China Economic Development Model

DAEJEON UNIVERSITY

Korean Economic Successes and Challenges Professor: Kim Sun Geun

Topic: China’s Economic Growth Model Prepared by: Siem Pichnorak Heang Rasmey Chea Chakrya Sok Vouchneng Academic Year: 2012-2013

Contents Introduction ................................................................................................................................................ 3 China Economy: Quantitative Outlook .................................................................................................. 5 1.

GDP .................................................................................................................................................. 6 a.

Overview of China‘s GDP......................................................................................................... 7

b.

Share in GDP............................................................................................................................... 7

2.

Inflation ........................................................................................................................................... 8 a.

Inflation Rate in General ........................................................................................................... 8

b.

Monthly Inflation ....................................................................................................................... 9

3.

Export and Import ......................................................................................................................... 9 a. Foreign Trade................................................................................................................................ 11

4.

Investment..................................................................................................................................... 12 a.

Investment .................................................................................................................................. 12

b.

Foreign Investment .................................................................................................................. 13

c.

Registered Companies in China ............................................................................................. 13

d.

Outward Investment by Area ................................................................................................ 14

e.

Foreign Indirect Investment ................................................................................................... 15

5.

Labor Force and Employment ......................................................................................................... 15

China Economy: Qualitative Outlook ................................................................................................... 17 I.

Technological Capabilities .......................................................................................................... 17 1.

Acquiring Manufacturing Capabilities ................................................................................. 18

2.

International Experience with Technological Change ........................................................ 19

3.

Lessons from Late-Starting Economies ................................................................................. 20

4.

Promoting Research and Development ................................................................................ 20

II.

Human Resources ........................................................................................................................ 21 1.

Labor & Wage Costs ................................................................................................................ 22

2.

Human Resource Programs .................................................................................................... 23

III.

Government Intervention and Policies ................................................................................. 24

IV.

State-owned Enterprises ......................................................................................................... 25



State-owned Enterprises and Technology Transfer ............................................................ 27

V.

Foreign Direct Investment (FDI) ...................................................................................................... 29 

FDI and Technology Transfer................................................................................................. 33

Conclusion ................................................................................................................................................... 35 List of Reference ....................................................................................................................................... 37

Introduction 30 years ago, China was the strong enemy of capitalism, but now China is deemed as the country which is has open market and attracts a mass number of FDIs. China economic growth is fast and impressive. However, China economy has been through many periods. After the establishment in 1949, China ruled the country following centrally planned economy. Mao Zedong took control of China from 1954 to 1976. From 1966 to 1968, he implemented the cultural reform policy which claimed that elite people are the ones who destroyed the government and Chinese society. ―Schools were closed and millions of young people were mobilized as Red Guards, who were encouraged to challenge old ways. Books and artwork were damaged, along with thousands of museums and temples. Individuals in positions of authority were denounced and attacked, and widespread anarchy and terror disrupted the urban economy and industry. Officially, the Revolution was declared over in 1969. However, chaos and political power struggles continued until Mao's death in 1976. Since then, most of the tenets and reforms of the Cultural Revolution have been abandoned.‖1 Although the cultural reform ended in 1968, every citizen of China continued to live in a very abusive way. They were forced to work under Mao‘s order. Mao did not care about his citizens and he just told to his citizens to do anything that could help him to reach his goal which was to expand the economics of China to catch up with the US economy. Mao Zedong passed away in 1976; Deng Xiaoping took control over China. He was a politician and economic reform leader of the communist party of china who changed Chinese economy from planned economy into market economy to open China to foreign trade, foreign investment and foreign technology. Foreign companies were 1

(Chegg) http://www.chegg.com/homework-help/definitions/cultural-revolution-47

permitted to participate in joint ventures with Chinese companies and eventually to be able to open wholly-owned companies under Chinese regulations in selected areas of Chinese economy growth rate 8% to 10%. This helped China to double its economy about every 7 years. Deng Xiaoping designed and implemented many policies in order to push its economy to move far forward rapidly in the market economy for over 30 years, and because of this, he is recognized as “the Architect of China’s Rise”.2 The famous quote of Deng Xiaoping is ―It doesn't matter whether a cat is white or black, as long as it catches mice‖. This means that he did not care if the leadership of the country was socialism or communism, but what he cared the most was whether that leadership style could move country forward in a speedy way or not. Because of his implementation of market economy, average citizens started regaining the rights to control their own destinies. Furthermore, individuals also gained to a certain extent a mission of shared responsibility for determining the direction of society‘s development, and this market economy provided freedom to pursue the goals that individual choices. In October 2005, China approved the 5 year economic plan aimed at building a harmonious society through more balanced wealth distribution and improved education, medical care, and social security. China launched Economic Stimulus Plan to specifically deal with the global financial crisis of 2008-2009. It focuses on increasing affordable housing, easing credit restrictions for mortgage and SMEs lower rates such as those on real estate, sales and commodities. By the end of 2009, it appeared that Chinese economic was showing a sign of recovers. China is estimated to become the largest economy in the world by about 2020 in terms of purchasing power parity.

