Determinants of Location for Foreign-Owned and Exporting Firms in China

The perfect location is a vital component in the success of a business. The right location gives a company access to transport, labour, customers and raw materials. It is a critical element in a company’s setup plan which should be part of its whole corporate strategy. While market size is an important consideration for firms, the higher number of firms in large markets bids up the cost of immobile factors. The relative strength of these factors in determining location depends critically on trade costs. The view that both market size and access to intermediate inputs affect foreign investors’ decisions is supported by anecdotal evidence (Cheng, Leonard and Kwan, p. 380).

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We consider the importance of market and supplier access in determining foreign entry, taking into account spatial aspects. We allow for the possibility that firms purchase inputs not only from within their own province, but also from other provinces within China and from the rest of the world. Our measures of market and supplier access take into account the varying degrees of interindustry linkages (Caves, p. 22). We are able to provide an assessment of the relative importance of production costs and market size effects in attracting new entry. China is a particularly interesting country in which to analyze FDI flows. Rising inequality between Chinese provinces has been of growing concern to the Chinese government which has introduced a number of policies aimed at mitigating this development (Dean, Lovely and Hua, p. 42). With over 90 percent of foreign investment being directed to the coastal regions, the influx of FDI has widened regional disparities between coastal and central regions within China. By providing an assessment of the importance of market access and supplier access relative to production costs, we provide some guidance on the kinds of policy instruments that would be most successful in attracting FDI to disadvantaged regions (Du, p. 45).

There exists evidence suggesting that in an effort to protect industries from competition, local governments in China are erecting barriers to entry of goods from other provinces. The presence of such barriers is consistent with anecdotal evidence. Access to customers and suppliers of intermediate inputs are key determinants of FDI inflows. It is also important take into account linkages to neighbouring regions. After allowing for such linkages, the effects of market and supplier access increase significantly (Keith and Ries, p. 48). The presence of customers and suppliers in the province of entry matters much more to a firm than market and supplier access to the rest of China (Bai, Du and Tong, p. 402). This may be due to the underdeveloped transport infrastructure and informal barriers to trade and is consistent with the fragmentation of the Chinese market. Availability of infrastructure, such as rail lines, is positively correlated with foreign entry, whereas high tariffs on imported inputs deter entry (Brennan and Luo, p. 17).

Provinces which are more open to foreign trade attract more foreign firms. Barriers to trade whether in the form on tariffs on imported inputs, informal barriers to inter-provincial trade or underdeveloped infrastructure play a significant role in the location decisions of foreign investors. The arrival of foreign direct investment in a city will stimulate entry by local specialized suppliers (Desai Foley and Hines, p. 35). Growth of this upstream sector in turn makes a city more attractive to subsequent foreign investors. Dynamic simulations illustrate an important corollary: agglomeration effects magnify the impact of local incentives considerably. Early recipients of incentive zone status attracted 30% more investment than they would have in an incentive-free environment. Absent agglomeration effects, the gains attributable to incentives decline to 13% (Lin, p. 30).

The efficacy of programs designed to attract FDI constitutes only one element of the analysis of their welfare consequences. In addition, one would need to calculate the benefits to local citizens associated with each foreign investment and the costs in terms of foregone tax revenues. Productivity growth rates in cities are positively related to the level of foreign direct investment (Keith and Mayer 965). The relationships between local residential land rents, industry productivity, local industry employment shares, and local employment diversity are different when firms in an industry are most interested in proximity to specialized inputs, proximity to their customers, or proximity to other firms that can generate beneficial spillovers (Amiti, p. 821). When it comes to exporting firms, especially those in industries such as textile, paper, petroleum and coal, proximity to industry-specific inputs is of primary importance when deciding where to locate (Lin and Wei, p. 46). Exporting firms in these industries prefer to locate in places where people are employed in a wide variety of different industries, so they will benefit from positive externalities. Exporting firms put equal weight on locating close to inputs and on locating in diverse places. Changing government policies, such as environmental regulations, tariffs, taxes and subsidies, trade agreements, and labour standards also affect the location decisions (Zigang, p. 21).

Local protection is a strong factor discouraging entry of foreign firms into China by hindering their access to local producers of intermediate inputs located in other provinces or by restricting their ability to sell their products in neighbouring provinces or in other parts of China. Access to international markets is an important factor in entry decisions. Provinces that have good access to sea and river berths and are open to international trade attract more foreign entry (Liu, p. 99). Dismantling inter-provincial barriers will increase market and supplier access for both Chinese and foreign producers, attracting entry of new firms and allowing provinces to follow their comparative advantage in the production structure. China as a source of low cost labour and with an attractive, rapidly growing domestic market represents growth for many companies. The fact that the coastal regions especially those in close proximity to Hong Kong and with historic ties to the West and Taiwan also have sophisticated financial systems and capital markets, also make China a prime location (OECD, p. 24).

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When it comes to exporting firms in China, the advantage of one location over another is based upon natural and human resources, the price, quality and productivity of inputs. There are also the international transports and communication costs, investment favour or discrimination besides the artificial barriers to trade. The fundamental facilities, cross-national values, language and culture are other factors. Finally, commercial practice and politics, research and development, the concentration of production and sales, economic system and political strategy and resource allocation systems are among the advantages deciding on a location (Wignaraja, p. 34).

The market size or the Gross Domestic Product directly affects the expected revenue of an exporting firm. In fact, one major motivation for exporting firms is to look for new markets. The larger the market size of a particular region, the more a firm will export to it given other things remains constant. The level of agglomeration in China is positively related to the determinant location of foreign firms (Girma and Yundan, p. 26). Labour quality has a positive impact on location of exporting firms in China. It is found that there is a relationship between wage or labour cost and the presence of exporting firms in China. The higher the labour costs in a certain province the lower the number of exporting firms (García-Herrero and Siu, p. 23).

A significant relationship exists between the degrees of openness as defined by the percentage of state owned enterprises and foreign investment. We use the share of state-owned enterprises in a region to measure its degree of openness and progress of reform. The more state owned enterprises there are shows that the region is not open to foreign investment and the government may have imposed strict regulation against foreign investment (Taylaor, p. 10). It may also indicate that either the government wants other governments to invest and not private firms. Some of the regulations that China may impose on foreign direct investment may encourage investment by other governments rather than private investors For example if there is a high initial cost this may be a deterrent to private investors but not to other governments which are not limited by finances. Some provinces in china may not be open to reform and may not have important investment facilities such as capital markets and sophisticated financial systems which may also discourage foreign investment by private investors but other governments may not be deterred (Wei, p. 78).

Works cited

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  2. Bai, Chong-En, Du Yingjuan, and Tong Sarah Y. “Local Protection and Regional Specialization: Evidence from China’s Industries,” Journal of International Economics 63 (2004): 397–417.
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  4. Caves, Richard E. Multinational Enterprise and Economic Analysis. 9(2007): 17-26
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  13. Lin, Huang and Wei Shang-Jin, “One China, Many Kingdoms? Using Individual Product Prices to Understand Local Protectionism in China.” (2002): 41-46.
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