Rethinking Chinese FDI Round-Tripping

Last night, I started reading Yasheng Huang's Capitalism with Chinese Characteristics. Later, I'll post a real review, but for now here's an excerpt from a short review by Tyler Cowen which I agree with:

This very serious work reexamines the role of the state in the Chinese economy.
. . .
I do not have the detailed knowledge to evaluate all of these claims but in each case the author offers serious evidence and arguments. This book does not make for light reading (though it is clearly written), but it is quite possibly the most important economics so far this year.

The the evidence in the book is causing me to rethink issues that have arisen in past posts. The first is in regards to a post I did on a report by the US Small Business Administration which argued that ~50% of the $319.4 billion discrepancy between the values reported by China and her trade partners was due to the round-tripping of currency through Hong Kong to take advantage of Hong Kong's de facto tax haven status. Huang's case study of Lenovo has opened my eyes to the most powerful purpose for round-tripping money from China to Hong Kong and back into China as FDI: to take advantage of the more liberal Chinese laws and regulations afforded to foreign invested enterprises (FIEs).

Here is a condensed timeline of Huang's history of Lenovo:

• 1984 - Lenovo China is founded in Beijing with RMB 200,000 loan from Chinese Academy of Sciences
• 1988 - Lenovo China received HK$900,000 to invest in a JV in Hong Kong
• 1993 - Hong Kong Lenovo raises US$12 million in IPO Hong Kong Stock Exchange, and reinvests this in China operations
• Lenovo (Beijing) and Lenovo (Shanghai) become wholly owned foreign-invested enterprises by Hong Kong Lenovo
• By the end of 1997, every single one of Hong Kong Lenovo's Chinese subsidiaries was either a wholly foreign owned entity or a foreign JV

By off-shoring corporate ownership, Lenovo could operate in China as a foreign company which offered it three major advantages over domestic enterprises: 1) access to foreign capital markets; 2) substantial tax incentives; and 3) "highly biased" liberalized policy incentives. Conceptualizing the benefits of access to foreign capital markets and substantial tax incentives is easy. Conceptualizing the policy incentives afforded to Lenovo as an FIE can be simplified to a single point: as a domestically registered company Lenovo China "was denied a production license in computer manufacturing in China," and a production license was only granted to Lenovo after it had become an FIE.

Huang begins his book with the case study of Lenovo in order to show his readers that:

the Chinese economy is so complicated that what appears to be straightforward and obvious on the surface is not at all so once we dig into the details.

The purpose of round-tripping is no exception. To show just how pervasive FDI round-tripping to take advantage of incentives offered to foreign firms is, Huang uses INSEAD professor Donald Sull's book, Made in China: What Western Managers Can Learn from Trailbralzing Chinese Entrepreneurs. Professor Sull's book uses case studies of eight companies, Lenovo, Sina, UTStarcom, AsiaInfo, Haier, Galanz, Wahaha, and Ting Hsin, as "proof positive of China's fertile entrepreneurial environment and rising competiveness." These eight companies have something in common, but it is not that they are Chinese. No. Seven are registered as foreign firms in China, and one, Haier, has all of its main business and production units registered as FIEs in China. Huang's conclusion:

corporate success in China requires a combination of Chinese management and foreign legal status.

Huang is a master at highlighting complexity. I'm amazed.