2

(Factor, 2010)

China Economy: Quantitative Outlook Qualitative analysis shows economic indicators of the country. Thus, it is important to be familiar with those data. The below table taken from National Bureau of Statistics Human Development Report 2007, 2008 and 2009 of United Nations Statistic Division illustrates the overall economic situation in China.

The data from the above table illustrates that: -

In term of GDP, it increased sharply from $2,712.92 in 2006 to 5, 745.13 in 2010. It was about double amount. Moreover, with only one year period which was between 2007 and 2008, the amount of GDP grew significantly.

-

In term of GDP real growth, the rate was quite similar in 2006 and 2007, which was around 11%. However, there were slight drops in 2008 and 2009 to below 10%. Noticeably, the rate jumped to above 10% in 2010.

-

In term of GDP per capital, it shows the upward trend. It started from $4, 7548 in 2006 to $7,517 in 2010. In short, for the 5 year period, amount doubled.

-

In term of inflation rate, it indicates the increasing rate if compared the rate in 2006 and 2010.

-

In term of unemployment rate, the statistics in China shows that the rate was always 4 percent. It illustrates the slight changes between the 5 years.

Four main focused areas that will be discussed in the following sections: GDP, inflation, export and import, investment, and labor force and unemployment.

1. GDP In the first part of economic indicator, we will show two key points of GDP such as overview of China‘s GDP and share in China‘s GDP. In accordance with World Bank (WB), gross domestic product (GDP) is the value of all final goods and services produced in a country in one year. GDP can be measured by adding up all of an economy‘s income-wage, interest, profits, and rentsexpenditure- consumption, investment, government purchases and net export (exports minus imports). In this first section of GDP of China, there are two main tables to be shown and the analysis such as the overview of China‘s GDP and share in GDP.

a. Overview of China’s GDP

The chart from National Bureau of Statistics of China shows the overview of China‘s GDP as the following: 

From year 2006 to year 2012, GDP in year 2007 shows the largest growth.



From year 2008 to year 2012, the GDP growth has been in moderate change.



Also, the GDP growth has been mostly around 8 percent to 10 percent.

Overall, from the chart above, it can be inferred that the GDP growth in china has dropped from the year 2006 to year 2012. However, China has been still the top growth.

b. Share in GDP

In accordance with Asian Development Outlook Database, the charts above shows the components of current GDP by focusing on three main fields such as agriculture, industry and services in year 2010 for some countries such as People‘s Republic of China, India, Republic of Korea, Malaysia, Philippines, and Thailand. In case of People‘s Republic of China, industry is the top contributor to the GDP in year 2012, while service is the top contributor for most of countries such as India, Republic of Korea, Malaysia, Philippines. It is noticeable that agriculture is no longer a big part of GDP for all of the above mentioned countries, and especially China that used to depend much on it.

2. Inflation Inflation is defined as the rate at which the general level of prices for goods and services is rising and subsequently purchasing power is falling, according to the Investopedia. For the second part which is inflation part, we will show the general of China‘s inflation rate and the monthly inflation rate in China.

a. Inflation Rate in General

The table indicates that: 

For over the period of time which is about 7 years starting from year 2006 to year 2012, the inflation rate in China has been up and down.



Noticeably, the biggest change in term of inflation rate happened in 2009.

b. Monthly Inflation

The line graph that was taken from the CEIC Data Company is about the monthly inflation in China in year 2009, 2010 and 2011. When going deeply to the monthly inflation of China, it is able to notice that the inflation rate in China usually starts going up for early the months of the year and it reaches the peak at the year end.

3. Export and Import For the third part of this economic indicator which is about export and import, it consists of overview of China‘s export and import and foreign trade in China.

a. Export and Import

In accordance with CEIC Data Company, it shows many interesting points: -

Firstly, the export and import in China are in the parallel trend.

-

Secondly, it should be noticed that during the year 2009, both import and export growth rate sharply increased. It can be impacted by USA‘s dollars.

-

Last but not least, in year 2010, both of them could reach the summit which was about $80 billon for import growth and roughly $40 billion for export. 

Export and Import Main Products

The significant export products in China include the following: -

Industrial Products

-

Processed Agricultural Product

-

Agricultural Products

The significant export products in China include the following: -

Agricultural and Industrial Raw Material

-

Capital Goods

-

Consumption Goods



Export and Import Partners and Types

-

Export Partners and Export by Commodity

-

Asia (ASEAN) is the top one export partner.

-

Heavy Industry represents 80 percent of export.

-

In term of commodity, electronic products stand a quarter of export products 

Import Partners and Import by Commodity

For China, there are many big export partners: - Japan is the main import partner. - Agricultural and industrial raw material stands 70 percent of import products.

a. Foreign Trade

Source: National Bureau of Statistics of China.

Foreign trade plays quiet important role to learn more about the export and import. From the table, it is understandable that: 

It demonstrates that foreign trade in China has been growing year by year. For instance, the number of export in China goes up by starting from 2,240.2 in 2006 to 3,082.6 in 2011. For import, it begun from 2,027 in 2006 to 2,814. 4 in 2012.



Also, in term of foreign trade, it shows that export has gone behind the import.

