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Everything revolves around money

Introduction

It is important to define what is foreign direct investment for the understanding the whole discussion. There are many definitions of the term Foreign Direct investment (FDI),but the most commonly accepted is the definition given by IMF which is defined as “FDI is where an investor residing in one economy owns 10% or more of the ordinary shares or voting power /effective voice in management in another country and companies those entities in the host country that are subsidiaries(>50% ownership);associates (>=50%ownership)or branches (wholly or jointly-owned, unincorporated enterprise ) of the parent.” (IMF, 1993).A simple definition would be “An investor based in one country acquires an asst on another country with the intent to manage that asset”.(OEDC,2000) .

A study of the existing literature suggests that FDI patterns contributing to the growth of the emerging market has undergone a significant change over time. The FDI trend in last five years indicates a shift of flows from the developed world to the developing world and emerging markets .FDI is impacting development in these emerging markets in a significant way. During the 1950-60’s most of the foreign investment came into the developed world and Reuber et al (9173) who studied FDI volume and patterns in various countries, observed that FDI flows into the developed world were disproportionately high when compared to the developing world. Even in the modern times, United States the most developed country in the world, still attracts the highest FDI and in 2005 it absorbed in the highest FDI of $ 94.5 billion as compared to China which consumed $ 60 billion only. Till 2000, more than 75 % of the trade was within the developed nation of the ‘triad’ – US,Europe,and Japan (Porter, 1990 ; WIR, 2005). According to AK Kearney FDI confidence index 2005 study, even though the US received the highest FDI in 2005 it does not command the number one position, in terms of FDI attractiveness, and trials behind at third position after China and India.

In the developing world ,the East Asian countries were the pioneer in realising the potential of FDI from The Trans National Corporations (TNC’s) in developing their economies. These countries devised strategies to attract FDI to meet their growth objectives (Zhang, 2001; Lall , 1993). As a result of opening up their economies to FDI from TNC these countries grew rapidly and within a relatively short time period became a significant economic force. These came to be recognized as the ‘ four tigers’ – South Korea, Hong Kong (China ), Taiwan and Singapore. The success of the ‘Asian tigers” in the last two decades has created a role model for the less developed countries. Modern emerging market can learn lessons from the experience of these tiger economies. East Asia saw a 46% increase in the inflow , to reach $ 105 billion, in 2005 alone, driven largely by a significant increase inflow to China.

As a result of significant growth of ASEAN countries from FDI, the developing world is competing to have a larger ‘share of the FDI pie’. Wheeler and Mody (1992) describe the competition between host countries to attract foreign investors to their respective countries as ‘location tournaments’ in which host countries are trying to attract FDI by making available substantial incentives to attract TNCs to their homeland. Desire for FDI may encourage governments to adopt competitive and investment oriented economic policies(dunning, 1999). For more than 15 years now, emerging markets are vying with each other for getting a larger share of the global FDI pie. During 1991-96 over one hundred countries made a total of 599 changes to liberalize FDI regulations, in 1997 alone, 76 countries made 151 liberlization changes( United Nations,2005). A large number of such countries are in Asia(Sethi et al,2003). Countries continue to adopt new laws and regulations with a view to making their investment environments investor friendly. Out of 271 such changes pertaining to FDI introduced in 2004, 235 involved steps to open up new areas to FDI along with new potential measures. In addition, more than 20 countries lowered their corporate income taxes in their bid to attract higher FDI(WIR,2005). In order to attract FDI, at the international level, the number of bilateral investment treaties (BITs) and double taxation treaties (DTTs) increased to an all time high of 2392 and 2559 respectively in 2004, with developing countries concluding more of such treaties with other developing countries (UNCTAD,2005).

