In early June, hoping to ease growing trade tensions with the European Union, China agreed to place voluntary limits on the growth of its textile and apparel exports to Europe. The decision came hours before the EU was set to impose its own trade restrictions on China. A few days later, deep misgivings about China's rising economic and political clout fueled a fierce debate over a major Chinese oil company's bid to buy U.S. producer Unocal. Topping Chevron's original offer of $16.8 billion, the $18.5 billion bid from the government-controlled China National Offshore Oil Corporation (CNOOC) came under fire from U.S. lawmakers. These two incidents highlight the new economic reality: China is no longer just a destination for foreign direct investment (FDI)--it is the home for Asia's new multinationals.

Bamboo Networks to SEZs

Since the 1500s, southern China has been a springboard for emigrants to Vietnam, Thailand, Indonesia and elsewhere in Southeast Asia. These overseas Chinese have developed an informal "bamboo network" that transcends national boundaries and extends throughout the region, where entrepreneurs, business executives, traders and financiers of Chinese descent are major players in local economies.¹ Today, the array of complementary business relationships comprises more than fifty million ethnic Chinese, who control many of Asia's largest public companies and who have contributed to the rise of China's new multinationals.

When, a century ago, the first wave of globalization swept across the developed economies of western Europe and North America, East Asia enjoyed a boom of its own. Chinese capitalists launched operations outside China while investing in their home country.

After 1949 the People's Republic of China opted for a command economy inspired by the Soviet model. Despite rapid growth, productivity was dismal. The civil war and the communist rule that followed led to massive capital outflows to neighboring Hong Kong, Taiwan and Southeast Asia. Chinese "emigrant entrepreneurs" played a critical role in the industrialization of Hong Kong, contributing to the significance of the city as a global textiles and garment hub.² With the Cold War, capital outflows from China were replaced by two-way flows between Hong Kong and Southeast Asia. Postwar globalization arrived in mainland China only after the failures of the initial national modernization efforts (the Great Leap Forward in the 1950s and the Cultural Revolution in the late 1960s), which contributed to famine, devastation and dissension.

In January 1975 Deng Xiaoping and Zhou Enlai drafted the "Four Modernizations", calling for modernization in agriculture, industry, science and technology, and national defense. The transition from import substitution to export orientation led to China's "reform and opening." Following the successful reforms of the agricultural sector, Deng moved on to the next stage of China's modernization, industrial reform, in 1984. The government established Special Economic Zones (SEZs) close to Hong Kong and then opened the coastal provinces and major cities to overseas capital. The reformers saw the bamboo network of the overseas Chinese in the south as an asset through which the SEZs could be integrated with Hong Kong, Macao and Taiwan, as well as the rest of the world. Still, overall annual FDI averaged only around $1 billion.

Chinese FDI abroad started even more modestly. In 1979 a chosen few companies began to invest overseas, typically on the basis of existing overseas trade linkages. A third of overseas operations were located in Hong Kong and Macao, another third in the United States, Japan and Thailand. The first multinational was a Beijing restaurant in Tokyo, a joint venture of a Chinese and a Japanese company. Despite significant expansion in overseas investment, by 1985 only 143 Chinese enterprises had made the jump, investing $170 million in 45 countries (less than 3 percent of China's total inflow of FDI). These businesses were mostly in low-tech services, such as Chinese restaurants, located in the major cities or Chinatowns of countries like the United States, Japan and Thailand. Investment in other service sectors, such as construction and shipping, was located primarily in Hong Kong and Macao.

High-Tech Zones and Natural Resources

With the initiation of industrial modernization in the coastal provinces, Chinese reformers also began to pay increasing attention to the modernization of science and technology, the third priority of the modernization program. The development of high-tech industries was seen as vital for boosting FDI inflows and attracting foreign multinationals. If the idea for the SEZs came mainly from other East Asian export processing zones and free trade zones, the model for the high-tech zones originated in Silicon Valley.

