Vale Columbia Center on Sustainable International Investment

The unbalanced dragon: China’s uneven provincial and regional FDI performance

by

Karl P. Sauvant, Chen Zhao and Xiaoying Huo*

Among developing countries, China attracts most foreign direct investment (FDI). Where is this investment located within China, what explains its distribution and what are policy implications?

We used UNCTAD’s FDI Performance Index to answer the first question.[1] Although developed for countries, it can be applied to sub-national units. It uses provincial GDP to ascertain whether a given territorial unit has received FDI inflows as expected from its economic size. Standardizing the data accordingly reveals three clusters of provinces for 2007-2010 (table 1, figure 1 below):

·       The first cluster encompasses virtually all coastal provinces: they have an index value above 1, i.e. perform better than their economic size would lead one to expect. They account for 9 of the top 11 performers of Mainland China’s 31 provinces, municipalities and autonomous regions (“provinces”).

·       The provinces in the middle cluster underperform (index value of 1-0.5). They include 5 central provinces, but also 3 western and 2 coastal provinces.

·       The provinces in the bottom cluster underperform significantly (index value below 0.5), comprising primarily the country’s western provinces (8 out of the 10 provinces in this cluster).

Clearly, the further away a location is from the coast, the less FDI it attracts: the Coastal Region over-performs, the Central and especially the Western Region under-perform. These three clusters roughly correspond to China’s administrative regions (Coastal, Central and Western Regions), respectively.[2]

The Coastal Region has always been the best performer. Importantly, however, its share in China’s total FDI inflows declined from 89% in 1987-1990 to about 75% in 2007-2010; that of the Central Region rose from below 4% to about 17%, and that of the Western Region fluctuated mainly below 10%. Still, the share of the Coastal Region in total FDI inflows remains higher than its share in China’s GDP (84% vs. 56%); for the Central Region (10% vs. 25%) and the Western Region (6% vs. 18%), the reverse is true. However, while the Coastal Region as a whole has always performed better than its GDP predicts, its index value has declined from an average of 1.6 in 1987 to 1.3 in 2010; the Central Region improved its index value, but remained under 1; the Western Region remained under 0.5 for most of the period 1987-2010 (figure 2 below). This shows a moderate shift of FDI flows away from the coast to the interior.

Why this pattern and what to do about it?

First, while China’s overall regulatory framework is the same for all provinces, the Coastal Region benefitted from early economic liberalization and the establishment of Special Economic Zones; this created an enabling environment for export-oriented and market-seeking FDI. Liberalization began only later for other parts of China. While the Central and Western provinces have advantages that apply only to them,more could be done, e.g. granting longer tax incentives (and compensating tax losses centrally). Also, the degree of ease of doing business in provincial capital cities shows a pattern (table 2 below) similar to our index ranking,pointing toa potential to-do for policy makers. Moreover,officials need to understand better what role enterprises play in economic development and how a law-based market system works.

Second, the Coastal Region has the best economic determinants: high economic growth and mature markets, developed supplier industries, modern infrastructure, cheap skilled labor, and a favorable business culture; it also benefits from closeness to Hong Kong and strong links with overseas Chinese. Massive efforts are being made to improve the interior’s physical infrastructure, strengthen its science and technology capacities and upgrade its educational and skills offerings. Theseneed to continue: they lay the foundations for attracting more investment. Supporting enterprise development and industrial clustering would also be important, as would be higher wages to create a demand-pull.

Finally, all provinces in China have undertaken active investment promotion, but the coastal provinces could build on more favorable regulatory and economic conditions. Elsewhere, such promotion needs to be strengthened, by upgrading the capacity of investment promotion agencies (IPAs) to attract and service investors. The appointment of FDI Ombudspersons would help to identify areas for improvements and help mediate conflicts. Since coastal production costs are rising rapidly, the interior provinces could attract labor-intensive production from there, production that otherwise might move abroad. Twinning arrangements between coastal and interior IPAs could facilitate such internal relocation.

China’s Government has recognized that the country’s uneven development is a challenge that must be met. Key is to increase investment by domestic and foreign firms in the Central and Western Regions. Since, in the end, all investment is local, production conditions there need to be made more attractive. All three sets of investment determinants therefore require further strengthening. At the same time, efforts should not only concentrate on attracting investment, but ensuring that the attracted investment makes a significant contribution to the economic, social and environmental development of the recipient provinces.

The material in this Perspective may be reprinted if accompanied by the following acknowledgment: “Karl P. Sauvant, Chen Zhao and Xiaoying Huo, ‘The unbalanced dragon: China’s uneven provincial and regional FDI performance,’ Columbia FDI Perspectives, No. 62, March 5, 2012. Reprinted with permission from the Vale Columbia Center on Sustainable International Investment (www.vcc.columbia.edu).” A copy should kindly be sent to the Vale Columbia Center at vcc@law.columbia.edu.