4. Investment Investment is defined by World Bank (WB) as outlays made by individuals, firms, or governments to add to their capital. From viewpoints of economy, only creating new capital is counted as an investment. It is a necessary condition for economic growth. In the part of the investment, there is covered some main points such as overview of Chinese investment, foreign investment in China , registered companies, outward investment by areas and foreign indirect investment in China.

a. Investment

Meanwhile, it shows that the fixed investment that is managed by the government. Also, compared to other share, for the manufacturing sector, investment cost 5,871 billion Yuan in year 2009. Also, real estate is the second largest investment that cost 4,313 billion Yuan. Last but not least, financial intermediation was the third investment with about 35 billion Yuan.

b. Foreign Investment

In term of foreign investment, energy and power shows the largest investment portion with $61.8 billion. Followed after energy and power, metal was the secondly largest investment with $22 billion in the year 2011.

c. Registered Companies in China Source: National Bureau of Statistics

Along with the data here, it can be illustrated that both number of registered companies and amount of capital by the registered companies have been increasing hand by hand.

d. Outward Investment by Area

Source: National Bureau of Statistic

From the data of the National Bureau of Statistic of China, it shows that in term of outward investment of area, Asia is the top one country for China outward investment.

e. Foreign Indirect Investment

Source: National Bureau of Statistic of China

From the data above, it is able to see that central east shows the largest amount of foreign indirect investment. In this case, foreign indirect investment is not so suitable for Beijing because from the data here the amount of it in Beijing is quite low.

5. Labor Force and Employment Labor force is considered by World Bank (WB) as all economically active people in a country between 15 and 65 which includes all employed persons, the unemployed, and member of armed service, but excludes students and unpaid caregiver such as homemakers. In case of China, labor force participation rate is half of the overall country population. Also, in term of labor ages, according to National Bureau of Statistic in China, there are 11 groups of labor ages. However, among them, the age group of 30-34

stands the highest number, followed by the group of 25-29 and the group of 40-44 respectively. Furthermore, manufacturing is the sector that most of the people work, whereas mining industry is the work that has only few people get involved since it is quite risky. Last but not least, in term of unemployment, those who finish vocational schools are in the high rank of facing unemployment problems, while graduate students are in the lowest percentage to encounter the unemployment. The table below shows the unemployment persons and unemployment rate.

Source: National Bureau of Statistic

China Economy: Qualitative Outlook I.

Technological Capabilities In less than 20 years, China has developed into industrial technological country

and become the world‘s leading manufacturer of mass-produced goods. By 2006, China had become the fourth-largest economy in the world and the third-largest trading nation. China is now aiming higher, preparing to compete with the industrial frontrunners on the basis of industrial production capability in more complex products and services as well as on the basis of industrial innovation and design in a number of fields. Furthermore, China is increasing on investment Research & Development (R&D) and trying to find innovative system that provides the quick result. Moreover, China is spending on R&D rose from 1.1 percent of GDP in 2000 to 1.3 percent of GDP in 2005. In term of investment on R&D, the growth of China‘s economy increased by an average annual rate 9 percent during this period. On a purchasing power parity basis, China‘s research outlay was among the world highest, far greater than that of Brazil, India, or Mexico (UNCTAD 2005).3 In China‘s case, speeding of technological development is acquiring urgency because returns on existing product lines are being squeezed by rising costs and a massive expansion in industrial capacity, both in China and worldwide.4 While the advantages of assimilating, applying, additionally refining and contributing to the march of ever-more complex technologies are obvious, several issues remain to be resolved. Two questions are particularly important for China. Firstly, what is the feasible pace of technology development and, in particular, the scope for pushing the technology frontier outward in a few important scientific fields with the potential 3

The art laboratory is described in ―China Supersizes its Science‖ (2007).

Schott (2006) finds that even though China‘s exports rank third in the degree of overlap with OECD countries, the prices it receives have been declining over time relative to OECD prices. 4

for significant industrial diffusion? Secondly at China‘s current level of development, what are mix policy initiatives that will cost-effectively deliver the desired rate of progress?

1. Acquiring Manufacturing Capabilities China has initiated in industrial strategies since 1950s, which aimed at achieving a measure of self-sufficiency in a wide range of capital and consumer goods. In the 1970s, China began investing stability in manufacturing capacity for the light customer items. Although during the 1980s, China lagged behind some of its industrializing neighbors, several decades of investment helped create a diversified industrial system, a large pool of engineering and production line skills, and a fund of learning from building, running, and maintaining manufacturing facilities by drawing mainly on domestic resources only as Japan and Korea had done earlier. Since 1980s, when China created ―Open Door‖ policy, China can integrate its economy to the global market. At that moment, China also gained technological knowledge by licensing investment industrial; by attracting foreign direct investment (FDI) through the knowledge workers and also cheap labors. Through this policy, China also can transfer technology form those investors and more importantly help the domestic R&D. In its effort to strengthen industry, China has been aided by two closely related trends. First, because of the maturing of certain technologies and the parallel growth of consumer markets, many manufactures have become standardized commodities. Second, the very process of ―commoditization‖ has been supported by the codifying of the associated technologies, some embedded in equipment, others available from suppliers. China has benefited more from these trends than most other countries, because it was better prepared to assimilate manufacturing technology, for a number of reasons. These included the advantages of a potentially huge domestic market, the early as well

