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The truth about US FDI in China

By T C A Srinivasa-Raghavan
October 13, 2007 08:47 IST
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It has always been something of a mystery to me as to how China attracts such huge volumes of FDI, especially when the rate of return there isn't very exceptional. I have, therefore, always believed that the data is dodgy.

For example, when China tells you how much FDI came in a particular year, it counts the entire project cost, not just the FDI part of it. Indeed, many people believe FDI into China is so high that it has a large effect on Chinese capital formation. But this is also not the case.

Now it seems there has also been a myth regarding the level of US investment in China as well. In a recent paper*, Lee Branstetter of Carnegie Mellon and C Fritz Foley of the Harvard Business School say that "a number of misconceptions distort the popular understanding of US multinationals in China." In seeking to correct those distortions they debunk four myths.

The first myth is that US FDI in China is large. The second myth is that US FDI in China is export-oriented. The third is that US investment in China comes at the expense of US investment elsewhere and the fourth is that US firms love China because of its technological capabilities. The truth, the authors say, is the opposite.

The first myth relates to the data. Thus, although even Chinese data "indicate that US FDI is a small component of total FDI in China, and data collected by US agencies show that American firms' investment in China is a small part of their total investment abroad," the truth is that Chinese estimates exceed US official figures "often by a factor of more than two." So if reality is one unit, Chinese data say it is two!

Why does this happen? Because, say the authors, China measures "actually utilised investment" by foreign invested enterprises, and these measures include investment that is financed by capital flows from the foreign parent as well as investment that is financed through local sources, including borrowing from local banks." How do you like that for cheek?

The second myth is about export orientation of US FDI. This is what the authors say. "What role do US affiliates play in this incredible surge of export growth? Almost none….The data illustrate that in 2004, about $39.7 billion of local affiliate sales were directed to the local market and only $3.7 billion were directed to the US market. In that year, US exports to affiliates and US imports from affiliates comprised less than 5 per cent of affiliate sales."

The third myth relates to a purely American problem: the perception that US FDI in China reduces it elsewhere, most notably in the US itself. Not true, say the authors. "…firms that expand in China are almost as likely to expand employment domestically as they are to cut it. This evidence is not what one would expect if growth in China were strictly displacing activity in the US."

Finally, the notion that China is now so good technologically that US firms are turning to it in droves. The fact, say the authors, is that technologically China is still nowhere in the picture.

The truth: "Less than 13 per cent of the $4.9 billion of the R&D that US multinationals performed in the Asia and Pacific region was performed in China...exports of high-technology goods are still quite dependent on imported components, technology, and expertise."

Overall result: "US affiliates based in China account for less than 2 per cent of total US affiliate sales, they contribute relatively little to aggregate Chinese investment, and they play a surprisingly small role in mediating the expansion of US-China trade."

It is not clear to me as to just what lessons India needs to draw from this paper. But one thing does seem pretty evident: China is likely to bluff more often than others do. The trick, as this paper demonstrates, is to call the bluff and see what happens.

*Facts and Fallacies about US FDI in China, NBER Working Paper No. 13470, October 2007

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T C A Srinivasa-Raghavan

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