FDI a pick-me-up for companies' profitability

China should continue to optimize its policies to attract foreign investors, especially to its western region where there is greater space for positive spillover effects

In an open economic system like China, foreign direct investment helps promote economic development and deepen reform and opening-up. For a long time, optimization of the business environment and a policy to attract foreign capital have led to expected year-on-year increase of FDI in China. Even now when global transnational investment is on the decline, China's foreign investment utilization is steadily increasing. Statistics show FDI inflows into China grew 7.2 percent year-on-year to $67.98 billion in the first six months of this year.

In general, FDI companies have advanced technology and management that give them an edge over domestic enterprises, and the domestic and foreign companies have strong similarity in industrial composition, the correlation coefficient being 0.94. The entry of foreign companies should, therefore, lead to fierce competition with domestic companies in the product market and have a significant impact on the market share of the latter companies.

Furthermore, China used to give foreign enterprises favorable tax treatment. Before 2008, the nominal tax rate for foreign companies in China was 15 percent and domestic companies 33 percent, which many believed led to unfair competition, because large-scale FDI foreign intensified the competition in the domestic product market and reduced domestic companies' profits.

But does FDI hinder domestic companies' growth and reduce their profitability? Research shows that instead of harming domestic companies' profitability, FDI actually promotes profitability of domestic companies.

The reason: apart from intensifying market competition, FDI also causes a wide range of spillover effects in the host country. As owners of advanced production technology and given their management experience, foreign companies are an important source of technology spillover. Through technology transfer, demonstration effect and flow of human resources, foreign-funded enterprises improve the production technology and management efficiency of domestic companies. Till date, 490 of the world's top 500 companies have invested in China, and nearly 800 foreign companies have set up R&D centers in the country. Many of them have invested in high-tech industries, and thanks to technology importation and spillover effects, domestic companies have improved their technologies and productivity.

FDI-induced market competition not only leads to a negative "market crowding effect" but also causes positive spillover effects. And if the positive effects are high and long term, then FDI increases rather than reduces the profitability of domestic companies. So far, the positive spillover effects of foreign capital in China have been higher than the negative effects, and hence have helped raise the profitability of domestic companies.

The positive effects of FDI on companies' profitability have been more evident in the western region of China, because the western region lags behind the eastern region in terms of economic development, and the technological gap between domestic and foreign companies is wider there. Also, the scale of foreign investment in the western region is still small, its quality low and market competition not that intense. As a result, the space for positive spillover effects of FDI is vast in the western region.

With the Belt and Road Initiative making progress, China's western region is becoming more and more attractive to foreign investors. In the first six months of 2019, the western region utilized $4.9 billion of foreign investment, up 21.2 percent year-on-year. Cities in western China such as Xi'an, Chengdu and Chongqing have become open inland economies. Of the world's top 500 companies, 285 have invested in Chengdu, which means the city has one of the highest numbers of regional headquarters of some of the world's top companies.

Since foreign investment has had a positive impact on the profitability of Chinese companies, China should continue to optimize and improve policies for foreign investment, guide FDI flow toward the western region and promote the growth of companies there. This is important, considering that the western region has accelerated the pace of opening-up.

The trade war instigated by the United States may hurt China's economy in the short term. But it has also prompted China to expedite its industrial upgrading, which will reduce its dependence on developed economies for advanced technology and high-tech products.

According to the latest data from China's Ministry of Commerce, between January and September, 45,922 foreign-invested enterprises were set up in China, up 95.1 percent year-on-year, and the actual amount of foreign capital used was $90.46 billion, up 2.9 percent year-on-year.

In September, 4,591 foreign-invested enterprises were set up in China, up 45.7 percent year-on-year, and the actual use of foreign capital was $10.83 billion, up 8 percent year-on-year. In particular, US investment in China in the first half of 2019 grew by 29.1 percent year-on-year, higher than overall FDI growth.

China's FDI utilization rate has steadily increased in the first nine months of this year. And China's expanding product market, industrial upgrading and improving business environment will make it more and more attractive to foreign investors.

Liu Canlei is an assistant professor at the University of International Business and Economics' Institute of International Economics. Kang Maonan is an assistant professor at the Tianjin University of Finance and Economics' School of Economics. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.