Document(s) 9 de 16

Guangdong experienced an average annual economic-growth rate of 14.1% between 1980 and 1993, which is higher than the 9.5% average for the whole of China during the same period. This impressive economic growth was the result of a swift and profound change in industrial structure that reshaped Guangdong into a large-scale, light-manufacturing base. Guangdong’s exports of light manufactures increased more than 26-fold in 11 years, from less than US$800 million in 1982 to more than US$20 billion in 1993. Guangdong also sold a large amount of household electrical products, textiles, apparel, footwear, toys, and other light-manufactured products to the rest of China. According to Guangdong’s Governor Zhu Senlin (1993), the rest of China consumed about 33% of Guangdong’s manufactured output in 1992, valued at about US$14 billion. Guangdong is ambitiously planning to increase the sale of its output to the rest of China to 40% of Guangdong’s gross domestic product (GDP) by 2000.

Lardy (1992) observed that, in the first half of the 1980s, there was little evidence that comparative advantage determined the composition of China’s exports. Guangdong has since become a national leader in exploring its comparative advantage. Because of abundant labour supply and low wages, Guangdong shifted its industrial structure to one of labour-intensive production (in the early 1980s), leading to the significant increase in the share of light manufactures in total exports from 34.5% in 1982 to 57.5% in 1986.

This shift in industrial structure was the result of China’s open-door policy, introduced in 1979, which allocated to Guangdong various rights and privileges to promote exports and attract foreign direct investment (FDI). Having three of the four special economic zones (SEZs) in Guangdong was the most important privilege that the province received.¹ These SEZs attracted Hong Kong investors. As a trading partner, financier, intermediary, and facilitator, Hong Kong has had a profound and pervasive effect on the development path and the industrial structure of Guangdong (Sung 1991). About 80% of Guangdong’s exports go to Hong Kong, and about 80% of its imports now come from there. Hong Kong is overwhelmingly Guangdong’s largest source of FDI, accounting for more than 90% of total inflows since the mid-1980s. In effect, an integrated economic area has developed since the late 1980s. The degree of interpenetration is so high that only limited value can be derived from analyzing the activities of Guangdong and Hong Kong separately (Goodman and Feng 1993). This economic transformation of Guangdong has extended to other parts of China. Thus, Hong Kong has contributed significantly to making China’s pattern of trade much more congruent with the country’s underlying comparative advantage than it was in the prereform era.

¹ These three SEZs were Shenzhen, Zhuhai, and Shantou, and the fourth was Fujian. Subsequently, in 1984, Guangzhou and 14 other coastal cities were opened up and, in early 1995, the Pearl River Delta, the Yangtze River Delta, and the Zhangzhou–Quanzhou–Xiamen region in Fujian Province were also opened to FDI. In the late 1980s, China also designated Hainan as an SEZ. In the SEZs and the opened areas, the planning controls are relaxed to promote FDI and the growth of market forces. Foreign investors are given preferential treatment in the form of tax exemptions and other incentives.

Foreign investors have been attracted to China by its low production costs (especially low labour costs) and by its large domestic market. The restrictions initially set up to prevent foreign businesses from penetrating the domestic market have been gradually relaxed, either in their scope or in their enforcement, especially at provincial and local levels. This is only one example of how China has continuously liberalized its foreign-investment regime to overcome such negative factors as a limited legal structure, nonconvertibility of the currency, and growing corruption. In the 1990s, China has been rapidly becoming one of the most liberal foreign-investment environments in the developing world. China also restricts foreign ownership less than do Japan and South Korea and is more liberal in opening up additional sectors to foreign investment (Lardy 1994).

In this chapter, we study the role of FDI in Guangdong’s rapid emergence as a light-manufacturing base. Our focus is on two light-manufacturing industries: household electric and electronic appliances and textiles and apparel. The next section analyzes trade–investment linkages by studying aggregate trade and FDI-flow data at the national and provincial levels. The aggregate analysis is complemented by firm-level surveys, discussed in the third section, using sales and sourcing data to examine the behaviour of foreign firms investing in Guangdong. Finally, we combine the results derived from the aggregate and survey data to draw some conclusions about the relationship between FDI and the rapidly emerging light-manufacturing base in Guangdong.

FDI and trade

National level

China’s open-door economic policy did not lead to an early specialization in manufactures. Between 1980 and 1985, the growth rate of manufactured exports matched the 8.5% average annual growth rate of total exports. However, after the implementation of domestic-market reforms in the mid- 1980s, such as price reforms and foreign-trade reforms, the open-door policy started to show major results. Manufactured exports grew by 23.9% annually between 1985 and 1993, which exceeded the average annual growth rate of total exports by 7.6% during the same period.

Low production costs, a huge domestic market, favourable investment incentives (such as tax holidays and lower land-use fees), and flexible foreign-investment policies (whereby investors are given latitude regarding investment forms, location, management, and so forth), from 1979, turned China into an attractive location for foreign investors. Between 1979 and 1994, China absorbed an estimated US$57 billion of FDI (UNCTAD 1995). The sectoral distribution of FDI was widespread, including high-technology-oriented industries, raw-materials exploration and extraction, and service-oriented operations. The bulk of foreign investment, however, targeted labour-seeking, resource-extracting, and service-oriented industries.

