Opinion | Here’s why incoming FDI is far more important to China than thought

China’s State Council has called on the ministries to further open the country’s economy to foreign companies. While analysts indicate this might be in response to stagnating inward foreign direct investment (FDI), complaints from foreign companies, the spectre of a trade war with the United States, and calls for reciprocity as Chinese companies invest abroad, there are more fundamental forces at play.

China does not need the money. In recent years, FDI has accounted for only about 2.5 per cent of the nation’s gross capital formation and foreign invested enterprises (FIEs) have supplied around 0.5 per cent of its fixed asset investment. So at first glance, the levelling off of annual FDI should hardly be a cause for concern. Additionally, although FIEs are currently responsible for just under 50 per cent of China’s exports and more than 50 per cent of its imports, the contribution of their net exports (exports minus imports) to GDP is only about 2 per cent.

However, the story changes dramatically when one looks past the inbound investment figures to the operations of the FIEs and their economic impact. FIEs generate more than 20 per cent of sales, employment, and value added in China’s industrial sector, and in some advanced areas – such as computers, autos, and chemicals – the percentages are substantially higher. Since the industrial sector accounts for roughly half of China’s GDP, industrial FIEs contribute approximately 10 per cent of China’s GDP just through their own operations.

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The impact of inbound foreign investment does not stop there. It ripples through the FIEs’ supply chains and the consumer spending of their employees and those of their suppliers. When all these are included, the total impact of the industrial FIEs rises to about 20 per cent of GDP. Adding similar analysis for FIEs in the services sector and the impact of the physical investments of FIEs brings the impact to around 33 per cent of China’s GDP and 27 per cent of the country’s employment. Instead of focusing on the US$125 billion in FDI that China received in 2016, we should instead be considering the roughly US$3.7 trillion in GDP impact generated by FIEs and their ripple effect.

A similar analysis of American firms operating in China indicates that in 2014 – while official Chinese statistics reported FDI inflows from the US of US$2.4 billion – the total GDP impact and ripple effect of those companies was US$437 billion, or more than 180 times the FDI inflow. The GDP impact of US companies was more than 13 times the net income of US firms in China that year.

Enright, Scott & Associates estimates that the impact of US firm Procter & Gamble alone – with its supply chain and distribution channels – was more than US$11 billion on China’s GDP and 600,000 on the nation’s employment in 2014.

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The estimates do not include a wide range of additional effects of inbound FDI and FIEs in China. These include the modernisation of Chinese industries, the creation of suppliers and distributors in China, bringing technology and R&D to China, fostering local spin-offs, improving business practices and standards, providing access to international capital markets for Chinese firms, modernising management training and education, bringing regional and global management to China, promoting legal and institutional reform, improving environmental and sustainability practices, contributing through corporate social responsibility initiatives, and providing advice on economic and business-related policies. The impact of FDI and FIEs in these areas could be even larger than those quantified above.