Foreign Investment in China

The growing amount of foreign direct investment in China encourages greater investment in other countries, particularly in Asia.

While foreign investors clearly are smitten with China, it appears that this infatuation has not lessened their affection for many other developing countries, contrary to conventional wisdom. In fact, China's alluring qualities may be making certain other nations, particularly China's Asian neighbors, more attractive than ever.

In Is China's FDI Coming at the Expense of Other Countries? (NBER Working Paper No. 11335), co-authors Barry Eichengreen and Hui Tong report that the growing amount of foreign direct investment (FDI) in China encourages greater investment in other countries, to the extent that they are part of the same interconnected global production network. The authors find that this complementary relationship is particularly evident in Asia, where China's economic explosion seems to be driving investors to support a regional supply chain for feeding China's burgeoning and varied enterprises.

Eichengreen and Tong show that as direct investment -- led by Japan --in China has gone up, it also has increased in places like Singapore, a major supplier of goods used in Chinese manufacturing, and Indonesia, which provides raw materials and energy to China. For example, Eichengreen and Tong observe that in order "to reap the full benefits of building assembly plants in China, firms may also need to invest in component production" -- such as electronic components used in Chinese manufacturing plants -- "in Singapore or Malaysia."

The positive effects of China's expansion may also extend beyond Asia. Eichengreen and Tong point out there "there has been much discussion" that increased investment in Latin America is being fueled in part by China's growing demand for that region's raw materials. "The increase in FDI in China thus may be encouraging additional FDI in other countries rather than crowding it out," they write.

Evidence that China's boom is essentially generating greater investments elsewhere runs counter to an often expressed view that China's rise has made it more difficult for other developing countries to attract foreign investment. However, Eichengreen and Tong point out that there are also instances in which investors appear to be giving certain countries -- and also certain industries -- the cold shoulder as they lavish attention on China.

For example, as Japan has increased its investments in China, it has decreased investments in the 30 countries of the Organization for Economic Cooperation and Development (OECD), which include Europe, Australia, Mexico, the United States, and Canada. Eichengreen and Tong believe that Japan has diverted investment away from OECD recipients because of a "desire to produce close to the market where the final sales take place."

Within Asia, the authors also find a weaker effect on FDI in low-income countries like Pakistan and Bangladesh that compete with China in the production and export of labor-intensive manufactures like textiles and apparel than in high-income countries like Singapore that produce components for Chinese exports. In addition, Eichengreen and Tong report that while China's growth has attracted more foreign investment to many of its neighbors, certain industries in these countries -- namely food processing and chemicals -- "are receiving less investment as a result of Chinese competition."

Overall, the story that emerges from this analysis is that, when it comes to the global allocation of foreign direct investment, "China's rise is both good and bad news." In general, it's good news for Asia (unless one happens to be in the food processing or chemical industries), but bad news for OECD countries. A key lesson, the authors observe, is that, tempting though it may be, there is little evidence to support "blanket statements" of any sort -- positive or negative -- about China's economic impact. They believe that the country's emergence as "perhaps the single most important new development affecting the world economy at the outset of the 21st century" should be viewed as a "mixed blessing requiring nuanced analysis.

-- Matthew Davis