Foreign Direct Investment in a Centrally Planned Economy: Lessons from China: Comment on
Kamath
Author(s): Richard Pomfret
Source: Economic Development and Cultural Change, Vol. 42, No. 2 (Jan., 1994), pp. 413-418
Published by: The University of Chicago Press
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Foreign Direct Investment in a Centrally
Planned Economy: Lessons from China:
Comment on Kamath
RichardPomfret
University of Adelaide
Shyam Kamath's recent study of foreign direct investment (FDI) in
China aims "to collate recently available data" (p. 108), in order to
draw lessons for FDI in other centrally planned economies (p. 109)
and for the future of China's economic development (p. 110).1The
article's conclusions are described as tentative, and they are rather
negative: the Chinese "FDI policy is unlikely to bear much fruit" (p.
123). In this comment I argue that stronger "lessons" can be drawn
from China's experience with FDI, and that this experience has been
a positive one. The major criticism of Kamath's article concerns its
failureto view the Open Door policy in a more dynamiclight. Kamath
mentions "considerable changes" (p. 108), but presents data mainly
on 1979-83 (and never beyond 1985)and treats this as the singleperiod
of the Open Door policy. Looking at the evolution of Chinese policy
underminesor even reverses many of Kamath'sconclusions.
Table 1 and figure 1 illustrate the growth of pledged and actual
FDI in China since 1979. The 1979-83 period was one of slow growth
in FDI, the first stage in openingup an economy that had been autarkic
for decades. Statements like "propertyrights do not exist" (p. 108)
capture the feelings of many foreign investors dealing with China in
these years. They were, however, an exaggeration,and, more important, Chineseauthoritiescame to recognizethe advantagesof codifying
propertyrights. This they started to do in a series of regulationsput
together in 1983-84, which provided the backgroundfor a boom in
pledged FDI in 1984and the first half of 1985. The boom ended as the
Chinese authorities became worried at their loss of macroeconomic
control, and as foreign investors found that while the situation had
improved, it was still not easy to do business in China. The biggest
single obstacle still facing foreign investors was the inconvertiblecur? 1994 by The University of Chicago. All rights reserved.
0013-0079/94/4202-0002$01.00
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TABLE 1
DIRECT FOREIGNINVESTMENTIN CHINA, 1979-90
1979
1980
1981
1982
1983
1984
6
$8
20
$63
28
$28
29
$29
107
$188
741
$1,060
$100
$74
$255
402
$926
331
$504
$531*
$227
$460
Equityjoint ventures:
Venturesapproved
Foreigninvestmentpledged
Actual foreign investment
Cooperativeventures:
Venturesapproved
Foreigninvestmentpledged
Actual foreign investment
4
4
. .
Actual foreign investment
Actual foreign investment
...
...
N.A.
...
320
$500
...
...
Whollyforeign-ownedventures:
Venturesapproved
None
None
Foreigninvestmentpledged
Jointoil developmentprojects:
Venturesapproved
Foreigninvestmentpledged
Actualforeigninvestment
Total:
Venturesapproved
Foreigninvestmentpledged
(Millions
...
70
$1,300
...
1,089
$1,480 $
4
$14
14
$262
12
$55
18
$44
26
$79
.
...
$40*
$43
$15
1
18
$170 $1,031
$497*
$292
None
None
$520
8
$110
...
4
$1,112
..
. ..
. .
348
$1,689
...
. . .
None
None
....
112
444
$1,590 $1,180
474
$1,767
$1,168*
$636
...
$
1,856
$2,619 $
$1,250
$
the years 1979-87, RichardPomfret,EquityJoint Venturesin Jiangsu
SOURCES.-For
in China: Ten Years of the Open Door Policy (Ames: Iowa State University Press, 1991), bas
(May 1988), p. 57; Almanac of China's Foreign Economic Relations and Trade (1986), pp
Review(March2, 1989),pp. 59-60; Business China(January30, 1989),p. 12. The last three
17-18, (June25, 1990),p. 43, (February4, 1991);andBusiness China(June25, 1990),p. 92,
EconomicRelationsand Tradedata.
* Totalfor 1978-82.
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RichardPomfret
415
$US Billions
A
7
Total DFI in 1990
-
$6.596 Billion
5
4
3-
Joint Oil
Development Projects
Cooperative Ventures
2-
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
$US Billions
B
43.5-
Total 1990 DFI
$3.437 Billion
32.5-
Joint Oil Development Projects
Cooperative
Ventures
21.51
0.5
0
1983
1984
1985
Produced by IEDP, East-West
1986
1987
1988
1989
1990
Center
FIG. 1.-Direct foreigninvestmentin China.A, Foreigninvestment
pledged.B, Actualforeigninvestment.
rency, and this issue came to a head in a well-publicizedconflict between American Motors and the Chinese authorities early in 1986.
That conflict was settled in an ad hoc manner, but the authorities
realizedthe need for a general solution. The outcome was the twentytwo Provisions of October 1986 that provided incentives for FDI, reduced the red tape and decentralizedthe approvalprocess for FDI,
and allowedjoint ventures to tradeforeigncurrencyat negotiatedrates
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416
EconomicDevelopment and CulturalChange
(i.e., henceforth hard currency could always be obtained at a price).
The consequence was a renewed and bigger FDI boom.
Thereare two lessons for other centrallyplannedeconomies. Lesson 1 is that simply allowing FDI is a necessary, but not a sufficient,
conditionfor substantialFDI to occur. Lesson 2 is the need to create
an appropriate "legal" framework (not necessarily in the western
sense, but at a minimum restricting the arbitraryabuse of power),
reducered tape, and allow some currencyconvertibility.These lessons
take time to be absorbed in a centrally plannedeconomy, as officials
need to overcome their suspicion of foreign capitalists and to understand foreign business practices and foreigners need to adjust to the
ways in which Shenyang or Kiev or Ulaanbaatardiffer from Chicago
or Essen or Bangkok.
