Dimensions: 6'' x 9'' 211 pages AEI Press  (Washington) Publication Date: September 2004 Paperback ISBN: 084474106-X Price: $ 20.00 Add to Cart   Examination Copies

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October 2004
U.S. Direct Investment in China
By K. C. Fung, Lawrence J. Lau, and Joseph S. Lee

As China continues to grow into a global economic powerhouse, U.S. firms are investing more than ever in operations in China. U.S. Direct Investment in China (AEI Press, 2004) examines the trends, characteristics, and implications of this investment using data from government and the private sector in the United States, China, and elsewhere; from international organizations such as the World Bank; and from the results of three surveys of foreign firms that have invested in China.

K. C. Fung is a professor of economics and cofounder of the Santa Cruz Center for International Economics at the University of California- Santa Cruz. Lawrence J. Lau is vice chancellor of the Chinese University of Hong Kong and the Kwoh-Ting Li Professor of Economic Development at Stanford University. Joseph S. Lee is dean of the School of Management at National Central University in Taiwan.

In recent years, five crucial developments have shaped relations between the United States and China: joint cooperation in the global war on terror since September 11, 2001; China's role in hosting multilateral talks regarding the North Korean nuclear crisis; the cross-straits political tension between Taiwan and mainland China; U.S. outsourcing to developing countries, including India, Russia, and China; and China's entry into the World Trade Organization (WTO). The U.S. Congress granted China permanent normal-trade-relations status in 2000, and China's WTO membership followed in December 2001. These developments have kept the United States and China working closely together, particularly on the economic front upon which the authors of this book focus.

Chinese Market Potential

Thanks to having the world's largest population, which had reached 1.28 billion by the end of 2002, and to economic reforms initiated in 1979, China is one of the largest and fastest growing markets in the world. China's real gross domestic product (GDP) grew by almost 10 percent annually between 1979 and 2003, reaching $1.34 trillion (at the market exchange rate) by the end of 2003. The World Bank estimates that China's economy is, in purchasing-power terms, the world's third largest, behind those of the United States and Japan.

Although its per-capita income is still relatively low by developed-country standards, China represents a significant consumer market for domestic and foreign investors. China's 40-percent domestic savings rate and rapid economic growth have created a large demand for capital equipment and technology, thereby providing a wealth of opportunities for U.S. technological firms. China has the largest cell phone market in the world, and the Chinese purchase more photographic film than Japanese consumers and more vehicles than Germans.

China's domestic retail sales figures demonstrate the depth and strength of its market potential. According to the authors, retail sales have grown twenty-seven-fold in China since 1979, increasing from a total worth of 147.6 billion yuan in 1979 to 4,091 billion yuan (approximately $500 billion) in 2002. The International Monetary Fund (IMF) recently stated that companies investing in the Chinese market enjoyed average returns of 13 to 14 percent on invested capital during the latter half of the 1990s.

China attracts U.S. investment because of its ever-expanding domestic market, abundant labor supply, preferential tax and tariff treatment awarded to foreign direct investors, the avoidance of transport costs and non-tariff barriers to trade, exploitation of China's natural resources, and attractiveness as a low-cost production base for the United States to supply Asian and other markets.

Initially, foreign direct investors, especially from Hong Kong, concentrated on material processing and assembly. Foreign firms commonly subcontracted portions of the production process to Chinese companies, largely to take advantage of low labor costs. The output would then be re-exported from China. As Chinese demand has grown and large surpluses in its current accounts have made foreign exchange more readily available, the focus of multinational corporations operating in China has shifted toward sales in the domestic market.

Characteristics of U.S. Investment in China

China continues to expand its openness to direct investment from abroad. Before the WTO agreement, China would not permit any foreign direct investment in telecommunications services; China now allows up to 49 percent foreign ownership in selected cities. The WTO agreement also allowed foreign life insurance companies to own 50 percent of joint ventures. Foreign banks may now conduct local currency business with Chinese enterprises, and China has committed to full market access for foreign banks by 2006.

In 2002, the United States became the second-largest foreign investor in China behind Hong Kong. According to U.S. government statistics, U.S. direct investment in China runs at an approximate annual rate of $1.4 billion, yet this figure constitutes only 1 percent of the average annual U.S. direct investment outflow of $127 billion. The Chinese government recognizes U.S. direct investment at a significantly higher level-almost $3.7 billion per year, or 8.97 percent of its average total annual direct foreign investment of $41.2 billion. The discrepancy is primarily attributable to the differing methods used to derive each government's statistic. The U.S. figure counts only equity invested; the Chinese figure also includes investment funds raised through other means.

