Foreign firms in China Successstrategic choices

1、foreign firms in china: success by strategic choices this paper is part of the research project “mncs strategies: authority sharing by co-evolution” in the research program “shifts in governance: local states and private networks in china” sponsored by the netherlands organization for scientific res

2、earch (nwo).xueyuan zhangpatrick reinmoellerbarbara krugever since the economic reform started in 1978 china has attracted the attention of western academics and the business world (e.g. oecd, 2005; prasad, 2004). with average annual growth rates of real gdp 9.4 percent between 1979 and 2004 this ca

3、nnot come as a surprise. rather unexpected, however, was the fact that china outperformed the european transition economies. one reason given for this development is the contribution by foreign direct investment (fdi), more precisely the establishment of subsidiaries (i.e. foreign firms hereafter) i

4、n china (e.g. eiu, 2003; lardy, 1995). china has not only been the largest fdi recipient among developing countries in 2004, she attracted fdi inflows of 60.63 billion us dollar surpassed only by the united states and the uk. this development raises some questions. first, to which extent does chinas

5、 overall development depend on past and ongoing fdi? second, what actually explains the trend? in what follows an attempt is made to analyse the processes and activities of foreign firms to invest and produce in china. after all, without regarding china as an attractive location for investment and p

6、roduction, the observed fdi inflow would not have occurred. if enough foreign firms succeeded in china to induce more firms and/or more capital to follow then we assume that one or more of the following factors must have played a role. (1) a selection effect: by carefully choosing the best suited en

7、try strategy only firms with a high probability to succeed invested in china. (2) an integration effect: by acknowledging the specificity of the local business environment and developing complementary capacities the foreign firms can exploit the business opportunities offered in china. it is worth m

8、entioning that once production has started and increasingly more since the middle of the 1990s firms are confronted with locally rather than nationally designed constraints and opportunities (e.g. segal and thun, 2001). (3) a learning effect: by flexibly reacting to an unfamiliar business environmen

9、t characterised by frequent and sometimes drastic changes firms need to employ structures and routines allowing smoothly adapting to new chances and constraints. these three factors are not independent from each other. in what follows they will however be treated separately for analytical reasons. t

10、he chapter is organized as follows: after a general overview of the fdi landscape since 1978 (section 1), the analysis describes the factors why firms invest in china (section 2). the analysis attempts to identify factors that firms decide on entry choice (section 3), the local embeddedness and adap

11、tation (section 4). the analysis offers with a dynamic perspective and general outlook (section 5). 1. overview the economic reform and open door policy in 1978 broke the wall with the western world. at the beginning (realized) fdi increased gradually yet remained small. nevertheless annual realized

12、 fdi in 1990 was about four times that in 1983. this picture changed dramatically in 1990s. in 1992 alone the realized fdi added up to 11 billion us dollar, almost three times the amount of 1991. in 2004, it reached more than 60 billion us dollar, which is almost five times the amount of 1992 and 17

13、 times that of 1990. to put these figures in perspective it is worthwhile to have a look at the russia, as the case of another transition economy and india, as a case of another large economy of similar income levels in the 1970s.as figure 1 shows, fdi inflows in all three economies increased during

14、 the 1990s yet those in russia and india remained far behind china. in 2004 for example china received about 9 percent of the world total fdi inflows, as compared to russias 1.8 percent and indias 0.82 percent. insert figure 1 about herefdi inflows mean more than the transfer of capital and technolo

15、gy. it changes the ecology of the chinese economy when more and more foreign firms operate in china (see the column 2 in table 1), after decades in which china had remained outside the international division of labour. by the end of 2004 more than two hundred and forty-two thousand foreign firms ope

16、rated in china yet more than 90 percent of which have started only after 1990. the contribution of these firms became considerable. they became a major source for tax revenue (see table 1, column 3). in 2004 for example foreign firms generated more than one-fifth of the total tax revenue indicating

17、their crucial role in the economy and the states finances.insert table 1 about heremoreover, foreign firms contribution to the national economy is not limited to the inflow of capital or the generation of tax revenue. they are also the driving force behind chinas integration into the international m

18、arket as can be seen in the foreign trade statistics (see figure 2). since the reforms, china imports and exports have rapidly increased, well above the increase in world ex- and import. by the end of 2004, the imports and exports of china reached 561.38 billion us dollar and 593.36 billion us dolla

19、r respectively, with an average annual growth rate of 17.5 percent and 17.7 percent respectively since the beginning of the reforms. as a consequence, chinas contribution to world exports increased from 1 percent (in 1980) to more than 6 percent (in 2004). the export success of chinas economy is to

20、a great part the export success of foreign firms in china (figure 2). while in 1986, the share of foreign firms export in total export was only 1.9 percent, this share has increased to 57.1 percent in 2004. insert figure 2 about hereeven more striking is the extent by which the composition in export