Because most FDI focused on industries in which China has a comparative advantage, the inflow of FDI was trade promoting (United Nations 1993). Increasingly, the country’s export growth became dependent on investments by foreign firms. China’s total exports tripled in a 7-year period, from US$30.9 billion in 1986 to US$91.8 billion in 1993, and the share of total exports produced by foreign firms increased from 1.6% to 27.5% — in 1993 foreign firms accounted for 70% of China’s total export growth (Lardy 1994).

The dynamic manufacturing sector has been the major driving force behind China’s trade expansion. In 1986, manufactured exports were only US$23.7 billion; by 1992, they had risen to US$116.3 billion (Table 7.1), an increase of almost 400%. Exports of manufactures to the United States and the European Community (EC) grew even faster, by 500% and 480%, respectively, whereas manufactured exports to Hong Kong and Japan grew at roughly the same rate as total exports. Manufactured-export growth to East Asian countries lagged behind but still grew at a respectable 260%.

Table 7.1. China’s exports of manufactures by selected ISIC category, year, and partner.

Source: ANU (1995) and UNCTAD (n.d.).

Note: NIE, newly industrialized economy; ASEAN-4, Indonesia, Malaysia, the Philippines, and Thailand; NA, not available; ISIC, International Standard Industrial Classification.

^a For exports, we define absolute trade intensity as A =X_cj / X where c is the country of interest (in our case, China); j is the country’s export partners (in our case, Hong Kong, Japan, Singapore, other NIEs, ASEAN-4, the United States, the European Community, and the rest of the world); X_cj is China’s exports to one of its export partners; and X is total world exports.

China’s imports of manufactured goods show a similar, though less pronounced, growth pattern (Table 7.2). Total imports increased from US$31.0 billion in 1986 to US$70.6 billion in 1992, or slightly more than double the value of 1986. The growth of manufactured imports from East Asia — particularly from Hong Kong, Singapore, and the ASEAN-4 (Indonesia, Malaysia, the Philippines, and Thailand) — was stronger than the growth of manufactured imports from the rest of world. Thus, China’s rapid trade development appears to have had a strong regional component. This implies that the Chinese economy is likely to be integrated more rapidly with the East Asian region — in particular, the Asian newly industrialized economies (NIEs) and ASEAN-4 — than with the rest of the world.

Economists have used different approaches to measure the degree of regional integration. Lawrence (1991) used a measure of extraregional trade to study East Asian integration, whereas Drysdale and Garnaut (1993) applied measures of intraindustry trade.² Petri (1993) applied measures of trade intensity similar to our own.³ We define absolute trade intensity for exports as the ratio of a country’s bilateral exports (to each trading partner) to total world exports. Similarly, for imports, the absolute trade intensity is the ratio of a country’s bilateral imports (from each trading partner) to total world imports. The relative trade intensities are simply a country’s bilateral exports or imports as shares of its total exports or imports. Because this chapter focuses on Guangdong’s manufacturing sector, all of our trade-intensity calculations are limited to this sector.

 ² See Chapter 1 for a definition of these concepts.

³ In terms of exports, we define absolute trade intensity (A) to be A = X_cj /X where c refers to the country of interest (in our case, China); j refers to the country’s export partners (in our case, Hong Kong, Japan, Singapore, other NIEs, ASEAN-4, the United States, EC, and the rest of the world); X_cj refers to China’s exports to one of its export partners; and X refers to total world exports. Obviously, the definition of the equation for imports is analogous. This definition differs from the one used by Petri (1995) because Petri uses total world trade rather than world exports or imports in the denominator.

The trade intensities allow us to compare China’s share of world trade through time and the changing distribution of its trade with the East Asian economies, on the one hand, and the rest of world, on the other (Tables 7.1 and 7.2). China’s share of manufactured world exports increased rapidly between 1986 and 1992. The absolute trade intensities of China’s manufactured exports to Hong Kong, Japan, the United States, and the EC nearly tripled in this period, indicating the increased importance of China as a manufacturing base. The sum of the absolute trade intensities of China’s imports of all manufactures from the nine East Asian economies is considerably higher than the sum of the indices with the rest of the world for the same time, which reflects the regional component of China’s trade development. Most notably, the absolute measures of trade intensity reveal that China’s trade in manufactured goods with Hong Kong was considerably larger than that with any other region between 1986 and 1992. Even taking Hong Kong’s entrepôt role into account, we found the trade interdependence between China and Hong Kong appeared to be strengthening with time (Chapter 4).

The export and import shares of China’s trade in manufactures show that Hong Kong, the United States, the EC, and Japan are China’s most important markets. Although the export share to these economies increased modestly from 42% to 48% between 1986 and 1992, the import share declined from 61% in 1986 to 38% in 1992. This seems to contradict the casual observation that China depends heavily on developed market economies for manufacturing imports and on developing economies as a market for its exports, especially when taking into account that about 40% of Hong Kong’s re-exports were destined for the developed world. The relative importance of China’s exports to the Asian NIEs, especially Hong Kong, remained stable in the 1980s but declined in the early 1990s, whereas imports from this region grew rapidly in the 1980s and leveled off in a dominant position in the early 1990s.