as successful penetration of foreign markets in light manufactures, both of which encouraged investment in capacity, and the rapid increase in workers with secondary and tertiary education. Export-led growth was greatly aided by the flow of FDI, as firms in Hong Kong (China) and other neighboring economies shifted production facilities to take advantage of China‘s low-wage industrial workforce and establish a foothold in the Chinese market.5 As a result of the transfer of hard and soft technologies aided by the growth of human capital, industrial capability has grown by leaps and bounds, facilitated by the elastic supply of rural workers to China‘s burgeoning industrial cities in strategic locations along the east coast. The buildup has been supported by rising investment in urban, transport, and energy infrastructure, which has helped sustain China‘s cost advantage, making it the workshop of the world for a range of mass produced goods.

2. International Experience with Technological Change Empirical evidence indicates that the returns from R&D investments can be appropriate. Indeed, private returns can average 28 percent, while social returns can be as high as 90-100 percent. The elasticity of total factor productivity with respect to R&D ranges from 0.03 to 0.38, with higher rates in the United States than in Europe or Japan. Whether and how China can attain these outcomes is an open question, which can be partially enlightened by examining the experience of a few countries. Comparator can be divided into three groups: large industrial countries, such as the United States, Japan, and Germany, that are innovative and leading exporters of complex manufactures; smaller industrial economies that have attained notable levels of innovation in key industries, including Finland, Israel, the Republic of Korea, Sweden, and Taiwan (China); and large industrializing countries, such as Brazil and India, that have become globally competitive producers of a limited range of manufacturers and services through the acquisition of specific technological expertise.

5

(Berger and Lester, 1997)

3. Lessons from Late-Starting Economies Late-starting economies offer another perspective on technological capability that is largely consistent with the conditions described already. Nowadays, Brazil, Finland, India, Israel, the Republic of Korea, and Taiwan (China) become members of technological elite. In the majority of cases, governments took the initiative in creating tertiary level teaching institution and axial research institutes. For example, KAIST (Korea Advanced Institute of Science and Technology), created in 1981 in the Republic of Korea, and ITRI 10 (Industrial Technology Research Institute), created in 1973 in Taiwan (China), contributed significantly to the strengthening of the technology base. According to these experiences, China has also developed that kind of model following by successful factors that those countries have already succeeded. Furthermore, Governments are committing more resources—public as well as private— to R&D, and they are trying to position universities to support these initiatives by improving the quality of the education they provide, conducting more research, and developing and commercializing technologies through linkages with businesses. Behind these initiatives is a growing recognition that a broadening of technological capability through more and better basic research and more ambitious programs for developing technologies is vital for growth.

4. Promoting Research and Development Increasing spending on R&D up to a certain method is necessary to build technological capacity. How much spending is needed to reach this threshold, how quickly it should be achieved, and how far beyond the method spending should be pushed is uncertain. Fiscal incentives for R&D are widely used in industrial countries and have been introduced in China as well. The weight of international empirical evidence suggests that they are effective in rising corporate spending on research.

In addition, tax incentives are complemented by direct central and sub-national government spending on R&D. Grants by various ministries have reached significant levels and are rising faster than revenues. Furthermore, procurement policies of government agencies are designed to favor firms that are designated as innovative. This is especially helpful for firms in the telecoms, electronics, automotive, and customized software industries. Today, nearly 400 of the 500 firms have invested over 2,000 projects on R&D in China. The world‘s famous manufacturers of electronics, computers, telecommunication equipment, power-generating equipment, and pharmaceuticals have extended their production networks to China. Moreover, by the end of 2001, there were more than 120 foreign R&D centers in China, making China the second largest foreign R&D playground in Asia and the sixth largest one in the world.

II.

Human Resources Nowadays, many countries are looking for China, not only purchase low-cost

supplies, components, and services, but also to establish factories there. No doubt, low cost of goods and labors help China to attract hundreds of billions in investment dollars from companies of all kinds, from furniture makers to electronic components manufacturers. China is able to produce products for 30 to 50 percent less than the U.S. Now, China tries to move forward to industrial prominence in pursuit of higher manufacturing standards. For the future market strategy, the low labor cost will be the fourth strategy. The top three strategies are high quality, innovation, and service/support. Now, new groundbreaking research from the same research team on the HR practices of China manufacturers reveals even more provocative findings:



Many China plants are operating U.S. facilities‘ operational performances, and getting these results is the adoption of many HR best practices and programs.



China plants with foreign equity structures are more likely to be pursuing HR best practices and are typically better able to turn practices into improved performance than their state-owned or private counterparts.

1. Labor & Wage Costs Total labor costs in China amount to 25 percent of cost of goods sold, which is above that of U.S. plants (20 percent), while overhead expenses were higher in the U.S. (27 percent) than China (20 percent). Some of this difference could be due to accounting fluctuations and how costs are allocated in China compared to the U.S, but it more likely reflects the labor-intensive production environments prevalent in many China facilities, especially state-owned plants. In addition, the labor percentage may take into account housing, meals, transportation, and medical benefits often provided to China employees.

