Analysis of China's Political Economy for Foreign Direct Investment

The report analyzes China's political economy from political, economic, and legal contexts to determine its attractiveness for foreign direct investment. It discusses the benefits, risks, and costs associated with China's political, economic, and legal system with reference to empirical evidence.

Running Head: GLOBALISATION
Globalisation
Name of the Student
Name of the University
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Executive Summary
Foreign Direct Investment refers to the inflow of capital from a foreign country to the domestic
country. The investment is made in such a way that it benefits both the investor and investing
country. The internal economic environment of a nation plays a crucial role in determining FDI
flows. The report has selected China to analyze its political economy from political, economic
and legal contexts. For this, proper data has been collected to critically discuss about
attractiveness for foreign direct investment to this country.

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Table of Contents
1.Introduction...................................................................................................................................3
2. Political Economic Analysis........................................................................................................3
2.1 Political System.....................................................................................................................5
2.2 Economic System..................................................................................................................5
2.3 Legal System.........................................................................................................................9
3. Recommendation:......................................................................................................................10
4. Conclusion:................................................................................................................................10
5. Reference List............................................................................................................................11

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1.Introduction
The paper aims to discuss attractiveness of China as a destination of foreign funds
outflowed from Australia. The flawless growth of China in the past last few decades holds an
important place in economic development of modern world. In the last thirty years, China has
accounted a GDP growth close to 9.5% (worldbank.org, 2018). In fact, in terms of GDP China is
now considered as the fourth largest economy in world.
There are several factors that makes the nation attractive for FDI. With its unprecedented
growth experience for a considerably long period China overtook USA as the largest recipient of
foreign fund. The existing large amount of capital can attract other countries to invest more
capital in the developing nation. China’s attractiveness towards foreign funds also rests on rapid
development infrastructure, availability of resources, productivity and skills of workers and
business value chain. Favorable regulatory environment, economic and political stability,
business environment and trade openness are other factors contributing to growing foreign
investment in China (Holmes et al., 2016).
The report analyzes political economic environment of China. The benefits, risks and cost
associated with political, economic and legal system are discussed with reference to empirical
evidences.
2. Political Economic Analysis
Political economy discusses about production and trade along with their links with
government, custom and law for a country (Frieden & Eichengreen, 2018). Moreover, this theory
discusses on distribution of wealth and national income.
China is experiencing a huge change in its political, economic and legal ground and
through these changes; each factor has helped others to become strong (Malesky & London,
2014). Thus, China has obtained huge significance in world economy by transforming and
industrializing itself to grow rapidly and extensively.
Country: China
Political Economy
Analysis
BENEFITS RISKS COSTS

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Political System  Single party
system
 Policy
stabilization
 Efficient
government to
take challenges
 Corruption
control
 Vulnerable
economy
 Insufficient
political
support for
investment
 External
shocks and
domestic
political
instability
 Limited FDI
due to political
instability
 Strong public
restriction for
foreign
companies
Economic System
(Socialist market
economy)
 Efficient resource
allocation
 Necessary
government
support.
 High growth rate
 Low wage rate
 Weak currency
 High debt
 Financial risk
due to
economic
restricting
 Ageing
population
 Shrinking
workforce
 Openness to
corruption
 Weak response
public
enterprises to
investment.
 Inefficiency of
state run
enterprises
 Growing
dependency on
government
subsidies
Legal System  most committed
system
 use negotiation to
resolve disputes
 leader tries to
maximize
 Product sell
restriction due
to legal system
 Tax are
imposed on
the U.S
 Decreasing
number of
foreign
companies
 Decreasing
number of FDI

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benefits and
effectiveness of
this legal system
companies
2.1 Political System
The political system of China takes the form of a socialist republic that a single party,
which is, the Communist Party of China, conducts (Jia, Kudamatsu & Seim, 2015). Hence, the
Communist Party, State Council and their local and provincial exercise state power within this
republic country.
Benefits:
Firstly, under the single-party system, China can formulate a long-term plan to develop
the nation and to ensure policy stabilization, where other parties cannot oppose. Secondly, the
government is highly efficient and effective to take challenges and opportunities. Thirdly, China
can control corruption during the period of social transition.
Risks: Foreign companies and economy of China are vulnerable due to external shocks, regional
political unrest and epidemics. Moreover, foreign firms conduct their business in this country
with uncertainty as politics influences investment decision.
Cost: Political instability can restrict inflow of foreign direct investment in China. Moreover,
public restriction can discourage foreign companies to conduct their business in China.
2.2 Economic System
The economic system of China is characterized as a socialist market economy. The
market economy contributes to an efficient allocation of resources. In the market economic
system there is co-existence of public and state-owned industries (china.org.cn, 2018).
Benefits
China’s shift towards a more market oriented economy resulted in an increase in China’s
GDP since 1978 (cia.gov, 2018). The benefits of China’s economic system can be seen viewed in
terms of different macroeconomic indicators.

