Is China diverting FDIs?

Is China’s FDI Coming at the Expense of Other Countries?


China’s emergence has been perhaps the single most important new development affecting the world economy in recent times. By some estimates the country has contributed more than a quarter of the growth of global GDP in recent years.

Since the early 1990s, China has become a major destination for foreign direct investment. The country now has the third largest stock of FDI, after only the United States and United Kingdom. Although the country first opened its doors to FDI in 1979, the momentum picked up when Deng Xiaoping reaffirmed China’s commitment to market-friendly reforms during a tour of the southern provinces in 1992. Inflows first exceeded $30 billion in 1993 and ranged from $35 billion to $45 billion from 1994 through 2000, reaching $47 billion in 2001.

With China attracting foreign investment in a big way, there is an argument that the country has allegedly made it more difficult for other emerging markets to attract FDI. Thus, when FDI inflows into Mexico dropped from $3 billion in 2000 to $2 billion in 2003, it was attributed to China. When foreign direct investment in Malaysia fell from RM 19 billion in 2001 to RM 2 billion in the first half of 2002, Prime Minister Mahathir blamed China. Has China’s emergence as a low-cost production and export platform and its growing attraction as a destination for FDI made life tougher for other countries?

The increase in FDI into China must be seen in the context of the global growth of FDI. Net FDI flows to developing countries rose steadily over the 1990s, from $21 billion in 1989 to $179 billion in 1999. The bulk of these flows went to a handful of countries, notably China, Brazil, Argentina and Mexico. The economies of Central and Eastern Europe also attracted growing amounts of FDI over the course of the decade. But FDI in developing countries accounted for only a minority of the world total. In the second half of the 1990s, some 68 per cent of global FDI inflows were received by the advanced economies, a share that rose to 79 per cent in 1999-2000.

The FDI receipts of other Asian countries held up well through 1996, and their subsequent slump was presumably a consequence of the financial crisis of 1997-98. But flows of FDI to developing countries then declined by 26 per cent between 1999 and 2003, while those to China rose sharply. This created worries that China was diverting FDI away from East Asia and Latin America.


The main sources of China’s FDI have been Hong Kong, Taiwan, Singapore and Japan. Together these four countries have accounted for more than 50 per cent of China’s FDI receipts in the typical year. Japan is widely seen as an economy that may be redirecting its foreign direct investment from other potential destinations towards China.

Research on the subject by Barry Eichengreen a noted scholar does not indicate FDI diversion by China from other Asian countries. If anything, there is some evidence that the emergence of China as a more attractive destination for FDI has also made other Asian countries more attractive destinations for FDI. In many cases, China and these other economies are part of the same global production networks. Japanese firms are among the leaders in attempting to exploit these complementarities. Many, Japanese firms seem to be downsizing their operations in Singapore and ASEAN while relocating to China in response to both lower costs of production and the attractions of a large domestic market.

On the other hand there is some evidence of FDI diversion from OECD countries. This could be because FDI is often motivated by the desire to produce close to the market where the final sale takes place. Future growth potential clearly lies in China and other countries in East Asia. Again, Japanese firms seem to be among the leaders in redirecting their foreign investment in this way. Japanese FDI flows to China and other Asian countries tend to be positively, not negatively, correlated. The main exceptions are food processing and chemicals, where global supply-chain linkages are plausibly less prominent than in, say, consumer electronics.

China’s rise is thus good news for Asia, except for food processing and chemicals industries, which are receiving less foreign investment as a result of Chinese competition. On the other hand, China’s rise may be bad news for OECD countries in general and their manufacturing sectors in particular. In short, globalisation only seems to be creating a level playing ground.