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Candidate Number: 35747

MSc in China in Comparative Perspectives (Anthropology Department) 2007 Dissertation in partial fulfillment of the requirements of the degree

Foreign Direct Investment in China and India: Development Experiences and Determinants in a Comparative Perspective

Word Count: 9965

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TABLE OF CONTENTS Acknowledgement Abstract List of Abbreviations and acronyms List of Tables

1. INTRODUCTION

2. DETERMINANTS OF FDI: A THEORETICAL EXPOSITION

2.1 FOREIGN DIRECT INVESTMENT DEFINED 2.2 MAIN THEORIES OF FDI 2.2.1 INDUSTRIAL ORGANIZATION THEORY 2.2.2 INTERNALIZATION THEORY 2.2.3 PRODUCT LIFE-CYCLE THEORY 2.2.4 ECLECTIC THEORY OF INTERNATIONAL PRODUCTION 2.3 SUMMARY

10 12 13 14 14 15 17

3. FDI IN CHINA AND INDIA: AN OVERVIEW

18

3.1 TRENDS AND PATTERNS OF FDI 3.2 SOURCE-COUNTRY COMPOSITION 3.3 SECTORAL COMPOSITION 3.4 REGIONAL DISTRIBUTION

18 24 28 31

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4. DETERMINANTS OF FDI

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4.1 POLITICAL ENVIRONMENT AND FDI POLICY REGIME 4.2 ECONOMIC DEVELOPMENT 4.3 SOCIETY 4.4 TECHNOLOGY DEVELOPMENT 4.5 BUSINESS ENVIRONMENT 4.6 LEGAL SYSTEM 4.7 SUMMARY

35 39 41 43 44 46 48

5 SUMMARY AND CONCLUSIONS

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5.1 FINDINGS 5.2 POLICY IMPLICATIONS 5.3 LIMITATION OF THE STUDY 5.4 FUTURE RESEARCH DIRECTIONS

49 51 53 53

BIBLIOGRAPHY:

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ACKNOWLEDGEMENT

I express my deep sense of gratitude to Professor Stephan Feuchtwang for his talented suggestions and intellectual stimulus on this dissertation. I would also like to thank Dr. Victor Teo and all other staff in the Anthropology Department for their tutoring and support throughout the year. Special thanks go to the UK Foreign and Commonwealth Office and the British Council for their generous financial help with my study in the London School of Economics and Political Science. I am deeply indebted to my daughter, Youyou Hu, for the immense sacrifice she has made for bearing my absence, when she needed me most.

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ABSTRACT The analogies between Chinese and Indian economies draw obvious comparison. This research seeks to understand the FDI inflows and examines the main determinants in the two countries. Since the empirical work over the past decades has not produced consensus as to the determinants of FDI, Dunnings O-L-I paradigm offers a unified framework of the various theories. To identify the differences of determinants of FDI inflows in China and India, the changing patterns of FDI are closely studied with special reference to the source countries of FDI, the sectoral composition and regional distribution. Moreover, this study develops a PESTEL framework for analyzing the recent experiences and determinants of FDI inflows in China and India. It concludes that on the determinants of political and FDI policies, economic development, society and business environment, China does better than India; whilst India is ahead of China in terms of technology and legal system.

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List of Abbreviations and acronyms CJV EJV EU FDI GBPC IPA IT IPR LDC MNC MNE NIE OECD SEZ TNC UNCTAD WFOE WTO Contractual Joint Venture Equity Joint Venture European Union Foreign Direct Investment Global Business Policy Council Investment Promotion Agency Information Technology Intellectual Property Right Less Developed Country Multinational Corporation Multinational Enterprise Newly Industrializing Economies Organization for Economic Cooperation and Development Special Economic Zone Transnational Corporation United Nations Conference on Trade and Development Wholly Foreign-owned Venture World Trade Organization

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List of tables
TABLE 3.1 FDI INFLOWS IN CHINA 1979-2005 TABLE 3.2 FDI INFLOWS IN INDIA, AUGUST 1991-2005 TABLE 3.3 COMPARISON OF FDI INFLOWS TO CHINA AND INDIA TABLE 3.4 TOP TEN SOURCE COUNTRIES (REGIONS) OF FDI IN CHINA, 1979-2005 TABLE 3.5 TOP TEN SOURCE COUNTRIES (REGIONS) OF FDI IN INDIA, AUG. 1991-2005 TABLE 3.6 SECTOR-WISE FDI INFLOWS IN CHINA, 2000-2005 TABLE 3.7 SECTOR-WISE FDI INFLOWS IN INDIA, AUG. 1991-2005 TABLE 3.8 PROVINCE-WISE FDI INFLOWS IN CHINA, 1979-2005 18 22 23

24

26 28 30 32

TABLE 3.9 REGION-WISE FDI EQUITY INFLOWS IN INDIA, 2000-2006 33 TABLE 4.1 COMPARISON OF SOFTWARE INDUSTRY IN CHINA AND INDIA (YEAR 2005) 38 TABLE 4.2 COMPARISON OF SELECTED ECONOMIC INDICATORS: CHINA AND INDIA 40

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Foreign Direct Investment in China and India: Development Experiences and Determinants in a Comparative Perspective
1. Introduction China and India enjoy a lot in common: long histories, giant markets, huge populations and soaring growth rates. Both countries have an ancient and prestigious cultural heritage; both are under the influence of the Soviet model and have embraced economic reform and liberalization China in the late 1970s and India in the early 1990s. Now both are in the process of liberalizing their economies as they open up to foreign direct investment (FDI), which is not at the same stage and we shall take a closer look at it below. FDI has increasingly been considered as a catalyst to market growth for the developing countries, particularly in countries such as China and India. More importantly, besides supplementing capital, FDI, as a principal conduit of technology upgrade, know-how transfer and managing skills exchange, heralds the globalisation of host economies (United Nations Conference on Trade and Development. 2005; UNCTAD 2006). The global competition for FDI among developing countries is increasing and in this context, both China and India are aiming for a high share of the FDI pot for they are now getting increasingly integrated with the global economy as they open up their markets to international trade

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and investment inflows. The remaining sections of the paper are as follows. The theoretical justification for the research propositions is examined in Chapter 2. In Chapter 3, a overview of FDI trends and patterns in both countries is presented. The changing patterns of FDI are closely studied with special reference to the source countries of FDI, the sectoral composition and regional distribution, which are used as the background information for following chapters. Relevant determinants of FDI inflows into each country are discussed and compared in Chapter 4 by using a PESTEL analysis format. Finally, the major findings of the paper are summarized in Chapter 5. The policy implications are addressed and the limitations of the study are highlighted before presenting the future research directions. 2. Determinants of FDI: A Theoretical Exposition The past three decades have witnessed the emergence of a sizable body of literature dealing with various dimensions of the determinants and motives of FDI flow. A review of these studies is essential to know about the different determinants of FDI and to see how far these determinants can be applied in the following empirical study on China and India. The first section of this chapter seeks to define FDI and the impact and effects of FDI. The second section then reviews the existing discussion on FDI and shows that FDI is determined by different factors under different macro economic conditions.

