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Revisiting FDI in China

Revisiting FDI in China D N GHOSH This is a response to the comments by Matthew C J Rudolph (EPW, February 18, 2006) on my article (


I did not elaborate it any further, for in that process I would have deflected from

Revisiting FDI in China

the economic significance of some of the substantial benefits that have accrued to


his is a response to the comments by Matthew C J Rudolph (EPW, February 18, 2006) on my article (‘FDI and Reform: Significance and Relevance of Chinese Experience’, EPW, December 17, 2005). Discussion in India on the role of FDI swings from one extreme to the other. We have a strong body of opinion that sets out China as exemplar, and on the other, we have many who seek to explain away some of our failings, attributing it to the different systems and implying that, if authoritarianism can produce some spectacular results, so be it. The experience of China in inducting FDI needs to be appraised in the context of the conjuncture of political and economic circumstances in which it has been taking place. This was the theme of my article.

At the outset, I wish to clear the cobweb of confusion that seems to run through Rudolph’s scattered observations on my paper, namely, that I am inclined to take China as exemplar for India. This is not so. Having discussed the FDI story in China, I have set out clearly my views:

What kinds of lessons can we draw from Chinese experience? It is often said that if we shed our inhibitions about free inflow of FDI and follow in the footsteps of China, we would be in a position to attain a higher growth trajectory and realise our full potentials. This is flawed and misses out the true significance of Chinese experience.

Again, underlying some of Rudolph’s observations, there seems to be an insinuation that I have underestimated India’s strengths. This is not so; even at the cost of repetition, let me reproduce what I stated:

As India possesses some of the basic prerequisites for the development of a market-oriented economy, its approach to FDI could be arguably different….We have a strong private sector, that remained somewhat chained during the central planning paradigm, but with the restrictive regulations cast away in the beginning of the nineties, it has started demonstrating its entrepreneurial dynamics. We have been fairly successful in establishing a regulatory structure that can enforce a fair balance between entrepreneurial initiative and market discipline. In contrast to China, we have our rule of law, property rights and enforcement machinery that are being continuously strengthened and fine tuned. We have a financial system that is fast approaching international benchmarks. Our SOEs are far more efficient in terms of productivity and managerial capability. If, with all the assets that we possess, we are lagging behind China, the explanation has to be sought, not in the halting flow of FDI per se, but somewhere else.

I will clarify this further in the concluding part of my response.

Core of Chinese Experience

What is the core of the Chinese experience? I beg to be excused for recapitulating it. I need to do so as Rudolph has gone off at a tangent, digressing from the main thrust of my piece, quoting and interpreting some of my sentences out of context. While Rudolph agrees with me that FDI was for some purposes the “preferred instrument of change”, he asserts that I have not “sufficiently emphasised the political advantages that rendered the institutional structure of FDI-intensive development preferable. That this institutional ensemble was politically useful to CCP is attested to by its durability over the last quarter century.” I am puzzled over this observation; my narration does clearly bring out why the collective leadership that emerged after Mao had no option but to accept FDI as the preferred instrument in some sectors. What I stated was:

As the preceding paragraphs bring out, the political regime has deployed FDI as a solid supporting mechanism for the modernisation of Chinese industry and expansion of its trade in the first two decades of reform. Stability in the investment regime was the official watchword after the Tiananmen crackdown. The regime could not afford any slowdown in growth, far less any reversal of the reform process already in place from the 1980s. ...the basic dynamic of Deng’s open door policy continued; the regime could not afford to stop it, save at the cost of its own legitimacy.

China by allowing FDI in some sectors, particularly in town and village industries (TVEs).

