Monday, November 26, 2007

How to Make Sense of China's FDI

In spite of the causes for concern, standard economic rationales for FDI take on unexpected new forms in China, and may justify some, perhaps even much, of China’s outward FDI. Three rationales are of note.

First, the internalization theory of FDI, appropriately reinterpreted, suggests that Chinese companies, with vast experience in navigating complex bureaucracies, might do well in countries with similar institutional environments.

Second, in certain maturing industries, outward FDI from China, even into advanced economies, might make economic sense. This ownership reversal, which we develop from the perspective of Grossman and Hart (1986), argues that the party possessing manufacturing capabilities becomes the “boss” as the locus of competition shifts from innovation to production cost and quality control.

Third, China’s outward FDI may be justified economically to SOE insiders who overvalue control due to their distrust of markets and sense of national pride. This third rationale can continue as long as those who control China’s business enterprises continue to accept below-market share valuations in exchange for these perceived benefits of control.

That is the conclusion from a very interesting paper by NYU's Bernard Yeung and two coauthors entitled: Perspectives on China's Outward FDI. Read the whole thing here.

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