The global trade is undergoing a significant transformation and there is an opportunity for the developing and underdeveloped nations to utilize this opportunity to their advantage by giving up restrictive old patterns of thoughts and pursuing economic growth. World Bank report (World Development indicators,2003) suggests that globalisation is giving an opportunity to emerging markets to integrate their economies and societies with the modern unified world. Globalisation can mean rapid growth and poverty reduction in countries like China and India that were poor 20 years back. During the period of 1990 and 1999, 125 million people were moved out of poverty because of globalisation. Highlighting consequences of globalisation a Goldman Sachs study: ‘Dreaming with BRICs: The Path to 2050’ reports, that the BRIC economies (Brazil, Russia, India, China) together could be larger than the G8 in dollar terms in less than 40 years from now. China has been growing at the rate of 9% annually consistently for more than a decade now and doubled its GDP in last six years but other countries have not seen such a consistent growth as China. On the other hand, when there is an opportunity there is a threat of loosing out on the growth train. Emerging markets need to strategize their resource to achieve growth. This is the right time for emerging markets to learn from leaders in attracting foreign investments and formulate ambitious growth plans.

Emerging markets have an option to grow faster if the current trends of globalization continues in the future.

India is on radar of the global investors and has attracted lot of media attention in last few years due to ‘outsourcing’ and ‘BPO services’ from US and EU, it has been a laggard in opening its economy to foreign direct investment (Bajpai and Sachs,2000). On the other hand, China has attracted ten times more FDI than India and grown at a faster pace to become three times larger economy as compared to India. India has to learn a lesson from China. Though the AT Kearney confidence Index ranks India ($5 billion) second after China($60 billion) in FDI attractiveness but the gap between the two seems significant and the investor confidence for India has to yet translate into actual flows comparable to China. Blonigen and Davies(2004) state that the factors that determine FDI into developed countries are different from the factors that govern the FDI flows to the less developed countries.

Economic reform of China and India – Historical perspective

The Chinese and the Indian started their new self-government roughly at about the same time in 1948 & 1947 respectively. The Chinese economy was a bit ahead both in terms of its size and its infrastructure.Indiasuffered the indignity of being ruled by a foreign power and its infrastructure was designed to serve the colonial masters to collect and transfer money toEngland. China stayed politically independent except for trade and commerce, which in the coastal areas was in the hands of the colonials.Indiaalso suffered being divided intoIndiaandPakistan. In 1950, Chinese statistics of that time stated that Chinese population was about 500 million and an economy was about $75 billion. At the time of independence in 1947,Indiahad 370 million soles and a $45 billion economy. Other $20 billion component of the economy had been transferred to East & West Pakistan.

Economic System from 1950 to 1965

BothIndiaandChinaopted for the Soviet model of central economic planning and five years or seven year plans to usher new era of prosperity. Money was scarce for development hence foreign aid was needed.Indiareceived some but its association with the Soviets was a stumbling block. Soviets had no big surplus of money hence they could not spare much. Whatever money they had, initially they preferred to give it to the Chinese. Hence,India’seconomic progress in this period stayed mediocre.Indiabuilt dams to irrigate the land for agriculture and generate electricity. Steel mills were built to supply raw materials to the factories. Famines were averted but not much else could be done as the West promised aid and then withdrew it (USwithdrawal of Steel mill help at Bokaro).

Chinareceived all of its development related money from the Communist Soviets. Premier Chou En Lai boasted of food self sufficiency in 1956 (true or not is unknown). The industrial production was supposed to triple from 1957 to 1962 in what is today remembered as The Great Leap Forward. This later turned out to be a net waste of money.

There is one area thatChinaalways had whichIndianever had i.e.British colony ofHong Kong.It was the Chinese window to sell their products to the rest of the world. The Chinese who left mainlandChinawere welcomed inHong Kong. It was a duty free heaven. There, they set up businesses, which exported Chinese made products. It is estimated that about $5 billion dollars a year of Chinese made products were sold to the world during this period. In other words the Communist Chinese, usingHong Kongas a gateway, exploited British ingenuity of trade and export. Hence Chinese had no need for borrowing money elsewhere, they had their own. It allowed them to break free from the Soviet influence by 1960. Chinese have always overstated their food production. It suited them well.

Indiafrom 1954 to 1965 struggled. Grossly mismanaged industry never delivered. Power plants, never produced the rated amount of electricity. Bureaucracy and the politicians were greedy and inexperienced to run the economy. Hence when the famine visitedIndiain 1965, there was not enough power being generated to make up for the deficient monsoon. BenevolentAmericastepped in with shipment of huge amount of food toIndia.