Across all types of ownership structures in China, wages were approximately $121 per month, compared to $2,160 per month in the U.S. (see Table)

Those reasons that make U.S invest more in China rather in its country.

2. Human Resource Programs In the (IW) / Manufacturing Performance Institute (MPI) China Study, as with the earlier IW/MPI U.S. Census survey, plants were asked about the existence and effectiveness of six specific human-resource programs— recruiting and hiring, performance management, employee development and training, leader/supervisor development and training, teaming, and safety and health. Does the plant have a program in place? If so, what is its effectiveness: ―not effective,‖ ―somewhat effective,‖ or ―highly effective?‖ The vast majority of China facilities indicate that these HR initiatives are in place; with adoption rates comparable to or higher than those of U.S. Census facilities (see Table). With the exception of safety and health programs, the effectiveness of the programs (percentage of plants with a program that is rated ―highly effective‖) was significantly better in China than in the U.S. Adoption rates in China plants were generally highest among joint-venture and foreign-enterprise plants, with effectiveness highest among the China Joint Venture/Foreign Enterprises.

III.

Government Intervention and Policies

Like other neighboring countries in Northeast Asia, China economic growth has been dictated by government via government intervention and influence. Government has played a very crucial role in the initial development stage of Japan and South Korea. Likewise, China roots their strategy in the work of Friedrich List, a less well-known classical economist, who argues that government invention is important to economy growth. Such strategies include selective protectionism and promoting champion industries to generate domestic manufacturing activities. There are three major economic policies which determine China‘s economic model – import control, export subsidies and FDI attraction. Government, under the control of Chinese Communist Party (CCP), is head of economic growth, for government create policies and intervene into market when necessary. For example, the government of China always devalues its currency to achieve export growth. China has a unique development model and government intervention is also different from other economies. In China, government influences the market through State-owned Enterprises (SEOs). Those enterprises are the government investment arms which contribute massively to tax revenue and national revenue. SOEs also play role as economic policies implementers. As a centrally planned economy, it is not surprised that Chinese government still maintains the dominant position in its economy because it is seen as sensitive issue for CCP. It can be understood that there are three major actors in Chinese economy. Those actors, SOE/SHE, TVE/SME and FDI/FIE, are essential in activating domestic production, export growth and technology transfer. It worthwhile to understand that he nature of SOE and FDI is big with huge capacity, while SMEs are not really brought up into discussion. However, SMEs and private sector are growing in the recent decades and they will continue to rise and contribute largely to national economy.

IV.

State-owned Enterprises

SOEs/SHEs (State-owned Enterprises/State Holding Enterprises) are defined as enterprises owned by state.6 SOEs are either centrally owned or owned by provincial or local governments. Centrally‐owned SOEs include entities managed by the State‐owned Assets Supervision and Administration Commission of the State Council (SASAC); state-owned financial institutions supervised by the China Banking Regulatory Commission (CBRC), China Insurance Regulatory Commission (CIRC), and China Securities Regulatory Commission (CSRC); and entities managed by other central government ministries such as the Ministry of Commerce, Ministry of Education, Ministry of Science and Technology, and others ministries. State-holding enterprises‖ are firms whose majority shares belong to the government.7 TVE refers to the stateowned small firms located in township or village-ship level and are under the control of local government. With regard to the bureaucracy, SOEs‘ managers are chosen by the communist party and are controlled by the ministries, SASAC (State Asset Supervision Authority Commission) and local governments. These three bodies are controlled by State Council of the National People Congress. SASAC monitors central SOEs and subsidiaries and local SASACs control local subsidiaries. Therefore, SOEs, SHEs and TVEs are the important procurement agents of Chinese communist party. Since 1978, China has conducted many reforms over SOEs to adjust to the free market environment and achieve efficiency. The WTO accession in 2002 also saw the decrease in importance of SOEs amid the rise of private sector in China. Unsurprisingly, SOEs are still the dominant force in Chinese economy, contributing to the 40% of total national outputs and employ more than 29% of urban workers.8 In addition, Chinese SOEs are the giant fortune corporates or the owners of many firms listed in foreign stock markets. China‘s reforms have led its economy to be more market-oriented with the increase in numbers of private investment and FDI. Though the share of SOEs in (National Bureau of Statistics 2002) (Lee, 2009) 8 (Andrew Szamosszegi & Kyle, 2011) 6 7

GDP has been dramatically declining, those enterprises are still playing essential roles in many aspects such policy implementation, national revenue and acquisition of foreign technology. In 2008, SOEs and SHEs accounted for more than 34% of total industrial value. Although the number of SOEs decline, the efficiency has been advanced, so those enterprises proportionally contribute more to GDP growth. Figure1: Value added of industrial SOE and SHE as a share of total industrial value

To achieve efficiency and effective reforms, a number of SEOs have been private. However, there are some major strategic industries which are very sensitive to privatized, and those industries are well-protected by the government as the arms of foreign technology and transfer and diffusion which are strategic for technology development and military sector. Those industries are biotech, information technology, advanced materials, advanced manufacturing, advanced energy technology, marine technology, laser technology and aerospace technology. SOEs dominate service sector in China, especially banking and financial and IT sector.

