The impact of the Chinese engagement in southern Africa with a country focus on Nigeria

Master's Thesis , 2010 , 153 Pages , Grade: 1,0

African Studies - Culture and Applied Geography

In the present 21st century the global distribution of power among countries seems to be changing. While since World War I predominantly the United States of America have begun to gain worldwide importance especially politically and economically, it is currently experiencing a slow loss of power due to a number of reasons. One of such is the development in Asia towards economic liberalization and linked with it the rise of China. In particular after the death of Mao Zedong in 1976, the Asian country has introduced several reforms under its new political leader Deng Xiaoping that led to ongoing fast economic growth until today. Together with the increasing economic strength China aims for more international influence and recognition as a world power. A demonstration of such claim could be seen in the media on October 1st 2009 when China was celebrating the 60th anniversary of the finding of its People’s Republic in the form of the biggest military parade ever.
In order to turn this signal of a new global distribution of power into reality, China can not solely rely on a strong economy but needs to establish international political ties too. One reason concerns the geological structure of the largest Asian country because it can be considered to be poor in natural resources. As a result it needs to secure its economy by importing those and hence in the search for international partners it decided to focus also on the African continent.
While in the beginning of the 20th century the European hegemony was unbowed in Africa and no country could withstand the traded goods from Europe this development changed drastically just six decades later. The former European dominance on the African continent yielded a rise in influence from other countries like China and India. Or more generally in the words of a Financial Times reporter: “Europe was the past, the US is the present and a China-dominated Asia the future of the global economy.” If this quotation will come true remains to be seen, but China is certainly working towards that goal and among other things the (re)establishment of close relations with many African states is one part of the current governmental strategy.
The following master thesis shall be devoted to the phenomenon of China’s return to the African continent since the mid 1990’s. The research question which shall be answered at the end is “what is the impact of China’s engagement in Sub-Saharan Africa with a country focus.

Table of contents

1 Introduction
1.1 Research methodology

2 Literature survey
2.1 Trade theories - Reasons pro trade
2.1.1 Adam Smith - Absolute advantage
2.1.2 Ricardo - Comparative advantage
2.1.3 Heckscher - Ohlin theory
2.1.4 Krugman - New trade theory
2.1.5 Porter’s diamond
2.2 Investment theories
2.2.1 Product life cycle theory
2.2.2 Oligopolistic reaction theory
2.2.3 O-L-I paradigm
2.2.4 Overview of study results about FDI
2.2.5 Theoretical gain through FDI

3 China’s early reach out to Africa
3.1 Beginning of the Sino African relations
3.2 Sino - African relations from 1949 - 1989
3.2.1. Chinese Diplomacy serving ideological aims
3.2.2. Chinese Diplomacy serving political aims
3.2.3. Setback in Chinese struggle for Africa in the late 1960’s and the revival in the 1970’s
3.2.4. Begin of a new political era after Mao Zedong’s death
3.2.5. Tiananmen and its impact on the Sino African relationship
3.3 Development aid as a political instrument from 1950’s - 1990’s

4 China and it’s return to Africa
4.1 Overview of the Asian giant
4.2 Impression of Africa’s macro environment
4.3 China’s political cooperation with Africa
4.4 China’s developmental cooperation with Africa
4.4.1 China’s position in the international aid system
4.4.2 Different types of development aid and its amplitude
4.4.3 Is China stimulating “bad governance” in Africa?
4.5 China’s economical cooperation with Africa
4.5.1 Trade with Africa
4.5.2 Financing and investing practices in Africa
4.5.3 Migration into Africa

5 China’s influence in Nigeria
5.1 Country profile of Nigeria
5.2 China’s political relations with Nigeria
5.3 China’s development aid relations with Nigeria
5.4 China’s economic relations with Nigeria
5.4.1 Trade with Nigeria
5.4.2 Financing and investment practices in Nigeria
5.4.3 Migration into Nigeria
5.5 Analysis of primary research results

6 Evaluation of China’s presence in southern Africa
6.1 Analysis of the Sino-African relationship
6.2 Recommendations

7 Conclusion

8 List of literature

List of Illustrations

Illustration 1: Absolute advantage and the benefit from trade

Illustration 2: Comparative advantage and the benefit from trade

Illustration 3: Porter’s diamond

Illustration 4: Product life cycle stages

Illustration 5: O-L-I paradigm

Illustration 6: GDP PPP growth rate, 2005 - 2030

Illustration 7: African corruption perception index 2009

Illustration 8: Maternal mortality ratio per 100.000 live births

Illustration 9: Global HIV estimates, 1990 - 2008

Illustration 10: National income and natural resources of African countries

Illustration 11: Chinese foreign aid by year and region, in $ million

Illustration 12: Chinese foreign aid by funding source, average of 2003 - 2007

Illustration 13: Chinese foreign aid by type and region in $ million, 2003 - 2007

Illustration 14: ODA commitments of major donors, 2007

Illustration 15: Chinese GDP development in %, 1990 - 2009

Illustration 16: Chinese balance of trade development from 1990 - 2006, in $ billion

Illustration 17: Top ten oil net importers in million barrels a day, 2008

Illustration 18: Chinese - African trade volume in $ billion, 1989-2008

Illustration 19: Job losses in the textile industry, 2004-2005

Illustration 20: Comparative cost of a garden furniture in southern Africa and China

Illustration 21: FDI inflow into Africa, in % of the global share, 1995-2006

Illustration 22: Top 6 Sub-Saharan countries, receiving Chinese FDI in %, 2006

Illustration 23: Approved Chinese FDI flow to the African continent, in $ million

Illustration 24: Nations share of natural resource commitments in relation to countries receiving most monetary infrastructural support, 2001-2007

Illustration 25: Map of Nigeria

Illustration 26: Nigerian GDP growth rate in %, 2003-2010 (2010 estimated)

Illustration 27: Inflation development in Nigeria in %, 2003-2009

Illustration 28: Chinese development aid by type in Africa, 2002 -2007

Illustration 29: China’s top 5 global exporting regions by value in 1999 and in 2008

Illustration 30: Relative increase of the Chinese export value to selected regions, 1999-2008

Illustration 31: Sino Nigerian total trade development in $ million, 1999-2008

Illustration 32: Africa’s top 5 global exporting regions by value in 1999 and in 2008

Illustration 33: Trade export development of African countries with China, 1999-2008

Illustration 34: Overview of a country’s share of total African exports, 1999-2008

Illustration 35: Share of Nigerian FDI inflow compared to Sub-Saharan Africa, 1970- 2008

Illustration 36: Professional background of interviewees

Illustration 37: Perception about the Chinese presence in Nigeria

Illustration 38: Perception about more engagement of the EU, the US, China or other countries in Nigeria and Africa in general

1 Introduction

In the present 21st century the global distribution of power among countries seems to be changing. While since World War I predominantly the United States of America have begun to gain worldwide importance especially politically and economically, it is currently experiencing a slow loss of power due to a number of reasons. One of such is the development in Asia towards economic liberalization and linked with it the rise of China. In particular after the death of Mao Zedong in 1976, the Asian country has introduced several reforms under its new political leader Deng Xiaoping that led to ongoing fast economic growth until today.¹ Together with the increasing economic strength China aims for more international influence and recognition as a world power. A demonstration of such claim could be seen in the media on October 1st 2009 when China was celebrating the 60th anniversary of the finding of its People’s Republic in the form of the biggest military parade ever.