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2.1 Foreign Direct Investment Defined FDI is an important instrument in the process of globalization and plays a crucial role in the development of the economies of the developing countries. As defined by the Organization for Economic Cooperation and Development (OECD), it reflects the objective of obtaining a lasting interest by a resident entity in one country (direct investor) in an entity resident in an economy other than that of the investor (direct investment enterprise). Krugman and Obstfeld define FDI as international capital flows in which a firm in one country creates or expands a subsidiary in another (Krugman and Obstfeld 2000: p.159). They go on to highlight that the distinct feature of FDI is that it involves not only the transfer of resources but also the acquisition of control. Sdersten and Reed further point out that FDI is in essence a bundle of capital, technology and management skills transmitted by multinational enterprises (MNEs) or transnational corporations (TNCs) (Sdersten and Reed 1994: p.489). Unlike conventional definitions of FDI, the official Chinese counterpart incorporates three forms of direct foreign-invested enterprises
1

(sanzi qiye). They are equity joint venture (EJV) (hezi jingying qiye),

contractual joint venture (CJV) (hezuo jingying qiye) and wholly foreign-owned venture (WFOE) (waishang duzi jingying qiye) (Huang
1

They are usually established through 1) mergers and acquisitions with another company; 2) a direct subsidiary (greenfield FDI); 3) an EJV; and 4) buying a controlling stake of the public listed company.

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1998). In case of India, the earlier definition of FDI differed from that of the IMF, as well as that of the World Investment Report compiled by the United Nations Conference on Trade and Development (UNCTAD) 2 . Since 2003, with the establishment of the Technical Monitoring Group on Foreign Direct Investment, a new method of compilation of the FDI statistics has been adopted in India, which makes the data internationally comparable. The new system includes equity capital, reinvested earnings and other capital, which are mainly intra-company loans (Tamuli 2006: pp.2-5). Much of the discussion on FDI in former years, particularly in the extractive industries, MNCs were perceived as exploitative terms (Dos Santos 1969: p.21; Cohen 1973), and indeed were seen to be the cause of much of host economies problems (Caves 1982). In India, the takeover by the British East India Company of control over the whole India had created the East India Company syndrome (Gupta, Dahiya et al. 2005: p.149). The ideological change came about during 1990s, when FDI inflows had become the most important component of total capital flows to developing countries, notably in East and South East Asia. FDI not only adds to external financial resources for development, but is also more stable than other types of flows. Kawai and Urata demonstrate how
2

IMFs definition includes external commercial borrowings, reinvested earnings and subordinated debt, while the World Investment Report excludes external commercial borrowings.

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FDI upgrades the technological capability of the recipient economies (Urata and Kawai 2000) and Urata further notes the importance of FDI for promoting trade (Urata 2001). OECD, Yusuf, Nabeshima and Altaf identify the role of FDI in fostering recipients participation in global production networks (OECD 2002; Nabeshima, Yusuf et al. 2004; Yusuf, Altaf et al. 2004). Moran has done a research covering 183 projects across 30 countries in 15 years and point out that FDI has a positive impact on the national income of the host economy in the majority of projects (Moran and Institute for International Economics (U.S.) 1999). 2.2 Main Theories of FDI There have been a prolific number of empirical studies on the determinants and motives of FDI. Some studies have concentrated upon the ownership specific advantages of the foreign firms which are necessary to outweigh the disadvantage of being foreign. These studies have tried to find out the significance of various ownership advantages arising due to propriety knowledge, financial assets, product

differentiation, plant economic of scale, size of the firm and multi-plant operations etc. We hereby categorizes such theories as external (supply-side) approaches. Other studies have focused on the locational specific advantages as low cost of labor, reduced tariffs, fiscal incentives, market size and characteristics of the host economy, favorable FDI policies of the host government, political stability and other locational

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factors. Here this study categorizes such theories as internal (demand-side) approaches. In sum, the external factors include economic conditions outside the host country, while internal factors include the economic conditions of the host country. Traditionally, most empirical papers have focused on the role of the external factors in determining FDI flows into developing countries. These theories so far mainly stress on the ownership specific advantages of the firms and three of them are examined as follows. 2.2.1 Industrial Organization Theory Hymer and Kindleberger argue that the ownership advantages (including inventory, cost, financial or marketing advantages) motivate them to establish subsidiaries in the host countries (Kindleberger 1969; Hymer 1976). These advantages which they assume to be exclusive to the firm owing them explain why American-type FDI is predominant in a particular sector of industry but it may be unable to portray a general pattern of FDI. Another industrial organization approach, developed by Caves, is based on models of oligopolistic competition. He treats a MNC as a creature of market imperfections that lead a firm to possess specific advantages over local firms in the host country (Caves 1982). In fact, some Japanese scholars refute its limitation to explain Japanese-type FDI, which is based on location factors rather than

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technological superiority, economic scale and management skills (Ozawa 1979; Kojima 1996). 2.2.2 Internalization Theory The internationalization theory, created by Buckley and Casson, and developed by Rugman and Hennart, is primarily concerned with the transactions cost approach (Rugman 1981; Hennart 1982; Casson and Buckley 1983). The basic hypothesis of this theory is that MNEs emerge when it is more beneficial to internalize the use of such intermediate goods as technology than externalize them through the market. The core prediction of the theory is that, given a particular distribution of factor endowments, MNE activity will be positively related to the costs of organizing cross-border markets in intermediate products. 2.2.3 Product Life-cycle Theory In a classic article published in 1966, Vernon was the first to investigate the relationship between FDI and technology. He uses a microeconomic concept, the product cycle, to explain a macroeconomic phenomenon, which is the foreign activities of US MNCs in the postwar period (Vernon 1966). He argues that the product life-cycle can be divided into three stages as new product stage, matured product stage and standardized product stage. In the early new product stage, firms place factories in the home country since the demand for a new product is too small elsewhere. As the

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expansion of production in the home country becomes too expensive, the mature oligopolist invests in a host country with high income elasticity of demand and similar consumption patterns to the home country. Therefore it develops into the second stage of matured product. As the product turns into increasingly standardized and its competition is based on price, the product is manufactured in less developed countries (LDCs) for export. Although this theory considers changes in technology and implicitly assumes that the MNCs would acquire the manufacturing plants in the countries with abundant low-cost workers, it is not a dynamic theory for the rate of change and the time-lag between product stages are not considered. Chen rebuts that it is also unable to explain FDI in non-standardized products and special products for overseas markets (Chen 1983: pp.28-9). The theories explained above mention only the home country macro-economic, industry specific and firm specific external (supply-side) factors. But it is necessary to bear in mind that the host country must possess certain locational advantages to attract FDI. The O-L-I paradigm developed by Dunning seeks to offer a comprehensive framework by combining the company comparative advantages and host country location endowments. 2.2.4 Eclectic Theory of International Production The eclectic paradigm of international production, which postulates that

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FDI is determined by three sets of factors, namely ownership (firm-specific) advantage, internalization advantage and location

(country-specific) advantage, is developed by Dunning and modified by his associate Narula (Dunning 1981; Dunning 1988; Dunning and Narula 1995; Narula 1996). According to Dunning, the rationales of FDI can be well-defined by O-L-I paradigm: Ownership (O) advantages: economies of scale, exclusive production and technical expertise, managerial and marketing skills. These are the prerequisite to ensure or enable the MNCs to recover the costs of investing abroad. Itaki further argues that these O advantages largely take the form of privileged possession of intangible assets and the use made of them are assumed to increase the wealth-creating capacity of a MNC, and hence the value of its assets (Itaki 1991). Location (L) factors: low labor costs, potential foreign market, favorable investment incentives. These pull factors of host country contribute to the MNCs decision to employ ownership advantages to produce aboard. Internalization (I) factors: Comparing with licensing and exporting, by using greater organizational efficiency or ability to exercise monopoly power over the assets under the governance, an internal market is created between parent-company and affiliates to control

