (annual turnover) and internationalization (percentage of foreign sales). Since Chinese market is just one part of their foreign business, the percentage of business related to China is no more than 10 percent for the majority.

When asking about the main motivation for doing business in China, eight of the ten choose market expansion in the first place, compared to the two response collections choosing gaining knowledge. Even though market expansion can be achieved through export or the international supply chain, eight of these ten companies choose to have direct investments in China. Their main focuses in Chinese market are cash flows, profits, operation ratios or working capital, separately. Marketing risk and operational risk would be the major risks with investments in China.

5.2 Motivation of FDI in China

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25 amount or the actual amount of stocks and flows are higher than joint ventures and wholly owned enterprises (Yunwei Zhu, 2002). In 1986, the number of joint venture projects had actual surpassed the amount cooperative enterprises. From 1986 to 1997, joint venture enterprises have developed rapidly, and gradually become the main form of foreign direct investment in China. The year 1997 came to be a key point for FDI transformation (http://wenku.baidu.com/view/129a7306de80d4d8d15a4fca.html). The government allowed multinational companies in China to establish wholly-owned companies; and the wholly-owned company became the most popular pattern of FDI in 2000. Moreover, many of the original joint ventures eventually changed to wholly foreign-owned enterprises in order to have more profits and more power for decision making. Currently, there are two main ways for the transformation: one is asking for more controlling interest, the other is to move their affiliates into areas where they can have more holding power. Foreign investors can also get absolute control for the Chinese business through mergers and acquisitions, especially after China's WTO accession. Although FDI entering through mergers and acquisitions accounted for only about 5% of all the utilization of foreign capital in 2000, the process is increasingly showing the main features in the last decade. In the new inflow of foreign capital, the "greenfield" investment account for the sole major incremental manner. Besides, R&D centers for many technological companies are established in China to accumulate the resources in China.

From the above, we can conclude that, without policy restriction, the tendency for foreign investors is to have wholly-owned affiliates, among which greenfileds are also included. The foreign investment activities can provide the companies with that opportunity of joining a new market and also cheaper production cost. For small or medium enterprises, they can get one step further to the international business by having a foreign investment activity. And they can be benefited from the economic tie between two countries. Of the ten Dutch and Belgium companies, eight of have chosen to have direct investment even though their annual turnover is less than 25 million and their sales to China are less than 20 per cent.

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26 more actively involved in international business activities. The advantages of foreign direct investment come from a long-term relationship between two countries. This happens when a country involves itself in another country by transferring technology, expertise, or otherwise having an impact on this economy. It has an extraordinary role in maintaining the growth of global business as it can provide new markets and cheaper production facilities.

China is a typical country with surplus labor force, especially large rural population that lack of high education. Since 1990’s, a majority of FDI has flowed into the secondary industry. The expanding FDI affiliates create a lot of job opportunity that promotes the transfer of rural surplus labor to non-agricultural industries. The number of employees in foreign-invested enterprises increases year by year, from 6.12 million in 1999 to 45 million in 2012. The number of employees that foreign-invested enterprises absorbed is quite impressive. Yet, most of the foreign-invested enterprises are in the labor intensive industry so that the majority employees are lack of high education. The labor intensive industries do not need high-educated employees. Following this logic, the education will be a negative power for attract FDIs. However, two of the targeted companies want to acquire knowledge in China and thus they need high-educated or experienced employees. This is consistent with our previous findings that the education has no influence on FDI decisions.

It is generally accepted that with advanced levels of educational attainment, especially higher degrees will generate more salary nowadays (Elman & O’Rand, 2004). More than 90 per cent of foreign capital is invested in manufacturing like electronic and telecommunications equipment manufacturing, real estate development industry and social services. The extractive industry, finance and insurance, scientific research and education usually have nothing to do with FDIs. Five of the asked companies pay their attention on the profits and others are more concentrated on cash flows and operational ratios. The cost of production is an important determinant for profits. That is why the lower labor cost can attract more FDI, which has been proved in the previous regression result.

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27 service sector, or the whole production chain which includes research and development, procurement, sales and after-sales service. That’s why multinational corporations emphasize the importance of industrial agglomeration. Dunning & Lundan (2008) emphasized that cluster advantages can be result from three effects: 1) the natural endowment effect, which includes natural resources or low labor costs. 2) net work externality, one region that has absorbed FDI will therefore has the advantages to absorb more new foreign investors; 3) Policy-oriented effects. The host government policies can offer investment incentives for multinational investment. Mucchielli (1998,2008) combines the agglomeration theory with Dunning and concludes that there are four factors that will affect the location choice of multinational companies: first, the host market demand and market potential (market-oriented ); second, the host regions’ production costs (cost-oriented); third, the agglomeration of subsidiaries from the same home country or region (strategy-oriented); fourth, the host local government introduced preferential policies for FDI (policy-oriented). With the ten Dutch and Belgium companies that being surveyed, eight of them are mainly motivated by the potential large market in China. In the last several decades, the Chinese government has adopted an export-oriented strategy in FDI and the market-oriented FDI is not encouraged and even limited in some areas. The relatively small Triad FDI therefore can be explained as follows. What the MNCs from the Triad want most has been to sell their products locally rather than exporting abroad. In the previous part of this paper, the market size is measured by the consumption level the GDP level. Western Europe countries indicators are mostly market-oriented. This makes the variable real GDP per capita and consumption level meaningful to be examined.