In order to turn this signal of a new global distribution of power into reality, China can not solely rely on a strong economy but needs to establish international political ties too. One reason concerns the geological structure of the largest Asian country because it can be considered to be poor in natural resources. As a result it needs to secure its economy by importing those and hence in the search for international partners it decided to focus also on the African continent.

While in the beginning of the 20th century the European hegemony was unbowed in Africa and no country could withstand the traded goods from Europe this development changed drastically just six decades later. The former European dominance on the African continent yielded a rise in influence from other countries like China and India. Or more generally in the words of a Financial Times reporter: “Europe was the past, the US is the present and a China-dominated Asia the future of the global economy.”² If this quotation will come true remains to be seen, but China is certainly working towards that goal and among other things the (re)establishment of close relations with many African states is one part of the current governmental strategy.

The following master thesis shall be devoted to the phenomenon of China’s return to the African continent since the mid 1990’s. The research question which shall be answered at the end is “what is the impact of China’s engagement in Sub-Saharan Africa with a country focus on Nigeria?”. For evaluating this central issue the author is going to look specifically at three research objectives. The analysis of China’s motives for being active in Africa from a political, development aid plus economical perspective will provide sufficient information for a holistic respond to the key question. For an adequate structural approach the following paper will be divided into five main parts.

The first main part is to provide the reader an overview of different trade and investment theories from economists like Smith, Ricardo, Heckscher-Ohlin, Krugman, Porter, Vernon and Dunning. This presentation of theoretical models shall be the academic basis for this thesis. In chapter three the beginning of the Chinese African relationship will be highlighted. The author will start off with mentioning when both cultures had their first contact that is conveyed to the point when China started a serious initiative to seek for alliances from the 1950⁝ڳ and onward. This part will serve as an access to the topic and will show what the earlier Chinese motives were.

The fourth section will address the return of the Chinese to Africa from the mid 1990’s on and in particular what the reasons for this anew engagement were and still are. At this stage potential differences to section three will be pointed out because it will be interesting to see what circumstances affected the Chinese foreign policy decisions in both periods with respect to Africa. In chapter five it will be the goal to reveal a close up view of the Sino-Nigerian relationship. Starting with a country profile of Nigeria, over the Chinese political, development aid as well as economical relations with the most populous African country, the author will finally emphasize the results of primary research conducted in form of a survey.

The last greater chapter is a very essential one and will give attention to the impact of the Chinese presence in Sub-Saharan Africa. The author will try to answer the question whether the Chinese activities on the continent are beneficial for the majority of the population or if such are just another form of neocolonialism that is adjuvant only for a small number of chosen people. The country evaluation together with a broader analysis based on the information from part four shall serve as representative enough to deliver a judgment whether the opportunities outbalance the threats or vice versa. Derived from those, possible recommendations to help revitalize African economies with respect to the Chinese influence will be pointed out.

Taking the current topic under study the added value of the following final thesis for the author plus additionally for the reader is to receive comprehensive, up to date information about why and how the Chinese government is reaching out for Africa. The answer to this double-barreled question is one of world political format, hence as an international master student it is first of all personal interest plus it fits perfectly in the context of the international masters program.

1.1 Research methodology

With reference to the old proverb “Well begun is half done”, it is essential to think about the research approach and the method at the beginning of the thesis. Since there are a variety of strategies available the selection depends on parameters like the type of research question, the overall objective, the available amount of time and other resources as money for instance. Beyond, there are two main approaches of reasoning in research, the deductive and inductive method. By applying the former one the researcher is moving from general observations to more specific ones whereas the base of the inductive technique are particular observations on a small scale that if a pattern can be found would lead to broader generalizations or the formulation of a theory. Informally speaking one could call the deductive method a “top-down” approach while its counterpart process is a “bottom-up” one.

Some of the available research methods are experiments, action research, grounded theory, ethnography, archival research, surveys or case studies.³ With each of these, potential researchers pursue different intentions. The aim is now to highlight the main characteristics in order to find the appropriate strategy which helps to answer the research question of “what is the impact of China’s engagement in Sub-Saharan Africa with a country focus on Nigeria?”. For this key task it shall once again be emphasized that the analysis of why China is focusing on Africa particularly from a political, development aid plus economical view or in other words the examination of the three research objectives is indispensable.

The first form of research concerns the experiment. This type is often used in natural science but as well in social science and psychology. The primary aim of it is to study cause-and-effect relationships, meaning whether the change of one variable evokes a change of another one. Often two groups of people are chosen and while in one group a certain event causes a specific action it shall be explored if in the second group despite the absence of the same event from group one the same specific action is still going to occur. People investigating issues with experiments usually need to find answers to research questions beginning with “why” and “how”. Usually experiments can involve deductive as well as inductive reasoning plus are executed with a small number of samples which are often on top atypical. Since this circumvents adequate validity only via the investment of money a representative sample size can be achieved. Another problem is that experiments are conducted in controlled settings which do not necessarily reflect reality.

A different technique is the action research which is repeatedly utilized to search for improvements of quality of an organization including its performance. The dissimilarity and the strength at the same time to other research methods is the focus on action to promote change hence “how” questions shall be mainly answered here. It is a time consuming research. There are four steps involved, namely diagnosing, planning, taking action and evaluating and after the execution of these the same procedure will be repeated again until no more change processes can be detected. Apart from that the individual enforcing the study is part of this action and this is beneficial as people creating change also better accept them.

A strong inductive approach is the grounded theory. Here, a theoretical framework will be formed via observations. The first data gathered will be used for predictions which will be tested in additional observations and finally can be either confirmed or not. This procedure will be maintained until generalizations or in other words until a theory can be expressed.

Ethnography is a further inductive method and has its roots in anthropology. The goal is that the researcher puts himself into the position of the research subjects and tries to comprehend their social world. This strategy is time consuming plus the investigation process needs to be flexible in order to be able to adapt to a change of observable patterns. Ethnography is a naturalistic approach which means that most data will be deduced from extended observations. Nowadays this type of research is also accepted in the field of business since it provides an understanding of processes from the perspective of those involved.

Moreover, investigators can use the archival method too which is based on administrative documents. Such can be of recent or historic format. The challenge here is to formulate the correct research question because even if access to administrative data exists these may not provide the needed information. Therefore, at the beginning it is advisable to evaluate the resources available and only then state the research question.