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key resources of competitiveness or to reduce the risk of selling them as well as the right of use of them, to foreign firms. Compared with the above theories, which were founded on ownership advantages in the form of technology and finance, transaction costs and differential factor endowments, the unique feature of Dunnings O-L-I paradigm is to unify and summarize the various theories, although it is still a frame which synthesizes most FDI theories rather than a new theory per se. It signified the ownership, locational and internalization advantages of the firm and, by extension, the ownership and internalization advantages of the home country, and locational advantages of the host country of FDI, which Dunning stipulates that O-L-I is applicable to home country and host country FDI (Dunning 1981). According to this theory, FDI is chosen as a market entry strategy so that a firm can exploit its ownership advantages through internalizing transaction costs in a specific location, which possess locational advantages. 2.3 Summary To conclude, the relative significance of the motives and determinants as contained in the above theories differs not only between firms and regions but also from time to time for a particular firm or region. It is very difficult to generalize about the determinants of FDI and it is true that most firms are influenced in their behavior by more than one

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objective and sometimes different values are placed on the same objective. The difference in the strength of the determinants is most marked between China and India which differ radically with regard to economic structure, development characteristics and socio-economic profiles. Nevertheless, the above theories provide us with a rich collection of motives and determinants that can support and guide the following study of the explanatory variables of FDI flows into China and India. 3. FDI in China and India: an overview This chapter examines and discusses the trends and patterns of FDI inflows into China from year 1991 to 2005 and India from August 1991to 2005. Based on published official data, it provides a clear picture about the longitudinal and latitudinal analysis of FDI inflows, the country of origin, sectoral composition as well as regional distribution of FDI in both countries. 3.1 Trends and Patterns of FDI China During the period 1979-2005, China has approved a total number of 552,942 foreign-invested companies with a cumulative foreign capital investment (contract value) of US $1285.7 billion, of which US $622.4 billion was effectively invested. Table 3.1 FDI Inflows in China 1979-2005 (US $billions)

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Contracted FDI3 Paid-in FDI4 Year 1979-1991 52.669 13.018 1992 58.124 11.008 1993 111.36 27.515 1994 82.680 33.767 1995 91.282 37.521 1996 73.276 41.726 1997 51.003 45.257 1998 52.102 45.462 1999 41.223 40.318 2000 62.380 40.715 2001 69.192 46.878 2002 82.768 52.7 2003 115.07 53.505 2004 153.479 60.63 2005 189.065 72.406 Total 1285.673 622.426 Sources: Bureau of Foreign Capital, the Ministry of Foreign Trade and Economic Cooperation (the Ministry of Commerce since March, 2003)

Analyzing Table 3.1 reveals the FDI development in China can be divided into three stages: 1979 to 1991, 1992 to 2001, and 2002, the year after the Chinas entry into the World Trade Organization (WTO) to present. From late 1978, China cast off its self-reliance policy and adopted the policy of reform and open-up. FDI in China grew rapidly during the first half of the 1980s. Entering the second half of the 1980s, the growth rate in China leveled off and turned negative in the aftermath of the Tiananmen massacre (Chai and Roy 2006: p.133). According to Chen, the annually growth rate reached 20 percent at that period. Moreover, the paid-in FDI soared to US $4.36 billion in 1991, making it the largest FDI
Contracted FDI based on signed contracts, but not always actual inflow. Its better for gauging the intention to invest. 4 Paid-in FDI was actually invested in host country. Its a better measure of the actual size of the investment flow.
3

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recipient among developing countries. (Chen 2002). In 1992, after Deng Xiaopings tour in the Southern provinces, Chinas reform and opening up policy was further intensified. Besides 11 open coastal provinces, part of the interior regions was open up for FDI. Furthermore, two new investment categories were created, namely, the export-oriented and technology-advanced projects, which were entitled to additional incentives regardless of their location. From US $4.3 billion (paid-in FDI) and US $11.97 billion (contracted FDI) respectively in 1991, the FDI volume increased dramatically to US $11 billion and US $58.1 billion, a jump of more than 150% and 380%. Only since the outbreak of the Asian financial crisis in 1997, the growth momentum has slowed down (Zhang 2006). The WTO accession in November 2001 provided another impetus to FDI and China received US $52.7 billion in 2002, which made China the Asias and the developing worlds largest recipient of FDI. As noted in World Investment Report 2003, in year 2002, for the first time, China surpassed the United States to become the largest global recipient of FDI, accounting for 9.88 percent of the global flows of FDI (Wu 1999). India In accordance with the requirements of the economic development in different phases, the Indian governments policy toward FDI has evolved over time (Kumar 1998). In the 1950s, soon after the independence, the

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anti-FDI environment in India was largely based on two factors. The first was the strong nationalistic sentiments in the wake of independence. Second, whatever narrow industrial base the country had at that time, an overwhelming part of it, almost three-fourths, was British-owned. Political and business leaders wished for the day when such a large foreign ownership of industries could be contained and Indian industry and market became a place for Indian entrepreneurs (Das 2006). Therefore, FDI was discouraged by a) imposing severe limits on equity holdings by foreign investors and b) restricting FDI to the production of only a few reserved items (Gakhar 2006). In the 1980s the attitude toward FDI began to change, adopting the policies of liberalization of industrial approval rules, a host of incentives and exemption from foreign equity restriction. In the middle of 1991, a package of economic reforms was introduced by the government, which had greatly affected the magnitude and pattern of FDI inflows received by India (Gupta, Dahiya et al. 2005). The average for 1985-90 was less than US $2 million per annum. To put the lack of significant FDI in the Indian economy in perspective, one should take note of the two following statistics. First, the stock of the FDI in 1990 was less than US $2 billion, while the inflow was US $100 million (Kapur and S.Athreye 2001: p.130). These statistics are enough to bring home that India was a minor player in global FDI flows before

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1991. After the macroeconomic reform process began in 1991, the economy was gradually opened up to FDI and policy endeavors were made to attract it. This becomes clear from Table 3.2 that India is fast emerging as an attractive destination of foreign investors. Table 3.2 FDI Inflows in India, August 1991-2005 (US $millions)
Amount of Paid-in FDI5 Financial Year (April-March) August 1991-March 2000 15,483 2000-2001 4,029 2001-2002 6,130 2002-2003 5,035 2003-2004 4,673 2004-2005 5,535 2005-2006(up to Dec.2005) 4,719 Total 45,604 Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India

The above table presents the first high point of FDI inflows was reached in 2001, when it topped at US $4 billion. In 2004, with a total amount of US $4.6 billion FDI inflows, India was the fifth largest recipient of FDI in the developing world. China, Hong Kong SAR, Singapore and Korea were larger recipients than India. Compared to China, India appears to remain an underperformer in the global competition for FDI. However, conclusions based solely on those figures in Table 3.1 and 3.2 need to be interpreted carefully, as the above indexes have used FDI data provided by official sources in each country
5

The Indian data on inflows do not cover the approval amount of FDI. It is estimated that on an average just 35.8% of approved amount has flown in India from 1991-2000.