21、 changed. chinas exports have shifted from natural resource-based products (e.g. grain and oil) to labour-intensive products (e.g. garment and textile products), and lately increasingly more to technology-incentive products (e.g. machinery and computer products) (see table 2). in 2004 machinery and

22、electronic products added up to 54.5 percent of the total export values, of which more than 70 per cent were contributed by foreign firms (china nsb, 2005). another example is emergence of a chinese it-sector in the 1990s, which proved to be internationally competitive to the effect that today china

23、 belongs to the top three world exporters (amighini, 2005). in this case too, foreign firms dominate chinas exports. 87.3 per cent of exports of high-tech and new technological products had been produced by foreign firms in 2004 (china moc, 2005).insert table 2 about hereall in all, the picture summ

24、arised above demonstrates the remarkable performance of fdi and foreign firms in china at the macro level, and invites a more detailed analysis of the underlying processes. the first question is why foreign firms would go to china? 2. why investing in china? economic analysis of foreign trade and fo

25、reign direct investment in china often cites determinants such as market size, economic development, labour market condition and infrastructure (e.g. cheng and kwan, 2000; wei and liu, 2001). market size (measured by gdp or gdp per capita) in combination with economic growth translates into business

26、 opportunities for foreign investors. likewise a huge labour force in combination with low (labour) costs plus a small but remarkably well trained technical personnel add to the attractiveness of china as a factor market (e.g. lu and liu, 2004; martin and manole, 2003). chinas infrastructure especia

27、lly transportation and communications is also no longer a bottleneck but contribute to the attractiveness as a location for fdi (china nbs 2005). another group of studies stress institutional factors, i.e. institutional incentives for fdi. the reforms were accompanied by liberalization in the foreig

28、n trade sectors such as the establishment of special economic zones, special tariffs and tax rates all attempting to attract fdi (e.g. fu 2000; ng and tuan 2002) and keeping the operating costs within china at a low level (e.g. krug 2004; krugman 1994). corruption and regulatory burden though ubiqui

29、tous have so far only started to deter investors from north america and europe (e.g. khan, 2001) while investors closer to china or her culture do not seem to be worried. it explains that asian investors from hong kong, taiwan, macao, singapore, south korea and japan, still dominate fdi inflow in ch

30、ina (e.g. li, et al. 2001; lu and zhu, 1995; yang, 1997; zhang, 2005). all in all, these studies confirm that both economic advantages and institutional incentives attract fdi to china. however, the studies focusing at the macro level dismiss two crucial aspects. first, china cannot be modelled as o

31、ne, let alone one integrated market. thus foreign firms need to respond to local rather than national boundaries of markets and institutions (e.g. dollar et al. 2003). second, the success of fdi in china depends crucially on the activities of foreign firms in particular their decision what to produc

32、e and where in china, how to organise business relations and how to deal with local jurisdictions.thus it is assumed in what follows that a firm-level analysis is needed to identify (systematic) factors by which the specificity of fdi in china and the performance of the fdi sector can be explained.

33、studies in international business and strategy addressing this issue point to the importance of choosing the “right” entry strategy, responding flexibly to the local environment while developing the capacity to adapt to changing circumstances (e.g. caves, 1996; ghemawat, 2003). in the following, we

34、discuss entry choices and local embeddedness of foreign firms in china respectively, attempting to sort out the major underlying considerations and their dynamic features to understand the behaviour of foreign firms in china. 3. investing by strategic entry choices3.1. perspective from international

35、 business and management one promising starting point for explaining why china has been chosen by foreign companies or mncs is the widely accepted dunnings eclectic approach (1977, 1988). at the core of the eclectic approach lies the question why foreign companies establish subsidiaries instead of e

36、xporting their products. internalizing production in this “eclectic approach” refers to the decision to invest in subsidiaries and is assumed to depend on two further considerations. the first consideration is a location advantage which according to the approach is not limited to differences in reso

37、urces or labour cost differentials. the advantage takes also into account the transaction costs in cross-border trade which can be circumvented when the production is located in, lets say, china. the second consideration is an ownership advantage when companies that need to keep control over their f

38、irm-specific assets, such as intellectual property rights, brand names, or research and development will forego contracts with chinese partners but insist on subsidiaries. in other words, the approach suggests behavioural patterns of foreign investors regarding the international production decision.