The second last type of exploring a topic refers to the use of surveys. It is a popular deductive strategy in the area of business and provides answers to “who”, “where”, “how much”, “how many” and “what” questions. Descriptive as well as exploratory surveys allow the collection of data from a large sample size in a fairly low priced way. The information is standardized and often has a quantitative focus. Besides, a survey is easy to explain and to understand as well dependant on the scope the analysis might be time consuming. Two negative aspects correspond to the limited amount of questions that can be asked plus the chance to create a poor opinion poll.

Finally the case study method shall be mentioned here. The renowned case study researcher Yin defines the scheme as “…an empirical inquiry that investigates a contemporary phenomenon within its real-life context, especially when the boundaries between phenomenon and context are not clearly evident.”⁴ This strategy is completely different to an experiment where research is being done in a controlled setting. The advantage of such method is that the researcher will obtain a holistic view on specific phenomenon inclusive detailed information rich in content hence it is the opposite of just receiving numerical data, as for instance often in surveys. It can help to extend or verify knowledge that has been discovered through other types of research earlier. Typical research questions that can be answered in this context begin with “why”, “what” or “how”. Generally it is also possible to combine several data collection formats. Critics may highlight that case study research may due to the limited scope not be suitable for generalizations or validation of theories.

Now, after underlining some of the research methods the most appropriate format to use in this dissertation seems to be the case study strategy. This is due to a few reasons. First of all, the author has chosen the deductive process because the procedure for exploring the impact of the Chinese engagement in Sub-Saharan Africa will be to go from the broad perspective down to the narrow one, when outlining the effects on a national basis. In other words, the conclusion will be deduced from theory to an observation which can confirm the theory or not. Within that context some methods already dropped out since they use the inductive approach.

The research question will as well start with a “what” which narrows the options down to the survey and case study technique. Apart from that the advantages of the latter one are predominant for this project. The goal for the primary research part is to provide some personal experiences from a small group of Nigerian people therefore the focus will lie on qualitative instead of quantitative information. This will happen via a questionnaire since the scope and number of questions is straightforward. Besides, a questionnaire will give the interviewees the chance to complete it in a flexible time frame. Finally, the argument that a case study is not applicable for theory validations is not relevant here since this aspect shall not be the mission of the dissertation anyway. Instead of wanting to reliably prove or disapprove a theory the main goal here is to enhance secondary research with actual experience.

After the determination of using the case study method the question is how to proceed successfully in conducting the research. Three prominent case study researchers, namely Helen Simons, Robert E. Stake as well as Robert K. Yin addressed this structural procedure and based on their work six steps can be identified which are being customized for this work.

First of all, the research question needs to be defined. For this final project this will be “what is the impact of China’s engagement in Sub-Saharan Africa with a country focus on Nigeria?” This question represents the research focus and has been chosen since it is in the interest of the author to find an answer to it plus it is researchable. In a literature review the author noted that there are some writers touching the Chinese presence in southern Africa from different angles but only fragmented information about the Chinese impact in the specific country of Nigeria could be found. The primary goal of the research is to develop an understanding for what is currently happening in Africa with respect to the Chinese. For more than fifteen years now the Asian country is again very active on the African continent and the question is why and more importantly what are the effects of such presence for the African people who are the research objects. In order to find answers to the research question there are three research objectives that have to be analyzed. The first one is linked to the Chinese political motives for cooperating with Africa. Why is China reaching out for Africa from a political perspective and what are the effects for the southern continent? Moreover, the second objective is to evaluate the reason(s) for the Chinese willingness to provide development aid to Africa including a focus of the impact of such action. Also essential to clarify is the question why is China economically engaged in Africa with reference to FDI, trade and migration? The evaluation of all three research levels combined will eventually lead to a holistic analysis of China’s impact in Sub-Saharan Africa and in particular in Nigeria.

In a second phase it is important to define what type of case study, what data gathering and analysis technique shall be used. There is a variety of authors having different approaches. For instance, the academic writer Yin underlines that based on a 2x3 matrix there are six different identifiable types of case studies in research, namely either single or multiple case studies plus there is a distinction between exploratory, descriptive and explanatory ones.⁵ Since this classification seems to be reasonable it shall be applied here. Therefore, in this paper the author is going to use the single descriptive one because it matches best with the aim to describe the real life experiences of Nigerian citizens or people having Nigeria related experiences with the Chinese. Important to note is that the research question beginning with “what” more or less automatically stands for the appliance of the descriptive approach.

Concerning the data to be gathered, it needs to be generally stated that there are several ways of how to receive information, like literature search, interviews, observations, mail/email/online surveys etc. For the purpose of this project the author will mainly concentrate on secondary literature (books, articles etc.) but to get firsthand experience primary research in the form of a questionnaire will be conducted too. The advantages of using existing data and the disadvantage of hands on data at the same time are the ease of access due to the internet, the low costs to acquire books, magazines etc., the possibility to gain quick knowledge about the theme and to evaluate the information needed from primary sources. On the other hand, through a questionnaire the author wants to collect first hand opinions regarding what Africans think about the Chinese influence. Such thoughts enrich an assignment enormously and allow at least a tendency if the available publications are true. The entire study will be designed to be valid in its structure and findings plus reliable with its accurate measures.

An online questionnaire is an appropriate tool to collect data here, since the author can ask questions that come up during the writing process and also an online based form guarantees a simple and fast way of access. It makes it easy for people to pass the link to others who might be better able to answer the questions. Compared to interviews which allow a dialogue, the more static questionnaire is favorable here since the questions and the objectives behind those are clear. Finally, people might find it more convenient to complete the short survey when they have time without fixing an appointment that in the end might result in a stressful situation.

Regarding the type of data to be collected in the primary research part the author prefers qualitative rather than quantitative research. The aim of this investigation style is to uncover, to explore and to understand what people with a link to Nigeria have in mind when thinking about the Chinese in the largest African country. It is rather a description of a phenomenon than the classification of features or the construction of statistical methods. It is not about numerical data, generalizations or the most efficient data instead the analysis of words and pictures with a “rich” content as well as the interpretation of subjects (despite being subjective) are more valuable here.

The third aspect in a case study method refers to the preparation of collecting data. Since the practical part of this thesis is based on a single descriptive case study with a manageable number of people completing the questionnaire the preparation is mainly restricted to the proper selection of questions plus to monitor the return rate. Before sending the questionnaire the author is going to conduct a pilot testing with a few people to detect and eliminate flaws. Moreover, the preparation at this point also includes the finding of adequate target people likewise the writing of an introductory letter for participants providing information about the project. In more complex case studies it is useful that investigators take part in training sessions where amongst others they inhale in detail the different methods and techniques needed to conduct the research as well as where they learn specific guidelines for the data collection process or how to ask good questions plus interpret these too. Due to scope limitations of this thesis it is not necessary here.

