In recent years, China has topped the list of destinations for foreign direct investment (FDI) among developing and emerging market countries. But has its stellar performance come at the price of reduced FDI elsewhere in Asia? Generally, no, argues a new IMF Working Paper, although Singapore and Myanmar may be exceptions.
Many developing countries have been eager to attract FDI flows, which are not as volatile as other types of capital flows, tend to boost technology transfers and raise growth rates, and can spur domestic investment. China’s success in attracting FDI has been impressive. Only 25 years ago, China’s share of FDI in developing Asia was about 10 percent. By 2002, the country’s share was 70 percent (see chart).
With success, however, have come fears that China has diverted flows from other countries in the region. For a clearer sense of what has, in fact, happened, our study, using a new methodology, analyzed data for 1984-2002 for 14 Asian economies (Bangladesh, China, India, Indonesia, Korea, Malaysia, Myanmar, Papua New Guinea, Philippines, Singapore, Sri Lanka, Taiwan Province of China, Thailand, and Vietnam).
The study found that, on average, China does appear to have diverted FDI flows during this period. Between the early 1990s, when China began opening its doors to FDI, and 2002, flows to other countries declined by an average of 1.3 to 2.1 percent of GDP a year, depending on the estimation method used. A closer look suggests, however, that this crowding out was concentrated in two countries—Singapore and Myanmar.
Favorite among Asian emerging markets
By the early 2000s, more than 70 percent of foreign direct investment in emerging markets in Asia went to China.
Data: IMF staff calculations.
What explains the change in flows?
Singapore and Myanmar experienced large declines in FDI inflows—between 1.9 percent and 2.8 percent, and 3.9 percent and 4.5 percent of GDP a year, respectively. For Singapore, the most probable explanation for the decline seems to lie in the role played by overseas Chinese. They account for a significant share of foreign investment in China and invest because they have family connections or, at least, linguistic and cultural ties. Some overseas Chinese are similarly connected to Singapore. If these investors focus their investment on regions to which they are connected, a decision to invest in China might indeed come at the expense of Singapore.
Myanmar’s situation is trickier. Political developments there have led many traditionally large suppliers of FDI (including the United States and the European Union) to severely restrict FDI in Myanmar. The imposition of new restrictions plays a role in the dynamics of foreign investment in the country but is obviously unrelated to China. A more likely possibility is that Singapore, the second-largest foreign investor in Myanmar, may have diverted some of its FDI to China at Myanmar’s expense (China and Hong Kong SAR are the two main destinations for Singaporean investment).
It is also sometimes argued that low-income economies, which compete with China for low-wage investment, suffer more from China’s competition, while countries that invest more in human capital and research and development are less affected. The study tests these assumptions, with the results suggesting that low-income economies did not suffer more from diversion of FDI than higher-income ones. Low levels of secondary or tertiary education or fewer scientific publications per person are not associated with increased crowding out by China either.
China’s emergence as a major destination for FDI flows did not, during the period studied, seem to have a negative impact on most of its neighbors. The sheer size of China and the likelihood that India may soon follow in its footsteps make it important, however, to continue analyzing the regional and global impact of these two demographic giants.
IMF Asia and Pacific Department
Copies of IMF Working Paper No. 05/189, “FDI Flows to Asia: Did the Dragon Crowd Out the Tigers?” by Benoit Mercereau, are available for $15.00 each from IMF Publication Services. Please see page 96 for ordering details. The full text is also available on the IMF’s website (www.imf.org).