Multinational enterprises, foreign direct investment and trade in China: the chain of causality in 1980-2003.

• Author: Zhang, Jianhong

ABSTRACT

Multinational enterprises (MNEs) play a dominant role in the international business (IB) literature. Traditionally, by far the majority of IB studies deal with issues at the micro level of the individual MNE, or at the meso level of a sample of individual MNEs in industries. This paper focuses on the impact of MNE behavior through foreign direct investment (FDI) on a country's international trade, and vice versa. In so doing, this study responds to a recent plea for more macro-level studies in IB into the effect of MNE behavior on the macroeconomic performance of countries as a whole, particularly developing and emerging economies. In the current study, we focus on the largest developing or emerging economy of all: China. Applying sophisticated econometric techniques, we unravel the causality and direction of FDI--trade linkages for the Chinese economy in the 1980-2003 period.

Keywords: China, FDI, Trade and Causality

INTRODUCTION

Recently, Meyer (2004) and Ramamurti (2004) convincingly argued that international business (IB) research should partially be redirected to macro-level issues so as to inform opinion and policy-makers about the role of multinational enterprises (MNEs) in the world economy, particularly by linking rich and poor economies. After all, as Meyer (2004: 259) rightly points out, IB studies can help to deepen "our understanding in how foreign direct investment (FDI) influences economic development and national welfare." The present paper is an attempt to offer such an IB-inspired contribution. Following Meyer's (2004) and Ramamurti's (2004) lead, we deal with the societal effect of FDI--i.e., on export and import--in a developing and emerging economy.

In effect, we focus on the largest developing or emerging economy of all: China. Applying sophisticated econometric techniques, we unravel the causality and direction of FDI--trade linkages for the Chinese economy in the 1980-2003 period. In so doing, we of course limit our attention to one specific potential macro-effect of FDI--as a potential determinant of the host country's export and import. Hence, our study is complementary to the majority of macro-oriented IB studies, which tend to focus on the impact of FDI on technology (productivity) spillovers (e.g., Hejazi & Safarian 1999; Liu et al. 2000; Feinberg & Majumdar 2001; Buckley et al. 2002; Chung et al. 2003). More specifically, our paper concentrates on empirically exploring an important link in a transition economy (cf. Peng & Luo 2000): the relationship between aggregated MNEs' foreign investment behavior, on the one hand, and China's pattern of international trade, on the other hand.

An important exception to this dominant attention to the issue of technology linkages is Brouthers et al. (1996). They study the impact of MNEs' FDI on the balance of payment in developed and developing countries. Their key argument is that this impact will differ with the dominant MNE motives as to why to engage in FDI in the first place. On the one hand, MNEs tend to invest in developed countries for reasons of market access, triggering increased imports. On the other hand, FDI in developing countries is likely to be predominantly motivated by a search for resource advantages, leading to increased exports. As a result, the aggregate impact of FDI on the trade balance will be negative in developed countries, but positive in developing economies. Brouthers et al. (1996) produced cross-section evidence for this logic with a wide set of countries in 1988-1991. For China, for instance, they report a positive effect of inward FDI on the trade balance.

The current study offers a threefold empirical and methodological contribution to the literature. First, following Brouthers et al.'s (1996: 369) suggestion, we study FDI--trade linkages in a longitudinal context, analyzing data for the 1980-2003 period. Second, related to this, we investigate causality issues by applying sophisticated econometric techniques--i.e., Granger-causality and cointegration approaches. Third, in so doing, we seek to deepen our understanding of a key aspect of the societal effect of MNE behavior: FDI's impact on the host country's trade.

LITERATURE

INTERNATIONAL ECONOMICS AND INTERNATIONAL BUSINESS

The mainstream in the classic theory of international trade in IE views the mobility of goods and factors as opposing forces. As part of international integration processes, trade in goods leads to the convergence of product prices, and thus of factor rewards; alternatively, migration or FDI triggers a convergence of factor rewards, and hence of product prices. This is the so-called Mundell principle. The well-known Heckscher-Ohlin-Samuelson-Mundell framework suggests that international trade of goods can substitute for international movement of factors of production, which includes FDI. Similarly, the other way around, international factor mobility, including FDI, may substitute for--and hence reduce--trade in goods. In Mundell's words, "Commodity movements are at least to some extent a substitute for factor movements ... an increase in trade impediments stimulates factor movements and ... an increase in restrictions to factor movements stimulates trade" (Mundell 1957: 320).