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whose definition and measurement methods vary significantly. The following Table 3.3, using the data from World Investment Report, elucidates a relatively accurate comparison based on international standards. Table 3.3 Comparison of FDI inflows to China and India (Amount in US $millions)
1990-2000 (annual average) 30104 1705 134670 2002 2003 2004 2005

China 52743 53505 60630 72406 India 5627 4585 5474 6598 Developing 163583 175138 275032 334285 economies World 495391 617732 557869 710755 916277 Source: UNCTAD, World Investment Report 2006 (www.unctad.org/wir)

Indias share of global flows to developing countries appears to be very small, especially compared with those received by China. The reported inflows of US $6.6 billion in 2005 represented a mere 1.9 percent of total inflows to developing economies, in contrast to US $72.4 billion inflows to china with a share of 21 percent (Ray 2005). However, as noted by Pfefferman, an IMF 2002 paper asked whether something was wrong with Indias FDI numbers. The IMF found out that the Indias FDI statistics exclude reinvested earnings, subordinated debt and overseas commercial borrowing, which are included in FDI of other countries (Pfeffermann 2002). On the other hand, the Chinese statistics are believed to be overestimating the real FDI flows in view of round-tripping of Chinese capital to take advantage of more favorable tax

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treatment of FDI. According to the World Bank, round tripping accounts for 20%-30% of FDI in China (World Bank. 2002). This argument is supported by Songs research, which shows that the Mainlands inward FDI from Hong Kong is overstated by the amount of non-Hong-Kong (Mainland, Taiwanese and others) capital channeled via Hong Kong, as Hong Kongs investment in the Mainland appears to be too larger for the size of the Hong Kong economy (Song 2005: p.30) In summary, China and India have pursued radically different FDI development strategies. So far the absolute amount of FDI going to China is still much larger than India, but the gap in growth rates is narrowing. 3.2 Source-country Composition China Since 1979, more than 200 countries and regions have invested in China. In the past, most of Chinas FDI came from Hong Kong or Macau, following by those from USA and Japan. More recently, with normalization of political and economic relation between China, South Korea and Taiwan, the latter two regions have become important sources of FDI in China. Table 3.4 Top ten source countries (regions) of FDI in China, 1979-2005 (Amount in US $billions)
Rank 1 2 Sector Hong Kong Taiwan Paid-in FDI 288.948 62.119 %age of total china FDI 46.62% 9.98%

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3 United States 54.385 8.74% 4 Japan 53.445 8.59% 5 South Korea 31.318 5.03% 6 Singapore 28.956 4.65% 7 United Kingdom 13.287 2.13% 8 Germany 11.517 1.85% 9 France 7.47 1.2% 10 Netherlands 6.967 1.12% Sources: China Foreign Investment Report 2006, Ministry of Commerce

As Table 3.4 shows, Newly Industrializing Economies (NIEs), including Hong Kong, Taiwan, Singapore and South Korea, have been the major investors in China, accounting for 66.28% of the total accumulated FDI inflows. They represent mainly small and medium-sized businesses that are export-oriented and involved in assembly and processing operation. Among them, Hong Kong is keeping as the most important player. However, its share has dropped from 70% in 1992 to 46.6% in 2005. It is estimated, with the Chinas success in industrial upgrading and greater openness to the outside world, the role of Hong Kong in providing and intermediating FDI inflows into China will be further reduced in the future. It should also be stressed here that published FDI figures of Hong Kong are overstated for the large proportion of round tripping capital, although no reliable estimates of such part are available. The USA and Japan have been by far the largest foreign investors among developed countries investing in China, representing 17.33% of the total China FDI. The United Kingdom, Germany, France and the Netherlands constitute the main sources of European Union (EU) in

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China, as together they account for 6.3%, which was quite weak. India Table 3.5 Top ten source countries (regions) of FDI in India, Aug. 1991-2005 (Amount in US $millions)
Rank 1 2 3 4 5 6 7 8 9 10 Sources: %age of total India FDI Mauritius 11,115.47 37.25% United States 4,912.75 15.8% Japan 2,059.33 6.79% Netherlands 1,987.18 6.65% United Kingdom. 1,911.77 6.26% Germany 1,338.88 4.27% Singapore 962.41 3.14% France 772.99 2.55% South Korea 748.98 2.28% Switzerland 613.58 1.98% Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Foreign Direct Investment Policy, April 2006 Sector Paid-in FDI

Table 3.5 gives percentage share of major country sources in the actual inflow of FDI in India during 1991-2005. Mauritius, as the top-place contributor, account for 37.25% of total FDI inflows. It is estimated that Double Tax Avoidance Treaty entered into with Mauritius, exempting capital gains from Indian Income Tax, 1961 and benefiting foreign investors, could be only one of the reasons of spurt in FDI inflows from Mauritius (Chopra 2003: p.158). Hence, investors from other countries, principally the United States, route their investments through Mauritius to take advantage of the tax treaty. The United States occupies the second position with a share of 15.8%

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and Japan stands at the third rank having a share of 6.79%. The share of major EU source countries, including the United Kingdom, Germany, France, Switzerland and the Netherlands, is approximately 21.7%. In reviewing the source countries of FDI inflows to China and India, two conclusions can be drawn. First, in China there is a clear pattern of concentration of FDI inflows. A large part of Chinese FDI comes from Chinese-owned or overseas Chinese owned companies located in Hong Kong, Taiwan, Singapore and other NIEs. This proportion to a certain extent forms the basis for the economic integration of the region, which is sometimes referred to as Greater China. The plausible explanation here is that the relative geographical and cultural proximity of China and other East Asian countries with major sources of capital such as Japan and Singapore may have put India a disadvantage. However, projects from such countries are mainly in labor-intensive ones, small in scale, with a low level of capitalization and little technology transfer. By contrast, source-country composition in India is more diversified. Kumar studied the changing sources of FDI in India and indicated that the European countries were the major sources of FDI inflows to India until 1990. However, they had declined steadily from 66% in 1990 to 31% by 1997, while US emerged as the biggest player over this period with a share of 13.75% in 1997 (Kumar 2003). Second, India boasts a relatively larger share of FDI from developed

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countries (including US, Japan and EU), which accounts for 44.3%. In comparison, China only holds a share of 23.63%. Although the EU constitutes the worlds largest home base for FDI, it is relatively underrepresented in the Chinese FDI, at least as compared to its overall FDI position in the global economy. As Bulcke and Zhang point out, the weak FDI position of the European Union in China has directly affected the competitiveness of the EU companies in the Asian emerging markets (Bulcke, Zhang et al. 2003: p.3). 3.3 Sectoral Composition China Table 3.6 Sector-wise FDI inflows in China, 2000-2005 (Amount in US $millions)
National total Agriculture Mining and 58328 81102 58106 33635 53800 35495 quarrying 2584417 3090747 3679998 3693570 4301724 4245291 Manufacturing Electric Power, gas and water 224212 227276 137508 129538 113624 139437 production and supply 90542 80670 70877 61176 77158 49020 Construction Transportation, storage, postal, and 101188 90890 91346 86737 127285 181230 telecommunications services Wholesale and 85781 116877 93264 111604 158053 159871 retail trade and catering services Banking and 7629 3527 10665 23199 25248 21969 insurance 2000 2001 2002 2003 2004 2005 4071481 4687759 5274286 5350467 6062998 6032469 67594 89873 102764 100084 111434 71826