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8.20%
39.50%
52.20%
Percentage Share Of Different Sectors in GDP
Agriculture
Industries
Service
Figure 1: Contribution of three major sector in total output
(Source: cia.gov, 2018)
39.10
%
14.60%
44.40
%
1.90%
Different Component Of GDP
Household consumption
Government expenditure
Gross Investment
Net export
Figure 2: Different component of GDP and its share
(Source: cia.gov, 2018)

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Economic growth of a nation is one important indicator that determine the flow of foreign
fund in a nation. A rising growth trend helps to build confidence of foreign investors. The figure
below indicates trends in economic growth of China.
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
Economic Growth
Year
Growth rate
Figure 3: Trend economic growth in China
(worldbank.org, 2018)
As shown from the above graph after reaching peak in 2006, China’s economic growth has
slowed down. The economic growth though has slowed down but it still higher than many
contemporary economies and therefore, keeps the nation still an attractive destination of FDI
(worldbank.org, 2018).
Prevailing wage rate is another important determinant of foreign capital flow.
Multinational companies invest in nations having a relatively low wages in order to conduct
labor intensive production operation. China is a relatively labor abundant nation which helps the
nation to maintain a relatively low wage rate (Federico, 2014). Wages in China though have been
constituted an upward trend but it is much lower in comparison to Australia.

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2011 2012 2013 2014
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$155 $176 $196 $217
$1,103 $1,137 $1,223 $1,216
Australia and China
CNY AUD
Year
Wage (in AUD)
Figure 4: Wage comparison between China and Australia
(Source: hornetgroup.com.au, 2016)
Weak exchange rate of China’s Yuan against Australian dollar is another factor that might attract
Australian capital in China.
Figure 5: Exchange rate of Australian dollar against Chinese Yuan
(rba.gov.au, 2018)

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Risks
Despite a favorable economic environment measured in terms of weak currency, low wage
and stable growth rate the economy of China runs with several risks. The global financial crisis
of 2008 interrupted the double digit growth figure of China expressing limitation of export
driven growth. The economy is facing severe financial risks owing to economic restricting
initiated by communist party (Prasad, 2016). High credit levels, ageing population leading to a
contraction of available workforce are other factors that might pose a threat to international
competitiveness of the nation.
Costs
The socialists’ market economic system though helps China to become the second largest
economy in world, the economic system is not free from its cost. In such a system, ties of
business and politics open the system towards corruption. The State run industries are not
responsive to investors, which limits private investments (Chen, 2017). This might limit
available money in the long run needed for a smooth growth. State run industries are not much
profitable or productive as they rely heavily on government subsidies.
2.3 Legal System
Legal system of China is socialist and depends on the civil law. The highest law of this
country is the Constitution of the People’s Republic of China. The court system of this country
has four levels, which are, grassroots, intermediate, higher People’s Court and Supreme People’s
court (Zhang, 2018). The country operates the largest and extensive mediation power across the
world.
Benefits: China’s legal system is one of the most committed one that use negotiation to resolve
disputes. Moreover, the leader tries to maximize benefits and effectiveness of this legal system.
Risks: Without valid registration or license, provided by the Chinese authority, producer cannot
sell product in market. The structure of the transaction determines tax liability of a U.S company
under Chinese law.
Costs: Due to restricted legal system, foreign companies may not start their business in China
and consequently FDI can decrease further.

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3. Recommendation:
To increase FDI, China can reduce its legal system for foreign companies. Moreover, the
government can focus on political stability in domestically to maintain continuous growth of the
economy.
4. Conclusion:
The report has stated about political economy of China through focusing on its political,
economic and legal system. Each section has some benefits, risks and costs related to FDI.

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5. Reference List
Chen, S. (2017). The context of social policy reform in China: theoretical, comparative and
historical perspectives. In Social Policy Reform in China (pp. 37-50). Routledge.
China sourcing in 2016 - is it worth it for the Australian market?. (2016). Retrieved from
http://hornetgroup.com.au/china-sourcing-2016-is-it-cost-effective/
Economic System. (2018). Retrieved from http://www.china.org.cn/english/features/38200.htm
Federico, S. (2014). Industry Dynamics and Competition from Low‐Wage Countries: Evidence
on Italy. Oxford Bulletin of Economics and Statistics, 76(3), 389-410.
Frieden, J. A., & Eichengreen, B. (2018). The political economy of European monetary
unification: An analytical introduction. In The political economy of European monetary
unification (pp. 1-21). Routledge.
GDP growth (annual %) | Data. (2018). Retrieved from
https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?locations=CN
Historical Data | RBA. (2018). Retrieved from https://www.rba.gov.au/statistics/historical-
data.html#exchange-rates
Holmes Jr, R. M., Li, H., Hitt, M. A., DeGhetto, K., & Sutton, T. (2016). The Effects of Location
and MNC Attributes on MNCs' Establishment of Foreign R&D Centers: Evidence from
China. Long Range Planning, 49(5), 594-613.
Jia, R., Kudamatsu, M., & Seim, D. (2015). Political selection in China: The complementary
roles of connections and performance. Journal of the European Economic
Association, 13(4), 631-668.
Malesky, E., & London, J. (2014). The political economy of development in China and
Vietnam. Annual Review of Political Science, 17, 395-419.

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Prasad, E. (2016). China’s Economy and Financial Markets: Reforms and Risks. Brookings. edu
Research US-China Economic And Security Review Commission Hearing On “China’s
13th Five-Year Plan.
The World Bank in China. (2018). Retrieved from
http://www.worldbank.org/en/country/china/overview
The World Factbook — Central Intelligence Agency. (2018). Retrieved from
https://www.cia.gov/library/publications/resources/the-world-factbook/geos/ch.html
Zhang, X. (2018). Rethinking International Legal Narrative Concerning Nineteenth Century
China: Seeking China’s Intellectual Connection to International Law. The Chinese
Journal of Global Governance, 4(1), 1-21.