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28 transportation infrastructure. Communications systems matter about the information collection and dissemination. Advanced communication infrastructures can reduce the cost of information collection to facilitate the exchange of information, so that investors can better understand the changes in the investment environment and thus reduce investment risks and increase return on investment. The volume of business post and telecommunication service has become a measure of the amount of the basic communication infrastructure. As to the surveyed ten companies, even though they are not asked for their specific destination of FDI to China, almost all of them establish their affiliates in the east coastal area.

5.3 Risks faced when joining a new market

The Chinese government wants inward FDI in order to create more job opportunities and stimulate the economic growth. However, the FDI operations cannot always generate mutual beneficial situation. The foreign investors are undertaking risks of joint venture enterprises because it reduces the profit of local Chinese enterprises. The wholly-owned enterprises will be faced of more risks both from the government’s policy and the internal decision-makings. Besides this, the market expectations and competitors can also get the investments into trouble. In the ten collected responses of the questionnaire survey, half of the companies choose operational risk while the others choose market risk as the greatest risk when having investment in China. Based on the definition of operational risk, the handling of operational risks is part of the firms’ internal management. Errors and mistakes are made from human’s confederations on investment decisions. In this paper, the focus is mainly on the external factors for FDI decisions.

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29 expand their market size, aiming at the Chinese domestic market. The exchange rate between the Euro and RMB will not burden the foreign investors on exports, and their production costs are incurred within China.

Before capital investment, the investors or managers need a planning process to determine whether the long-term development projects are worthy. Replacement of equipment, the new plants and new R&D input are all parts of the investment structure. When making the decisions, several methods can be adopted. Apart from the investors’ personal preference, the risk-taking is related with the choice of methods. Managers arrange the overall resources among several investing projects to maximize the shareholders value. The demand of owners forces the managers to use selection techniques for the evaluation of a capital investment project. Normally, there are four financial selection techniques the manager may use for the evaluation of an investment project. The Net Present Value (NPV) and Internal Rate of Return (IRR) methods are considered to be discounted cash flow (DCF) methods. The Payback Period (PBP) and Average Accounting Rate of Return (ARR) methods are so-called non-DCF methods. When discounted cash flow (DCF) methods are used in capital budgeting decisions, the cost of capital is expected to be accounted for in the applied hurdle rates, which represents the minimum rate of return on a project or investment required by a manager or investor. The DCF methods are expected to help selecting or ranking value derived from the capital investments by concluding the time value. In this point of view, the NPV is considered to be the most accurate technique to evaluate projects, and it is also the most sophisticated of the four, followed by the IRR method. Both non-DCF methods are considered to be less accurate, of which the PB method would be the least sophisticated.

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31

6. Conclusions and suggestions

In this paper, the FDI inflows in China are analyzed. China faces an influx of FDI income the several last decades. After 2000, the national policy for foreign investors has been polished. The investment environment in China is more open since 2000 and FDI has become a regular mechanism. Normally, foreign investors in China have a global strategic objective. They want to expansion their foreign market and the FDI is obviously a good choice. When making investment decisions in China, the situation of the host region are examined by the foreign companies. Market-oriented FDIs account for the majority of the capital inflows. The GDP level and the consumption level are more important. The foreign direct investments in China have the tendency to become cluster, which will facilities the production chain. Investors can also benefit from labor mobility. China has provide the foreign investors with much cheaper labor cost, which will decrease their production cost and generate more profits. Moreover, the infrastructure and average education level are adequate for the foreign investors’ needs since few of them are motivated by gaining knowledge. Based on the results above, the FDI decisions are greatly influenced by the lagged FDI amount. The agglomeration of FDI is attractive for foreign investors because of resources endowment and external network. The economic level, labor cost and consumption level are also important for foreign investors. However, the openness of the provinces has no relationship with the FDI decisions. The import and export goods in China are not totally rely on the foreign investments.

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32 supply chain. Besides, China’s economy development relies much on the export. Some of the foreign investments are also exporting-oriented. If they are not seeking for resources, the maritime transportation and coastline will then be attractive.

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Appendix

Variable Definition Calculation

FDI FDI inflow in China

FDI amount divide the provincial-population, in US dollar

LFDI

One year lagged FDI inflow in China

Lagged FDI amount divide the provincial-population, in US dollar

OPEN

The percentage of trade turnover to GDP

Percentage

GPC Real GDP per capita

Real GDP divide the provincial population, in US dollar

ROAD

The length of railways and highways within a province

Total length divide the provincial area

TELE

business volume of post and telecommunication service

total expenditures divide the provincial population

EDU

graduates of universities and technical school within one

province

graduates per year

LABC

labor cost in manufacturing sector

Yearly wages, in US dollar

CSM

consumption expenditures within one province in one

year

What do the foreign investors look for in China?