China’s Round-Tripping FDI: Scale, Causes and Implications Dr. Geng XIAO The University of Hong Kong 20 November LAEBA ANNUAL CONFERENCE The Emergence of China: Challenges and Opportunities for Latin America and Asia 3-4 December 2004, Beijing, China

Patterns of China’s FDI Sector distribution: –Manufacturing and real estate Regional distribution: –Coastal and high income Source Region: Impact of FDI on the Chinese economy China’s Balance of Payment –Co-existence of Capital flight and FDI

Why Study Round-Tripping FDI in China? The prevailing view on China’s FDI: –China attracted too much of the global FDI at the costs of other developing economies. –Hence, China’s currency should be revaluated to restore the international balance in capital flows and competitiveness. How much of China’s FDI is round-tripping?

Incentives for China’s Round-Tripping FDI 1.Tax advantages and fiscal incentives 2. Property rights protection 3. Expectations on exchange control and exchange rate 4. Competitiveness of Hong Kong and overseas financial services

Two Types of Round Tripping: Rent-Seeking or Value-Seeking? Round tripping for escaping regulation – Creates no value added – Due to lack of property rights protection Round tripping for value added services – Creates value added through better offshore financing – Most cross-border mergers and acquisitions belong to round-tripping – Hong Kong as a modern international financial and trade centre at the heart of round-tripping

Estimating China’s Round Tripping FDI Table 10.1 to 10.6 –Row A : FDI flows from the source region to China as reported by the source region. –Row B: FDI flows from the source region to China as reported by China. –Row C = Row B - Row A = the unverifiable FDI flows from the source region to China. Part of Row C is likely caused by round tripping FDI. –Row D = Row C / Row B; which is the ratio of unverifiable FDI.

Dealing with Statistical Reporting Errors If there are no significant statistical reporting errors, Row D could be regarded as a proxy for the average ratio of round tripping FDI into China. If the statistical reporting errors are non-biased in the sense that they average to zero over the years, Row D would also be regarded as a close approximation of the round tripping FDI ratio. If the statistical reporting errors have systematic bias towards over-reporting by China side independent of the round tripping bias, we should then adjust Row D downward by the size of the systematic statistical reporting errors.

Size of Statistical Reporting Errors The standard deviation is a useful indicator on the likely range of both statistics reporting errors and the volatility of round tripping FDI. We assume the systematically biased statistics reporting errors is as large as one half of the standard deviation of Row C (the unverifiable part of FDI) during the observed period.

The Case of Hong Kong The standard round tripping story for Hong Kong The complication due to the listing of Chinese companies in Hong Kong stock market The issue of offshore financial centre

Size of FDI Projects and Round-Tripping Is round tripping more likely to happen for small projects and small enterprises? Which source region has small FDI projects and small FIEs? What does the size of FDI projects correlate with? Conclusion: Round-tripping is likely to happen from all source regions due to the abundance of overseas Chinese?

Major Findings The round-tripping FDI in China was estimated in the range of 30% to 50% On average, the round tripping FDI is about 20% to 30% of China’s capital flight. Competition for FDI is not a zero-sum game and depends endogenously on the host country’s capacity to create new capital