Table 7.2. China’s imports of manufactures by selected ISIC category, year, and partner.

Source: ANU (1995) and UNCTAD (n.d.).

Note: NIE, newly industrialized economy; ASEAN-4, Indonesia, Malaysia, the Philippines, and Thailand; NA, not available; ISIC, International Standard Industrial Classification.

^a For imports, we define absolute trade intensity as A = M_cj /M where c is the country of interest (in our case, China); j is the country’s import partners (in our case, Hong Kong, Japan, Singapore, other NIEs, ASEAN-4, the United States, the European Community, and the rest of the world); M_cj is China’s imports from one of its import partners; and M is total world imports.

Tables 7.1 and 7.2 also reveal China’s trade relationship with the various regions in textiles, apparel, electrical machinery, and other industries. China has an increasing dependence on the East Asian region in textile and apparel products. In 1986, the share of textile exports to East Asia was 62%, and the share of textile imports from the region was about 79%. By 1992, these shares had reached 71% and 93%, respectively. Within the region, Hong Kong and Japan were China’s leading trading partners, with Hong Kong accounting for 47% of exports and 77% of imports. The US and EC markets, as well as those of other regions, absorbed together about 30% of China’s textile exports, with a declining trend over time; they were not an important source of textile imports.

Hong Kong and the United States were the most important markets for China’s apparel exports, accounting for 36% and 32%, respectively, in 1986. These shares declined to 35% and 21%, respectively, by 1992. It is noteworthy that the Japanese and European markets became increasingly important, rising from a common share of 20% in 1986 to 34% in 1992. In 1992, 85% of China’s imports of apparel came from Hong Kong and 8% from Japan.

The export and import shares for electrical machinery show that Hong Kong, the United States, and the EC were the most important markets for China’s exports and that Hong Kong, Japan, and the EC were important importers. It is worth noting that the export share of electrical machinery to Hong Kong dropped sharply from 75% in 1986 to 49% in 1992. However, Hong Kong’s share of China’s imports of electrical machinery increased rapidly from 31% to 51% in the same period. The US market became increasingly important for China’s electrical-machinery exports, increasing from 9% in 1986 to 23% in 1992 after the rapid development of China’s direct trade with other economies in the early 1990s. This development coincided with the onset of foreign firms’ exporting their output. It is interesting to note that, by 1992, the United States was no longer an important market for China’s imports of electrical machinery, which were mainly sourced from the East Asian economies, especially Hong Kong and Japan. This reflects China’s search for cheaper and more adequate technology transfers.

The import and export performance of China’s other manufactures displays a pattern similar to that for its trade in electrical machinery. Hong Kong gained rapidly in importance as China’s major import market for other manufactures, rising from a share of 17% in 1986 to 43% in 1992. The relative importance of Hong Kong as China’s export market was successfully maintained at around 35%. In contrast to the shares of Hong Kong, the shares of Japan in China’s two-way trade of other manufactures experienced a significant decline between 1986 and 1992: imports dropped from 33% to 16%, and exports declined from 12% to 9%. Whereas the share of China’s imports of other manufactures from the EC declined from 23% in 1986 to 14% in 1992, the relative importance of the EC market for China’s exports rose slightly from 15% to 16% in this period. The US market became increasingly important to China’s exports of other manufacturing between 1986 and 1992, with export shares rising from 16% to 25%. Nevertheless, China’s trade with the East Asian region (including Hong Kong and Japan) accounted for the bulk of trade in other manufactures, with export shares steady at just more than 50% and import shares holding at more than 60% for the 7-year period.

In conclusion, China’s manufactured exports to all regions increased in intensity, showing slightly more dependence on the US and EC markets for exports over time, with expanding markets for electrical machinery and other manufactured products in the United States and expanding markets for apparel in the EC. At the same time, China was increasingly dependent on the East Asian economies for manufactured imports.

The growing importance of the interdependence of China’s trade with the East Asian economies can most probably be explained by deterministic factors, such as, other things being equal, transportation costs and international-transaction costs, which depend in part on past investments in physical infrastructure, information, and education (Frankel 1993; Petri 1993). Moreover, the rapid growth of foreign-investment inflow from this region promotes China’s regional integration with these economies. This will become more evident as we look at the development of the economic integration of Guangdong and Hong Kong, an area referred to as Greater Hong Kong (Goodman and Feng 1993).

Guangdong Province

Guangdong emerged as China’s wealthiest province in the early 1990s. Its rapid economic growth and export expansion relied heavily on the influx of foreign investment, which was a result of China’s special regional-development strategy, including the establishment of three SEZs in Guangdong. Foreign investment surged, growing at 49% annually between 1986 and 1993, from US$0.6 billion in 1986 to US$7.5 billion in 1993. This is equivalent to about 33% of China’s total FDI inflow. Although FDI data by sector are not available at the provincial level, it is evident from the available aggregate data that FDI and exports are strongly correlated.

