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... current thinking on WTO- induced global competition for FDI and the lack of empirical evidence on the effect of the regulation policy in Chinese manufacturing industry The main objective of this... with the change in Chinese economic, industrial and regional development after the accession of WTO China encourages more FDI inflows into targeted manufacturing industries, such as environment-friendly,... sensitive, threatening or harming national economics China’s accession into the WTO did provide a good incentive for China to attract FDI The liberalization of FDI increases the output by the FIEs, which
THE IMPACTS OF WTO ACCESSION ON FDI IN CHINESE MANUFACTURING INDUSTRY ZHAO YI (M.Soc.Sci in Economics), NUS A THESIS SUBMITTED FOR THE DEGREE OF MASTER OF ECONOMICS DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY OF SINGAPORE 2014 Declaration I hereby declare that the thesis is my original work and it has been written by me in its entirety. I have duly acknowledged all the sources of information which have been used in the thesis. This thesis has also not been submitted for any degree in any university previously. Zhao Yi 10 March 2014 i Acknowledgement This research is under the kind guide and cooperation of many people. I would love to express my sincere appreciation to the following individuals for their support during this research: My supervisor Associate Professor Lu Yi, for advising on the main idea and methodology of this work, and for sparing his valuable time to discuss key issues. A/P Liu Haoming and Dr Sng Tuan Hwee, for their insightful inputs and advice during the presentation of this thesis. Li Yunong, Duong Hai Long, and other fellows from my batch for providing precious advice on the technical details. My parents, for their endless support during my Master’s study. ii Contents Declaration………………………………………………………………....i Acknowledgement…………………………………………………...…....ii Abstract……………………………………………………………………iv List of Tables…………………………………………………………..……v List of Figures…………………………………………………………....…v List of Abbreviations………………………………….…………………....vi 1. Introduction………………………………………….……………….1 2. Literature Review………………………………………………….….4 2.1 The benefits of FDI……………………………………………..….4 2.2 FDI policy………………………………….……………………....5 3. Empirical Framework……………………………………………....…8 3.1 Policy……………………………………………………..............8 3.2 Data...……………………………………………………………...10 3.3 Variables…………………………………………….………....11 3.4 Methodology …………………………………………………......13 4. Results..……………………………………………….……….…..…16 5. Robustness check……………………………………………….…..…20 6. Conclusion………………………………………………….….….…22 References…………………………………………………………..…24 Appendix……………………………………………………………...…29 iii Abstract In an attempt to comply with China’s joining into WTO in 2001, the Chinese Government published a new Guiding Catalogue for Foreign Investment Projects to further liberalize its FDI regime. This paper studies the impacts of this policy on FDI activities in Chinese manufacturing industry using dataset of the Chinese manufacturing industries over the period of 1998-2007. By adopting a Difference-inDifference approach, this study presents evidence suggesting that this policy significantly raised the openness to FDI of the encouraged sectors in the manufacturing industry. It is found that the promotion policy has a positive and statistically significant impact on the output share of Foreign-Invested Enterprises (FIEs) and employment share of FIEs. Thus the new catalogue significantly increases Chinese’s openness to foreign investment and improves the FDI intensity. Key words: WTO; FDI promotion; Policy; DID iv List of Tables Table 1: The contrast of Catalogue 1997 and Catalogue 2002………..……9 Table 2: Descriptive Statistics…………………………………………….30 Table 3: Single Industry’s Shares of FDI in manufacturing sector……….31 Table 4: The grouping strategy………………………………….…………11 Table 5: Baseline specification, dependent variable: output share……….16 Table 6: Baseline specification, dependent variable: employment share...18 Table 7: Full sample (Including Hong Kong, Macau, and Taiwan)…..….21 List of Figures Figure 1: FDI, net inflows to China from 1994-2012 ……………………………...29 Figure 2: The source countries of inward FDI flows from 1991 to 2008…..29 Figure 3: The amount of industries with over 10 billion FDI …………….30 v List of Abbreviations FDI: Foreign direct investment FIEs: Foreign-invested enterprises FTZ: Free trade zone GDP: Gross domestic product HMT: Hong Kong, Macau, and Taiwan SEZ: Special economic zone SOEs: State-owned enterprises WTO: World Trade Organization vi 1. Introduction According to the OECD, Foreign Direct Investment (FDI) is defined as “a category of investment that reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor.” (OECD, 2008) The liberalization of FDI has become a global trend and countries globally are competing for investment. This is no exception to China. The Chinese government started attracting FDI since the reform and opening-up policy in 1978. As early as mid-1980s, China has implemented a set of specific regulations on governing FDI inflow. Among them, the Guiding Catalogue of Foreign Investment Projects has been implemented as an important one, whose aim is to provide the criteria for the judging, examining and approving of FDI projects. Since 1992, FDI inflow in China has accelerated