39、 it suggests for example that firms will the sooner establish subsidiaries the higher the value they attach to their firms-specific assets. likewise, firms will the sooner establish subsidiaries the higher the locational advantage offered by a host country such as china. firms will the sooner establ

40、ish subsidiaries the higher the transaction costs in the conventional foreign trade. in the case of china as described earlier the location decision needs to take into account the differences within the chinese economy. therefore, the last question is better formulated as follows: firms will establi

41、sh subsidiaries in that part of china which offers the best comparative advantage with respect to location. not part of the original dunning model yet a necessary complement in the case of china is the reference to risk diversification arguments. they suggest that investors or mncs benefit from loca

42、tional diversification when doing so offers scale and scope economies, more flexibility, and learning opportunities (e.g. hall and lee, 1999; rugman, 1979). thus, it can be assumed that firms will diversify risks by investing in different locations selected according to their respective advantage. w

43、hat is however not explicitly addressed by the dunning model is the question of how exactly production in china (or any other place) gets organised. entry mode studies offer further insights when they draw the attention to different forms of ownership and collaboration with chinese partners. these s

44、tudies show that the three dominating ownership modes, i.e. contractual joint venture (cjv), equity joint venture (ejv) and wholly foreign owned subsidiary (wfoe) can be explained by three considerations: transaction costs, capability exploitation/exploration, and institutional constraints. transact

45、ion cost consideration will cause foreign investors to claim more shares and control when confronted with asset specificity and/or opportunism on the one hand; and on the other hand, firms will opt for less (ownership) shares when facing uncertainty such as political or economic risks (e.g. anderson

46、 and gatignon, 1986; meyer, 2001). capability exploitation/exploration consideration will cause foreign investors to opt for ejv when they expect additional returns from broadening their resources and knowledge base (exploration) via a chinese partners distributional networks or local knowledge (e.g

47、. madhoc, 1997). on the other hand, firms will insist on wfoe when they expect higher returns from exploiting their firm-specific resources and capabilities (e.g. agarwal and ramaswami, 1992; luo, 2001). institutional consideration reminds firms that often enough the envisaged ownership forms is dep

48、ending on (chinese) regulation, but also on a perceived political (confiscation) risk (e.g. gomes-casseres, 1990; yiu and makino, 2002). in what follows it is assumed that both streams of literature, the eclectic approach and entry mode studies, together provide a fruitful guideline for investigatin

49、g the behaviour of foreign firms in china. 3.2. choosing the right location in chinathat firms invest in china, and starting at the end of the 1990s increasingly more has already been shown earlier. thus, the next question is to look for reasons behind locational choice within china. the statistics

50、shows that foreign firms unevenly spread within the country. as can be seen from figure 3, when listed according to province the ten most favoured locations are all to be found in the eastern region three regions are be separated in china. the eastern region includes: beijing, tianjin, hebei, liaoni

51、ng, shanghai, jiangsu, zhejiang, fujian, shandong, guangdong, and hainan. the central region includes shanxi, jilin, heilongjiang, anhui, jiangxi, henan, hubei and hunan. the western region includes guangxi, neimenggu, sichuan, chongqing, guizhou, yunnan, shaanxi, gansu, qinghai, ningxia, xinjiang a

52、nd xizang. . the eastern region hosted 82.43 percent of the total foreign firms that had been established by the end of 2004. this has to be seen in contrast to the twelve provinces called the western region, seven of which are found at the end of the list. the western region altogether hosted 6.53

53、percent of the total foreign firms up to 2004. that leaves the eight provinces that are called the central region hosting 11.04 percent of the total foreign firms up to 2004 (china moc, 2005). this pattern does not change so much since 1980s (oecd, 2002). insert figure 3 about hereempirical studies

54、analyzing the reasons for patterns of locational choice in china point to factors such as openness for trade, different economic growth rate, manpower, infrastructure, and preferential investment policies at the sub-national level (e.g. broadman and sun 1997; chadee, et al. 2003). however, the locat

55、ional advantage is also reflecting something that can be called investment climate which is generated by local jurisdictions (e.g. dollar, et al. 2003). thus, for example, many consulting reports and empirical studies attribute the high concentration of fdi in the eastern region, i.e. the pearl delt

56、a and yangtze areas, to the general investment climate, based on higher gdp per capita, high concentration of modern small and medium enterprises, higher education level, advanced transportation infrastructure, good shipping connection, and proximity to major international ports such as shanghai and

57、 hong kong (e.g. kpmg, 2003, 2005; pricewaterhousecoopers, 2004). a closer look, however, point to another determinant, namely the institutional advantage offered by special economic zones (sezs), “open” coastal cities, and development zones. since the early eighties, china has opened certain jurisd

58、ictions to foreign investors (such as sezs, open coastal cities, and open coastal regions), mostly found in the eastern region. these jurisdictions are often endowed with better infrastructure, less state intervention and better developed legal systems. empirical studies confirm that foreign firms p

59、ositively respond to these institutional advantages by deliberately locating their investment in these locations (e.g. li and park, 2006; ng and tuan, 2002). in a second step sub-national administrative levels were allowed to establish their own development zones. this led however not to a wider geographical spread, instead the new development zones closely followed the locational choice of fdi (see table 3 and compare with figure 3) insert table 3 about herewi