At about 1965, the master bureaucrat inChina, Chou En Lai, was stating repeatedly thatChinahad made a major breakthrough in economic area. At about year-end 1965,Indiawas in the grip of famine; whose effects lasted two years. Comparatively,Chinawas under the influence of a Cultural Revolution, which was devastating food and industrial production.

Economically Chinese economy had grown in size from $75 billion in 1950 to $140 billion in 1970 with 750 million mouths to feed. Indian economy had grown to about $90 billion with about 550 million mouths to feed. Economically, advantage to the either side was not huge. The difference in per capita income did not change much, since 1950. The Chinese had a bigger economy, but had too many mouths to feed. The Cultural Revolution upheaval had brought negative growth both in industrial and agricultural sectors. This trend continued well into the early seventies.

New Era in Chinese economy begins in 1970s

The Cultural Revolution failed inChina. Mao Zedong and his coteries power had been weakened and he was looking for outside help. US were looking for allies in the Soviet backyard to encircle them. The marriage of US interests and the Chinese interests was just a matter of time. No joint pacts were signed but indirect understanding was stuck in whichUSagreed to economically helpChina, if Chinese maintain military pressure along Soviet border. Mao readily agreed, but then President Nixon resigned. Other presidents after Nixon took some steps but not enough to open the money and technology floodgate. Change took place when strongly anti Soviet President Reagan got elected in 1980. He was going to do everything to undermine the Soviets. Helping the former enemy Chinabecame buzzword of that administration.Afghanistanwar of early eighties helped President Reagan to get all theUSCongressional approvals.

Money in large sums did not arrive inChinauntil 1982. Prior to this both Mao Zedong and Chou En Lai had died and a more pragmatic leader had taken control of the Chinese destiny. In this periodHong Kongmaintained the primary role of providing an outlet for the Chinese products, duty free. Rest of the world viewed theUS-Chinaco-operation as a positive development. Oversees Chinese Diaspora started to invest heavily in the Chinese manufacturing sector. DirectUSbusiness investment followed.

Indian economy after suffering an agricultural setback during 1965, recovered a bit. Exploding of nuclear device in 1973 brought a fresh focus ofIndia’s economic capability. Desire for food self-sufficiency resulted in tremendous resources being placed for agricultural management. A new government 1975 removed some barriers to the economic development. Result, economy recovered. Performance of the Indian economy from 1970 to 1980 was a bit better.

In the context ofIndia-China, Indian leaders could not read thru the fine print of China US rapprochement. In fact they missed the point that this relationship is a political statement to keep the Soviets busy in the East while the West makes gains in theEurope. In returnChinawill be developed to equalize Soviet power in the East.

By the end of the seventies, Chinese economy was $180 billion and 980 million mouths to feed. This performance was poor. Political turmoil had taken a huge toll. But by the mid seventies a new pragmatic leader had taken control inBeijing. He was willing to do anything to getUS money and technology

Indian economy maintained 5.5% growth path throughout seventies. By 1980, it was $150 billion economy with 700 million mouths to feed.

Interestingly, per capita economic gap had been narrowed a bit inIndias favor.Chinahad reeled under its political uncertainties.

The Great US Give Away toChinabegins in 1980s

The 1980, was the beginning of the period when US moneys was pumped into the China. To make it easy for the monies to flow from the West to China, Chinies enact laws and rules to facilitate the arrival of direct cash from the US and European businesses. In returnChinaagreed to maintain an equivalent Cash reserve in US banks or buy treasury bonds. The money started to trickle, initially in small doses of about $3 to 5 billion a year from 1982 to 1986 and then increased to $10 billion a year until 1992. President Clinton for his own ideological reasons opened the floodgate. It reached $20 billion a year until 1998 and then after the Asian financial crisis in 1997-98, it was increased to $40 billion a year till 2003. Year 2004& 2005 are witnessing an unprecedented $50 billion to $55 billion year Foreign Direct Investment.