while Chinese government progressively attracted foreign investment by adjusting its FDI policies. It became the second biggest recipient of FDI in the world. At the end of 1997, to offset the negative influence of Asian financial crisis, the catalogue was amended for the first time on 29 Dec 1997, which was to be implemented from January in the following year. So after a decrease due to the Asian financial crisis in 1997, FDI inflows into China surged again. Figure 1 shows the inward FDI flows to China from year 1994 to year 2012. In 2001, China joined the WTO and signed the General Agreement on Trade in Services (GATs). Under China’s commitment to GATs, it is obliged to eliminate all quotas and quantitative restriction. In addition, China eliminates most restrictions on 1 foreign entry and ownership structure, and reduces most forms of discrimination against foreign firms. Under the agreement, China’s overall tariff level decreases from 22.1% to 17%. Besides this general agreement, the State Council of People’s Republic of China published a new version of the Guiding Catalogue of Foreign Investment Projects, which was to be implemented from 1 April 2002. Policies and regulations encouraging FDI inflows produce significant effects. Indeed, by 2003, China received more than US$50 billion FDI and it even once surpassed the U.S and became the largest FDI recipient and the largest manufacturing base in the world. It is significant that the accession of WTO improves the openness to FDI in China. Common determinants of FDI have already been identified and tested in various literature including large market size, labor cost, labor quality, share of the State-owned enterprises, stable macro and political economic environment etc. (Dunning 1993, Shapiro & Globerman 2001, Nuunernkamp2002). However, it is crucial for policy makers to know whether policy plays an important role in promoting the FDI activities. In this paper I will explore the effect of this catalogue change, which China has amended to comply with its accession to the WTO, on the actual FDI activities. The study is based on China Industrial Data from year 1998 to 2007. It uses the Difference-in-difference approach to examine the impacts of the liberalizations of regulations on actual FDI activities among different industries in manufacturing sector. Panel data regressions employing year and industry fixed effects and other control variables will be carried out. First, it shows that this policy has a statistically significant positive effect on the output share and the employment share of Foreign-invested 2 Enterprises. Second, this policy has been a significant determinant in boosting foreign investment, including investment from Hong Kong, Macau, and Taiwan as well. This paper is organized as follows: Section 2 begins with an introduction of the literature. It explores the benefits of FDI to host countries and focuses on the effect of host countries’ FDI promotion policy. Section 3 discusses the data and empirical methodology that were used in my analysis. Section 4 presents the result, which is the relationship between the policy and the openness to FDI. Section 5 deals with robustness checks. Section 6 concludes by summarizing the findings. 3 2. Literature Review 2.1 The benefits of attracting FDI Many research papers have focused on the benefits of attracting FDI. Firstly, FDI promotes the GDP growth. Without FDI, it would be slower for the economic growth. (Whalley&Xin, 2010; Borensztein et al., 1998) Berthélemy and Demurger (2000) found a fundamental role played by FDI in provincial economic growth in China by a simultaneous-equation model using a sample of 24 Chinese provinces from 1986 to 1996. Secondly, FDI produces the spillover effect. Chinese indigenous firms benefit greatly from R&D spillovers. Wei and Liu (2006) found a positive inter-industry productivity and intra-industry productivity spillovers by investigating 10,000 Chinese indigenous and FIEs from 1998 to 2001. Thirdly, FDI boosts the export and skill upgrading. Aitken et al. (1997) showed that exporting multinationals reduced the exporting costs for indigenous Mexican firms in the same region by using panel data on 2,104 Mexican manufacturing plants. Harding and Javorcik (2012) found that policies, which aimed at boosting FDI inflows in certain industries, could improve a developing country's ability to upgrade its export. They found that unit values of exports tended to be higher if the industry was targeted to attract FDI inflow by investigating 105 countries from 1984 to 2000. They argued that the industries that were chosen to be targeted by the FDI promotion agencies will tend to have higher FDI inflow than those that were not. This effect was more significant for developing countries than developed countries. Given the fact that inward FDI brings a significant number of benefits to the host 4 countries, it is necessary to examine the determinants of attracting FDI. This paper would focus on the effect of FDI policy in attracting FDI in Chinese manufacturing industry. 