The most important forms of foreign investment in Guangdong are equity joint ventures, contractual joint ventures, and wholly foreign-owned enterprises. These FDI forms differ in the degree of risk involved and the permanence of cooperation. A contractual joint venture is an arrangement whereby the local and foreign partners loosely cooperate in joint projects or activities, according to terms stipulated in a contract. It involves less of a long-term investment commitment and risk than do equity joint ventures and wholly foreign-owned enterprises. Equity joint ventures grew rapidly in the 1980s, although the growth was to some extent cyclical. Wholly foreign-owned enterprises gained rapidly in importance as a form of capital commitment, rising from 1.6% of total FDI in 1985 to 24% in 1993. Difficulties finding a reliable local partner and cooperating in control management have led foreign investors to prefer wholly owned investments in some cases. The sectoral distribution of FDI shows that a significant proportion was injected into resource-extracting and -processing industries, which are labour-seeking, followed by real-estate development and service-related investment (Table 7.3).

Hong Kong was overwhelmingly Guangdong’s largest source of foreign investment. The FDI from Hong Kong increased from US$0.6 billion in 1986 to US$6.8 billion in 1993. For four of these years, FDI from Hong Kong accounted for about 90% of total FDI and was never less than 70% of the total (Table 7.4). The low share in total FDI of the rest of the world has a downward bias, however, because many countries routed their investments in Guangdong through Hong Kong, using its entrepôt role in trade and investment. For instance, much of the Taiwanese investment in China was committed through Hong Kong. Similarly, some US and EC multinational enterprises (MNEs) also routed their investments through their branches or companies incorporated in Hong Kong.

Because of Hong Kong’s dominant share of total FDI, Hong Kong is determined to extend its economic frontier into neighbouring regions through more intensive economic integration, thereby gradually becoming the hub of the South China Economic Zone, as portrayed by Chen and Wong (in Chapter 4). To some extent, this rapid economic integration is affected by complementary factors. Hong Kong has severe shortages of labour and land but has expertise in financial and commercial services, as well as an abundance of capital and many industrial entrepreneurs, whereas Guangdong has plenty of land and a large pool of trainable labour but is poorly endowed with factors such as entrepreneurship, soft and hard technology, capital, professional skills, and infrastructure. In 1990, monthly wages in Guangdong’s most developed areas were no more than 20% of those in Hong Kong. Rent for land in the SEZs was between 5% and 14% of that in Hong Kong. Such large differences in the cost of production inputs are the driving forces behind increased economic integration, which is also due to the geographical proximity and cultural affinity of the two regions.

Hong Kong also played a dominant role in Guangdong’s foreign trade, accounting for about 80% of Guangdong’s exports and imports. Guangdong’s exports to Hong Kong maintained a higher growth rate than to any other region since the mid-1980s, the share rising from 72% in 1986 to 86% in 1993 (Table 7.4). Hong Kong’s import share grew as well, albeit not as rapidly, rising from 73% to 79% of total imports in the same period. Unfortunately, no cross-sectoral data are available for analyzing the sectoral distribution of Guangdong’s exports and imports to and from different regions in the world.

Table 7.3. Foreign direct investment in Guangdong: forms of ownership and sectoral distribution (%).

Source: Guangdong Statistical Bureau (n.d.).

Table 7.4. Guangdong’s exports, imports, and FDI by geographic and sectoral distribution.

Source: Guangdong Statistical Bureau (n.d.), China SSB (n.d.), and authors’ own compilations.

Note: FDI, foreign direct investment; NA, not available.

A sectoral analysis of Guangdong’s overall trade performance shows that the shares of textiles and apparel in total exports grew rapidly, increasing from 6% and 3.4%, respectively, in 1985 to more than 13% each in 1993. Exports of electrical and electronics products accounted for about 10% of total exports in 1989, reaching a share of 13% in 1993. On the other hand, imports of textiles experienced a decline between 1986 and 1993, with the share in total imports dropping to 0.5% by 1993. Imports of apparel and electrical and electronics products grew slowly, each only accounting for a share of about 4% of total imports by 1993. This analysis shows that the structural distribution of Guangdong’s exports and imports appears to be highly correlated with the sectoral distribution of FDI, the bulk of which was in traditional, labour-intensive industries, as well as in offshore assembly operations and other kinds of vertical cooperation, with Hong Kong being the primary investor and dominant trading partner. This correlation between FDI and export performance confirms the hypothesis that FDI in industries in which a country has a comparative advantage is trade promoting.

FDI not only turned Guangdong into an export production base but also brought about its specialization in light manufacturing. The share of China’s textile exports produced in Guangdong increased from 4.8% in 1986 to 24.4% in 1992; the share of apparel exports increased from 3.3% to 8.3% in the same period; and the share of exports of electrical and electronic products increased from 11.6% in 1989 to 14.4% in 1992 (Guangdong Statistical Bureau n.d.; China Resources Trade Consultancy n.d.).

