China, as any other developing country, has needed foreign technology for its economicdevelopment. For the first two post-revolution decades, China remained suspicious of foreigncapital and hoped that by importing foreign capital goods and using reverse engineering it could meetits technological needs. Such a policy had limited success even after the opening of China followingPresident Nixon's visit to Beijing in 1972 and the gradual of normalization relations with the UnitedStates and other nations. Between 1972 and 1978, China imported equipment and a number of newplants from the industrialized West but found only limited success in developing indigenoustechnology through the reverse engineering route. Under Deng Xiaoping's economic reforms,attitudes toward foreign capital began to change. During the first stage (1979-83), foreign investment was restricted to four Special Economic Zones (Shenzhen, Zhuhai, and Shantou inGuangdong Province and Xiamen in Fujian Province). In spite of the incentives provided, the inflowof FDI remained low - an average of only $360 million annually over the five-year period. Duringthe second stage (1984-91), Hainan Island and fourteen coastal cities in ten provinces were opened to foreign capital. (11) In 1990, the government eliminated time restrictions on the establishment of joint ventures, provided some assurances against nationalization, and allowed foreign partners to become chairs ofjoint venture boards. In 1991, China granted more preferential tax treatment for whollyforeign-owned businesses and contractual ventures and also for foreign companies that invested inselected economic zones or in projects encouraged by the state (such as energy, communications,and transportation). In 2000 and 2001, China revised significantly its laws on foreign-ownedenterprises and joint ventures. It eased export performance and domestic content requirements,attempted to make the legal framework more transparent, and ensured thatforeign-investment-related enterprises would not be nationalized except under special circumstances. China's entry into the World Trade Organization in December 2001 also stimulated FDI flows intothe country. Financial incentives also are used by the central and regional governments to attract foreign investment. These include reductions in or exemption from central and local taxes and lowering ofimport duties on foreign-made equipment and construction materials. (12) In its designated priorityareas, the government also gives preferential treatment to foreign investors. Currently such areasinclude agriculture, resource development, infrastructure, and export-oriented and high technologyindustries. (13) On the negative side, widespreadcorruption and bureaucratic hurdles continue to deterforeign investment, but the government is trying to remedy the situation by imposing harshpunishments on corrupt officials who are caught. General aspects of China's market also have added to the attraction for foreign investment. With its 1.28 billion people and rapidly rising incomes and purchasing power, China presents a hugepotential market. Per capita incomes around Shanghai and in Guangdong province already havereached an estimated US$5,000. China also possesses a comparatively well-developed socialinfrastructure, including a compulsory nine-year education system that has helped provide a supplyof reasonably literate workers with some technical competence. Labor is abundant, wages low,strikes uncommon, and discipline problems are rare. The eastern and coastal regions of China,moreover, include sufficient transport and communications facilities for foreign investors to exportgoods or distribute them within China. In its 2002 FDI Confidence Index survey of top corporate decision-makers, A.T. Kearney (a business consulting firm) found that "confidence in China is booming." For the first time since thesurvey began, in 2002 China surpassed the United States to become the destination most likely toattract investment. More than any other country, investors held a more positive outlook towardChina, with 46% more optimistic about the Chinese market then than in the previous year. They arealso expected to commit more first-time investments to China than to any other country. (14) The surge in FDI into China coincided with a similar trends worldwide. The second half of 1990s saw an unprecedented increase in the world outflow of foreign capital - a more than six-foldincrease from an annual average of $225 billion during 1990-95 to $1,492 billion in 2000. According to the World Investment Report (WIR), there were three forces at work - all related toglobalization. First, many governments liberalized capital flows into their national economies. Thisallowed foreign investment to enter more freely. The process was further accelerated by theprivatization of government-owned enterprises in both developed and developing countries. Second,increasing costs of production and various technological developments induced enterprises to spreadtheir operations and