2.2. FDI policy Policy is an important factor that attracts inward FDI. It is crucial to concentrate on the effect brought by host country government’ policies and investigate into the investment regulations in attracting FDI. The FDI promotion began with the preferential policies. Since the reform and opening-up of China in 1978, the Chinese authorities have considered attracting FDI an essential task because it introduces new technologies, capital and know-how after several decades of autarky. In 1980, four special economic zones (SEZs), which include Shenzhen, Zhuhai, Xiamen, and Shantou, were established in the southeastern coast to attract foreign capital and advanced technology. In 1984, 14 more coastal cities and Hainan Island were opened to FDI. In 1985, 3 zones (Yangtze River delta, Pearl River delta, and the Zhangzhou-Quanzhou-Xiamen region) were set up to welcome FDI. In 1990, the Shanghai Pudong New Development Area was also extended to become one of the SEZs. In 2013, China (Shanghai) Pilot Free-Trade Zone even became the first free-trade zone (FTZ) launched by the Chinese government. All in all, ongoing effort to encourage FDI has been made. There is an ongoing debate as to whether FDI policy works effectively or not. In fact, there is a mix of answers to this question. Many studies found that FDI policies indeed work and it has a significantly positive impact on the location decision of foreign investors in China. A positive effect of investment incentives on inward FDI 5 flows was found by many scholars. (Grubert&Mutti, 1991; Loree&Guisinger, 1995; Cheng&Kwan, 2000; Taylor, 2000; Kumar 2002; Jones&Wrwn, 2006) Brewer (1993) showed that different kinds of government policies can directly or indirectly influence FDI through their effects on market imperfections. These policies include monetary policies, capital controls, government transfer pricing policies, antitrust (competition) policies, labor relations policies and intellectual property laws. Devereux and Griffith (1998) proposed that the fiscal incentives, for example, tax policy, do affect the FIEs’ decisions of FDI, especially for export oriented FDI. The effective marginal tax rate of the government would affect the cost of capital, which determines the optimal level of output of FIEs in each location. It would then influence FDI location decisions. Ng and Tuan (2001) found that foreign investors in Guangdong had considered that “economic and government policies” and “government administration” as two most important factors to influence their investment decisions. Buckley et al (2006) showed that policy activities promoted the multinational firms on a selective basis in Ireland. The education and training policy in Ireland coordinated to guarantee the supply of skilled labor so that the labor cost kept competitive for attracting FDI. Furthermore, Cohen (2007) argued that whether the host government takes action is the most decisive factor regarding whether the investment environment in a certain country is attractive to FDI. However, some research finds that policies have a weak influence on FDI activities. Caves (1996), Villela and Barreix (2002) concluded that tax incentives are ineffective once the dominant determinants of FDI have already been decided. These dominant determinants include the market size, presence of competitors, access to raw 6 materials, and availability of skilled or cheap labor. Only when it comes to regional FDI location decision, tax matters because non-tax factors become similar within the country. Nunnenkamp (2002) argued that little changes have been made by restriction or regulation on FDI. On the contrast, traditional market related determinants, such as population and GDP per capital of the host countries, are still fundamental factors to attract FDI. Moreover, Branstetter and Feenstra (2002) argued that Chinese government had put on more weights to the welfare of SOEs than the welfare of consumers. So it was politically difficult for China to follow through when it came to liberalizing its trade and FDI regimes, such as under the WTO accession. Therefore, it is very interesting to investigate the effect of FDI policy because the competition among the developing countries to attract FDI is becoming more and more fierce. Different host countries come up with various kinds of incentives or removal of restrictions to promote the inward FDI. Very little empirical research has been done to examine the effect of FDI policy in China, especially after China’s joining into the WTO. Thus, the current study attempts to supplement the literature by examining the effects of the FDI policy in Chines manufacturing sector after China’s access to WTO. The question addressed by this study is: How effective is the government policy in attracting FDI flowing to China? My empirical analysis, based on FDI data from Chinese Industrial Database, follows the difference-in-differences approach. I investigate whether industries that were becoming more “Encouraged” industries for attracting FDI exhibited higher degree of openness to FDI after the amendment of the regulation Guiding Catalogue of Foreign Investment Projects in 2002. In other words, I 7 compare FDI activities in “encouraged” industries before and after year 2002 to that of non-encouraged industries during the same time period. 