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465751 513655 566277 523560 595015 541807 Real estate 386039 393142 463481 587364 499657 586523 Other sectors Sources: China Foreign Investment Report 2006, Ministry of Commerce; China Statistical Yearbook, National Bureau of Statistics

Table 3.6 examines the distribution of FDI inflows by industry from 2000 through 2005. It shows that nearly 65-70 percent concentrated primarily in the manufacturing sector. The next highest share, approximately 9-11 percent, is in real estate. Beyond those two sectors, FDI in China is scattered across various sectors with single-digit or lower percentage shares. On the whole, the industry concentration of FDI in China is not very high compared with the industry concentration in other countries (IMF 2002). Regarding manufacturing sector, it is observed that FDI has been concentrated in the various fields, in particular the electric and electronic equipment sector, the textile sector, and the chemical and pharmaceutical sector. However, a shift of FDI away from manufacturing towards services sector is forecasted because the significant liberalization following Chinas membership in the WTO. The greatest liberalization will be in financial services, telecommunications, and distribution. These sub-sectors in the service sector are expected to see rapid increase in FDI. India The sectoral distribution of FDI in India between August 1991 and December 2005 is given in the following Table 3.7. Table 3.7 Sector-wise FDI inflows in India, Aug. 1991-2005

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(Amount in US $millions)
Rank 1 2 3 4 5 6 Sector Amount of FDI inflows 4,885.88 3,143.09 2,971.66 2,890.12 2,521.49 1,899.51 %age of total India FDI 16.5% 10.34% 9.64% 9.58% 8.41% 5.86%

Electrical Equipment6 Transportation Industry Service Sector Telecommunications Fuels7 Chemicals (Other than Fertilizers) 7 Food Processing Industry 1,173.18 3.67% 8 Drugs and Pharmaceuticals 948.54 3.18% 9 Cement and Gypsum 746.79 2.54% Products 10 Metallurgical Industries 627.32 2.12% 11 Consultancy Services 444.48 1.59% 12 Miscellaneous Mechanical 435.45 1.51% & Engineering 13 Textiles 430.07 1.32% 14 Trading 374.23 1.16% 15 Paper and Pulp 363.46 1.1% Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Foreign Direct Investment Policy, April 2006

The table 3.7 shows the electrical equipment is the largest beneficiary of FDI inflows, which represents one of the most spectacular achievements for the Indian economy. Transportation, service sector and telecommunications, which can be categorized as the tertiary industry, emerge as significant recipients with a share of 30 percent. Compared with the old pattern of FDI stock before liberalization, the relative importance of manufacturing sector has declined with the opening up of infrastructure and service sectors. Furthermore, within the manufacturing itself, the preference pattern of FDI is shifting away from heavy
6 7

Computer software and electronics are included Power and oil refinery are included

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industries to light industries. To sum up the foregoing discussion on sectoral distribution of FDI in China and India, we note that both countries witness that the opening up of new industries has led to increased investments in service sector, thus bringing down the share received by manufacturing. Within the manufacturing sector, both countries saw a steady upgrading of FDI inflows from labor intensive industries to capital and technological intensive industries and from traditional manufacturing industries to information technology (IT) related industries. Therefore, in the coming years, China and India will still present a David and Goliath image in attracting FDI inflows. 3.4 Regional Distribution China The geographical distribution of FDI in China is highly uneven and reflects the history of liberalization, deregulation and government policy, as noted in section 3.1. In the early period of reform and opening up, the reformers targeted Chinas coastal areas as the leading regions for the economic development and established four Special Economic Zones8 (SEZs) in Guangdong and Fujian Province. The analysis of Table 3.8 reveals that the coastal areas, particularly Guangdong and Jiangsu, are the major locations for FDI inflows. The other main locations for FDI were

The four SEZs are located in Shenzhen, Zhuhai, Shantou and Xiamen.

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Shanghai, Shandong and Fujian. Table 3.8 Province-wise FDI inflows in China, 1979-2005 (Amount in US $billions)
Amount of FDI %age of total inflows India FDI 1 Guangdong 151.657 24.36% 2 Jiangsu 89.848 14.44% 3 Shanghai 55.394 8.90% 4 Shandong 52.932 8.50% 5 Fujian 47.851 7.68% Sources: China Foreign Investment Report 2006, Ministry of Commerce Rank Province

Using Chinas provincial and municipal data, Hsiao and Shen found out that the development of cities and infrastructure and easy access to markets are two of the primary factors often determining MNCs choice of where to invest (Hsiao and Shen 2003). Another point is that the close geographical proximity and tight cultural and linguistic links between southern China and the overseas Chinese communities in Hong Kong, Taiwan and Macau have also contributed to the observed geographical pattern of FDI inflows in China. India The major portion of the FDI in India is found to be flowing into the economically richer states. The five richer Indian states, Maharashtra, Delhi, Tamil Nadu, Karnataka and Andhra Pradesh accounted for more than 66.65% of the FDI inflows into India. This trend in FDI inflows shows the economic inequality that already exists among the Indian states. Tamuli asserted that FDI inflows to these states seemed to respond to

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infrastructure availability, business managers perception of investment climate, educational qualification of manufacturing workers and productivity level of manufacturing industries (Tamuli 2006). Table 3.9 Region-wise FDI Equity inflows9 in India, 2000-2006 (Amount in US $millions)
Rank Regional office State covered Amount of FDI inflows %age of total India FDI

Maharashtra, Darda 1 Mumbai &Nagar Haveli, Daman & 7,486.6 24.91% Diu Delhi, Part of Up and 2 New Delhi 7,045 23.42% Haryana 3 Chennai Tamil Nadu, Pondicheery 2,295 7.64% 4 Bangalore Karnataka 2,052 6.82% 5 Hyderabad Andhra Pradesh 1,157 3.86% 6 Ahmedabad Gujarat 970 3.26% Sources: Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, India. Fact Sheet on FDI, from Aug.1991-Dec.2006

To summarize, locational benefits appear to be a prime consideration for foreign investors contemplating participation in any FDI projects both in China and India. Especially in China, the selective economic policy creates uneven regional economic development, which strongly affects the inflow and location of FDI. The study also finds out that the forces of convergence are very weak in two countries and the provinces (states) are showing a tendency of divergence rather than convergence. The geographical distribution of FDI in two countries today also is the result of local governments efforts to create a favorable investment, especially
9

Includes equity capital components only

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in fostering industrial clusters in their jurisdictions. The Indian economist Kurian notes that the better-off states are able to attract considerable amounts of private investment, both domestic and foreign, to improve their development potential because of the existing favorable investment climate including better socio-economic infrastructure(Kurian 2000: p.12). It seems both China and India express the concern that a growing polarization of the country can have an extremely damaging effect on national unity and harmony. A wider geographic spread of capital across the country are actively pursued by each country. In China, to narrow the gap, it introduced The West Development Strategy in 1998. In contrast, the Indias 10th five-year plan explicitly addresses the need to ensure equity and social justice and particular attention must be paid to the importance of ensuring a balanced development for all States (India. Planning Commission. 2003: p.8). 4. Determinants of FDI Following the analysis and literature review on determinants of FDI in Chapter 2 and the discussion on trends and patterns of FDI inflows to China and India in Chapter 3, this chapter in turn examines the various determinants of FDI and to see how far these determinants can be applied in both countries. Since the external (supply-side) factors explain the outward investment by different countries while the internal

