Foreign Investment and Entry Modes in China’s Economy

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Introduction

China has recorded significant economic growth over the last quarter of this century. This period has also seen the economy change from a centrally planned one to a more market-oriented one. This change in the way the economy is planned has brought about a transformation from a market that was mainly local with limited international trade to one where the private sector is a key player on the global economic front. Some of the changes that have taken place in the economy over the past forty years include the initial changes in the field of agriculture.

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The mode of entry of an organization is important in determining the success that it has in the new market or in the industrial sector. According to Kumar and Subramanian, an entry mode is an institutional arrangement that a firm chooses to operate in a foreign market (1997, p. 53). This essay looks at the effect that foreign investments have had on China, the entry modes used by the international companies to enter the market, and how these have changed over time. It also investigates the role that the government has played to influence this situation. The essay also evaluates the best method used by a manufacturing company moving from Canada to the Chinese economy because investment here according to Shira and associates is encouraged (2011).

Impact of foreign investment on China’s economy

The step of introducing and implementing the open-door policy and economic reforms in China that took place in 1978 has had a significant effect on China’s economic performance and foreign investment. The economy also became a model for other economies in the world, thus presenting the country as an important global economic driver. Foreign investment in the country has also improved people’s lives, reactivated the commercial markets, and/or led to the improvement in infrastructure around the country (Yu, Chen & Sun 2010, p. 3). From 1979 through 2008, Chinas economy grew at an average rate of 9.8%, which was over 6% higher than the global average at this same period (Yu, Chen & Sun 2010, p. 3). The country’s contribution to the global economy also grew within the same period by about 12.2%, and by 2006, it was around 14.5% (Yu, Chen & Sun 2010, p. 3). The country’s economy can only be rivaled by the US in terms of its contribution to the global economy.

The country had a shift in the economic policies that ensured that the economy was more market-oriented. This budget led to the influx of foreign investment and foreign capital. Some of the established effects that foreign direct investment, which was one of the main modes in which foreign investments came in, include economic growth and the growth in the investment in fixed assets in the country (Yu, Chen & Sun 2010, p. 3). Foreign investment also increased the export earnings from the products produced by these investors in the effort to optimize the structure of the export products (Ding & Knight 2009). Another effect that the increased foreign investment had was the creation of jobs and increased employment, meaning that more people were unemployed.

Foreign investment in China also affected domestic manufacturers both in a positive and negative way. These manufacturers got an opportunity to compete on the global front (Yu, Chen & Sun 2010, p. 3). The influx of foreign capital in the Chinese economy has had a significant impact on economic growth. In the period between 1993 and 2007, the influx was recognized as a major driver for the growth that China’s economy recorded. The labor force that international companies and foreign firms employed also contributed to the growth of the economy. There was also improved growth in the foreign currency reserves for the country. This also boosted its export and import trade, thus positioning it economically on the international economic front (Morrison 2012).

In 2010, there was a reported 445,244 foreign-invested enterprises in China, which employed more than 15% of the urban workforce. This represented roughly over 55 million workers (Morrison 2012). These companies and enterprises are also responsible for the foreign exchange that China earns. More than half of exports and over 49% of the imports that the country had were made by these significant organizations (Morrison 2012). These foreign organizations were also responsible for a large proportion of the Chinese export of high-tech products (Morrison 2012).

Entry Modes used by Companies

China has gone through a series of changes in the recent past in terms of its social, political, and economic environments as highlighted above. These factors have had significant effects on the entry modes used by organizations in this market over the period. Some of the entry modes used and/or are currently useful in China for international trading businesses include, “conventional import and export, flexible trade, international leasing, and counter-trade” (Luo 2000, p. 58). Companies may however opt to enter the market through foreign direct investment. Some of the available modes according to Luo include, “equity joint ventures, wholly foreign-owned subsidiaries, contractual joint ventures, umbrella companies, acquisitions, representative offices, branches, build-operate-transfers, licensing, and franchising” (2000, p. 58).

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One of the entry modes that have been applied in the past is the use of Equity Joint Ventures (EJV). This mode has accounted for a significant number of the entry modes used in the country. In 1996, this entry mode is described to have accounted for about 50% of the foreign direct investment (Menzies, Chung & Orr 2008).In this entry mode, organizations enter the economy as limited liability companies where the international owners enter a negotiated proportional ownership of equity and management with the local Chinese investors. The international as well as the local investors therefore own the organizations.

Some of the other entry modes used by the international organizations include the use of Wholly Foreign-owned Enterprises (WFOEs). These enterprises were also a preferred choice that accounted for 29.85% of the FDI value in 1996 (Luo 2000. p. 58; Johnson &Tellis2008). These are foreign organizations, which use their own capital, resources, management teams and technologies to run their operations. A law was passed in China, which defined the organizations in 1986 (Luo 2000. p. 58). The profits, losses or any other liabilities that these organizations encountered during their operations in China were recognized to be managed wholly by the organizations adopting this entry mode.

Another the traditionally popular entry mode was the Contractual Joint Ventures (CJVs), which accounted for 20.8% of FDI in 1994 (Luo 2000, p. 58). In this arrangement, the foreign investors and the Chinese business people enter a partnership for a specific venture that they decide to undertake. The terms may also lead to the creation of a joint venture with the same characteristics as a limited liability partnership, or in any other form of the agreement stipulated in terms of a venture agreement (Luo 2000, p. 59).