3. Empirical Framework 3.1 Policy The Guiding Catalogue of Foreign Investment Projects divided the industries into four groups, i.e. encouraged, restricted, prohibited, and permitted. The “Encouraged” group focuses on promoting the new technological, capital-intensive or environment-friendly industries. It contains new equipment whereby its demand exceeds supply. In addition, it also contains advanced technology which improves productivity or controls environment pollution. The “Encouraged” category is given preferential treatment because they are in line with China’s accession into the WTO. The “Restricted” group includes those whose production exceeds the domestic demand, those under monopoly by the State-owned Enterprises, and those that explore rare and precious mineral resources. The “Prohibited” group contains generally those which do harm to the national environment, or the natural resources; those which damage the public interest, security or human health; those which use excessive amount of arable land; those which jeopardize the development or protection of land resources; and those which endanger the security and function of military facilities. Projects that are not mentioned in any of the above groups are classified as 8 “Permitted”. The permitted catalogue is not published. To comply with China’s access to WTO in 2001, the new version of the Guiding Catalogue of Foreign Investment Projects has been implemented since 1 April, 2002. The new catalogue significantly improved the openness to foreign investment. Firstly, compared to the 1997 version, the encouraged group has increased from 186 items to 262 items, while the restricted group has decreased from 112 items to 75 items. The detailed numbers of referred items are shown in Table 1. Table 1. The contrast of Catalogue 1997 and Catalogue 2002 Amount of items Encouraged Restricted Prohibited Catalogue 1997 186 112 31 Catalogue 2002 262 75 34 Secondly, the changes to the Catalogue reflected government’s endeavor to attract FDI in accordance with the change in Chinese economic, industrial and regional development after the accession of WTO. China encourages more FDI inflows into targeted manufacturing industries, such as environment-friendly, export-oriented and high-technological industries. So this catalogue provides a distinct measure of liberalization to test the effects of policy. I would refer to it to construct a policy dummy variable in the next subsection. 9 3.2 Data The main dataset employed for the analysis was from the Chinese Industrial Dataset. They contain the annual survey of manufacturing firms. It is based at the firm level and covers the period from 1998 to 2007. The number of sample per year varies from a low of 161,877 in 1999 to a high of 336,768 in 2007. The dataset contains information on firms’ names, their basic financial ratios (for example, startup capital, assets and liabilities, income and distribution, wages, welfare benefits, value added tax and cash flow), their operation situation (output and employment) and their corresponding 4-digit Chinese Industry Code (CIC). The descriptive statistic is shown in Table 2 in the Appendix. Since our regression is at sector level, we firstly aggregate the firm level FDI values data to sector level by using the four-digit Chinese Industry Code (CIC) Classification, which includes 608 codes in our sample. Table 3 illustrates the CIC code with the corresponding content. What are listed are those “super big” industries with more than 10 billion Yuan inward FDI. (See Table 3 and Figure 3) However, the items in the Guiding Catalogue of Foreign Investment Projects are quite narrow product categories. So we use a coordination table to match them with HS-10digit, then we covert to the CIC 4-digit for our analysis. 10 3.3 Variable Policy maker often considers the Sector targeting as the best practice. (Loewendahl, 2001; Proksch, 2004; Harding&Javorcik, 2012) To measure the effectiveness of this policy, we follow the literature and use a dummy variable to demonstrate whether one industry is encouraged by the policy or not. Firstly, as discussed above, according to the Guiding Catalogue of Foreign Investment Projects, industries are classified to one of four categories: encouraged, restricted, prohibited, and permitted. For the convenience of grouping, we reclassified restricted and prohibited industries as “Discouraged” group. See Table 4. Table 4. Grouping Encouraged Unchanged Discouraged The grouping strategy 1997 Discouraged Permitted Encouraged Discouraged Permitted Encouraged Permitted 2002 Encouraged Permitted Encouraged Encouraged Discouraged Permitted Permitted Discouraged Discouraged 11 111 industries 489 industries 8 industries As shown in Table 4, within the manufacturing industries, there are 111 CIC-4 digit industries belonging to the “encouraged” group while only 8 belonging to the “discouraged” group. So we ignore the “discouraged” group and focus our interest in the “encouraged” group. The treatment group is industries with policy changes, e.g. “encouraged” group. The control group is industries without any policy changes from version 1997 to version 2002. Dummy variable is used to indicate FDI policy change and it is denoted as fdi_change. It equals to one if an industry belongs to the “encouraged” group, and it equal to 0 if it belongs to the “unchanged” group. Industries are classified according to the 4-digit CIC 2003 classification. fdi_change = 1 An industry belongs to the “encouraged” group 0 otherwise Using random samples both before and after policy changes, this paper is able to test whether the regulation causes increase or decrease of the openness to FDI. 12 3.4 Methodology The