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Time to encourage outward investment

By Yao Zhizhong (China Daily)
Updated: 2010-11-12 11:07

Decades ago, shortages in savings and foreign exchanges were the main reasons China implemented a policy that encouraged foreign direct investment (FDI). It followed the economic logic that FDIs should make up the shortages, by speeding up capital accumulation and boosting employment.

China's preferential policy toward foreign investment is believed to be one of the main factors the country has a growing economy.

FDIs, rather than foreign debts, helped avoid political hazards and foreign dependence brought by high-debt pressure, as well as financial risks caused by fast outflow of short-term foreign debts.

Advanced technology and management brought by FDIs have made the policy more of a success.

Since the late 1990s, however, shortages have been overcome and China now has an excess of savings and foreign exchange. The logic based on the shortfall has lost its foundation.

The inflow of FDIs helped social resources being transferred from relatively low efficiency government organizations to private companies with high efficiencies.

The regional market segmentation has been broken to propel free capital flows.

Now that market segmentation has been eliminated, low-efficiency State enterprises have been squeezed out of the market and private economy has become a driving force of China's economy. Therefore, benefits of FDIs in this regard may diminish.

Some people believe FDIs are a solution to China's technological advancement.

However, if FDIs bring in high technology, foreign companies' labor productivity should have been higher than that of domestic companies. But statistics show the opposite.

In 2006, labor productivity of foreign companies was 118,000 yuan ($17,700) a person; domestic companies labor productivity was 126,000 yuan a person. It shows that a significant number of foreign companies didn't bring in advanced technology.

China expects FDIs to bring in high technology, but they enter China for its market, cheap labor and land resources.

Foreign companies have costs to overcome language and cultural barriers, and have to spend more on supply chains and sales networks to adapt to local business environment.

Foreign companies need to achieve higher production rates to gain ideal profits. Higher production and sales costs than those of domestic companies will get them a higher production rate.

China's preferential policy toward FDIs helps foreign companies run with lower fixed assets and variable cost than domestic companies. They gain a high profits with lower production rate.

The policy attracts a lot of foreign investment of low technology and low efficiency. Of course, it is not what China wants.

To attract FDIs of high technology and efficiency, China needs to cancel some preferential policies regarding not only tax, but also land use, land price, financing and public supporting facilities.

When foreign companies have higher costs than domestic ones with no preferential treatment, the market will lean in favor of the high-performing ones.

In 2008, China canceled preferential income tax toward foreign companies, the most representative change of China's policy toward FDIs.

On Oct 18, the government canceled tax preferences toward FDIs. Preferences on land and administrative approval and management is also dwindling.

To cope with savings glut and excessive growth of foreign exchange reserves, China has begun to loosen its grip on Chinese companies' overseas investment - a move that goes with China's "go-global" policy.

In 2004, the National Development and Reform Commission and the Ministry of Commerce both introduced regulations on overseas investment.

Last year, the ministry made a further amendment to the regulation. The State Administration of Foreign Exchange in 2008 started to enact voluntary exchange settlements and last year, revised regulations on foreign exchange out of overseas investment.

Constraints on Chinese companies' access to foreign exchange have been loosened or have been canceled.

The author is a researcher at the Chinese Academy of Social Sciences.