Opinion

Is there a Chinese ODI model?

By Huang Yiping and Wang Bijun (China Daily)
Updated: 2011-04-26 13:40

China is already an important player in overseas direct investment (ODI). But for China, this is a relatively recent phenomenon.

Before 2004, the size of Chinese ODI was rather trivial. From 2004, China's ODI grew significantly together with a dramatic expansion of its current account surplus. Its ODI increased from $2.85 billion in 2003 to $56.53 billion in 2009, an average growth rate of about 55 percent a year. During the same period, its share in global ODI flow rose from 0.45 to 5.1 percent. In 2009, China not only became the largest investor among developing countries, but also the fifth largest investor in the world - preceded by the United States, France, Japan and Germany.

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China's case challenges the perception that ODI is dominated by developed countries. It is also exceptional in that while China enjoys comparative advantages in certain manufacturing industries, evidenced by its competitiveness in exports and domestic development, they are not areas in which Chinese ODI is concentrated. According to official statistics, most of China's ODI is in the service industry such as commercial financial services, and retail and wholesale sectors.

The industry distribution of Chinese ODI differs markedly from that of other countries. The primary sector (including resources) accounted for 18.7 percent of China's total ODI flow between 2006 and 2008. In comparison, those from developed and other developing economies were only 7.84 and 8.38 percent. These large differences can be attributed mainly to investments in mining, quarrying and the petroleum industry - the latter accounting for 97 percent of China's ODI in the primary sector. This may reflect the strategic use of Chinese ODI to secure long-term supply of resources.

The manufacturing sector got an extremely low share, only 4.7 percent, of China's total ODI - this despite the country's image as a global manufacturing center. To put this in perspective, the share of developed countries in the manufacturing sector averaged 24.1 percent and that of other developing economies, 15 percent.

China's prominent ODI role could simply be the result of the size effect. Since China is a large country, even a relatively low propensity to invest overseas could add up to a big number. It may be the consequence of financial control at home. Such financial policies reduce the cost of capital and make abundant capital available to State-owned enterprises. Or, they could be motivated by strengthening domestic production and economic transformation.

Since these potential explanations may not be mutually exclusive, what is the determinant factor behind China's ODI?

First, although the majority of China's ODI centers on the service sector - the majority in trade, finance and business activities - its response to the development/revealed comparative advantages of the service sector in host economies is different for OECD countries and non-OECD economies. For the Organization for Economic Cooperation and Development (OECD) member countries, the more comparative advantageous and better development of the service sector, the more ODI China will engage in.

From this it could be inferred that Chinese enterprises intend to learn from the experience and technologies of the service sector's development in OECD countries. In contrast, for non-OECD economies, the more comparative advantageous and better development of the service sector, the less ODI China will engage in.

Second, China's exports display a significantly positive association with its ODI. There are two interpretations for this trend. On one hand, the more China exports to these markets, the better knowledge and experience it will gain. For the new player of outward investment, such knowledge and experience could facilitate direct investment, just like speaking a common language or sharing a common border. On the other, Chinese ODI may be used to service exports.

Third, seeking a market is not a driving force for China's ODI. Neither the host economies' GDP nor their per capita GDP has any influence on China's ODI decision.

There are, therefore, clear differences between China's ODI and that of the developed economies. For China, high profits are not an obvious driving force. Instead, the international competitiveness of the advanced economies and the resource endowment of developing economies are more important for it.

The chief objective of China's ODI is to strengthen the competitiveness and sustainability of domestic production. Acquiring advanced technology, securing commodity supply or even facilitating exports are all ways of doing this.

"China's ODI model" may be transitional. As the Chinese economy develops further, its ODI behavior is likely to converge with that of the developed countries.

If wages keep rising rapidly, China may eventually move its textile, toys and travel goods factories to other low-cost countries. That investment would be more consistent with the market or low-cost-seeking motivations in the traditional foreign direct investment theory.

Again, if further liberalization of the financial industry triggers a rise in the cost of capital and a decline of the State sector, the importance of the "China ODI model" may also decline.

Still, an analysis of the "China model" could increase the understanding of the ODI behavior of other developing countries.

But there is much we don't yet know about Chinese ODI because of the lack of comprehensive company-level data and the problem of aggregate figures. So the current evidence is still very preliminary.

Huang Yiping is a professor of economics at China Center for Economic Research, Peking University and adjunct professor at Crawford School of Economics and Government, Australian National University. Wang Bijun is a doctoral scholar at Peking University and visiting scholar at Australia's Crawford School of Economics and Government.