difference-in-difference methodology is widely used for evaluating the impact of a certain event or policy. So I adopted the same approach to examine the impacts of the policy on the openness of FDI. I investigate whether industries that were positively influenced by the catalogue change for attracting FDI exhibited higher openness to FDI. As Lipsey (2007) pointed out, FDI flows may be a poor reflection of actual activities of foreign investors. Instead, the actual activities of multinational firms are the focus for most economists and policy makers. FDI is not only the flow of financial capital, but also a vehicle for the transmission of ideas and knowledge. The transmission of ideas and knowledge always happens during FDI operation: production, employment, capital investment, and R&D. Thus, we use the output share and employment share by the FIEs to proxy for the actual FDI activities. Then we compare FDI activities in encouraged (treated) sectors before and after the policy reform to those unaffected (control) sectors during the same time period. The basic model is: fdi_reg_output/output = + _ 2002 + + + + (1) The dependent variable is the output share of registered Foreign-invested Enterprises in industry i at time t. As discussed in Section 1, Hong Kong, Macau and Taiwan do not count in because of the “round tripping” issue. Some domestic capital flows to Hong Kong, Macau or Taiwan and then it is re-invested in Mainland China for 13 the tax evasion reason etc. They are not pure foreign investment. For the dependent variable, what we have is the firm level output data from year 1998 to year 2007. So we aggregate them into the industry level. X it is the control variable, which contains the following factors: Share_soe: The share of State-Owned-Enterprises within one sector. New_product_ratio: The value share of the new product to the total product Input intensity: The input value to the output value. If it is very high, it means that firms depend largely on their suppliers. This may influence their choices to locate their plants into the countries where suppliers agglomerate. Average size: This is the average of an industry. This may also influence FDI. Our empirical specification also includes industry ( ) and year ( ) fixed effects. The industry fixed effects net out all time-invariant characteristics specific to a certain industry that may be influential for FDI inflows. For instance, such characteristics include the availability of natural resources or the climatic conditions. Meanwhile, the year fixed effect nets out all time-invariant characteristics specific to a particular year. These fixed effects not only absorb FDI output shares among difference industries, but they also net out all observed and unobserved global factors that may change the relative FDI output share over time. 14 My regressor of interest is fdi_change*Post2002 which is at the industry level, and our dependent variable is also at the industry level. I cluster standard errors at the industry level. In addition, I check whether the policy change would have any effect on the employment share of registered FIEs in industry i at time t. The model specification is as follows: fdi_reg_empl/empl = + _ 2002 + + + + (2) The identification assumption is that our regressor of interest, fdi_change*post2002 is uncorrelated with the error term, E [fdi_change*post2002 , i.e., ]=0. (3) As discussed in Section 3.1, the revision of this catalogue was unexpected, and therefore it could be regarded as exogenous. This indicates the satisfaction of the identifying assumption (3). 15 4. Results The result corresponds to Equation (1) is presented in Table 5. The Fdi_change*post2002 is positive and statistically significant, showing that “Encouraged” industries tend to have higher output share compared to the control group and compared to the pre-2002 period. Table 5. Baseline specification, dependent variable: output share DV:fdi_reg_output/output (1) fdi_change*Post2002 0.027** 0.025** 0.027** [2.20] [2.10] [2.21] -0.247*** [-7.23] -0.028 [-0.36] share_soe new_product_ratio (2) (3) input_intensity (4) (5) (6) (7) 0.027** [2.21] 0.026** [2.13] -0.000 [-1.43] 0.025** [2.06] -0.244*** [-7.11] -0.012 [-0.16] 0.000 [0.01] -0.000 [-0.84] 0.036** [2.51] -0.244*** [-7.08] -0.011 [-0.14] 0.000 [0.01] -0.000 [-0.83] 0.009 [0.94] 0.019 [1.53] 0.017 [1.33] Yes Yes 4834 0.731 Yes Yes 4834 0.741 Yes Yes 4834 0.741 -0.001 [-0.02] average_size fdi_change _year1999 fdi_change _year2000 fdi_change _year2001 Industry dummies Year dummies Observations R-squared Yes Yes 4834 0.731 Yes Yes 4834 0.740 Yes Yes 4834 0.731 Yes Yes 4834 0.731 Note: Standard error clustered at CIC 4-digit. ***,**,* denotes significance at the 1, 5, and 10% level, respectively. The dependent variable is the output of FIEs to the sectorial output in industry i at time t. The data are available for 1998-2007. Fdi_change is a dummy taking one if the industry belonged to the “encouraged” group after the policy change, and zero if the industry was not encouraged. The fdi_change information is available at the 4-digit CIC 2003 level. All regressions include industry and year fixed effects. 