There are five main provinces and municipalities where U.S. firms commonly invest, listed by the authors in descending order: Jiangsu, Shandong, Liaoning, Guangdong, and Shanghai. U.S. firms tend to favor these provinces and municipalities on the coast because of their relatively high per-capita incomes, retail sales of consumer goods, and average monthly wage rates. Altogether, these five localities captured 68.3 percent of U.S. direct investment in 2002.

The authors identify three main methods of U.S. direct investment: Under an equity joint venture, U.S. and Chinese partners contribute capital to the venture and share profits accordingly. Within a contractual joint venture, the arrangements are more flexible, with specific contribution and profit distribution levels laid out in contracts. Lastly, a wholly foreign-owned enterprise is owned and controlled by a U.S. direct investor without any Chinese partner. 

China's manufacturing sector attracts the most U.S. investment. In 2002, nearly 60 percent of U.S. investment took place in manufacturing, with mining and utilities comprising 20 percent, the next largest share.

Surveys show that U.S.-invested firms as a group consistently realize profitable returns from their investments. Based upon data from the Bureau of Economic Analysis at the U.S. Department of Commerce, the average annual rate of return for U.S-invested firms between 1994 and 2002 was just over 10 percent. In 2002 alone, the average annual rate of return stood at 14 percent while the same rate of return for all U.S. direct investment hovered at around 8 percent. Additionally, the total net receipts by U.S. firms from net payments or royalties and fees from Chinese firms in 2002 amounted to $723 million.

Effects of Investment in China

Increasing investment in infrastructure by the Chinese government has promoted and will continue to promote growth in the Chinese economy. Starting in 2004 and continuing for the next several years, China plans to spend more than $1.2 trillion on infrastructure to develop its western and central regions, thereby helping to stimulate aggregate demand. Economic growth in China rose to 8 percent in 2000, 7.3 percent in 2001, and 9.1 percent in 2003, and the authors believe that 7 to 8 percent growth is likely to be sustained over the next several years.

Foreign investment has fueled the growth of trade as well, and the authors estimate that the bulk of the increase in total Chinese exports since 1990 has been due to the increase in exports by foreign-invested enterprises in China. Foreign-invested companies in China were responsible for $240.3 billion in exports in 2003, representing more than 50 percent of the value of all Chinese exports ($438 billion). Many of the foreign-invested companies import equipment, components, and parts from parent corporations in home countries like the United States. China became the fourth largest global exporter of goods and services combined in 2003, and the authors credit foreign investment with making China a player in world markets.

Foreign investment also spurs growth in China's GDP, largely by contributing to capital formation and adding a higher quality of machinery and equipment to manufacturing. In 2002 alone, foreign direct investment accounted for approximately 4 percent of China's gross industrial output and 10.4 percent of gross fixed capital formation.

In addition to boosting China's output, foreign direct investment can help China transform itself into a market economy by facilitating the emergence of the necessary financial institutions. By working with foreign firms and markets, Chinese domestic producers are encouraged to play by the rules of the market rather than the rules of the command economy, with which they have been more familiar. The need to compete on the world market can only improve China's productivity and economic efficiency, particularly through the transfer of technology.

Contrary to some of the heated rhetoric typical of a presidential election year, U.S. investment in China has not adversely affected the U.S. domestic jobs market to any significant degree; the authors instead argue that such investment proves to be "job enhancing, not job displacing" for the United States. Between 1993 and 1995, surveys show that 80 percent of U.S. firms investing in China did not shut down plants at home. In fact, in 1995, U.S.-invested firms in China imported more than one-third of their principal equipment from home, and more than 90 percent of such companies produced either completely different products or similar products at lower grade than those produced at home by parent companies. Today, U.S. direct investment in China still does not compete with U.S. domestic producers, according to the authors. Low-wage, low-skilled jobs employing Chinese workers today are more likely to have been lost by workers in Hong Kong or Taiwan, to which such jobs were lost from the United States thirty to forty years ago. Even as technological advancements continue, China tends to compete with Southeast Asian countries in manufacturing more so than the United States.

U.S. direct investment also increases the Chinese demand for U.S. capital goods, intermediate goods, services, and technology. The United States also consistently runs a surplus vis-ˆ-vis China in trade in services.

Looking Forward

The authors believe that U.S. direct investment in China will only continue to grow and prove profitable for both China and the United States. China needs, in particular, U.S. capital goods and technology, and the United States needs a reliable source of low-cost yet high-quality consumer goods. China cannot produce what the United States exports, and the United States has already largely stopped producing what China exports. U.S. firms will continue to invest in China to implement a strategy for gaining business in goods, services, and technology in what is potentially the largest market in the world. Both countries provide ample opportunities for foreign direct investment to grow further.

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