Competitiveness in India and China: the FDI puzzle

Abstract

Given their growth records, large markets, and reformed economic systems, both China and India appear to be equally likely candidates for foreign direct investment (FDI). Yet, China has received substantially more FDI. The literature comparing FDI in these two countries is small, and does not provide conclusive evidence to explain this puzzle. Applying the Porterian framework of the competitiveness of nations to compare China and India, we garner evidence that differences in demand, factor conditions and firm strategy, structure and rivalry are not sufficient to explain the differential in the two countries' FDI flows. Differences in related and supporting industries, as well as Porter's other two factors – government and chance – are more compelling. We identify China's early entry into East Asian production networks in the 1980s as a key factor pushing China ahead of India in terms of FDI. We argue that this coincidental mix of timing and geography (Porter's ‘chance’ factor), pushed forward in China by the establishment of special economic zones, gave China a sustainable competitive advantage for the following two decades. What is implied from these findings is that China's FDI sources have been much larger and heavily slanted towards East Asia and manufacturing, while India, having missed this particular historical phase, needed to find an alternate route to development and global competitiveness.

Keywords:

• China
• competitiveness
• economic reform
• foreign direct investment
• India
• production networks

Notes

 1. See Prime (2009) for a review of the literature comparing China and India in terms of economic performance.

 2. Along similar lines, G.P. Hinduja, President of the Hinduja Group, when asked about the lack of investment by expats in India stated unequivocally that the general lack of interest in manufacturing units in India by non resident Indians (NRIs) is because of bureaucratic hurdles and the lack of transparency and accountability at all levels. In addition, he noted that NRIs are not provided with the same infrastructure and network that local industrialists enjoy (http://archives.digitaltoday.in/businesstoday/netexcl/netex2106/hinduja.htm).

 3. The eight variables that are included are: rate of GDP growth, per capita GDP, share of exports in GDP, telephone lines per 1000 inhabitants, commercial energy use per capita, share of R&D expenditures in gross national income, share of tertiary students in the population, and political and commercial country risk.

 4. In order to compare these indices more systematically, a simple t-test of difference in means and a Wilcoxin test of medians of the rankings and scores of the indices were done on the data in Table 2. These results confirm that China has had statistically significant differences in inward FDI performance and potential compared to India.

 5. At least one estimate published in 2007 had India's wages a bit higher at US$1.60 per hour compared with US$1.50 in China (KPMG report cited in Note 4 in Gereffi and Guler 2010).

 6. Thursby and Thursby present results from over 200 multinational companies across 15 industries regarding the factors that influence decisions on where to conduct research and development (R&D). They note that for companies locating in emerging economies, the most important attraction was the growth potential in the market followed by the quality of R&D personnel. Poor quality of intellectual property protection was a detractor.

 7. Source: UNCTAD, 2010 based on information from OCO Consulting, LOCO monitor website (www.locomonitor.com). Note that these investments include new (greenfield) and expansion FDI projects, both announced and realized.

 8. Horizontal clusters are characterized by units which process raw materials to produce and subsequently market the finished product themselves. Vertical clusters are where the operations required in producing the finished product are carried out separately by different units, most of which are SMEs.

 9. For examples of such clusters in India, see UNIDO at http://www.unido.org/index.php?id = o4308. [Accessed on 9 November 2010].

10. In a search in the EconLit database on 22 October 2009 of journal articles since 1989 for the words ‘production networks’ in the abstract, out of the 218 items found only three had any reference to India. Most focused on China, Taiwan and East Asia generally, while a few dealt with Eastern Europe, the EU and the US. A recent book (Posthuma and Nathan 2010) deals with labour and production networks in India, but the focus is on the effect of global production networks on wages and working conditions within connected firms in India.

11. While Lo and Liu (2009) argue that without overseas Chinese investments China's FDI-GDP ratio is on average almost the same as that of India in the 1990s (Lo and Liu 2009, p. 244), there are two things to note. One is that a majority of these overseas Chinese were from Hong Kong and Taiwan, and second the data reported by Lo and Liu is post-1991. Our argument here is that that the initial flows of FDI that China received in the 1980s due to ‘location and timing’ (chance) resulted in a snowball effect leading to more FDI in the 1990s, regardless of the source of the FDI.

12. At the same time, Zheng (2009) finds the cultural variable to be insignificant when trying to explain FDI flows to China.

13. It should also be noted that the establishment of the special economic zones was a very controversial policy within the Chinese central government at the time, and objections continued until at least 1992 when Deng Xiaoping visited them for the first time and gave his public approval to the zones and the strategy behind them.