16 In column 2 to 5 of Table 5, I include the control variables (i.e SOE_share, new_product_ratio, input_intensity and the average size) one by one. Clearly, I find my results are robust after including these additional controls. In column 6, I include all these four control variables together and find the coefficient of the interaction term still significantly positive. In column 7, I find that the interaction term were not significant before the policy change took place in 2002. This implies that it is the policy change that leads to the significant change of the dependent variable. The magnitude of the effect is very meaningful: the sectors that were encouraged by the policy are found to have higher output share by the FIEs. The output of the FIEs increases significantly, in the key industries of the FDI promotion. The traditional industries, such as light industry, textile, machinery, metallurgy, building materials, petrochemical and chemical industry, still take quite a large proportion in Chinese economy. The Chinese government continues attracting FDI to develop the new technology and devices in these industries. For the more capital-intensive industries, such as electronic components, auto parts and accessories, computer peripheral equipment, chemical medicine, semiconductor, the catalogue change has set more openness and freedom to absorb FDI. Therefore the effect of this policy is quite significant. Through attracting FDI with high technology the policy increases the output of FIEs. Potentially it will increase the varieties, improve the quality, save the energy and improve the productivity. 17 Table 6. Baseline specification, dependent variable: employment share dv:fdi_reg_empl/empl (1) (2) fdi_change*post2002 0.021** [2.00] 0.020* 0.021** [1.88] [2.01] -0.208*** [-7.03] -0.050 [-0.85] share_soe new_ratio (3) input_intensity (4) (5) (6) (7) 0.021** [2.02] 0.021** [2.00] 0.000 [0.29] 0.020* [1.94] -0.209*** [-7.03] -0.025 [-0.53] 0.015 [0.33] 0.000 [0.71] 0.021 [1.62] -0.209*** [-7.03] -0.024 [-0.50] 0.014 [0.32] 0.000 [0.71] -0.001 [-0.21] -0.006 [-0.65] 0.009 [0.80] Yes Yes 4835 0.762 Yes Yes 4835 0.772 Yes Yes 4835 0.772 0.017 [0.35] average_size fdi_change _year1999 fdi_change _year2000 fdi_change _year2001 Industry dummies Year dummies Observations R-squared Yes Yes 4835 0.762 Yes Yes 4835 0.771 Yes Yes 4835 0.762 Yes Yes 4835 0.762 Note: Standard error clustered at CIC 4-digit. ***,**,* denotes significance at the 1, 5, and 10% level, respectively. The dependent variable is the employment of FIEs to the sectorial employment in industry i at time t. The regression result corresponding to Equation (2) is reported in Table 6. A positive and statistically significant coefficient was found on the interaction term. This means that the treatment group tends to have higher employment share by the FIEs. FIEs created more employment opportunities, which facilitated the labor flows from agriculture or SOEs to the manufacturing FIEs. In column (2) to (5) of Table 6, I added in the control variables one by one and showed that the signs of the coefficients for interaction term are significantly positive for all four regressions. In column (6), 18 my result is still robust after adding all four control variables at one time. Compared to the SOEs, FIEs are characterized by a high degree of managerial and operational efficiency because of the higher standards of recruitment, better training of the employees. FIEs can think strategically on a global scale and organize a more integrated production networks. So the increase of the share of employment by FIEs will lead to an upgrade of the skill, and higher overall wages. The results of both dependent variables are consistent with the findings of Harding and Javorcik (2011) who analyze the effect of FDI promotion policies among 164 countries. They conclude that FDI promotion policies really work especially for developing countries. With the encouraging policy, the FIEs have become an essential pillar for the Chinese manufacturing industry and have played an important role in the industrial development of modern China. Not only it boosts the output by FIEs, but it also transfer the low skilled labor to the high skilled labor since the FIEs always bring along new and high technology. In this way, the catalogue change did have a significant influence on the openness FDI as more output was produced and more employment share was created by FIEs. FDI intensity has been deepened in the Chinese manufacturing industry since the catalogue change in 2002. 19 5. Robustness Check The above analysis is based on the sample without FIEs from Hong Kong, Macau, and Taiwan. The reason is as follows. Firstly, according to the National Bureau of Statistics of China, the investment came primarily (45%) from Hong Kong, Macau and Taiwan. However, the data does not show the proportion of investment that was channeled through Hong Kong, Macau by foreigners, and the proportion which was from Mainland Chinese investors for the sake of “Round Tripping” (i.e. for the sake of tax evasion or cheating the preferential policy by registering a company in Hong Kong, Macau or Taiwan). Secondly, as PRC becomes more opened and liberalized, the role of HK diminished from 2001 to 2008. Figure 2 shows the changing structure of FDI inflows over time. Before 1990, a majority of FDI came from Hong Kong. This may be because of the geographic proximity and culture linkages. Between 1991 and 2000, it seemed that global investments to China were frequently channeled through countries which have extensive international