(demand-side) factors explain the uneven distribution of FDI among the

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recipient countries. Therefore the focus of this chapter will be on internal (demand-side) factors, although the separation of the two kinds of factors sometimes is impossible. It will present the PESTEL (political, economic, social, technological, environmental and legal) analysis of variables that have directly or indirectly determined the FDI inflows to both countries. 4.1 Political Environment and FDI policy regime China is still regarded as a communist regime and one of the most important characteristics of Chinese political system is the one party rule, while India is the worlds largest democracy. Therefore, the simplest language to describe the difference between the two countries is the worlds largest democracy versus the worlds largest autocracy. Although this metaphor indeed reflects some truth, the reality is much more complex. Both countries, despite enjoying different political systems, have actually come from the same place Soviet style planned economies and massive state-owned enterprises. Both countries undertook significant reforms in the 1980s and 1990s. As China modernizes, it increasingly encourages free trade and capitalist-based economic model which allows more democracy; whilst as India modernizes, its getting its democracy under control for the good of nation. The first reason for the FDI gap between two countries is that India is at least twelve years behind China in terms of launching reforms. As

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discussed in Chapter 3, China opened its doors to FDI in 1979 and has been progressively liberalizing its policy regime, while the reforms in India were introduced in June 1991, which aimed at reducing the extent of government controls over various aspects of domestic economy, increasing the role of the private sector, redirecting scarce public sector resources to areas where the private sector is unlikely to enter, and opening up the economy to trade and foreign investment (Cassen and Joshi 1995: P.13). In addition to the late start, Franda asserts that failure to effect far-reaching economic reform in the 1990s could be attributed as an immediate cause to the enormous factionalism characterizing Indian political life. For example, the BJP-led coalition formed in 1999 consisted of almost two dozen political parties with widely divergent platforms and interests (Franda 2002: pp24-27). Vardarajan also declares that India is perhaps the only democracy where businessmen dont become politicians and political system is dominated by political leaders who base their appeal on castemanship, regional factionalism and personal cults (Cable and Royal institute of international affairs. International economics programme. 1995). Therefore, a major consequence of the fragmentation of Indian political party life is the near-impossibility of conducting meaningful national FDI promotion campaigns. In this atmosphere, it is little wonder that FDI volume in India was only

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one-tenth of China from 2000 through 2005 (see above table 3.1 and 3.2). Additionally, during a debate in the Rajya Sabha on 20 August 2001, the then planning minister, Arun Shourie, was asked why India had received only $17 billion in FDI in a decade when China had attracted $323 billion. Shourie stated that the reason was that the Chinese government is market savvy, quick in decision-making and better still in executing decisions (The Statesman, 21 August 2001). Another essential reason for Chinas unparallel success is its strategy of creating Special Economic Zones (SEZs) and coastal economic zones, which has been discussed in section 3.4. Decision-makers in the public policy community proactively create an enabling environment for the inflows of FDI in the domestic economy, which are essentially located in the coastal areas of the eastern and the southern provinces of China (Das 2005). Therefore, the ability of China to attract FDI inflows is largely the result of special economic zones that give foreign enterprises better and specialized infrastructure and flexibility in domestic regulations. Compared with China, Indias SEZs scheme was launched in 2000, again 15 years later than China (Gakhar 2006: p.85). Furthermore, unlike China, India has not employed fiscal incentives such as tax concessions to attract FDI. Only in December 2004, the Indian government initiated the reform of the Foreign Investment Promotion Board, and has established the Indian Investment Commission to enhance and facilitate FDI in India,

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which acts as a one-stop shop between the investor and the bureaucracy. The one bright spot for India in its FDI competition with China has been the ability to invite more foreign software investors. The most telling demonstration of Indias superiority in software technology is in FDI inflows and trade statistics (see table 4.1). Table 4.1 Comparison of software industry in China and India (Year 2005) (Amount in US $millions)
Software industry FDI Software industry inflows Exports 932 3590 China 1451 10000 India Source: China Foreign Investment Report 2006, Ministry of Commerce; NASSCOM, India10

Software development in China is at the opposite end of the spectrum from that in India. Beijings effort to build sophisticated software production capabilities did not get started until the mid-1990s and the Chinese government provided little state support to this effort until the late 1990s. While Indias lead in software technology can be traced to 1984, when Rajiv Gandhi began to adopt the first liberal economic policies designed to develop this sector (McManus, Li et al. 2007). Compared to the above reform and FDI policies, it is worth noting that the government need to understand how their policies and behaviors shape the opportunities and incentives facing firms(WorldBank 2005:
10 NASSCOM is the apex software industry body in India. Useful information on the Indian software industry as well as doing business in India is available at its website, http://www.nasscom.in

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p.12). In brief, the government policies can play an important role in attracting FDI inflows. It is desirable to give some specific policy direction to foreign investors, as the cases of Chinas SEZ success and Indias software development demonstrate. 4.2 Economic Development Chinese gross domestic product (GDP), adjusted for purchasing power parity, ranked number 2 after USA, whereas Indian adjusted GDP ranked number 4 after Japan. Over the past two decades, Chinas average annual growth rate was above 9 percent, and the average annual inflation rate was kept below 3 percent. The Chinese economy continues its robust development, total growth in 2005 exceeded expectations at nearly 10 percent. In contrast, the Indian rate also jumped from about 3 percent a year during 1950-79 to between 5-6 percent a year during 1980-2004 (Chai and Roy 2006). According to the research on the contribution of GDP growth to FDI by Hsiao and Shen, the elasticity of a 1 percent increase in GDP raises FDI by 2.117 percent (Hsiao and Shen 2003). Therefore, if both countries could sustain their present growth in the future, they are likely to attract more FDI. Table 4.2 compares the current stage of Chinas macroeconomic performance and economic structure with that of India in terms of some key economic indicators. Table 4.2 Comparison of selected economic indicators: China and India

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Indicator

Unit

Year

China

India

US $ 2002 4580 2670 GDP per capita at PPP Gross national income US $ 2003 1,100 540 2.0 (per capita) 159th 2003 134th Rank Share of manufactured Percent 2002 90 75 1.2 products in exports Share of high-tech Percent 2002 23 5 4.6 products in exports Billion kwh 2002 1,640 597 2.7 Electricity production Share in multilateral Percent 2004 8.9 1.1 trade 2004 3rd 20th Rank Position in the WTO 2004 3rd 30th league table of exporters Position in the WTO 2004 3rd 37th league table of importers Foreign exchange US $ billion 2005 711 144 4.97 reserves Percent 2002 17 35 0.5 Rate of poverty Percent 2002 91 61 1.49 Adult literacy rate Per million 2002 584 157 3.71 Researchers in R&D people Share of IT industry in Percent 2002 3 NA GDP Sources: (1) World Development Indicators 2005, (2) International Trade Statistics 2005, (3) China Statistical Yearbook, National Bureau of Statistics

China/India ratio 1.71

The comprehensive comparison of the above economic indicators reveals that India currently is at the level that China had reached in the early 1990s. Hence, there is roughly a ten-year gap between Chinas and Indians economic development. These again prove that Chinas economic reforms, including those related to attracting FDI, were initiated so much earlier than Indias and proceeded at such a faster pace over the past three decades. However, in certain field, such as IT industry, India is ahead of China.

