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The Entry and Expansion of FDI

A comprehensive account of privatization in post-Mao China must also include a close look at the role of foreign capital, especially FDI, which has become an increasingly important force in the country’s new economy. A major feature of the entry and expansion of FDI in China is that, while the central government has held the authority to set the rules, local governments, especially subprovincial governments, have been the main gatekeepers and regulators. In the first three decades of reform, especially before China’s accession to the World Trade Organization (WTO) in 2001, there were significant entry barriers in terms of sector, region, and organizational form. Over time, however, many of these barriers were lowered or weakened, resulting in the expansion of the space for internationally related private economic activities. The driving forces for such change came not only from shifts in the central leadership’s own strategic calculations and growing international pressures for greater degrees of opening, but oftentimes from the behavior of local gatekeepers and regulators that deviated from centrally defined rules and mandates.

What drove local authorities to go beyond centrally imposed limits, according to Zweig (2002), was regional competition. By bending the rules on foreign investment local authorities sought to increase the attractiveness of the institutional environments under their purview, thereby gaining first mover’s advantage in the rivalry for external resources. There were variations, however, in the intensity of such efforts. To explain this, Huang (2002) looks to the preexisting conditions of reform. He argues that China’s regional economic fragmentation hindered the geographical flow of financial resources and thus raised the demand for the use of external capital to finance local economic development. During the early years of reform, private enterprises were denied access to credit and faced regulatory discrimination, whereas SOEs were inefficient and administratively barred from organizational integration across jurisdictional boundaries. This created a niche for foreign investors to emerge as a leading source of capital supply, and consequently local dependence on FDI grew. The higher the demand for foreign capital, the more concessions local authorities had to make to foreign investors, hence deepening the degree of privatization.

These explanations are useful in that they help us understand the interplay of internationalization and privatization by illuminating an important link between the political and economic benefits of foreign capital and the behavior of local officials. Yet there is more to the story. The rule-bending behavior of local officials was not free of political risk. As will be shown in chapter 6, without the help and support of local officials many foreign investors would not have been able to bypass national regulatory approval requirements, enter sectors with centrally imposed restrictions or even bans, take organizational forms (e.g., wholly foreign-owned venture, joint venture with minority or declining public ownership, and joint venture with domestic private enterprises) discouraged or disallowed under existing policies, and locate themselves in the same regions and sectors already populated by central or provincial SOEs. Facilitating these pursuits inevitably violated or deviated from the norms of administrative conduct and, if not properly defended and justified, could have negative consequences to the local gatekeepers concerned.

To be sure, unlike the domestic private sector, foreign investment was generally encouraged by the central leadership from the very beginning of economic reforms. This left local authorities with greater degrees of freedom to manipulate around centrally set rules. In comparison with domestic private enterprises, foreign investors were also more mobile in site selection— especially in the early years of reform, thus having greater bargaining power versus local gatekeepers. The question is how far the latter would go beyond the existing policy limits to attract and accommodate foreign capital. In fact, not all ofthem were noncompliant with the rules. Different tendencies toward such behavior therefore provide a useful window on the mechanisms whereby privatization deepened through localized economic internationalization.

As a major consideration in the self-i nterest calculus of local officials, dependence on foreign capital is a factor relevant to explaining the variations. But it is insufficient because understanding how the political risk generated in the interactions with foreign investors was tackled requires an examination of the interactions between local and higher-level authorities, which are interdependent. The ability of a local government to buffer or alleviate the political risk of rule bending depends greatly on the strength of its bargaining power with higher-level authorities. As I will show in chapter 6, during the first three decades of reform such bargaining power tended to be particularly strong in two diagonally different types of locales: those that contributed significantly to the revenue bases of higher-l evel authorities and, interestingly, those that relied heavily upon fiscal subsidies to cover the perennial gaps in basic public spending. The leverage came from the fiscal dependence of higher-level authorities on the former and from their need to contain or reduce the fiscal burdens posed by the latter, especially when the shortfalls were further compounded by significant local unemployment pressures. A close analysis of fiscal flows—especially various remittance and transfer arrangements, therefore, will be useful for unveiling the dynamics of the bargaining relationships within the state system, as well as their implications for local FDI policies. Given the importance of vertical bargaining to political risk management over the full spectrum of ownership-related issues, the investigation along this line of inquiry will also yield more clues to understanding the attitude and behavior of local officials toward the domestic private sector.

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