Figure2: SOE and SHE shares of domestically funded fixed investment in urban areas by sector, 2009

Figure 3 indicates the domination of SOEs and SHEs in Chinese economy. In conclusion, it is understandable that state sector remains important in Chinese national policies.

 State-owned Enterprises and Technology Transfer Technology development and advancement is the top priority of China. Many experts on China affairs agreed that China is once again implementing guojin mintui policy (the state advances as the private sector retreats) to fuel the strategic future industries.9 In the aspect of technology transfer, SOEs are the default vehicle for foreign technology acquisition. Before the accession of WTO in 2002, the investment regulation in China required all FIEs invested in Chinese market establish partnership with local firms through Joint Venture. In order to benefit from Chinese market, those foreign have to choose the SOEs as their partner because it helped strengthen the relations with government, and it was a must to have SOEs as partners in order to get the investment proposal granted. Furthermore, SOEs are the enterprises that have connection with government and mass economies of scale required in major projects. The share

9

(Andrew Szamosszegi & KyleCole, 2011)

of state‘s assets has been growing at the expense of private sector in the many strategic industries such as: steel, chemicals, coal, petroleum, mining, electricity generation, civil aviation, highways, water, finance, brokerage, insurance, real estate, posts, etc.10 Through Joint Venture and partnership, technology is being transferred, but IP is also problematic between foreign firms and host enterprises. Foreign companies limit the level of technology transfer by holding key technology. SOEs and other actors play an important role in creating ―indigenous innovations‖ through ―co‐innovation‖ and ―re‐innovation‖ of foreign technologies. There are two mega projects which are the examples of foreign technology transfer in China. For example, COMAC (China Commercial Aircraft Corporation‘s) agreements with General Electric (GE) and the other foreign aviation companies such as Rockwell Collins, Honeywell, Hamilton Sundstrand, Parker Aerospace, Eaton Corporation and Kidde Aerospace to build commercial aircraft and the agreements between China South Locomotive & Rolling Stock Corporation and its subsidiaries with Kawasaki Heavy Industries, Siemens, and Bombardier to build high‐speed rail in China.11 Foreign companies, through Joint Venture and mega project involvement, are lining up to integrate their technology and transfer that strategic technology to Chinese SOE partners. The State Council has shown its desire in creating and activating ―indigenous technological development‖ via The National Medium‐ and Long‐Term Plan for the Development of Science and Technology (2006‐2020) (MLP), issued on February 9, 2006. 12 James McGregor explains Chinese industrial ecosystem in his study in China Innovation Efforts that those policies include: 

a domestic patent regime that can be used to retaliate against foreign companies inside China if they file IPR violation lawsuits against Chinese companies outside of China;



compulsory certification and standards requirements that slow or block the entry of foreign products into the China market;



requirements for the disclosure of technology secrets and other proprietary information that serve to exclude foreign products from major Chinese markets; and



uneven and lax enforcement of IPR protection.13

(Is China Re‐nationalizing? 2010) (Andrew Szamosszegi & KyleCole, 2011) 12 (The Government of China, n.d.) 13 (McGregorJames, 2010) 10 11

V.

Foreign Direct Investment (FDI) China economic policy had been changed to export-oriented in the 1990s. In the same

period, China chose a number of coastal cites as the pilot sites to establish Special Economic Zones, which provide many incentives and preferential conditions for foreign investors. China has since then absorbed the largest portion of foreign investment and capital outflow in the world. China accounts for 80% of FDI inflow in Asia, and 50% in the world. It is deemed that foreign companies have been relocating to China to achieve cost efficiency as the result of cheap labor, but thing has changed. It is worth noting that FDI/FIE from developed countries are the primary source of fund in large-scale capital- and technology-intensive projects in China. The presence of giant companies such as IBM, GM, Motorola, Sony or Samsung has revealed the greater possibility of foreign investment in China. For the source of FDI, Hong Kong takes the first rank followed by Taiwan (including unofficial investment) and U.S. and other Northeast Asia countries such as Japan and South Korea. Other EU countries also invest in the large proportion in China. Unlike Japan and Korea, China has been utilizing FDI and foreign capital as the force to boost up export growth. In China, FDI/FIE take up three major forms, Joint Venture, Cooperative Enterprise and Solely Foreign Owned Enterprise. Before 2001, Joint Venture is the dominant form for FDI because those firms have to partner up with local firms to conduct business. Only the most advanced technology company can form the company under Solely Foreign Owned Enterprise. However, in the effort to comply with WTO regulations China had relaxed the restrictions. Now, Solely Foreign Owned Enterprise of FDI has replaced Joint Venture as the popular form of foreign investment. In order to understand the process of technology transfer from FDI to Chinese enterprises and the linkage between, we shall first understand the China‘s policies on FDI. Policies on FDI have been adopted and changed through time. The government use both carrot and stick to enhance export volume. The main policy on FDI is Export Performance. Export Performance was used as the measurement to access the capacity of export and to determine the level of incentives to be provided in particular cases. Export Performance regulation had been relaxed upon the accession of China in WTO. In addition, China has a wide range of law and regulations and policies over FDI. Those laws include Law of the People‘s Republic of China