Initially, by transforming Guangdong Province and then by fanning out to other parts of China, Hong Kong has helped to bring China’s pattern of trade into line with its comparative advantage. Hong Kong’s manufacturing sector, traditionally less important than in other NIEs, joined forces with South China in the last 15 years to form a much more self-sufficient “national” economy (Chen, P. 1994). By 1992, about 3 million people were employed by Hong Kong firms with investments in Guangdong or, more accurately, in the Pearl River Delta. Thus, Greater Hong Kong is a growing area of economic integration that originated in economic interaction of Hong Kong and the Pearl River Delta.

Guangdong’s economic integration with Hong Kong has been driven by independent enterprises searching for profitable patterns of trade or, in other words, purely by market forces in the sense described by Dobson (in Chapter 1) and by Drysdale and Garnaut (1993) in their analysis of East Asian integration. The advantages of Guangdong’s geographical proximity and cheap supply of production inputs were important reasons explaining why much of Hong Kong’s industrial capacity was transferred across the border. Nonetheless, China’s open-door economic policy as a stimulus to rapid economic integration cannot be overestimated. With this new policy, international trade was decentralized, prices for traded goods were partly liberalized, and foreign-exchange controls were relaxed. Preferential treatment and tax incentives were granted to foreign firms in the SEZs. A multiple-foreign-exchange-rate system, foreign-exchange control, and rent reduction were also effective measures for subsidizing exports and attracting foreign investors (Chen, P. 1994).

Interprovincial level

Because the economic development of Guangdong has been closely linked to developments in Hong Kong, one tends to overlook the economic relations between Guangdong and other areas of China, which are quite extensive. China’s regional-development strategy in the prereform era was to treat each province as a separate economic entity to be developed more or less independently of the others. The central-planning system’s overemphasis on vertical leadership resulted in the atomization of various ministries, industries, and localities. Virtually no horizontal economic links existed between different provinces. As a result, the interior of China pursued import substitution in the consumer-goods sector by effectively banning most imports. Similarly, coastal China broadened the scope of its own development to embrace the capital-goods industry, thereby further increasing its dependence on imported raw materials.

According to the World Bank (1990), the lack of horizontal economic links between the provinces could potentially result in either of two opposing scenarios for the country’s economic development. In the first scenario, the less-reformed interior would erect protective barriers, selling less of its raw materials to coastal regions and buying fewer consumer goods from these regions. Such barriers would perpetuate the autarkic development strategy for the interior, thus depressing its economic growth. As a result, coastal provinces would have to import more raw materials from abroad, which requires pursuing a manufactured-export-led growth strategy. Under this scenario, the economic disintegration of China could become reality.

In the other scenario, market reforms would spread into the interior. As barriers to trade and factor mobilities were dismantled, the interior would benefit from spill-over effects from the coastal provinces, thereby accelerating its pace of progress. This process would enhance the economic integration of the coast and the interior.

It is not immediately obvious which scenario is prevailing in the reform era because of the lack of data on interregional trade. There are many reports about increasing regional protectionism, which characterizes the first scenario. Some provinces have gone as far as setting up checkpoints along their borders with Guangdong or erecting other trade barriers to curb the outflow of agricultural products and raw materials. One extreme example is the rice war that appeared to have developed between Guangdong and Hunan during 1990 and 1991 where barriers to the movement of rice were erected (Chao 1991). On the other hand, strong evidence indicates an increasing interdependence of Guangdong and the rest of China. According to one estimate, in the 10 years from 1982 to 1991, an average of 20% annual growth in Guangdong’s industrial output was the result of demand from other provinces (Zhu 1992). What makes this estimate even more noteworthy is the fact that Guangdong tends to run a trade deficit with other provinces because of its large raw-materials imports. For example, in 1986, Guangdong imported raw materials worth 1.52 billion yuan from the rest of China while only exporting goods worth 0.35 billion yuan (Zhu 1992).

Because only a few statistics on interprovincial trade are publicly available, indirect methods must be used to estimate the magnitude of Guangdong’s trade with the rest of China. Guangdong’s total net exports are provided by the accounting framework of the Material Product System (MPS). The net overseas exports are subtracted from this figure to obtain Guangdong’s net exports to other provinces (Chong 1993). These residual net exports to other provinces are summarized in Table 7.5.

Table 7.5. Guangdong’s net exports (billions of yuan).

Source: Guangdong Statistical Bureau (n.d.) and Hainan Statistical Bureau (n.d.).

Note: Total exports are estimated as the difference between national income and national income available according to the Material Product System (MPS) account (World Bank 1990). Because net exports are derived as a residual, they include any statistical discrepancy. Net exports to other provinces are derived as the difference between total net exports and net exports to overseas; hence, they, too, include statistical discrepencies.

The most striking feature of Table 7.5 is the significant increase of Guangdong’s net imports from other provinces between 1985 and 1993, which indicates that Guangdong’s imports from other provinces grew much faster than its exports to the other provinces. This is consistent with the observation that Guangdong’s market share of manufactured goods in the inland area peaked in 1988 but started to decline as Guangdong-made products met strong competition from inland producers after reforms had spread into the inland areas (Yuan 1995).