business and financial services, such as Hong Kong, Macau or the British Virgin Islands. However, other Asian countries like Japan, Korea, Singapore, have become increasingly important. The percentage of American and European investors has also increased significantly. As discussed above, FDI from Hong Kong, Macau, and Taiwan accounted for quite a large share of total inward FDI in China before 2000. However, this share has declined steadily after China’s accession into the WTO. Investments from other countries such as EU, Japan, Korea and US have increased significantly since then. 20 Hong Kong alone made up of 60.9% of the FDI stock in China from 1985 to 1990, but its share has decreased sharply. In the earlier analysis, we excluded the FIEs invested by Hong Kong, Macau and Taiwan to avoid the “round tripping” issue. However, it is worthwhile to examine the difference between the group without HMT and with HMT. Now we include them into the analysis and find that our results are still robust. Table 7. Full sample (Including Hong Kong, Macau, and Taiwan) Dependent Variable fdi_change*post 2002 (1) (2) fdi_reg_output/output fdi_reg_empl/empl 0.175* (2.13) Yes Yes 4886 0.795 0.0218* (2.00) Yes Yes 4945 0.797 Industry dummies Year dummies Observations adj. R-sq Note: Standard error clustered at CIC 4-digit. ***,**,* denotes significance at the 1, 5, and 10% level, respectively. As shown in Table 7, after taking HMT into the sample, the output share and employment share by the FIEs in the more encouraged sectors still tend to be significantly higher when compared to the unaffected industries and when compared to the pre-2002 period. 21 6. Conclusion With the accession to WTO, China further revises the Catalogue for the Foreign Investment Projects to liberalize its FDI regime. It sets up more industries that are more open to FDI. The regulation has been a huge success since it significantly improves the openness to FDI in Chinese manufacturing industry. Catalogue reform is taking place step by step. There is a gap between current thinking on WTO-induced global competition for FDI and the lack of empirical evidence on the effect of the regulation policy in Chinese manufacturing industry. The main objective of this paper is to narrow this gap by making use of the Chinese Industrial Data from 1998 to 2007. The output share and the employment share by the FIEs are used in this paper to proxy the openness to FDI, and the main finding of this study is that FDI promotion policy has a significantly positive effect on the openness to FDI in Chinese manufacturing industry. The output and employment share by the FIEs in the targeted industries are likely to continue to rise, with this promoting policy by the government. The policy does have a positive impact on the openness and freedom to FDI in manufacturing sector, apart from the fact that China’s overall investment environment remains attractive, with relatively good infrastructure, efficient public services, abundant and well-educated human resources, low labor costs, huge and rapidly growing domestic market. In the industries that are deemed as the lifeblood of China, the majority remains SOEs. However, in those industries whose initial investments are huge, such as thermal power, or those whose technologies are new and creative to host country, for instance, electronic devices, the policy has done well in encouraging the FDI to take a part. 22 Meanwhile, one important point to notice is that the policy shows that Chinese government affords to become more selective to FDI. WTO significantly improves the openness to FDI, and meanwhile it has gradually amended the regulations to restrict or prohibit FDI in some certain industries, which are sensitive, threatening or harming national economics. China’s accession into the WTO did provide a good incentive for China to attract FDI. The liberalization of FDI increases the output by the FIEs, which may bring along technological spillover to domestic firms. Besides it increases the employment share by the FIEs, which encourages the domestic labor market to upgrade from low-skilled to high-skilled. Meanwhile the overall wage may increase due to the wage premium by the FIEs. There are three policy directions that may promote FDI in the manufacturing sector in the future. First, China should devote more efforts to the domestic physical infrastructure, especially in the less comparative zones, e.g. western area. 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China Economic Review, 21(1), 123-135. Wu, Y. (2000). Measuring the Performance of foreign direct investment: A case study of China”, Economics Letters, Vol 66(2) pp 143-50 Invest in China (maintained by the Ministry of Commerce): http://www.fdi.gov.cn/. Ministry of Commerce of the People’s Republic of China: http://www.mofcom.gov.cn/. National Bureau of Statistics of China: http://www.stats.gov.cn/. 