Let me take this opportunity of elaborating it. The principal criterion in determining the content and pace of reform was whether it would pose any threat to the continuation of the existing regime. The Chinese approach towards reform and growth has been fundamentally dictated by the overriding compulsion of the ruling political regime not to initiate any measures that might hold the potential for the development of alternate sources of political power that aspire to challenge the present leadership; this is reflected in the way they treated FDI and domestic private entrepreneurs. The 1982 constitution, adopted six years after the end of the Cultural Revolution took a step-motherly attitude towards indigenous private enterprise, acknowledging the property rights for only self-employed enterprises. Not until 1988 was the constitution amended to include a clause that permitted establishment of private companies with more than eight employees. Even this grudging relaxation was hedged with the right of the state to exercise “guidance, supervision and control over the private sector of the economy”, as a “supplement to socialist state-owned economy”. The political regime must have been nursing a lurking fear that domestic private entrepreneurs could emerge as a veritable power centre in the polity. The experience of the 1980s convinced them that small entrepreneurs, if allowed to grow unchecked, could ally themselves with political dissident groups. It is only recently, in July 2001, (to which I had drawn attention in my article) that the then president Jiang Zemin announced that the Communist Party would welcome private entrepreneurs to join as party members. This has been in pursuance of the theory of “three representatives” proclaimed by Jiang Zemin as the official ideology of the Communist Party, institutionalising the “alliance between power and money” of the political and economic elite.

The Chinese political regime has always proceeded cautiously, whether in FDI or in any other significant reform measure,

Economic and Political Weekly March 25, 2006 stepping on one stone at a time, as it has had no previous experience to draw upon. The evolution and pattern of FDI flow reflected the incremental nature of the process, starting with the special economic zones (SEZs), in the coastal provinces of Guandong and Fujian in the late 1970s, followed by another SEZ in Hainan and 14 cities in the coastal region as “open coastal cities”. I have not, in any way, painted, as Rudolph says, “China’s FDI policy as an enlightened ‘plan-rational’ means of optimising economic growth”. Talking of FDI and the spectacular growth of TVEs in particular, there has been a conjuncture of circumstances that contributed to it.

With the policy of economic decentralisation (initiated in the early 1980s), an integral part of which was the centrestate revenue sharing system – the local governments had strong incentives to promote TVEs, as these could substantially contribute to revenues which local governments could retain for themselves under the revenue sharing arrangements. A crucial factor that contributed to the upsurge of TVEs was the agricultural boom that came about with the Chinese political regime instituting the “Household Responsibility System”. This system provided peasants with incentives to produce more, with better prices and better land tenure; farmers acquired fixed-term land-use rights in the late 1970s, which have moved towards full property rights in recent years. This brought about a dramatic transformation of ambience in the rural and urban countryside that had passed through a disastrous era in which collective organisation was promoted and approximately 30 million people died of starvation.

Foreign investors did not work in isolation; they worked in close collaboration with the local governments and their agencies, and also with private business entrepreneurs. Their role widened in 1993, when, in the 14th Party Congress, the political regime took the first major move for reforming state-owned enterprises (SOEs), with the policy of “grasping the big and letting go the small”. A very large number of small and medium enterprises were allotted to the local governments, with full authority to restructure and modernise them. Restructuring took different organisational forms: equity joint ventures, cooperative joint ventures and wholly-owned foreign enterprises, though it was not until 1986 that wholly-owned foreign enterprises were permitted outside SEZs. The 15th Party Congress (1997) took another momentous step by allowing more flexibility to foreign investors, with president Ziang Zemin declaring that the state did not have to dominate every sector or have majority ownership in every enterprise to maintain broad control of the economy; it was decided to focus only on a few enterprises and privatise those that did not fall in this category. Local governments took full advantage of this for the development of their respective provinces.

I have elaborately discussed, in the section titled ‘FDI as a Catalytic Agent’ how TVEs in labour-intensive and export processing sectors came to be actively encouraged through various forms of collaborative arrangements between foreign investors, the domestic business class and local governments. I am therefore puzzled when Rudolph asserts that I have not adequately emphasised the role of small and medium sector enterprises (The data given there were taken, as I have acknowledged, from Huang Yasheng’s book, Selling China, CUP, 2003. I am somewhat amused by Rudolph’s snide remark that I have missed “the central thesis of Huang’s work”; in any event I was not reviewing Huang’s book). Indeed I am in complete agreement with Rudolph when he says,“The flourishing of small industry in rural China’s township and village industries (TVEs) was one undeniably positive consequence of China’s FDI policy. The TVE boom provided employment and spread the benefits of industrial growth beyond core urban areas.” The spectacular benefits that China derived from TVEs are given in this note.1