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To sum up, on the basic economic determinants, China does better than India. Chinas total and per capita GDP are higher, making it more attractive for market-seeking FDI. Its higher literacy and education rates suggest that its labor is more skilled, making it more attractive to efficiency-seeking investors. 4.3 Society The Dunnings O-L-I framework and other mainstream FDI theories discussed in the Chapter 2 do not take social factors explicitly into consideration. Undeniably, social factors are considered by MNCs and they have a tremendous impact on the causes and effects of FDI inflows. Firstly, the FDI gap between two countries is partly a tale of two Diasporas. China has a large and wealthy Diaspora that has long invested its money. During the 1990s, more than half of Chinas FDI came from overseas Chinese sources (Friedman and Gilley 2005). Yeung revealed that a large proportion of foreign investment in Dongguan, Guangdong Province was stemmed from overseas Chinese entrepreneurs (including the overseas-based subsidiaries of enterprises originating in China). The competitive advantage for overseas Chinese-funded enterprises in Dongguan was their ethnic or close relationship with local government officials (Yeung 2001). The discussions at section 3.1 and 3.2 also support Hong Kong and Taiwans ethnic relationship with China is a unique advantage, which enables investors to conduct negotiations and

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operations much easier. By contrast, the Indian diaspora was, at least until recently, resented for its success and much less willing to invest back home. Until now, the Indian diaspora has accounted for less than 10 percent of the foreign capital flowing to India. Recently, the Indian government has noticed this problem and organizations, such as The Indus Entrepreneurs (TiE) , were established to provide platforms for formation of social networks (McManus, Li et al. 2007: p.48). Besides the ethnic networks, the personal relationship (Guanxi) cultivated with local officials is also considered by foreign investors, especially those from Hong Kong and Taiwan. As Yeung indicates that some open-minded local government officials have established communication channels exclusively for foreign investors (Yeung 2001: p.131). It is regarded as an internalization advantage for foreign investors as it reduces the information costs for clarifying and understanding new policies. In contrast, feedbacks received from potential foreign investors indicate that Indias vast market-place and skilled workforce do not compensate for poor infrastructure and a corrupt bureaucracy (Fortune India 31 December 2003: p.8). The American congressman, Frank Pallow once complained that India is not a difficult place to invest, but India has to contend with the reality that its bureaucratic maze makes it more difficult to handle than the stringent bur clearer norms of more autocratic

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countries like China (Gakhar 2006: p.118). Hence, the FDI decision-makers are now acutely conscious of Indias corrupt and inefficient bureaucracy, which could turn into a veritable and bothersome hurdle. 4.4 Technology development Much has been made of the implications over China and Indias political systems, economic reforms and social relations, which maintain the accepted truth that China is 12 years ahead of India. While this may be true of the infrastructure development of China, it is not true for another important determinant of FDI, which India is ahead. With better English language skills, India may have an advantage in technical manpower, particular in information technology. Some of the differences in competitive advantage of the two countries are illustrated by the sectoral composition of their FDI inflows, which has been explained in section 3.3. For example, in information and communication technology, China has become a key center for hardware design and manufacturing while India specializes in IT services, call centers, business back-office operations and R&D (Winters and Yusuf 2007). Therefore, foreign investors perceive China and India as distinctly different markets. While China is well regarded by them as the leading global manufacturer and the fastest growing consumer market, India is viewed as a world-class services provider in business processes and

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ICT-enabled services. Therefore, the Times of India claims that India is the most preferred outsourcing destination in the world (Times of India Online. 15 February 2005). There is awareness in the global investment community that Indias service-oriented development over the last two decades has made it possible for it to bypass some of its glaring economic weaknesses, like a poor quality physical infrastructure. Moreover, as we have discussed at the above section 4.3, although with the help of its diaspora, China has won the race to be worlds factory. India could become the worlds office with the help of its diaspora on technological field. The development of Indian software industry discussed at section 4.1 shows the fact that Indias soft skill and technology are creating a tortoise that will ultimately overturn the hard Chinese hare (Smith 2007: p.176). Kiran Karnik, president of Nasscom comments that China has great potential but is far from being a serious competitor and lags three to five years behind Indias software industry, quoted by FT reporter (Yee 2007). 4.5 Business Environment As discussed at section 4.1, liberalization of FDI policy is a necessary variable for FDI, especially in the kick-off stage, but its not sufficient for expanding FDI inflows. The overall business environment continues to exercise a major influence on the magnitude of FDI inflows, for it signals to potential investors the growth prospects of host country. Hence, paying

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attention to the overall business climate and creating a stable and environment will crowd-in FDI. A survey of global executives was conducted by the Global Business Policy Council (GBPC)
11

in 2005 and published as FDI Confidence

Index. Both China (2.19) and India (1.95) are at the center of the FDI radar screen for they are considered as the 1st and 2nd most attractive FDI locations globally. This is the forth year in a row that China held the top spot and India rose from 3rd to 2nd place, surpassing the United States (GBPC 2005). In Year 2004, this extensive opinion-survey put China at the top with a score of 2.03 for having the best investment environment, the US second with a score of 1.45 followed by India with a score of 1.40 (GBPC 2004). A noteworthy observation here is that the gap in the value of the confidence index between China and India is getting tiny. The result of the GBPC opinion survey coincided with that of a 2005 opinion survey conducted by the World Investment Report team of the UNCTAD. This team conducted a larger sample survey of the global investing community, MNCs, FDI experts and investment promotion agencies (IPAs). Their results revealed that those who were surveyed regarded China as the most attractive location with 55% of the CEO surveyed were willing to invest the most in China, followed by India
This survey has a wide coverage in terms of sample size. It covers top decision-makers in the 1,000 largest MNCs of the world on their opinions of various FDI destinations and their investment intentions. These 1,000 MNCs contribute over 70% of total FDI flows and represent all major regions and sectors. The survey tracks the impact of political, economic and regulatory changes in the host economies by the global investing community and preferences of decision-makers in these MNCs. The confidence index ranges between zero and three.
11

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(36%). Again, both countries are considered as the most favored investment destination (United Nations Conference on Trade and Development. 2005). The World Development Report 2005 emphasizes that for

governments at all levels, a top priority should be to improve the investment climates of their societies. To do so, they need to understand how their policies and behaviors shape the opportunities and incentives facing firms(WorldBank 2005: p.12). From the above surveys, we can see that a virtual sea change has taken place in the business environment of India and it is catching up China very quickly. Therefore, in terms of overall business environment, India does not rank much below China. 4.6 Legal System Although the FDI literature focuses essentially on political and economic development, business environment and technology, to some extent, the legal system and barriers need to be taken into account as well for a comprehensive analysis. The lack of a well-structured and transparent legal system in China poses serious problems for foreign investors. A clear and strict hierarchical system of norms does not really exist yet. Moreover, different ministries and departments of the central and local governments have issued many diverse regulations, which result in the failure of the foreign companies to find out which regulations exactly apply to them. In