28 Appendix Figure 1. FDI, net inflows to China from 1994-2012 (in billion US$) 300 250 200 150 100 50 0 Source: World Bank Figure 2. The source countries of inward FDI flows (from 1991 to 2008) Source: China Statistics Yearbook, various issues 29 Figure 3. The amount of industries with over 10billion FDI (yuan), GDP deflator Amount of indutries with over 10 billion FDI (yuan) 35 32 30 24 25 20 20 15 12 10 5 4 6 8 8 2000 2001 0 1998 1999 2002 2003 2004 2005 Source: China Industrial Data Table 2. Descriptive statistics fdi_reg_empl/empl fdi_reg_output/output share_soe new_ratio input_intensity average_size No. of obs. 4935 4934 4935 3884 4935 4935 30 Mean Std.Dev. 0.205 0.185 0.273 0.216 0.219 0.211 0.081 0.102 0.771 0.089 325.211 400.692 Table 3. Single Industry’s Shares of FDI in manufacturing sector, percentage CIC02 Code description 1998 4411 Thermal power 4.1706 1810 Textile and garment 0.0349 4160 Electronic components 0.0273 1513 Beer 0.0236 3727 Auto parts and accessories 0.0167 2221 Paper and paperboard 0.017 4143 Computer peripheral equipment 0.0092 2822 Polyester fiber 0.017 3110 Cement 0.0159 4155 Integrated circuit 0.0109 3723 Bus 0.008 4151 Electric vacuum devices 0.0109 4143 Surveying and mapping tool 0.0093 4155 Communication terminal 0.0073 2230 Paper Products 0.0108 3090 Printing and dyeing industry 0.012 1921 Leather shoes 0.0097 2720 Chemical medicine 0.0084 3090 Plastic 0.012 3240 Steel rolling processing 0.0092 4153 Semiconductor 0.0035 2910 Tire manufacturing 0.0102 Note: These are the industries with more than 10million FDI inflow in year 2005 31 2005 3.7167 0.0264 0.0524 0.0124 0.0304 0.0173 0.0255 0.008 0.0109 0.0082 0.0145 0.0082 0.0255 0.0378 0.0124 0.0074 0.0113 0.0094 0.0074 0.0218 0.0192 0.0089 [...]... examine the determinants of attracting FDI This paper would focus on the effect of FDI policy in attracting FDI in Chinese manufacturing industry 2.2 FDI policy Policy is an important factor that attracts inward FDI It is crucial to concentrate on the effect brought by host country government’ policies and investigate into the investment regulations in attracting FDI The FDI promotion began with the. .. effect of FDI policy in China, especially after China’s joining into the WTO Thus, the current study attempts to supplement the literature by examining the effects of the FDI policy in Chines manufacturing sector after China’s access to WTO The question addressed by this study is: How effective is the government policy in attracting FDI flowing to China? My empirical analysis, based on FDI data from Chinese. .. Chinese manufacturing industry The main objective of this paper is to narrow this gap by making use of the Chinese Industrial Data from 1998 to 2007 The output share and the employment share by the FIEs are used in this paper to proxy the openness to FDI, and the main finding of this study is that FDI promotion policy has a significantly positive effect on the openness to FDI in Chinese manufacturing industry. .. its FDI regime It sets up more industries that are more open to FDI The regulation has been a huge success since it significantly improves the openness to FDI in Chinese manufacturing industry Catalogue reform is taking place step by step There is a gap between current thinking on WTO- induced global competition for FDI and the lack of empirical evidence on the effect of the regulation policy in Chinese. .. in the next subsection 9 3.2 Data The main dataset employed for the analysis was from the Chinese Industrial Dataset They contain the annual survey of manufacturing firms It is based at the firm level and covers the period from 1998 to 2007 The number of sample per year varies from a low of 161,877 in 1999 to a high of 336,768 in 2007 The dataset contains information on firms’ names, their basic financial... Taxation and investment promotion (No 4579) Inter-American Development Bank Whalley, J., & Xin, X (2010) China's FDI and non -FDI economies and the sustainability of future high Chinese growth China Economic Review, 21(1), 123-135 Wu, Y (2000) Measuring the Performance of foreign direct investment: A case study of China”, Economics Letters, Vol 66(2) pp 143-50 Invest in China (maintained by the Ministry of. .. Statistics of China, the investment came primarily (45%) from Hong Kong, Macau and Taiwan However, the data does not show the proportion of investment that was channeled through Hong Kong, Macau by foreigners, and the proportion which was from Mainland Chinese investors for the sake of “Round Tripping” (i.e for the sake of tax evasion or cheating the preferential policy by registering a company in Hong Kong,... and FDI regimes, such as under the WTO accession Therefore, it is very interesting to investigate the effect of FDI policy because the competition among the developing countries to attract FDI is becoming more and more fierce Different host countries come up with various kinds of incentives or removal of restrictions to promote the inward FDI Very little empirical research has been done to examine the. .. has declined steadily after China’s accession into the WTO Investments from other countries such as EU, Japan, Korea and US have increased significantly since then 20 Hong Kong alone made up of 60.9% of the FDI stock in China from 1985 to 1990, but its share has decreased sharply In the earlier analysis, we excluded the FIEs invested by Hong Kong, Macau and Taiwan to avoid the “round tripping” issue... government All in all, ongoing effort to encourage FDI has been made There is an ongoing debate as to whether FDI policy works effectively or not In fact, there is a mix of answers to this question Many studies found that FDI policies indeed work and it has a significantly positive impact on the location decision of foreign investors in China A positive effect of investment incentives on inward FDI 5 flows