The next step is the field phase. Here the information will be collected and stored systematically for further analysis. The case study will be flexible with changes be included throughout the process, if necessary. Although not applicable in this dissertation but still worth to mention is that in complex research projects field notes are being used to record feelings and to record the research progress. Such aside stories and testimonies can enrich a work but should be kept separately from the actual main data.

The fifth phase in conducting research properly refers to analyzing the data. The author should and will be open to possible new insights from the survey. This section will reveal the data to answer the research question and generally it can be said that the quantitative results will support the qualitative ones and not vice versa. The author will categorize the results and check if the answers given coincide with the information highlighted in secondary sources or if there are discrepancies. The findings will be strong if the primary data itself matches with one another and even stronger if the hands-on records match with the ones from secondary sources. On the other hand if the people being asked made conflicting statements the author will investigate the cause.

In the last step, the writer will transfer the research data in a comprehensible way to the reader who himself should be able to understand the study, the initial reason for it as well as the results. The reader needs to feel that the topic is widely covered within the defined boundaries. Generally, in this part the author should also state the initial position, the research question, the method used for the data gathering process, striking findings from the literature review plus conclude with a suggestion for further research.

Before finishing this section a few comments about the primary research shall be made too. First, the field research in this thesis shall only complement secondary research findings, ideally with matching results. Also, since the sample size will be small the result is not suitable for generalizations plus the outcome will only reflect the present situation. The challenge of conducting the primary research including the finding of adequate interviewees or the defining of productive questions will be overcome by proper preparation like the search for qualified representatives of the target group. People having knowledge about the Chinese African relationship will be found in transnational organizations or in special online forums, for example.

2 Literature survey

The topic of the present master thesis will highlight the early and current relationship between China and Sub-Saharan Africa and its implications for southern Africa. Since this is an issue of international relevance, the adequate theories covering such matter concern the ones dealing with growth and development plus the impact of trade and foreign (direct) investment (FDI). As dealt with in the masters program the author will base his paper on ideas from Adam Smith and Ricardo since they can be viewed as the founders of the classic economic and international trade theories which means they linked economic growth and development to trade. Other influential economists are for instance Heckscher, Ohlin, Krugman and Porter who tried to enhance the classic economic models. Since over time there were many other academics and specialists like Swan, Solow, Romer, Jorgenson and although having different approaches all approve trade as being generally a positive sum game for the world economy. Thus the thoughts of Smith, Ricardo, Heckscher-Ohlin, Krugman and Porter shall be used representatively for all trade supporters in this paper. But before outlining their main concepts it is useful for the general understanding to firstly look at the main reasons for trade.

2.1 Trade theories - Reasons pro trade

When countries decide to trade with other nations then out of several reasons five are often predominant. First of all differences in technology might be a trigger. If countries vary in the ability to produce goods and services out of resources like land, labor or capital, trade with one another might be advantageous.⁶ Also differences in resource endowments like the skills of a country’s workforce, the sophistication of a country’s capital stock (infrastructure, machinery and communications systems) as well as the domestic natural resources available are important aspects pro trade. If the preferences of individuals of two or more countries for products are diverse, then such differences in demand might lead to trade too. The fourth reason in favor of trade refers to the existence of economy of scale effects.⁷ One country might source a product from another nation since its production costs are decreasing with each unit being manufactured. Finally, government policies, like subsidiary programs or taxes can lead to beneficial production conditions in one country and therefore trade can be advantageous.

2.1.1 Adam Smith - Absolute advantage

In 1776 Smith released a book called “The Wealth of Nations” in which he talks about free trade as being beneficial for a country. In order to have a common understanding of the term free trade, the definition of the internationally recognized institution OECD shall be used here. “Free trade occurs when goods and services can be bought and sold between countries or sub-national regions without tariffs, quotas or other restrictions being applied”⁸. Smith underlined that countries vary in the ability to produce goods efficiently. Moreover, he said countries which can produce goods more efficiently than others have an absolute advantage and hence should trade these products with other countries.⁹ To demonstrate Smith’s concept the author will provide an example with the two countries France and Vietnam. Assuming that both nations have the same amount of resources, such can be used to produce either wheat or rice. Apart from that one should further assume that France and Vietnam have both 200 units of resources available. France needs 10 units to produce 1 ton of wheat and 20 units for 1 ton of rice whereas in Vietnam it takes 40 units for 1 ton of wheat and only 10 units to produce 1 ton of rice. Both countries could either harvest only rice, only wheat or a mix of both.

Illustration 1: Absolute advantage and the benefit from trade

illustration not visible in this excerpt

Source: Own design in imitation of (Hill, 2007, p. 171).

In Illustration one it can be seen that France has an absolute advantage in the production of wheat since it only needs an input of 10 resource units for an output of 1 ton of wheat whereas Vietnam needs an input of 40 units for the same output. Regarding rice, the situation is vice versa and Vietnam has an absolute advantage because it only needs half the input for the same output compared to France. Now in the case that both countries do not trade with the other and both would devote its resource in equal parts to the production of wheat and rice France would be able to harvest 10 tons of wheat and only 5 tons of rice. On the other hand Vietnam would only be able to produce 2.5 tons of wheat but 10 tons of rice. Another option already mentioned would be that each country specializes itself in the production of the good it can harvest with the least amount of resource units invested. If so, France would only fabricate 20 tons of wheat and Vietnam the same amount of rice.

If both countries would now engage in trade and swap 1 ton of wheat against 1 ton of rice the French as well as the Vietnamese natives could consume more of both wheat and rice. Furthermore, if the swapping is going to happen on a one to one basis meaning the price for 1 ton of wheat is equal to the price of 1 ton of rice, France could export 6 tons of wheat for instance and receive 6 tons of rice from Vietnam. When comparing these figures to the ones without trade the increase in consumption from specialization and trade is that France gains an output of 4 units of wheat, 1 unit of rice and Vietnam 3,5 units of wheat and 4 units of rice. The bottom line for Smith in the 18th century was that trade is beneficial for countries that have an absolute advantage in the production of one or more goods. Although Smith is often regarded as the father of modern economics, this conclusion of his principle is exposed to some critic. A major one lies in the converse argument that international trade does not seem to be favorable for countries that either do not have an absolute advantage in the manufacture of a certain good or for ones that do have an absolute advantage in the manufacture of all goods. At this stage Ricardo another economist enhanced the thinking of Smith with his theory of comparative advantage.