One indicatorof the second lesson being learned in China is the
changinginstitutionalform of FDI. Kamathstates that the majorform
has been the cooperative venture, which is the most flexible (p. 112).
That was true before 1986 (see table 1), but not after the equityjoint
venturewas mademore attractiveby the October 1986Provisions(and
a 1988law defined cooperative ventures more precisely). Even more
dramaticis the growthof wholly foreign-ownedventures (WFOs)after
1986.These changes reflect a dramaticreductionin Chinese suspicion
of capitalistsover the decade and a willingnessto adopta morepositive
and liberalattitudetowardFDI. Kamath'sstatementsthat WFOs have
been discouraged(pp. 122-23) and policy towardWFOs has been contradictory (p. 112) apply to the early 1980s but not to the present
situation.
The precedingdiscussion has focused on the chronology of FDI
in China, which reveals an evolutionarypattern ignored by Kamath.
Kamathalso provides a distortedpicture of the characteristicsof FDI
in China. All studies of joint ventures (JVs) in China find a bipolar
distribution,with the majorityof JVs capitalizedunder $1 million but
the value of FDI dominatedby the large JVs.2 Other characteristics
are correlatedwith these, insofar as the small JVs are typically export
oriented, labor intensive, formed disproportionatelywith Hong Kong
partners,and, before 1986, located overwhelminglyin the special economic zones (SEZs), while the larger JVs are more likely to have
North Americanor Japanese partnersand to be producingmore capital-intensivegoods for the domestic market.
Kamath's discussion is at best confusing and in places wrong.
It is simply not true that the 1979 Joint Venture Law's purpose is
"inward-orientedand not aimed at export-led growth" (p. 122); the
law specified the twin goals of technology transferand export expansion. Nor is it true that large multinational enterprises have not been
involved in substantial FDI in China (p. 122); firms like Gillette, Bell,
American Motors, Pilkington Glass, and Schindler Elevators were
early joint venture partners, and today there are few large manufactur-
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RichardPomfret
417
ing multinationalsthat have no presence in China.The irony has been
that the large firmshave often been unwillingto operatewith the latest
technology in China (and when they tried to, as ShanghaiBell did,
there were productionand marketingproblems), so that the hardware
technologytransferthat Chinese policymakershoped for has been disappointing.It is also unclearjust how successful these largeJVs have
been; they have made profits for the foreign investors on domestic
sales, but their contributionto Chinese welfare is uncertaingiven the
distorteddomestic prices.
The small export-orientedJVs on the other hand have been indisputably successful. The initial concentrationwas in the Pearl River
Delta, and Kamath is right to emphasize the role of the SEZs (especially Shenzhen) as the proving ground for this type of activity, but
after 1986the small JVs also spread to other coastal provinces in the
search for lower labor costs. To say that FDI has not been a source
of export earnings(p. 120)is no longer true; from $320 millionin 1985
(1% of Chinese exports), exports by JVs increased to $2.1 billion in
1988(5%of the total) and $5.9 billion in 1990.To say that Hong Kong
domination of these JVs compromises the objective of technology
transfer(p. 116)ignores the very importanttransferof managerialand
especially export marketingtechniques. The lesson with respect to
technology transfer is that you do not always get what you want;
policymakerslike to see technology transferembodied in shiny hardware, but software may be more crucial. The small export-oriented
FDI is beneficialto Chinabecause it is highly profitable(typicallythe
investmentis paid back in 2-4 years) and the relevantprices (i.e., the
world price for the output and the wage rate for contract labor) are
not highly distorted so that financialprofitabilityis a reasonableguide
to social desirability.
The final lesson from China, then, is that the law of comparative
advantageapplies to emergingmarketeconomies; that is, socially desirableprojectsare those with a positive net presentvalue when traded
goods are valuedat world prices and othergoods and services at appropriate shadow prices. For China it is obvious that its comparative
advantagelies in labor-intensivegoods, andforeigninvestorswith marketing knowledge played a key role in enablingthe country to benefit
from the internationaldivision of labor. Thus the Open Door FDI
policy has borne fruit, and Chinese policymakers recognize this as
they continue to push the door open wider and to lay out the welcome
mat.3
Notes
Planned
1. ShyamJ. Kamath,"ForeignDirectInvestmentin a Centrally
DevelopingEconomy: The Chinese Case," EconomicDevelopmentand Cultural Change 39, no. 1 (October 1990): 107-30.
2. For example, Nigel Campbelland P. Adlington,ChinaBusinessStrate-
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Economic Development and Cultural Change
418
gies (Oxford:PergamonPress, 1988)p. 144; and RichardPomfret,Investing
in China: Ten Yearsof the Open Door Policy (Ames: Iowa State University
Press, 1991), p. 107. Most of the argumentsin this comment are developed
more fully in the latter book.
3. Recent changes include allowing JVs to operate indefinitely.Kamath
explainsthe short durationof early JVs in terms of foreign investors' desire
to avoid risk and uncertainty(p. 118), but this makes no sense because when
a JV's termexpires, the assets revertto the Chinesepartner.Earlyagreements
often had a short termprecisely because the Chinesepartnerwantedto obtain
title to the assets andthe foreignpartneragreeddespitethis. This is an example
of the gougingmentalitythat soured many early JVs but which the Chinese
authoritiesquickly learnedto be counterproductiveshort-termism.
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