The actual magnitude of interprovincial trade between Guangdong and other provinces is still unknown. We know that Guangdong became attractive to foreign investors, that its industry was rapidly upgraded, and that its products penetrated the markets of other provinces. Goodman and Feng (1993) estimated that, in recent years, the goods produced in Guangdong were split equally between sales to other provinces, to international markets, and to the market in Guangdong itself. Assuming as a plausible benchmark that one-third of total exports was exported to other provinces, we can estimate the value of exports to other provinces in 1993 at 84.1 billion yuan. This implies that the estimated value of imports from other provinces for the same year is as high as 111.1 billion yuan, or 34.4% of Guangdong’s GDP. Therefore, imports from other provinces have been extremely important in sustaining Guangdong’s remarkable export expansion overseas. Furthermore, inland provinces benefited greatly from Guangdong’s integration with Hong Kong and its specialization in light manufacturing for the international market. (This observation lends support to the hypothesis of Guangdong’s increased economic integration within China.) The impact of FDI on Guangdong would be substantially underestimated if its role in boosting interprovincial trade were ignored in favour of its role of promoting external trade.

Guangdong’s economic exchange with inland areas takes on other forms as well, such as domestic-linkage (neilian) investments and labour services (Yukawa 1992). With the help of investments in other provinces, Guangdong established supply bases for raw materials and energy, as well as sales bases and marketing networks for Guangdong enterprises. Guangdong’s economic boom created a huge demand for labour, which was satisfied by large numbers of migrant workers from other provinces, more than three million by the early 1990s.

Inland provinces also benefit from these forms of economic relationship with Guangdong. The inland provinces invested in Guangdong to establish marketing and sales networks and, more importantly, to establish export channels for their enterprises (Zhu 1992). Moreover, labour inflow into Guangdong not only eased the unemployment problem for inland areas, it also generated significant amounts of income when migrant workers gave money to their families. Money sent back by migrant workers to one county in Sichuan was at times more than the total GDP of that county (Fan 1994).

In sum, despite some evidence to the contrary, it appears that interprovincial economic relationships have intensified since China adopted its economic open-door policy. Guangdong, which achieved prosperity through participation in international markets, also strengthened its ties with inland areas through various forms of economic exchange and has thus become the “locomotive” pulling the inland economies.

Firm-level analysis

The firm-level survey,⁴ conducted in August 1994, covered 30 foreign firms in Guangdong, of which 15 belonged to the household electric- and electronic-appliances sector and 15 belonged to the textiles and garment sector. These firms were the top 15 recipients of foreign investment in their respective sectors in 1993, the year for which data were obtained.

⁴ Assistance of the Economic Research Centre of the Guangdong Provincial Government is gratefully acknowledged.

The 15 firms in the electric- and electronic-appliances sector were concentrated in three cities: Guangzhou, Shenzhen, and Huizhou. The 15 firms in the textiles and garment sector, on the other hand, were spread among 10 cities and counties: Guangzhou, Shenzhen, Zhuhai, Jiangmen, Fushan, Shunde, Xinhui, Kaiping, Yangjiang, and Chaozhou. Only 3 of the 30 firms were wholly owned; the remaining 27 were joint ventures. Considering the parent’s home country or region, we found that 23 firms were based in Hong Kong and Macao; 5, in Japan (all in the electric- and electronic-appliances sector); 1, in the United States; and 1, in Singapore. This distribution is consistent with the overall distribution of foreign equity ownership.

The average annual sales amounted to US$41 million, with the highest being US$282 million and the lowest being only US$2.4 million. The local and international markets were equally important to the sample firms (Tables 7.6–7.9). Although 12 firms, or 40% of the sample, exported more than 67% of their output, another 12 firms sold more than 67% of their output to the domestic market. This means that market penetration and industry relocation were key factors for FDI in Guangdong. Furthermore, Guangdong seemed to be very lax in enforcing the requirement that all output be exported. The existence of such requirements was reported by 28 firms, but only 10 actually met them in 1993.

Most of the firms sold a large share of their output to their parents, although seven firms did not export to the respective parent at all (Tables 7.6 and 7.7). This suggests that firms were largely relying on their parents to market their output in international markets. In other words, networking was considered a corporate strategy through which markets were penetrated and developed. This was especially true of Hong Kong firms, of which 7 of 9 firms in electronics and 9 of 12 firms in the textiles and garment industry shifted back more than 67% of their output to their parents. Such wide marketing–networking tended to be one of the most important firm-specific characteristics of Hong Kong enterprises. From our conversation with firm managers, foreign firms in China were also very keen on developing their own export channels.

Table 7.6. Surveyed firms in electronics by investing country and destination of sales.

Source: Interviews and questionnaires.

Note: Numbers of firms with interaffiliate sales are not available.

^a This inconsistency is due to the fact that some MNEs committed FDI in Guangdong through their subsidiaries or companies incorporated in Hong Kong, which makes the percentage of sales to parent company and to home country different in the table.

Table 7.7. Surveyed firms in textiles and garments by investing country and destination of sales.

Source: Interviews and questionnaires.

Note: Numbers of firms with interaffiliate sales are not available.

^a This inconsistency is due to the fact that some MNEs committed FDI in Guangdong through their subsidiaries or companies incorporated in Hong Kong, which makes the percentage of sales to parent company and to home country different in the table.