2.1.2 Ricardo - Comparative advantage

When one can believe sources from literature, Ricardo became interested in economics after reading the “Wealth of Nations” from Adam Smith in 1799, with the age of 27.¹⁰ A few years later in his work “Principles of Political Economy and Taxation” he went beyond Smith’s idea and stressed that it would make sense for a country to specialize in the manufacture of those products that can be made most efficiently (e.g. due to higher labor productivity) and sell these on the international market whereas goods which cannot be manufactured most efficiently shall be bought from other countries.¹¹ Like with Smith’s theory, the author will provide an example to clarify Ricardo’s thinking. Taking the same general framework from above, the two countries France and Vietnam produce wheat and rice and the overall national resource limit is 200 units. Whereas France needs an input of 10 resource units to harvest 1 ton of wheat and 13.33 units for an output of 1 ton of rice, Vietnam must invest 40 units to gain 1 ton of wheat and 20 units for 1 ton of rice.

Knowing the maximum resource amount of 200 tons per country, France can either produce 20 tons of wheat or 15 tons of rice or something in between. Vietnam’s maximum output of wheat is 5 tons or 10 tons of rice or as well something in between. Therefore, as shown in the graphic below, without trade people in France could either consume 10 tons of wheat or 7.5 tons of rice and in Vietnam the people could either enjoy 2.5 tons of wheat or 5 tons of rice.

Illustration 2: Comparative advantage and the benefit from trade

illustration not visible in this excerpt

Source: Own design in imitation of (Hill, 2007, p. 173).

At this stage it can be noted that France has an absolute advantage in the production of both goods so regarding Smith’s theory, there would be no need for France to trade with Vietnam. But despite this circumstance France only has a relative advantage in the production of wheat, hence believing Ricardo’s model, trade would still be a gain for France. The western European country can harvest 4 times more wheat and 1.5 times more rice with the given resources than its Asian counterpart, so that France seems to use its resources for the wheat production more efficiently in comparison to its rice production. From this it follows that if France would increase its wheat production from 10 to 15 tons and use the rest for the making of rice, and if Vietnam would only concentrate on the production of rice both nations could enter into trade and benefit. Assuming that both countries would trade 4 tons of the goods they can harvest most efficiently, France would still have 11 tons of wheat and 7.75 tons of rice for consumption and Vietnam on the other side would have left 4 tons of wheat and 6 tons of rice. For France, this results in a surplus of 1 ton of wheat and 0.25 tons of rice and for Vietnam the gain is 1.5 tons of wheat and 1 ton of rice.

Eventually, this calculation reveals that trade is beneficial even though one country has an absolute advantage in the production of all goods. The basic conclusion of the theory of comparative advantage is that world production is greater with free trade and it is a positive sum game for all countries as long as they have just a relative advantage in the production of one good compared to another nation. For those who argue generally in favor of free trade, Ricardo’s theory is often cited. But in order to avoid an unilateral view of trade being beneficial based on just the mentioned model it has to be emphasized that the theories presented above include many utopian assumptions.¹²

First of all, a simple world with only two countries having only two goods was assumed but in real life there are a dozen nations with many products and services. Secondly, no consideration was given to transportation or insurance costs as well as price differences regarding the resources needed. Also exchange rate variations were not taken into account. Moreover, decreasing and increasing returns due to specialization were ignored but in reality the amount of resource units required to manufacture a good might vary when a country decides to focus on the making of that particular good. Also it is unrealistic to assume a fixed stock of resources for a country plus it is wrong to disregard changes in efficiency concerning the use of a country’s resources through free trade. The dynamism of unrestricted trade probably influences both factors. Finally, it was faded out that free trade might affect the income distribution of a nation. When dropping those assumptions then some economists underline that free trade is still positive for the majority of countries while at the same time those weaken the strength of Ricardo’s theory.¹³ On the other side, over the years many economists have worked on a verification whether the comparative advantage model is valid or not and they found out that Ricardo’s basic conclusion of free trade being beneficial is true even in a world with many countries and goods.¹⁴ Furthermore, economists collected and evaluated data whereupon countries really tend to export those products that they manufactured most efficiently.¹⁵

2.1.3 Heckscher - Ohlin theory

The Swedish economists Heckscher and Ohlin also believed in the comparative advantage theory put forward by Ricardo but with the difference that not labor productivity is the key element for the pattern of international trade but miscellaneous factor endowments, like capital, land or labor.¹⁶ The variety of factor endowments of different countries leads to differences in factor costs. The higher the availability of certain factor endowments in a country the lower the respective costs, hence the higher the comparative advantage. That means countries will likely to export those products that are produced mainly with factors being locally most abundant and on the other side goods will be imported that are manufactured mainly with factors being locally least abundant. As with Ricardo’s theory not the absolute amount of factor endowments is crucial but the relative one. For instance, even if a nation has a larger amount of labor and land, compared to another, the question is whether it has relatively more of one of them. Many economists prefer this theory because it has less simplifying assumptions than the one from Ricardo but the dilemma is that the sole validity of the Heckscher-Ohlin model could not completely be proven.¹⁷ Therefore, ostensibly one solution seems to be to focus again on the explanation that international trade pattern is determined largely by differences in productivity.

A more promising way to find a profound answer of how to explain international trade pattern is to analyze a key assumption of the Heckscher-Ohlin theory. One of such is that technologies do not differ across countries. But is that true? Rather not. Technological differences account for differences in productivity which itself influences international trade.¹⁸ Recent empirical studies tend to support this explanation.¹⁹ A famous example can be given with Japan in 1970’s and 1980’s. During that time, the country’s success in exporting cars was not just based on the opulence of money but to a great extent also on the innovations in the area of manufacturing technology through which the level of productivity of producing cars could be improved significantly. Hence, it can be derived that the Heckscher-Ohlin theory seems to be valid if differences in technology across nations are equalized or controlled for. The main proposition that international trade is advantageous is therewith still recognized as being correct.

2.1.4 Krugman - New trade theory

Circa 160 years after the publication of Ricardo’s book “Principals of Political Economy and Taxation” and about at the same time when the Swedish duo mentioned above won the Nobel Prize for their work in economics in 1977, Paul Krugman began to pave his way to the winning of the Nobel Prize in economics too. He worked on a trade theory that could amongst other questions satisfactorily explain why countries engage in the two-way trade.²⁰ The Heckscher- Ohlin theory lacked to adequately enlighten why nations exported cars and televisions for instance but concurrently imported these goods as well. Krugman presented a new tight approach to international trade by emphasizing the essential role of economy of scale effects.²¹ He believes in two essential aspects regarding the new trade theory. First of all, international trade is a trigger whereby manufacturers try to make use of the economy of scale effect which in turn leads to an increase in products available for consumers as well as a cost reduction of those goods. Secondly, in an industry with only two or few players (quasi monopoly or oligopoly), the game of world trade will be dominated by those enterprises which are first movers in their field of business.²²

Referring to the first point it is true that in a market where no trade is happening, many industries are limited in maximizing their sales efforts due to market capacity limitations. Usually, the smaller the market is, the lower the demand and vice versa. Simultaneously, the smaller a market the more limited is the variety of goods in many cases. Krugman underlines that consumers like to have a diversity of products available. This fact should give countries the incentive to optimize restrictions in favor of enterprises being able to offer a range of products to their people, theoretically. Theoretically, because the start of production of a new product variation involves setup costs which need to be recouped. Such investments only amortize themselves if the quantity manufactured is large enough to benefit from economy of scale effects.