Vernon (1966) developed the well-established product-cycle IE model of internationalization to explain the sequence from domestic production of a new product to its export and then foreign production by investigating the US multinational companies in 1950s and early 1960s. This developmental sequence indicates that foreign production may substitute for export from the home country, even creating import of the same product in a later stage. From the perspective of a host country, conversely, FDI is replacing its imports first and increasing its exports later. From a macroeconomic point of view, Kojima (1975 & 1982) points out that the comparative advantage of industries in home and host countries is crucial in determining whether FDI is export-oriented or not. Kojima's macroeconomic approach predicts that export-oriented FDI occurs when the source country invests in those industries in which the host country has a comparative advantage.

It is beneficial for an investing country if an FDI flow goes abroad from its comparatively disadvantaged marginal industry for the purpose of producing goods in the host country at costs lower than at home through the transfer of efficient technology and management. Subsequently, in the next stage, importing the associated goods back into the home country (or exporting them to third markets) may gain prominence. Additionally, this kind of FDI benefits the host economy, since it stimulates the export of new products from the host country. Therefore, on the one hand, if an MNE invests in a host country with comparative advantages that compensate for disadvantages in the home country, then FDI will increase the host country's trade. However, on the other hand, if an FDI flow comes from an industry with a comparative advantage in the home country but a disadvantage in the host country, then this FDI tends to be a trade substitute because this investment does not fit with the host country's comparative advantage, which eventually reduces the total output and trade volume of both countries involved. In developing host countries, FDI flowing into labor-intensive industries is likely to be trade-creating, whereas FDI flowing into capital-intensive industries is likely to be trade-replacing or trade-destroying.

A related literature investigates the relation of trade and FDI in the context of development issues. Based on the conceptual framework developed by Porter (1990), Ozawa (1992) formulated a comprehensive theory describing linkages between economic development and competitiveness that create international trade and FDI. Ozawa argues that an increase in trade flows occurs as a result of improved comparative advantage, which is, in turn, influenced by FDI leading to changes in the pattern of this advantage. He offers an explanation of the causal relationships between an outward-oriented economic policy and the impact of FDI on trade by emphasizing the effects of FDI on comparative advantage and structural upgrading in manufacturing. In this line of argument, FDI and international trade are not only increasingly complementary and mutually supportive, but also increasingly inseparable as two sides of the process of economic globalization (Ruggiero 1996). Furthermore, inward FDI may stimulate exports from domestic sectors through industrial linkage or spillover effects, especially through backward linkages, buying local-made intermediate inputs to produce exports (O hUallachain 1984). This effect creates a strong demand stimulus for domestic enterprises, and promotes exports.

The IB literature adds to the traditional IE perspective by opening up the black box of the MNE. For instance, the IB literature emphasizes the role of the motives underlying MNE behavior, in particular FDI strategies. With a different motivation, FDI has a different effect on trade. Motivations can be classified into three general categories: market-seeking and factor-seeking (Root 1977 & 1994), as well as innovation-seeking (Dunning 1992). Market-seeking FDI follows demand, penetrating foreign markets with a promising sales potential. Market-seeking FDI may have a negative impact on the host country's trade balance, since "the affiliates of foreign firms (in the US) do show an apparent tendency to export somewhat less and import significantly more than US firms--indeed over two and a quarter times as much" (Graham & Krugman 1989: 67). Factor-seeking FDI includes MNE behavior aimed at gaining access to raw materials and low-cost locations. FDI motivated by the quest for raw materials is used to produce goods with natural resources that are lacking or under-supplied in the home country. In general, this type of FDI increases exports from the host...