Table 7.8. Surveyed firms in electronics: intrafirm sales and procurement by foreign affiliates, 1994.

Source: Interviews and questionnaires.

Note: NA, not available.

Table 7.9. Surveyed firms in textiles and garments: intrafirm sales and procurement by foreign affiliates, 1994.

Source: Interviews and questionnaires.

Note: NA, not available.

Table 7.10. Surveyed firms in electronics by investing country and sourcing of materials and components.

Source: Interviews and questionnaires.

Note: Numbers of firms with interaffiliate sales are not available.

^a This inconsistency is due to the fact that some MNEs committed FDI in Guangdong through their subsidiaries or companies incorporated in Hong Kong, which makes the percentage of purchases from parent company and from home country different in the table.

Table 7.11. Surveyed firms in textiles and garments by investing country and sourcing of materials and components.

Source: Interviews and questionnaires.

Note: Numbers of firms with interaffiliate sales are not available.

^a This inconsistency is due to the fact that some MNEs committed FDI in Guangdong through their subsidiaries or companies incorporated in Hong Kong, which makes the percentage of purchases from parent company and from home country different in the table.

Table 7.12. Imported capital goods from parent.

Source: Interviews and questionnaires.

^a Both firms sourced 70% from the parent.

^b One firm sourced 5% from the parent; the other, 12%.

Eighteen firms imported more than 67% of input materials and components. Local sourcing was important to eight firms that purchased more than 67% of their inputs from the domestic market (Tables 7.10 and 7.11). Eleven firms reported that they were subject to local content rules, but only seven met these requirements in 1993. Overall, there seemed to be a correlation between sourcing and sales behaviour. In other words, firms producing for the domestic market sourced mainly from local suppliers, whereas highly export-oriented firms imported most of their inputs.

Almost 67%, or 19 firms, procured all imported inputs from their parents (Tables 7.10 and 7.11). Similarly, 19 firms bought all imported capital goods from their parents (Table 7.12). The main reason for sourcing capital goods, materials, and components from parents was that parents supply better-quality and lower-priced goods, besides providing updated technology and know-how. This is consistent with the theory that MNEs tend to internalize firm-specific capital; that is, they take advantage of the firms’ ownership relations (Dunning 1993). This implies that intrafirm trade increases internalization.

That Japanese firms behaved differently from other firms in the sample is notable. All five Japanese firms sold a high proportion of their output in China’s domestic market while sourcing a large share of inputs from abroad, which suggests that their main interest in Guangdong was to penetrate China’s domestic market. The analysis of Japan’s investment strategy in China leads to the conclusion that Japanese outward direct investment was motivated by securing vital resources, circumventing trade barriers, and strengthening competitive powers by penetrating local markets. Instead of committing large amounts of direct investment in the early 1980s, Japanese firms believed that exporting was a better approach to penetrating the newly opened, unpredictable Chinese market. As might be expected, when local market shares were threatened by the loss of international comparative advantage, direct investment in China by these Japanese industries surged. In contrast to Japanese firms, most Hong Kong firms established production bases in China with the intention of exporting a large share of the output.

Anecdotal evidence

Personal interviews were conducted with the general managers of two household electric- and electronic-appliances firms and two textiles and garment firms. For the sake of confidentiality, we shall refer to these firms as electric firms A and B and garment firms A and B.

Electric firm A is an air-conditioner manufacturer with an equity investment of US$5 million in 1984, of which the Japanese and the local partners own equal shares. Electric firm B is also a joint venture with a Japanese firm; it produces refrigerators and other appliances. Garment firms A and B are both joint ventures with Hong Kong firms. The shares of foreign and local contributions in garment firm A were 49% and 51%, respectively, of total equity investment; in garment firm B, 51% and 49%, respectively.

The survey findings, which demonstrated that Hong Kong firms tend to export to international markets whereas Japanese firms tend to target local markets, appear to be confirmed by the interviews. Garment firm A produced 8 of the 10 well-known Hong Kong brands of clothing and exported 100% of its output to the North American market through its parent’s marketing network. Guangdong’s cheap labour and land prices were the major reasons behind setting up this facility. In comparison, the Japanese electric firm A exported 60% and electric firm B exported nothing of their respective outputs to international markets. Most of their products were absorbed domestically. One of the firms’ managers mentioned that exporting was the only way to generate the foreign exchange needed to balance foreign-currency requirements.

Export orientation seemed to be negatively correlated with local input procurement. Garment firm A produced 100% for the international market and imported 100% of input materials from Italy. Electric firm A procured all supporting parts from local suppliers and imported only the core component — compressors — from the parent in Japan. Similar behaviour was observed in other firms that procured to a large extent locally and imported only the core components for which local supplies did not meet the quality requirements. Establishing good local linkages and networks was considered very important for foreign firms operating in China.

