The Effect of China's Rise on FDI Competition in East Asia: Crowding‐out or Crowding‐in?
| Date | 01 February 2016 |
| DOI | http://doi.org/10.1111/sjpe.12113 |
| Published date | 01 February 2016 |
| Author | Chan‐Hyun Sohn |
THEEFFECTOFCHINA’SRISEONFDI
COMPETITION IN EAST ASIA:
CROWDING-OUT OR CROWDING-IN?
Chan-Hyun SOHN*
ABSTRACT
This paper investigates the China Effect on FDI competition in East Asia: Does
China’s FDI crowd out or crowd in FDIs in ASEAN countries? Previous
research utilized a gravity equation that has no theoretical foundation for FDI
flows. This study applies a theory-based Knowledge-Capital Model modified to
incorporate preferential market-openings by FTAs and BITs that directly affect
investment and trade costs. Using country-pair data for China and ASEAN with
34 OECD home countries during 1985–2010, panel analyses are performed. The
results suggest that China’s rise does not threaten ASEAN countries but induces
a strong synergetic effect on FDIs into them. In attracting FDI inflows, China
and ASEAN countries are friends, not foes.
II
NTRODUCTION
A large number of developing countries are experiencing unprecedentedly sev-
ere competition when they try to host foreign direct investment (FDI).
Attracting FDI has become more and more competitive since the beginning of
the 1990s. Such FDI competition is a result of theoretical and empirical
knowledge: FDIs are intended to bring in advanced technologies and manage-
rial skills from multinational corporations in an FDI-sourcing advanced coun-
try (called the home country), to promote employment opportunities and
capital formation in the FDI-receiving developing country (called the host
country), and to facilitate diffusion of the home country’s technologies and
skills to the host country’s local firms; thereby, FDI enhances economic
growth of the host country. A higher level of FDI inflow means greater
economic growth. As a result, FDI competition is effectively growth competi-
tion for the developing countries.
Government officials and policy-makers in developing countries are keen to
emphasize the critical role of FDI in enhancing a nation’s economic growth.
They are eager to attract as much FDI inflow as possible. Even in harsh
*Kangwon National University
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12113, Vol. 63, No. 1, February 2016
©2016 Scottish Economic Society.
110
political circumstances, they adopt an investment liberalization regime and
develop various FDI-attracting policy measures.
East Asian countries are no exception regarding FDI competition. For
example, Malaysia has adopted an aggressive market opening policy for for-
eign investment since the mid-1980s and regarded this as a key driver for
exports and growth. Malaysia attracted massive inflows of FDI and boosted
its economy by over 8% in annual growth rate during the period 1988–1998.
Similarly, Vietnam implemented a foreign investment liberalization law in
1987, then aggressively attracting FDIs at an annual growth rate of 28% in
1988–2005. This surge of FDI inflows played a key role in expanding indus-
trial production bases and fostering the exports sector of Vietnam. As a lead-
ing free trade and open-market economy, Singapore has long been the top
FDI destination in ASEAN.
1
Indeed, there has been serious FDI rivalry in
East Asia.
2
The FDI competition in East Asia became much more complicated as
China joined in the rivalry. During the early stage of economic reform and
opening up to the outside world, China followed a gradualist policy toward
FDI. China experimented with FDI and confined it only to special economic
zones in Guangdong and Fujian provinces and only to export-oriented activi-
ties. Thus, China’s FDI inflows were not significant and did not have much
impact on neighboring ASEAN countries. However, FDI rivalry between
China and ASEAN has changed significantly since China became the top host
of FDI in East Asia after 1992. China after 1992 is an example where FDI
made a significant contribution to economic growth.
Figure 1 shows the FDI inflows of China and six major ASEAN countries
for the period 1982–2012. FDI inflows into China increased so rapidly that
for the first time China’s FDI exceeded that of ASEAN in 1992. With its
accession into WTO in December 2001, China became even more attractive to
FDI inflows. In contrast, most ASEAN countries except Singapore registered
declines in their FDI inflows after the Asian financial crisis in 1997. For
instance, Malaysia has shown a persistent decline in the ratio of FDI inflows
to gross domestic product. The gap of FDI inflows between China and
ASEAN persistently expanded afterwards.
Recognizing the threat of China’s rise in FDI competition, the Deputy
Prime Minister of Singapore, Lee Hsien Loong, in 2002 stated that Southeast
Asian countries had reached the point where competition with China had
become extremely difficult, and that FDI to China deprived other Southeast
Asian countries of investment flows.
3
The figures illustrate why ASEAN coun-
tries feel threatened by China’s rise. Many observers claim that China seems
to monopolize regional FDI and kick out all other East Asian countries from
FDI competition. China’s economic expansion seemingly absorbs all FDI
1
In this paper, ASEAN (Association of Southeast Asian Nations) refers to the six major
member countries: Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam.
2
The term East Asia is used to encompass only China and ASEAN countries: thus, it does
not include Japan, Korea, and Taiwan, as it is usually defined.
3
China Online, November 14, 2002.
THE EFFECT OF CHINA’S RISE ON FDI COMPETITION IN EAST ASIA 111
Scottish Journal of Political Economy
©2016 Scottish Economic Society
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