Some of the newer entry modes used in the Chinese market include the formation of Umbrella Companies. These companies are able to combine a number of operations such as sales, marketing, manufacturing, and other services for a broad product range (Luo 2000, p. 59). However, several regulations govern the operation of the Umbrella Companies in China. They include the taxation that the companies get and the number of FIEs that they can have under them (Luo 2000. P. 67). This mode of entry is the best for a Canadian company diversifying its operations from the steel industry to the other industries such as animal feed, grain beverages, and oilseed industry (Menzies, Chung & Orr 2008).

The other entry mode that companies and organizations may use in their way into China’s market is the acquisition of companies that are already operational and registered in the country. This strategy is said to be the easiest way for any international organization to enter the Chinese market (Luo 2000, p. 68). Investors willing to follow this route should assess the performance of the company, the area in which it is located, and the infrastructure available before buying it. The government of China has traditionally demonstrated little willingness to sell state-owned corporations. However, this step has changed over the last few years, with some of these corporations being listed in the international stock market. The government is however slow to allow full ownership of shares by the international companies, which are restricted to small proportions only (Luo 2000, p. 71).

Another of how organizations have entered the Chinese market in the past is through the opening of representative offices in the country, which are later used by the organizations to facilitate access through other modes that the organizations would deem necessary. The government has control over the sectors and industries that international organizations may enter China and the modes they may use in this entry (Luo 2000, p. 71). The opening of representative offices on the other hand is flexible, as the government has little control over the line of business that the organizations may enter with this mode. Some of the restricted sectors that foreign originations have been able to enter include banking, communication and media, insurance, and trading. It is through the entry mode that they have launched initiatives to try to convince the government to allow room for their participation in the sectors (Menzies, Chung & Orr 2008).

Some of the other entry modes that foreign organizations have used in their access to the Chinese market include the opening of branches, Build-Operate-Transfers (BOTs), and franchise and licensing. The opening of branches is one of the latest entry strategies. Just like the opening of offices, this strategy has allowed participation in some of the markets with tight government control such as banking. BOT on the other hand is mainly applied in infrastructure development. In this investment entry mode, companies build infrastructure projects, charge fees for the use of the same, and only transfer the project to the locals after the full costs have been realized. This model has gained popularity in China, with the major infrastructure project being carried out this way. In franchising and licensing, organizations venture into the Chinese market by contracting other local organizations and selling some of the rights. This strategy is an efficient way of reducing the control that the government has over the industry. However, it leads to lower profit margins compared to the direct investment.

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The government of China influences investment by foreign companies in a number of ways. An example of influence is in the formulation of policies that have an effect on the investment entry modes. Such is the 1994 Company Law that spelled out some of the terms that foreign organizations may follow in their investment in the country (Luo 2000. P. 74). The policies are also in the ownership of public companies. Foreign organizations have a limited say in the local public organizations, as they are not allowed to own the controlling shares. The minority shareholders are also not allowed to have a significant say in the organizations. The government is also restrictive in the sectors that the foreign organizations and enterprises may be engaging in. This situation is frustrating for most of them. The policies also limit the generation of profits in an enabling environment.

Conclusion

China’s economy has undergone a series of changes over the last few decades, growing to be an economic superpower whose economy can only be rivaled by the United States. This growth has been due to several factors among them being the development of international trade and foreign investments. Some of the entry modes that organizations have used in the past have been discussed. The government has also emerged as a significant influence on the entry mode that these organizations used.

References

Ding, S & Knight, J 2009, ‘Can the augmented Solow model explain China’s remarkable economic growth? A cross-country panel data analysis’, Journal of Comparative Economics, vol. 37 no. 1, pp. 1-34.

Johnson, J &Tellis, G 2008, ‘Drivers of Success for Market Entry into China and India’, Journal of Marketing vol. 72 no. 1, pp. 1–13.

Kumar, V & Subramanian, S 1997, ‘A contingency framework for the mode of entry decision’, Journal of World Business, vol. 32 no. 1, pp. 23-75.

Luo, Y 2000, ‘Entering China Today’, Journal of Global Marketing, vol. 14 no. 1-2, pp. 57-82.

Menzies, J, Chung, M, & Orr, S 2008, Doing Business in China: How Australian companies make their decisions when entering the Chinese market, Deakin Business School, Faculty of Business and Law, Deakin.

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Morrison, W 2012, ‘China’s Economic Conditions: Congressional Research Service7-5700.

Shira, D & Associates 2011, Corporate Establishment, Tax, Accounting & Payroll throughout Asia, Foreign Investment Industrial Guidance Catalogue, MacMillan, London.

Yu, P, Chen, K & Sun, X 2010, ‘Foreign direct investment and economic growth in China: evidence from a two-sector model’, Journal of Financial Management and Analysis, vol. 23 no. 1, pp. 1-9.

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BusinessEssay. (2022) 'Foreign Investment and Entry Modes in China’s Economy'. 29 March.

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BusinessEssay. 2022. "Foreign Investment and Entry Modes in China’s Economy." March 29, 2022. https://business-essay.com/foreign-investment-and-entry-modes-in-chinas-economy/.

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BusinessEssay. "Foreign Investment and Entry Modes in China’s Economy." March 29, 2022. https://business-essay.com/foreign-investment-and-entry-modes-in-chinas-economy/.