Foreign firms were likely to follow a “snow-ball” development pattern. The parent company usually established a small joint venture in the beginning and expanded its business later through additional investments, openings of new subsidiaries, or both. Garment firm A’s initial equity capital was only HK$2 million. After a few years of operating, it became quite successful; total sales reached HK$100 million in 1993. A new and larger factory was built to meet the additional demand. Electric firm A presented a similar picture. To meet the rapidly expanding business, additional capital of US$3.5 million was invested to enhance its production capacity. At the same time, about 10 sister companies were established across the country in Beijing, Shenyang, Changchuen, Dalian, Fushan, and Shenzhen among others.

Some advantages of FDI are believed to be the transfer of foreign capital and marketing and management skills to the host economy. Our interviews showed that the foreign partner tended to be responsible for technology and production management, but the local partner was in charge of personnel and other administrative management. Garment firm A reported that all technicians were hired from Hong Kong and were responsible for design and quality control. In electric firms A and B, Japanese engineers and technicians were found in the assembly shops training the Chinese workers at the time of the interview. The Japanese firms followed more closely their parents’ management styles, such as close, friendly, and cooperative relationships between workers and management. The Japanese firms also had well-managed workshops and employee-welfare programs. A unique characteristic of investing in China is the need to provide staff with food and appropriate accommodation. Hence, the four firms interviewed had to set up their own staff canteens before they could formally open for production.

In sum, the firm-level studies confirm that both international and domestic markets were equally important to foreign firms as sources for inputs and markets for output. Both market penetration and industry relocation seemed to be key reasons for the presence of FDI in Guangdong. Foreign firms relied heavily on their parents to provide them with technological support and management know-how by supplying firm-specific capital and technical and management personnel. FDI has transformed Guangdong into a light-manufacturing base by supplying this important package of foreign capital and marketing and management skills specifically tailored for such production processes.

Conclusion

Before China started its economic reform in 1979, there were large differences between the returns to the production factors of labour, land, and capital on the two sides of the Hong Kong–Guangdong border. At that time, Hong Kong was already very integrated in the world economy; its export-oriented manufacturing sector specialized in the production of light manufactures. However, further development was constrained by high labour costs and escalating land prices. Nearby, on the other side of the border, Guangdong had an abundant supply of labour and land, but the economy was underdeveloped and isolated from the rest of the world, thus lacking profitable opportunities for those factors of production. The severe limitations on factor mobility prevented benefits from these differences in factor prices from being explored.

China’s economic reforms and open-door policy enabled foreign investors, especially from Hong Kong, to establish production facilities in Guangdong with very low production costs. Hong Kong manufacturers gradually and cautiously moved their production lines across the border, being forced to do so by Hong Kong’s escalating rental and wage costs. Eventually, the pace of relocation picked up as remaining firms faced increasing competition from firms that had already relocated into Guangdong.

Hong Kong investors set up production lines for household electrical and electronic products, textiles and apparel, footwear, toys, and other light-manufactured products, in other words, for the goods in which Hong Kong firms had specialized. These labour-seeking industries are resource extracting and processing. As a result, FDI, especially that from Hong Kong, rapidly transformed Guangdong into a light-manufacturing base.

Initially, foreign firms were export oriented. As economic reforms took hold, income levels of the local population increased, and people’s tastes changed. This development rapidly increased the local demand for products made in Guangdong by foreign firms. Although China has been slow in removing restrictions on imports of consumer goods from abroad, it seems to be very lax in enforcing export-orientation requirements for foreign firms. Other restrictions preventing foreign businesses from penetrating the domestic market were also gradually relaxed as China liberalized its foreign investment regime and became one of the most liberal foreign investment environments in the developing world. As a result, foreign firms sold increasingly larger shares of output in China’s domestic markets. By the early 1990s, the international and the domestic markets became equally important to many foreign firms. This further stimulated Guangdong’s specializing as a large-scale light-manufacturing base.

With the rapid growth of its industrial production, Guangdong had to import increasing amounts of raw materials and intermediate products from abroad and from the rest of China. This development accelerated the integration of the province with the rest of the world and the rest of China. The almost unlimited supply of labour from other provinces enabled Guangdong to contain wage inflation, despite the remarkable speed of growth, thereby ensuring its continued comparative advantage as a low-cost producer.

Foreign firms sourced production materials and components both locally and from abroad. Sourcing from the parents seemed to be unsubstitutable and invaluable to many of the firms. Most of the foreign firms in both the household electric- and electronic-appliances and the textiles and garment sectors sold a large portion of exports to their parents and imported at least the core parts of their products from them, implying a high degree of reliance on the parents’ technology and marketing networks. Firm-specific capital and technical and management personnel provided by the parent ensured the supply of necessary technological support and management know-how.

The role FDI played in Guangdong’s emergence as a light-manufacturing base is underestimated if one focuses only on its role in promoting external trade while ignoring its role in boosting interprovincial trade. In fact, Guangdong’s rapid outward integration has been concurrent with its inward integration with the rest of China. The significant increase of interprovincial trade and investment flows, not to mention the labour inflow into Guangdong, created increasingly dense ties between Guangdong and other provinces. Such interprovincial economic cooperation, or integration, between the coast and the interior is now much stronger than in the prereform era. This development puts to rest some concerns about China’s economic disintegration as a result of its unbalanced regional development.

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