upon Foreign Wholly Owned Enterprises; Law of the People‘s Republic of China upon SinoForeign Joint Ventures, Law of the People‘s Republic of China upon Sino-Foreign Cooperative Enterprises, and the Guiding Directory on Industries Open to Foreign Investment.14 Through various regulations, China encourages favorable conditions for FDIs; therefore, FDIs receive more favorable treatments than the local firms. FDIs have been accessed and categorized into many types and receive distinctive treatments upon different industries and regions. China is steering its policies to utilize and benefit from FDI advanced technology. Guoqiang Long in his paper ‗China Policies on FDI‘ outlines the purposes of China in attracting FDIs: •

transforming traditional agriculture, developing modern agriculture, and promoting the industrialization of agriculture;

•

producing transportation infrastructure, energy sources, and raw materials, and other basic industries;

•

tapping into cutting-edge, technology-oriented industries such as electronic information, bioengineering, new materials, and aviation and aerospace, as well as establishing local R&D centers;

•

encouraging foreign businesses to utilize advanced and applicable techniques to transform traditional industries such as machinery, textiles, and consumption goods manufacturing industries as well as to upgrade their equipment and facilities;

•

using raw and renewable resources comprehensively, initiating environmental protection projects, and modernizing public utilities;

•

encourage export-oriented FDI project;

•

building up the industries in western regions. Boosting export growth and transferring technology are the two important

objectives which China desires to obtain from FDIs. Chinese export performance policies on FDI are very complex, but it can be understood that those policies are designed under the following purposes:



strengthening the country‘s industrial base and increasing the domestic value added,

 14

promoting linkages,

(LongGuoqiang, 2003)



generating and increasing the level of exports,



balancing trade,



promoting regional development



transferring technology.15 Export performance regulation includes three policies such as compulsory, neutral and

voluntary. Compulsory policies required that ―FDI shall be able to keep a balance of exchanges, or make sure the proportion of their domestically made products in the total number of products reaches a certain benchmark or a certain percentage of their products must be exported.‖ 16 But compulsory policies are against WTO regimes, and were relaxed. Neutral policies facilitate the fair conditions for export to compete internationally. For example, the tariff and VAT exemption for re-export processing imports so that Chinese products can compete in foreign markets. Voluntary policies encourage exports by incentives, for example, an enterprise with 70 percent of export products is entitled to a 50 percent cut in corporate income tax. 17 In addition, China focuses on processing trade with imported materials (PTI) and processing trade with materials supplied by clients (PTS). Through tax system reform, import and export tax has been reduced, favorable for export and importation of capital goods from foreign countries. In the same vein, spare parts and raw materials importation tax is exempted if the final products are exported. Transnational investment inflow into China can be categorized into two: ―domestic market seeking‖ and ―efficiency pursuing ―or ―export orientation‖. China has the competitive advantage in term of cheap labor compared to more developed countries. In the same light, because of import substitution between 1949 and1979, China has a great deal of industrial base and skilled workers, making its growth the miracle. China also has the large market potential to growth. Therefore, foreign companies are lining up to invest in China. However, the cheap labor competitive advantage has been seized due the increase in wage. So China is working to improve its domestic market and capital and technology intensive industries. Figure3 points out the reasons why FDIs choose China as their investment destination.

(LongGuoqiang, 2003) (Law on Foreign-invested Enterprise, PRC) 17 (LongGuoqiang, 2003) 15 16

Figure3: Factors affecting the decision of FDIs doing export processing in China

 FDI and Technology Transfer As mentioned, China top priorities in attracting FDI are export growth and technology acquisition. China has a great potential for FDIs to invest, and that is one reason that China can achieve its objective. China also has concrete policies to benefit from this and make technology transfer happen to help transform its traditional industries through advanced and applicable technology. There are three main categories of technology transfer 1. Filling the technological gap 2. Introducing advanced technology 3. Improving existing technology. But how can China push those foreign firms to transfer technology? First of all, it happens because of ―domino effect‖. This effect creates cluster industry which is favorable for general economic climate. Once FDIs in same industry are competing in the same region, it push forward the development of supporting industries and the technology is diffused; SEZs in China‘s Pearl River Delta and Yangtze River Delta regions can be the practical example. FDI helps introducing new advanced technology to Chinese local partners. Figure 4 illustrates the level of technology used by foreign companies according to different forms of FDI.