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contrast, India enjoys a strong British-based legal and accounting system, which helps it to attract more capital from Western countries. Therefore, the absence of reliable legal and secure property rights and vast differences in culture help to explain Chinas below par performance in attracting FDI from Western countries, compared with the performance of India which has been demonstrated in section 3.2. Meanwhile, Indias long history of private property, democracy and similar law system with Western countries should prove attractive for potential foreign investors. In other words, even if economic policy is great and politics stable, if there are no property rights and contract enforcement in a country, there's no way anyone can do business. One of the key issues on legal affairs is the protection of intellectual property rights (IPR). The most significant change in the Chinese business regulations for foreign-invested companies was the introduction and improvement of IPR during the 1990s. The introduction of patent law has removed a major obstacle to lure FDI in high-tech industries. However, the full implementation of IPR protection regulations remains weak in China. For example, according to the Software Piracy Study of Business Software Alliance12, China has a very high software piracy rate with 82 percent in 2006. In contrast, Indias rate is a littler lower than China, which stands at 71% (BSA 2006). Additionally, the Patent Law in
The Business Software Alliance (www.bsa.org) is the organization dedicated to promoting a safe and legal digital world. An important mission of BSAs research portfolio is the BSA/IDC Global Software Piracy Study, which tracks the state of software piracy across more than 100 countries.
12

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India is being revised in conformity with the required standards of the WTO in 2002 (Chopra 2003: p.132). Concisely, there is a growing patent culture in both countries. The Indian companies are striving to move up the value chain and are increasingly approaching their competitive positioning with

intellectual-property-based differentiation. At the same time, under domestic and international pressure, the Chinese government has tightened its enforcement of IPR protection and will improve judicial performance of contracts and other business codes, including those governing IPR and counterfeiting. 4.7 Summary From the above PESTEL analysis, we may find that the FDI favors China over India in the following significant areas: pro-business government, overall business environment, incentives provided by the host government, quality of infrastructure and macroeconomic management. All these add up to create a superior investment environment in China than in India. The same set of decision-makers has favorable opinions on Indias English-speaking workforce, software talents, rule of law, cultural affinity and regularity environment. As we have seen, the relative attractions are now becoming better balanced. Given a choice, some investors have switched to prefer India. 5 Summary and Conclusions

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5.1 Findings Research on the characteristics and determinants of FDI in China and India is still at the developmental stage. The existing literature on FDI is appraised in chapter 2. However, most of the traditional studies of FDI explain only the company advantages, transaction costs and differential factor endowments, while Dunnings O-L-I paradigm unifies the various theories. According to this theory, FDI is chosen as a market entry strategy so that a firm can exploit its ownership advantages through internalizing transaction costs in a specific location, which possesses locational advantages for FDI. The third chapter details overall trends and patterns of FDI inflows in China and India, including its development stages, sources, regional and sectoral distributions, along with the governments policy changes towards FDI. Since the host countrys internal factors play an important role in influencing the magnitude, importance, pattern, form and impact of FDI in the economy, the Chapter 4 deals with and compares the main determinants by adopting the PESTEL analysis format. Hence, this research has proved to be a useful experiment in the analysis of the FDI development experiences and determinants strategies of both countries. The main conclusions of the present study are given below: One important finding is that multiple factors, rather than a single

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factor, influence the volume and pattern of FDI inflows, which include political and social stability, sound macro-economic environment, well-developed soft and hard infrastructure, competitive supporting industries, the availability of skilled labor, and open trade and FDI regimes. Indeed, these factors are considered fundamental; they create an environment that enables foreign firms to enter an economy and contribute to its growth and development. Through the PESTEL analysis, this study finds out that in terms of political and FDI policies, economic development, society and business environment, China does better than India; whilst India is ahead of China in terms of technology and legal system. A second major conclusion of the study is that changes in a countrys FDI policy regime are not enough to ensure the desired inflow of FDI. Actually, the policy coherence, consistency, transparency, and effective implementation matter. In the forefront of effective implementation of FDI policies is the speedy processing and approval of FDI applications. This means that both countries shall streamline its bureaucracy, simplify approval and remove restrictions on foreign ownership, therefore create a climate of certainty and friendly policies towards FDI. A third major conclusion of the study is about the question whether the recent improvement in the image of India in the global investing community will affect FDI flows to China. It can be answered by saying

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that it will have little impact. This relates only to the part of FDI that originates from MNCs, which is a small proportion of total FDI going to China. Regional FDI flows that originate from the Chinese Diaspora will not change its pattern of FDI. Besides, the sectors that are going to attract the global FDI in the immediate future in the two economies are very different. Coupled with the economic impact of the 2008 Beijing Olympic Games and the 2010 Shanghai World Expo, rising FDI in services and high-tech manufacturing might contribute to a new round of FDI growth in China. As for India, in spite of the opportunities available for attracting FDI, several challenges remain to be met in order for the economy to sustain a higher growth path, and enhance competitiveness in order to position itself favorably in the global competition for FDI. 5.2 Policy Implications In addition to the general policy implications that have been drawn above, studies of determinants of FDI inflows conducted in the framework of an extended model of location of foreign production (Kumar 2002) have found that a countrys ability to attract FDI is affected by structural factors such as market size (income levels and population), extent of urbanization, quality of infrastructure, geographical and cultural proximity with major sources of capital, and policy factors (namely tax rates, investment incentives, performance requirements). Based on the above discussions, India is at the verge of an FDI take-off. Whether this

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potential materializes or not will necessarily depend on how the government manages and upgrades its business policy environment in the foreseeable future. At the same time, to maintain sustainable growth, China needs to improve its ability to attract and use FDI, especially on the issues of establishing a rule-of-law society and encouraging human capital enrichment. As a guideline to both policymakers, it seems reasonable to suggest that the encouragement of FDI should take forms that bring long-term benefits to the host countrys economy. These may include the upgrading and extension of infrastructure and public expenditure on education and training. Another important implication for both countries and economic analysts is that we shall stop treating India and China as simple, one-dimensional entities weighable on a single scale to judge which is the success and which the failure. Indeed, each, as revealed above, increasingly sees the other better in some ways and worse in others. For example, two policies that China can learn from India are: human resource development and the development of local supporting industries. Human resource development not only ensures an adequate supply of skilled labor for foreign investors, but helps a country achieve overall economic efficiency and move up the economic development ladder. Moreover, the competitive supporting local industries will promote technology spillover, one of the positive effects for host country.

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5.3 Limitation of the Study An important limitation of this study is its use of secondary data and information which may sometimes be problematic. For example, as noted in chapter 3, the FDI inflows in China is reported to be overestimated thus the gap between China and India can be exaggerated. Another limitation is that we cannot compare the determinants of FDI by different investors. FDI from different countries contains different levels of technology and would have different motives to invest. However, the existing data are very aggregate and this study has to examine the determinants of FDI as a whole, whether they come from the United States, Europe, Japan and other countries or regions. 5.4 Future Research Directions This research has proved to be a starting point in the comparison of the FDI trends, patterns and determinants between China and India. Drawing on the PESTEL analysis of the Chinese and Indian FDI inflows presented in the preceding chapters, the further research will perform a strengths, weaknesses, opportunities and threats (SWOT) analysis on both country as well as compare and contrast them in relation to each. Furthermore, comparative analyses in regard to U.S. foreign investment in China and India are needed since it is now the major investor country source to both countries. In addition, as China and India continue to utilize FDI as an integral part of its economic development strategy, it will be interesting to

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do increased research on changing provincial or state environment for FDI in both countries, particularly with reference to the interior or backward provinces (states).

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