Therefore, he argues pro trade since national markets can be combined to larger world markets giving enterprises the chance to profit by decreasing unit costs as well as by an enlarged market size. In compliance with the new trade theory, scale effects can be realized in particular if companies in each country specialize in the making of a different small range of goods whereas consumers experience a gain by having a variety of products to choose from.²³

For instance, when two automobile companies, one from France plus one from Germany think about launching a new car, certain fundamental financial calculations need to be done as a basis for the decision making process. Assuming both nations would refuse to trade, the plans of their companies for introducing a new automobile might fail due to limited estimated demand within each country and therefore exploding development costs. Following Krugman’s idea, if both countries would trade with one another, each firm could specialize itself in one sector, being it sports cars, off-road cars, low budget cars etc. This strategy leads to cost savings on the one hand and a combined demand for each car type in both countries on the other hand. Customers gain from lower prices and a greater variety of goods.

The second aspect noted earlier, corresponds to Krugman’s viewpoint that in industries where the number of companies is small like the chemical, the heavy truck, the aircraft or the tire industry, it seems to be extremely important to capture the status of being the first company to produce a certain good. This first-mover advantage helps to dominate a market and to keep competitors at bay because the exploitation of economy of scale effects can be a barrier of entry to others. An example is the commercial aircraft industry with the two major players Boeing and Airbus which henpeck the market mainly due to their cost savings from scale effects.

In the end, the new trade theory put forward by Paul Krugman is at variance with the original theory founded by the two Swedish economists Heckscher and Ohlin. While they tried to explain international trade patterns just with the different relative factor endowments a country has, Krugman accentuates the advantage of being the first in a market by pointing to the corporate desire of maximizing economy of scale effects and therewith optimizing the margin. Furthermore, his ideas are compatible with the ones from Ricardo since scale effects can increase the productivity hence they are an essential element of comparative advantage. Although there are critics who oppose the value of international trade empirical investigations seem to confirm its positive effects for the market participants.^{24 25}

2.1.5 Porter’s diamond

Such advantageous effects were also judged to be existent by Michael Porter, a famous economist professor of the Harvard Business School. In 1990 he publicized the results of a study in which he explored the reasons why certain countries are more competitive than others in a particular industry.²⁶ Porter, as an advocate of international trade, was not satisfied with the proposition of existing trade theories because in his view those only revealed part of the story. For instance, Ricardo’s plus Heckscher-Ohlin’s approaches could not fully provide an explanation why Switzerland is more successful in the production of precision goods than Great Britain. In order to solve this puzzle, Porter came up with four determinants that influence the environment in which domestic companies are competing. Illustration 3 shows the interrelation.

Illustration 3: Porter’s diamond

illustration not visible in this excerpt

Source: Own design in imitation of (Porter, 1990, p.77) in (Hill, 2007, p.188).

Beginning with factor endowments, Porter did not reinvent the wheel since Heckscher-Ohlin already mentioned those elements as being essential but what the Princeton professor did was to establish a hierarchy among those. He differentiates between basic natural factors like resources, climate, demographics or location and advanced factors like skilled workforce, research facilities or communication infrastructure that are necessary to compete in an industrial sector. In contrast to the former ones, the latter factors can be influenced by individuals e.g. via investment.

The attribute demand condition refers to the home demand for the industry’s good or service. This determinant is essential and can help to improve the competitiveness of a country’s enterprises. Local customers are especially vital and if they require decisive quality standards usually domestic firms absorb those requests which ultimately push them towards innovations.

Furthermore, relating and supporting industries mean the presence of supplier plus related industries that are competitive in an international sense. For example, if suppliers upgrade their production line then the benefits from that action can spill over into other companies. Porter found out that successful firms within a nation attract supplier or related industries to form a geographic cluster hence benefiting from short distances.

Finally, the box firm strategy, structure and rivalry stand for the conditions that govern how companies are found, organized as well as managed and in addition what the local rivalry situation looks like. Porter, states two crucial points. First, the management style executed in international firms often differs from country to country. Whereas in Germany many CEO’s have an engineering background, numerous CEO colleagues from the US have a finance degree and that has an impact on their leadership. Secondly, he points to a correlation between an intense domestic competition and the level of relative advantage in an industry. A strong rivalry environment forces companies to keep pace and ideally constantly launch innovations.

Summing up, Porter postulates that industries in countries are most successful and therefore competitive if these four attributes (or the diamond how he calls it) are most favorable. Important to note is that the diamond is a mutually reinforcing system because the more attributes are beneficial the higher the competitiveness of the firm plus the impact of one attribute is dependent on others. Good demand conditions for instance have to go along with the willingness to respond to them perhaps due to rivalry. Apart from that Porter noted that the two attributes chance and government can also influence the national diamond. If a local industry sector is very innovative it can crowd out its rival in another country. Certain governmental decisions like antitrust or tax policies or choices to stimulate investments for educational purposes can affect the diamond too. As much as this model appears to make sense it has not been comprehensively empirically tested so far hence it can be assumed that all theories except for the one from Adam Smith contribute something to the truth about the international trade pattern.

2.2 Investment theories

Closely linked with international trade is nowadays the aspect of investments in different markets. In the models of the classical trade theories from Smith and Ricardo but later also in the 18 enhanced one from Heckscher-Ohlin foreign direct investment (FDI) does not play any role due to the assumption of the international immobility of production factors. This assumption was existent because in those times investments in foreign countries involved a high risk and were therefore unusual. It was not before the founding of the OECD in 1961 that a largely freedom of movement of capital was established among industrialized nations resulting in an improved risk analysis for foreign investments. Within that context multinational enterprises (MNE’s) take a key role since they can be defined as “firms that control facilities - other than those exclusively devoted to sales - in two or more countries”.²⁷ A national company only transfers to a multinational one by FDI and since MNE’s engage in global trade to a high degree, they are important institutions in the further spread of direct investments. After organizations began to increasingly invest in foreign countries in the second half of the 20th century academics and researchers came up with new economic theories involving capital movements. But before three of such will be introduced it is essential to have a common understanding of what FDI is, hence the author uses the definition released by the OECD:

“Foreign direct investment (FDI) is the category of international investment that reflects the objective of a resident entity in one economy to obtain a lasting interest in an enterprise resident in another economy.”²⁸

Based on that definition the most common types of FDI are mergers and acquisitions which refer to the transfer of existing assets of a domestic company to foreign enterprises as well as Greenfield investments meaning capital spending to build new facilities or expand beyond existing facilities.²⁹ Moreover foreign direct investments can be of horizontal shape if foreign companies invest in the same industry abroad and vertical. The latter type can be subdivided in a forward and backward version while forward implies an industry abroad selling the products of the home company in the foreign market and backward implies a firm abroad providing input for the local company’s production process.