China's high-tech development program was initiated in 1986, when the State Council called together more than 120 senior Chinese scientists to draft China's strategic high-technology plan. To implement the plan, the State Science and Technology (S & T) Commission designed the Torch Program, which aimed at the commercialization, industrialization and internationalization of "high and new technology." One of the program's key components was to establish Science and Technology Industrial Parks and innovation centers. Meanwhile, the program also became responsible for the "high and new technology industrial development zones" (HNTIDZs) focusing on a dozen strategic industries, including microelectronics, aerospace, biotechnology and, more recently, information technology. Concurrently, the government took steps to improve the investment environment, which triggered another phase of FDI, with annual inflows exceeding $3 billion.

These measures were mirrored by the Chinese government's bolder steps toward outward investment. In the latter half of the 1980s, 620 new Chinese businesses invested more than $860 million in over ninety countries. Instead of restaurants, natural resource development projects, along with assembly and transport, dominated Chinese overseas investments. Large, state-owned enterprises, including trust, steel and chemical giants, joined in. Of the newly established overseas firms, 50 percent were in Asia and 18 percent were in Africa. However, it was the developed countries that attracted the attention of Chinese investors, with Australia targeted as the single most important host country for natural resource development projects. But though the growth rate of Chinese FDI was almost 50 percent greater than the growth rate of multinationals worldwide, Chinese FDI accounted for only 0.1 percent of the global total.

The tumultuous early years of reform contributed to inflationary pressures, unrest and, ultimately, the Tiananmen events. The momentum was recaptured only in 1992. Following his tour of the southern coastal provinces, Deng was now calling for "faster, better, deeper" economic growth.

Enter the Global Giants

As the Chinese government introduced market-oriented reforms to again attract U.S. and other investors, capital inflows accelerated dramatically. Initially, this FDI phase led to the geographical expansion of Chinese firms from Hong Kong, Taiwan and Southeast Asia. Now China also showed up on the radar screens of U.S. corporations. After Deng's southern tour, U.S. investment flows to China grew more than fivefold to $556 million in 1993. Over the latter half of the decade, U.S. capital flows to China averaged $1.1 billion annually.

Through foreign multinationals--the so-called foreign-invested enterprises (FIEs)--FDI played a critical role not just in China's economic reforms and opening, but in the rise of Chinese multinationals. Until the late 1980s only 2 percent of the foreign multinationals in China were regarded as technologically advanced, and enterprises using advanced technology made up just 5 percent of total FDI in China. After the mid-1990s the FIEs replaced the small- and medium-sized enterprises of the overseas Chinese as major investors. Capital inflows soared from $11 billion in 1992 to $50 billion in 1999.

Located in the United States, western Europe and Japan, the FIEs are global giants, owned by institutional investors, engaged in worldwide operations and excelling in high-tech industries. Accounting for only 10 percent of total national industrial assets in 2000, they provided more than 27 percent of the gross industrial output value, 24 percent of the total value added and 29 percent of the total industrial profits. At the end of the growth years in 2001, more than 400 of the world's top 500 manufacturing companies had invested in China. The FIEs accounted for an estimated one fifth of the GDP growth. In particular, the rapid export growth of China resulted from the dramatic expansion of FIE exports as a percentage of national total exports--from less than 16 percent in the early 1990s to more than 50 percent in the early 2000s.

For more than two decades, China has been the most attractive FDI host among all developing countries. China's accession to the World Trade Organization and selection to host the 2008 Olympics has accelerated investment initiatives. In 2004 the capital inflows amounted to $60 billion. Still, these large absolute numbers must be put into perspective. Like the United States, China is actually a small recipient of FDI relative to its GDP, ranking 37th worldwide.

In the early 1990s the Chinese government encouraged manufacturing enterprises to deploy the so-called "two resources and two markets" strategy to target both domestic and international markets, while seeking resources (capital, know-how, raw materials) domestically and globally. The sectoral distribution of Chinese investment abroad shifted from resource development (more than 60 percent in 1991, 32 percent in 1997) to manufacturing (39 percent in 1997). Initially, this was the result of the government focus on several mature manufacturing sectors to establish overseas operations, particularly industrial machinery and electronics. Today, increasing competition maintains market discipline.

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