In the nineties the British relented on its position on the colony ofHong Kong. They decided to transfer it back toChina. By then,Chinahad become a major trading nation.

From 1980 to 2000, Chinese turned in a huge growth, mainly at the back of Foreign Direct Investment. Its growth averaged 7 to 8% every year. By the year 2000, Chinese economy had grown to$800 billionstrong. This twenty years period from 1980 to 2000 had been an epoch making period in Chinese history. Never before in two thousand years history such a dramatic development had taken place.

The development of the Chinese economy had a very interesting feature. Whereas the FDI built the factories, the Chinese used their own cash to build the infrastructure and prestige projects for the foreigners to see and get impressed. They built a huge airport inShanghaiwith Maglev train system. Civil and road construction took precedent over rural development. Interestingly Chinese claim of the same living standard as the West is true in the cities only. In the rural areas, it is another matter. It is hard to believe that with only $850 per capita income, Chinese cannot compare themselves with the West. In fact they are still at poverty line threshold.

Indiafrom 1980 to 2000

Indiamaintained a bit slow pace of progress during this period. Not much of FDI was comingIndia’s way. A foreign aid cum soft loan package of about $1.5 billion a year all thatIndiagot. Political upheaval in the eighties created uncertainties. Bad and antiquated laws protected the local industry, and discouraged the private sector. Situation came to a head on when in 1992,Indiaran out of money to buy raw material and spares abroad. Hence first step was taken to open up the market. These minor reforms allowed private sector to make a major progress. A much bigger step but still inadequate was taken from 1999 to 2004. At that time a much smarter political coterie was in power. They did much more than the steps of the 1992 reforms. Economic progress did not matchChina, but economic growth of about 6% was achieved. Whereas the Chinese quadrupled their economy and curtailed their population (1.2 billion),Indiacould only triple its economy, but let its population grow unhindered. By Year 2000 Indian economywas $475 billion with 950 millionmouths to feed. Surprisingly, the slow poked Indian economy had generated momentum. By Year 2004, it started to grow at about 8% a year with a very little FDI.

In this period, the historic difference of about 20% in per capita income diverged. Chinese per capita income in year 2000 was 30% higher thanIndia. This must be un-nerving for political and economic leaders inIndia. They had to do something dramatic. At President Clintons behest, US companies started to outsource IT services toIndiafollowed by BPO services floodgate. It is now being followed by more knowledge-based industry. This onset provided the Indian businesses to reach out to the world. It is just a matter of time thatIndiawill narrow the per capita income gap, which currently favoursChina. In addition, there is a difference. Chinese products are sold at rock bottom prices to retain and grab a bigger share of the market. On the other hand,Indiagets a fair share of the margin for all its services exported. The latter helps greatly in new capital formation and building up its cash reserves. It has created a highly paid consumer class in the country. This is an envy of the world.

Years 2001 to 2005 forChinaandIndia

Chinawas making a phenomenal progress on the back of FDI. It has turned in a 9% growth rate with $55 billion FDI in 2004-05. Its economy today is a bit higher than a trillion dollars. Surprisingly,Indiahas turned in 7% growth with bad monsoon and only $2.5 billion in FDI (and about $8 billion in loans and aid).India’s economy is at about $650 to $700 billion level. On per capita basis the improvement achieved by the Chinese from 1980-00 will be narrowed in next 10 to 20 years. Indian IT Services, BPO Services and KPO services industry together with medical services industry and products and services roughly earn three times more than the cheap Chinese products. India has a very confident and very profitable service industry.

REF– SOUTH ASIA ANALYST GROUP,India-ChinaEconomic CompetitionHistorical Perspective, Hari Sud, 2005,PG 1445

  • http://en.wikipedia.org/wiki/Economy_of_India
  • http://books.google.co.uk/books?hl=en&lr;=&id;=bz4bsgKHlsIC&oi;=fnd&pg;=PA120&dq;=indian+economic+reform&ots;=DZ5wEEPAwE&sig;=rscHcz9O8RRoCb30RkhP8gx7dyo#v=onepage&q;=indian%20economic%20reform&f;=true it is a book..13,11,


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