Two Track Approach to Reform

While FDI was deployed by the political regime as a new catalytic instrument of growth, let us not get away with the impression that SOEs were allowed to languish. For the key SOEs, 500 or so, (out of a total of 16,800) regarded as ‘sanctum sanctorum’ of the command economy, China had a different approach. Notwithstanding their well known inefficiencies and mounting pressures for privatisation, China did not let go of the control over SOEs and pushed through massive investments financed from the banking sector into them, in lieu of direct budgetary resources (which in fact was only a technical cosmetic for presenting a better fiscal picture). She never allowed the urgency of infrastructural development to be deflected by any other conventional consideration. In fact, if we look at the road journey along the capitalist path, decisive liberalisation measures of the key financial and economic institutions came much later, towards the end of the 1990s. In heavy industries, communication, energy, mining and defence, the SOEs continue to remain under state tutelage, following the dictates of the state and getting assured support from the state-owned banking system for financing their ventures. Significantly, until 1998, the largest Chinese banks were under instructions not to lend to private firms. What China ensured was, in effect, the transfer of the bulk of household savings in banks to investment in infrastructure On this policy plank was built up the infrastructure in all key areas, in energy, telecommunications, roads, ports and real estate that have today turned out to be spectacularly successful. Part of the success may be attributed to FDI, but it was inducted in select SOEs for accessing their technological expertise and management skills, but without diluting state control.

China’s policy of progressive market orientation proceeded in a compartmentalised fashion, one can see, as we have tried to describe earlier, how the consensus has actually worked out in practice. We see market forces in full play in the development of labour-intensive and export processing industries, and simultaneously, how, some key SOEs were kept under strict state control; similarly, also the duality of approach in the phasing of reforms in the price sector, in the restructuring of SOEs and the financial sector. A marketbased economy developed alongside a centrally planned economy, China did not commit to any predetermined policy pattern; it could not. The reform paradigm, under post-Mao leadership, which was collective in nature, had to be necessarily accommodative to divergent points of view; in fact, this would appear to be so from the way state market relationships have evolved from the beginning of the reform process in 1978. The course that reform took was the outcome of an interactive process between conservatives and reformers: conservatives refer to those who upheld the essential features of the planned economy, and sought to strengthen and improve planning, making it less allencompassing rather than introduce market forces throughout the economy, while the reformers, in contrast, sought a market-oriented reform that would redefine planning in terms of making long-range development plans, forecasting, and exercising macroeconomic controls.2

I have confined myself to responding and clarifying certain significant aspects of FDI policy in China where, in my view, Rudolph has missed the principal thrust of

Economic and Political Weekly March 25, 2006

my paper. I am not responding to many of his observations, which are not directly related to the theme of my paper. For example, in the section titled ‘China: Leninist Capitalism’, he has discussed some aspects of securities in the two countries. The securities market in India is highly developed today, thanks to the painstaking reforms that were carried out over the last decade. In comparison, the securities market in China is highly politicised; “securities finance in China”, as Rudolph observes, “does not provide a market for companies or a market for corporate control”. I have chosen not to discuss the role of foreign institutional investors (FII) in capital market reform, for that would take me completely outside the scope of my article, confined mainly to the role of FDI in China.

Relevance for India

At its core China’s FDI policy is essentially pragmatic, as conceived and executed by its ruling political regime. I am glad that Rudolph agrees with this when he says,

China’s experience shows that policymakers have more room for manoeuvre than they think. With external macroeconomic conditions probably more stable today than they have been any time since independence, Indian policy-makers are in a better position to make strategic decisions about how to craft FDI-related institutions. … For example, it may be desirable to encourage investment in specific locations, and in specific sectors, such as small-scale industry.

The reasons, as Rudolph says, are twofold: creation of employment opportunities and removal of social disparities.

I am in complete agreement. At the cost of being repetitive, let me quote what I had stated:

In a dynamic global economy, we cannot afford to have an investment regime with certain preset do’s and don’ts... China has demonstrated the absurdity of armchair archaic conventional arguments against foreign investment. If China could manage the high rate of FDI inflow without compromising its sovereignty, it does not make sense for our political class to nurse all the time a kind of vague and unspecified apprehension that FDI could erode our security and sovereignty and that we would be a plaything in their hands. In our economy where public and private sector have grown in partnership, and taken together, are striving to scale commanding heights, we have to shun any kind of paranoia about FDI-inflow. If I

were to point out a single lesson that our

political regime has to learn from China,

it is this quality of learning from experience

and allowing different economic agents for

exploiting and developing the potentials

that we possess.