2.2.1 Product life cycle theory

In literature one can find quite a few theories on FDI and due to the scope of this paper three shall just be highlighted here. In 1966, the economist Raymond Vernon presented a new model, the product life cycle theory, with which the reasons for trade and FDI could be explained. In conjunction with the current topic, the focus shall lie on the explanation why investments occur.

Vernon’s idea rests upon the observation that until the 1970`s the majority of new goods were developed by US enterprises plus were launched first in the US too. He legitimated his findings by pointing to the size and wealth of the US market because in his opinion this framework would provide local firms with opportunities to continuously invent consumer products. Pioneering companies seem to favor a close distance of production facilities and the business market to reduce risks and uncertainty linked with the launch of new goods. Also to get a fast and high return of investment a wealthy market does absorb expensive innovations easier than countries with a low income level on average. Therefore it follows that FDI measures depend on the stages of product development that are changing over time.³⁰

Within his life cycle model Vernon distinguished between three phases which are extendable and not necessarily mandatory. At the beginning there is the product introduction phase in which the development, production and market launch of a new and not standardized good is happening within a company’s home market. A close market distance is advantageous on grounds of high demand for coordination and communication during the inventing and manufacturing period, the need for highly qualified workforce and uncertain customer preferences. The next phase is called the maturing stage which is characterized by market penetration of the home country as well as tapping a new market. The products are becoming more standardized and besides exporting the goods new markets will be served by establishing local production plants. Innovations are now mainly needed for making the production process more efficient. Finally in the standardization phase the products are hardly differentiated anymore and the manufacturing process is standardized as far as possible. The market transparency is high just as the price elasticity of demand. Employers can now benefit from economy of scale effects. Throughout these stages it becomes obvious that production costs are coming to the fore while the location of production is taking a back seat. The distance to market is not a relevant factor anymore in the third phase hence the fabrication expands to low income countries. The firm’s home country fades to a net importer instead of initially being a net exporter. Illustration 4 shows the location of production within the product life cycle stages.

Illustration 4: Product life cycle stages

illustration not visible in this excerpt

Source: Own design in imitation of (Werneck, 1998, p.67)

Throughout the life cycle stages the location of production transfers from the home to low income countries because the issue of minimizing costs becomes increasingly vital. Since the publishing of Vernon’s life cycle theory some critic was expressed and many experts agree that nowadays recent developments of international direct investments cannot be properly explained by this model. One aspect concerns the stepwise progression from the production in the home country over exports to production in a low income country. These days the sequence can be different and does not automatically follow a certain pattern of just three steps.³¹ Another argument contra the life cycle theory is based on the fact that it only refers to country specific benefits as a reason for moving the production site. Company advantages are left out in this original version.

2.2.2 Oligopolistic reaction theory

A few years after Vernon proposed his model Knickerbocker believed his own idea and formulated the oligopolistic reaction theory. Although other theorists addressed FDI related issues too, it was Knickerbocker who discovered a special phenomenon and examined it over a longer period of time. He found that companies invest in foreign markets as a result of market interdependencies. In detail, he recognized patterns that in oligopolistic dominated markets enterprises align their investment actions with the ones of its competitors.³² In case of a changing oligopolistic balance, companies adapt to the situation and based on his idea two options are possible. First, a company could use the “follow-the-leader” strategy meaning it invests in the country where its competitor(s) already did so. This imitation approach shall prevent a competitive edge in many ways of the firm that first transferred capital into the market. A second choice can be to cross invest. If a foreign competitor decides to realize FDI on a company’s home market it can strike back by trying to penetrate the competitors home market too. Ultimately, an oligopolistic balance will be achieved with no firm having significant competitive advantages again. Critics argue that Knickerbocker’s theory only might be suitable to explain the reactions of some firms in oligopolistic markets in the primary plus some segments of the secondary sector in developing countries and they further emphasize the major flaw that he is not able to explain why firms in the first place decide pro FDI.³³

2.2.3 O-L-I paradigm

When in 1976 John Dunning presented his eclectic theory in Stockholm, it was the provisional completion of formulating theories for explaining FDI. While former theorists brought forward partial analytic explanations Dunning integrated previous approaches. The structure and allocation of international production arises out of the existence and or combination of three varying facets.

“The eclectic paradigm seeks to offer a general framework for determining the extent and pattern of both foreign owned production undertaken by a country’s enterprises and also that of domestic production owned by foreign based MNE’s.”³⁴

The international engagement of a firm being it via export, licensing or FDI is determined by three conditions that need to be on hand for realizing FDI measures.³⁵

1. An enterprise doing business abroad usually faces specific costs related to doing business outside the home market. Therefore, in order to stay profitable and to compete against its foreign rivals it needs to either earn higher profits or reduce its costs. In the end the key is to have a unique benefit that other market participants do not have. Such core competencies (ownership factors) are any innovation activities like special know-how or product and process novelties etc. Moreover, the company ideally has monopolistic benefits which include having patent rights or scarce natural resources. Other firm specific advantages refer to the ability to coordinate complementary but separate activities more efficient via economy of scale or economy of scope effects. Beyond, risk diversification or arbitrage possibilities through transfer prices also lead to a gain of common governance. Ownership factors can be used independently from the location of business ventures.

2. Besides the existence of the above-named firm specific advantages their utilization within the company must be more advantageous than outsourcing business units or organizing transactions with external partners. This internalization advantage can happen via the extension of existing or the set-up of new value chains. The incentive for internalization can be found in market imperfections of external markets. In this context such imperfections can have structural or transactional reasons. While the former term corresponds to cost creating entry barriers for the company which can be circumvented through acquisitions and mergers, the latter notion means inefficient coordination of market transactions for instance through licensing. Not following an integrated business strategy implies risks, like losing key knowledge to competitors as well as often involves high costs due to quality saving measures or enforcement of contracts.

3. If the foregoing prerequisites are met, FDI is only beneficial if the investing company can use locations specific advantages abroad too. Such do not just include factor endowments like the ones mentioned by Ricardo (resources, labor, distance to markets etc.) but also judicial (e.g. policies regulating property rights), economical (e.g. size of the market telecommunication costs), social (e.g. attitude towards foreigners) and political (government policies affecting FDI measures) framework requirements. Without those location factors being positive the serving of foreign markets would be limited to just exporting or any form of licensing.

The degree of international engagement is determined by the three mentioned factors. Illustration 5 further clarifies the interrelationship.

Illustration 5: O-L-I paradigm

illustration not visible in this excerpt

Source: Own design in imitation of (Dunning, 1981, p.32).