Figure4: Difference of technology used by types of FDI (percent)

More than that, China encourages those foreign companies with advanced technology to establish R&D centers in China instead of activating indigenous R&D. Foreign firms create R&D centers in China because they expect to meet domestic demands, to benefit China‘s wealth of scientific research and technological talent and to improve relations with government. There is a wide range of incentives in which foreign get once establishing the R&D center. The policies to encourage R&D include:



any imported equipment and supporting technology confined to the FIE‘s laboratory and used for pilot experiments (and not production)are exempt from tariff and other import taxes;



income from the transfer of technology that has been developed solely by an FIE is exempt from sales tax;



an FIE with technological development expenses at least 10 percent over its previous year is entitled to a 50 percent discount of its total technological development expenses in the current year‘s corporate income tax; and



FIEs with R&D centers in China are allowed to import and sell a small quantity of high-tech products on a trial basis in the local market, if they are goods produced as a result of the R&D by their parent companies.18

More importantly, the local government also provides facilitation through reducing land use fee and employee recruitment. R&D centers usually cooperate with local research institutes which strongly supported by government to achieve join technology breakthrough. Through these local R&D institutions, technology can be transferred and diffused to local firms Another mean of technology transfer is the creating spillover effect. Crowding out effect is the undesirable outcome when a country decided to invite FDIs. However, in the case of China, it is the spill over rather crowding out because China has a giant market so that FDI cannot dominate. Plus, China has a well-established industrial base to allow local firms to serve as the suppliers for giant FDIs rather dying out. 18

(China Ministry of Commerce, 2003 p.107)

Furthermore, China uses swap market for technology, which requires foreign firms to import advanced technology in order to enter into domestic market. With regard to technology diffusion, FDI provides technical assistance by assisting domestic enterprises to reach new technology requirements, joining hand to advance technology, training staff for domestic companies. In particular, the Lenovo Group worked with Oracle to develop ERP software to meet the demands of small and medium-sized companies; the Langchao Group cooperated with LG to develop company-used Composite Solution.19 Last but not least, FDI provide the production base for domestic enterprises to develop and succeed in new products. Through various cases, we can understand that Chinese giant companies both state-owned and private are responsible for technology transfer and diffusion. Therefore, it is arguable that the linkage between FDIs and domestic enterprises has been strongly tied via government policies, especially joint venture and partnership. In particular extent, SMEs/TVEs are also playing essential rules as the agents of technology transfer and development through the linkage with FDIs. SMEs are the effective suppliers to giant SOEs and FDIs in the production chain.

Conclusion China has been through a number of reforms since the establishment in 1949, but the economic miracle started after the reform in 1978 under leadership of Deng Xiaoping who decided to open up China for market economy. China economy growth is the successful story which can be a lesson learned for developing country. China is growing bigger and faster, and will take US position in 2016 according to OECD report. Various economic indicators show the great success of China, but it is just the successful part of the story which represents China from the quantitative outlook. China has great market, well-established technology and industrial base as well as effective human resource which allow China to maintain growth for the long term future. The roles of 19

(LongGuoqiang, 2003)

SOEs are very important in the case of China. State sector serves as the default vehicle for national revenue generation and technology acquisition. WTO accession saw the great move forward with a great deal of reforms, allowing China to benefit from open trading relation and to attract more FDI to achieve its end objectives which are to boost export

growth

and

technology

transfer.

Before

WTO

membership,

China had implemented successfully the export performance policies which include compulsory, neutral and voluntary export policies. As a result, it boosts further exports. More impressively, China has implemented many policies to achieve foreign technology acquisition. Those strategies include creating cluster industries through establishment of SEZs, encouraging foreign firms to create R&D centers and utilizing policies to generate spillover effects. Despite successes, China also has many weaknesses which shall not be overlooked. The last part of this report will outline the weaknesses of China economy with suggested strategies to sustain growth.

Weakness of China Economy

Suggested Strategies



Export-driven Economy





Poor financial sector



Aging population



Financial sector reforms



Poor service sector



Fight corruption and further political



Increase in wage



Political problems



Undervalued currency



and inflexible exchange rate



Monetary policy reform



Low quality products



Open up for more competition as the



Over protected markets



Innovation weakness

Encourage domestic consumption and service sector

reforms 

Skill and capital intensive industry development

mean to improve quality 

Expand development activities to the Western region.

List of Reference Andrew Szamosszegi , & Kyle, C. (2011). An Analysis of State‐ owned Enterprises and State Capitalism in China . Washington: Capital Trade, Incorporated. Chegg. (n.d.). Chegg. Retrieved from Cultural Revolution: http://www.chegg.com/homeworkhelp/definitions/cultural-revolution-47 Chow, G. C. (2004). Economic Reform and Growth in China. JEL. Factor, M. (2010, December 30). NY Daily News. Retrieved November 27, 2012, from Deng Xiaoping: http://articles.nydailynews.com/2010-12-30/news/27085881_1_dengxiaoping-china-petroleum-socialism-with-chinese-characteristics KEIDEL, A. (2008). China‘s Economic Rise—Fact and Fiction. Carnegie Endowment for International Peace. Lee, J. (2009). State Owned Enterprises in China: Reviewing the Evidence. OECD. Long, G. (2003). China's Policies on FDI: Review and Evaluation. McGregor, J. (2010). China's Drive for 'Indigenous Innovation': A Web of Industrial Policies. APCO. Rawski, T. G. (2011). THE RISE OF CHINA‘S ECONOMY. Foreign Policy Research Institute Footnotes, 16. Richard S. Wellins, J. R. (2005). Super Human Reseources IN China: Practices, Performance and Opportunities Among China's Manufacturers. Washington: Development Dimesions International. World Bank. (2012). China 2030. Washington: World Bank. Yusuf, S., & Nabeshima , K. (2007). Strengthening China's Technological. The World Bank Research Group.