risks internationally. Concurrently, the cost of transportation andcommunications fell, thereby enabling firms to locate their production processes in different partsof the world and to supply products, parts, and accessories from long distances. Finally, increasingcompetition forced enterprises to enter new markets at an early stage and to transfer someproduction there to "nationalize the product" and to reduce production costs. These forces also wereat work for FDI in China. As shown in Figure 2, after averaging around $2 billion per year during1984-88, FDI flows intoChina rose dramatically in the 1990s to $46.9 billion in 2001 and further to $52.7 billion in 2002(according to Chinese statistics). In 2001, FDI inflows to China accounted for 6% of the world totaland 22% of inflows into developing economies. (See Appendix A.) These FDI flows have beenincreasing in recent years despite global recessionary conditions that caused total world FDI flowsto drop nearly by half in 2001. Chinese statistics on FDI, however, differ considerably from those of other nations. For example (as discussed later in this report), the U.S. Department of Commerce shows American directinvestment in China at less than a third of the level that Beijing reports. Most FDI into China comes from either "Greater China" or from the three major industrializedmarkets: the United States, Japan, and the European Union. Hong Kong continues to be the numberone source. (Even though Hong Kong reverted to Chinese sovereignty in 1991, it still is counted asa "foreign" entity for trade and capital flows.) In 2001, Hong Kong provided $16.7 billion or 36%of China's total of $46.9 billion of actually utilized FDI. Much of Hong Kong's investment inChina, however, actually is Chinese capital doing a "round trip" to take advantage of investmentincentives and protections for foreign investors. (15) Taiwan provided another 6.4% of the FDI andMacao 0.6%. Some of Taiwan's FDI in China also flows through Hong Kong or offshore taxhavens. Singapore provided 4.6%. Hence, nearly 47% of the officially tabulated FDI inflows intoChina originated in areas sometimes designated as the Greater China region. Other major investorsin 2001, were the United States with 9.4%, Japan with 9.2%, and the EU with 9.0%. The offshoretax havens account for nearly 15% of total FDI flows into China, but this FDI actually originatesfrom countries such as the United States, the EU, Japan, Taiwan, or even the PRC, but for variousreasons was routed through tax havens such as the Bahamas, Virgin Islands, Cayman Islands,Bermuda, and Western and Eastern Samoa. In the early stages in which foreign capital was allowed to enter China, the main vehicles of entry were joint (equity) ventures, cooperative joint ventures, and wholly foreign-owned enterprises. In joint ventures, capital was provided by two or more parties who managed the enterprise andshared in the risk according to their contributions to the capital. In the cooperative joint ventures,much of the capital was provided by the foreign partner, while land, building, and workable assets were provided by the domestic side. The nature and degree of participation and the sharing of riskwere established in the contract. On the stipulated date of termination of the contract, all the assetsbecame the property of the Chinese side. In wholly owned ventures, the foreign firm put up all thecapital. In the 1980s, 42% of all FDI into China was invested in cooperative joint ventures and 39% in joint (equity) ventures. Hence, 80% of all FDI inflows came into joint ventures of one or the othertype. Investments into wholly foreign-owned enterprises accounted for only 10% of the FDI inflows. Another 10% entered in other forms such as compensation trade or international leasing, etc. (SeeTable 1). Table 1. Foreign Direct Investment in China by Type, 1979-2002 (in percentage) Source: China. Ministry of Foreign Trade and Economic Cooperation. Statistics About Utilizationof Foreign Investment in China. Various years. During the 1990s, the relative importance of cooperative joint ventures declined significantly. In 2002, they accounted for less than 10% of FDI inflows. The share of joint equity enterprises wentup during the first half of the 1990s reaching around half of total inflows in 1991 after which theydeclined, initially slowly, but by 2002 were only 28%. Typically in joint enterprises, the Chinesepartner was able to contribute expertise on land and labor acquisitions and political connectionsnecessary to navigate the Chinese bureaucratic system. As the enterprise developed, however, suchskills became less and less important relative to management and operational skills provided by theforeign partner. Currently, more and more foreign companies are opting to establish wholly-ownedenterprises over which they have complete control. On the other hand, Chinese authorities, with theirgrowing experience in dealing with foreign enterprises, have become more confident in allowingthem to operate without a native partner.