Extrapolation of the present into the future, as economic analysts are prone to do, often creates a euphoria that makes us less conscious of the very real possibility that trajectories of economic growth may undergo unpredictable shifts. While globalisation has opened up great opportunities for both the countries, it also imposes severe constraints on the manoeuvrability of national polities in adjusting their policies to maintain the sustainability and quality of growth that is acceptable to the vast majority of people. In this task of maintaining a balance between the enabling and constraining implications of globalisation, different countries of the world have to work out policies that are appropriate to the specifics of their polities, but in the long run their sustainability is also crucially dependent on the structure and governance of the international institutions concerned with trade, investment and finance.

It was not the purpose of my paper to suggest any specific areas for investment by foreign investors. Let me however, since the point has now been raised, refer to some areas that are critical for our sustained growth. While over the past decade and a half large and medium industries have demonstrated their entrepreneurial capabilities, a lot remains to be done in agriculture, small business and allied industries, particularly in all those labour-intensive and export processing industries where, given the right kind of support, we could have made similar strides as China. India has to make massive public investments to bring about the second phase of revolution, in agriculture and allied activities, in irrigation and a wide range of supportive ruralurban linked infrastructural services. Processing and marketing of food and horticultural products and marketing of a wide range of artistic and other products can make a substantial difference to livelihoods in our rural and urban countryside. As we cannot survive or grow without global integration, it is critical that the state takes a pragmatic view, as China has done, in exploring and developing innovative forms of public private collaborative efforts, in which foreign investors may be assigned specific roles.

Let me hasten to emphasise that I am not suggesting, in any manner, emulation of some kinds of Chinese examples I had occasion to indicate in my paper. These are bound to affect the sensitivities of our people in the rural and farming community and will also be unacceptable to large sections of people in our democratic country. We have to be careful, for example, as to what kinds of contract farming could be suitable for our country. I may cite Pepsi’s operation in China: the company has emerged as the largest potato grower in China, in inner Mongolia and in Beihai, China’s southern coast, with a 40 per cent share of a $ 50 million a year market.3 Such kinds of FDI would be absolutely unacceptable in our democratic polity.

When we consider specifics, we have to keep one fundamental question in mind: why is it that there is such a great divergence between our growth index and our human development index? If growth is for a better quality of life, then development must lead towards it. Both in respect of China and India, we should not only talk of who is winning the race toward a higher growth rate. Whether it is a democratic or an authoritarian society, the country that makes the faster move towards convergence of the two indices, and at a level much higher than it is today, will ultimately win the race.



1 Output in the industrial sector in China expanded at four times the rate of other industrial enterprises during 1994-97 and labour productivity in foreign investment enterprises (FIEs) is almost double that in public sector enterprises. Employment in FIEs in urban areas quadrupled between 1991 and 1999, to a total of 6 million, accounting for 3 per cent of China’s employment. This has been particularly important in ameliorating unemployment pressures emanating from ongoing reforms of SOEs. FIEs are particularly important employers in the coastal provinces, accounting for 10 per cent of urban employment in Guangdong, Fujian, Shanghai and Tianjin as of 1999. FIEs had built up a highly competitive and dynamic competitive sector for exports and they played a key role in the growth of Chinese exports: between 1985 and 1999 the share of exports accounted for by them grew from 1 per cent to 45 per cent, half of overall export growth and import growth during this period. (Wanda Tseng and Harm Zebregs, ‘Foreign Direct Investment in China: Some Lessons for Other Countries’ in Wanda Tseng and Markus Rodlauer (eds), China Competing in the Global Economy, IMF, 2003.

2 Suisheng Zhao (ed), Decision-making in Deng’s China: Perspectives from the Insiders, Armonk, NY 1995.

3 Chad Terhume, ‘To Take China, Pepsi Turns Farmer’, Asian Wall Street Journal, December 19, 2005.

Economic and Political Weekly March 25, 2006

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