Ownership specific advantages are solely a necessary requirement for successful activities on overseas markets but itself are an insufficient base for developing a strategy for internationalization. Only the combination of all three elements of the eclectic paradigm will provide an informative foundation to decide how to enter new markets. If a company cannot spot internalization or location benefits it should stick with contractual modes (licensing) of market entry. If just location specific advantages in a new country are missing, then Dunning suggests exports as being appropriate. FDI measures should only be preferred if all three preconditions are satisfied.

Although Dunning’s eclectic paradigm brought a greater insight into the reasons why companies engage in FDI, this theory is not free of critic. Some authors argue that his model is lacking originality since it is just a combination of previous approaches.³⁶ Apart from that critics emphasize missing behavioral science aspects. Dunning did not succeed in integrating different disciplines into one self contained theory. Another allegation concerns formal-theoretic deficits meaning until today one can find only a few commentated tables from Dunning but not a clearly formulated version.³⁷ The final objection can be applied to many theories, this is the static character. Dynamic aspects are only partially integrated into the theory in the form of comparative-static elements.³⁸

2.2.4 Overview of study results about FDI

Over time there have been many authors debating about the relationship between economic growth effects in a market resulting from FDI inflow and despite the great amount of theoretical as well as empirical research only conflicting evidence was found so far relating both factors. While some researchers claimed to have found a positive correlation between investing in a foreign country and seeing rising economic welfare others deny that such an effect exist. In 2003 the researcher Choe,³⁹ plus in 2005 the researchers Carkovic and Levine⁴⁰ published a study in which they asserted that they could not find macroeconomic evidence in favor of positive economic effects through FDI activities. Another category of authors of macroeconomic studies like de Mello⁴¹ or Eller et. al⁴² attest that FDI efforts only have weak beneficial impacts within a receiving nation. In their view foreign capital gives the prospect of an opportunity to fight the lack of sufficient local capital and linked to it the overall low productivity but often real positive effects are missing due to external factors.⁴³ Besides those researchers mentioned there are also several ones emphasizing that FDI⁴⁴ does have significant positive effects on economic growth even though its magnitude⁴⁵ might differ depending on specific host country conditions like the available amount of human capital or the level of education of workers. ⁴⁶

In face of the numerous empirical studies which have been conducted the last years concerning FDI⁴⁷ and its impact on the receiving country the main question is why are the results so diverse? The disparity can be explained by few reasons of which two major ones shall be highlighted here.⁴⁸ The first difficulty concerns the collection of primary data sets because usually investigators form groups of nations that are often not homogenous but the opposite. That means the multiple target countries are characterized by structural variations hence should rather not be lumped together. Secondly, researchers did not use one single proven econometric method of testing and estimating but a variety of different ones. That can be explained by the lack of an existing specific global standard in market research but should not be an excuse since such matter can lead to inconsistent study outcomes.

2.2.5 Theoretical gain through FDI

Now, after looking at the results of studies if FDI is advantageous for economic growth it needs to be clarified how foreign capital might put a host country’s economy in motion. The OECD generally has a positive attitude towards the use of FDI and although it recognizes challenges regarding maximizing the benefits for the receiving nations the organization presents several pro aspects.⁴⁹

Firstly, the OECD argues that despite some critical voices about FDI and its effects, one should see the topic from a helicopter view. Trough FDI support a country feels more integrated in the global economy process likely resulting in a more active role of becoming a recognized commercial partner or in other words the commercial cross boarder activities might increase.

Apart from that technology transfer is being named in literature as one of the top externalities a country can profit from by foreign capital. Multinational enterprises (MNE’s) are usually financially sound institutions with a high degree of technological knowledge from which in many cases developing nations can learn. Therefore, the chance to capitalize on technological spillover being it vertically (e.g. suppliers), horizontally (e.g. competitors), through the transfer of skilled workforce or the transmission of R&D knowledge is an opportunity one should not neglect. Especially the linkage to local suppliers is a valuable opportunity for trainings or technical assistance in order to raise their performance plus product quality. On a horizontal basis the technology transfer does not happen regularly since foreign companies fear the loss of vital know-how to competitors. Researchers assume also that the smaller the technology gap between the foreign and domestic firm the higher the spillover effect and vice versa.⁵⁰

Moreover, an advantage of FDI is said to be the human capital enhancement. The direct component of this argument touches the further education of local employees in the MNE subsidiary. Locals get a chance to receive trainings hence they improve one’s competitiveness on the job market and some people even become entrepreneurs. The indirect impact might be that in order to attract FDI, the domestic government initiates programs to increase the level of general education because this is fundamental in order to play a role in the business world. A scarcity of skilled-labor often does anything but convince foreign investors to do business in that country.

A fourth aspect in support of FDI practices affects the competition. The OECD argues that although it is hard to measure the degree of competition in a host country’s market, foreign companies may eradiate positive signals for economic development.⁵¹ In many cases foreign enterprises distinguish oneself from local firms through a higher level of productivity, more efficient use of resources and therefore frequently lower prices. This circumstance might be advantageous for an economy in a developing nation because if domestic firms want to continue their business they have to increase their level of competitiveness which in the end benefit the natives. People might keep their job and prices drop, hence the living conditions can rise.

Like always there are two sides of the coin meaning the local government needs to monitor this development. If MNE’s enter a new market in a developing country and their presences tend to massively hurt competition, for example due to a strong international market position or weak competition policies then it remains a challenge for the government to intervene. Regarding the OECD, there are a few measurements to minimize negative competition effects like efficiency enhancing laws or enforcement agencies. One good strategy is to take the offensive and boost the country’s openness to international trade, hence expand the local market.

FDI initiated by a foreign company might as well spur the development of local enterprises. This might include synergies within the foreign MNE, the rise of efficiency plus reduction of costs within the local firm and maybe also the development of new business segments. Certain spillover effects being it technology or human capital ones can result in efficiency gains for unrelated businesses too. Empirically verified are significant efficiency enhancements in local companies acquired by foreign MNE’s.⁵² Especially in industries where economies of scale effects play a dominant role such improvements can be strongly detected. In this context some controversies have occurred too because those corporate midterm benefits were often realized at the expense of short term job losses. But overall, in the opinion of the OECD, local firm restructuring processes enforced by foreign investors have more long term positive than negative consequences for many developing nations.

A final argument pro FDI on the part of the OECD strikes environmental and social facets. Host countries in particular developing nations are likely to profit from technological spillovers because technology (even old one) from Western countries is said to be more environment friendly than old local machines. Furthermore, the word efficiency is again important to mention since the environment will be preserved if less resources are used. Besides many examples of positive externalities it would be wrong to blind out those cases where industries just want to get rid of their waste, hence prefer to settle down in areas with weak environmental standards or where people accept environmental damage in exchange for small monetary compensation. On the other hand empirical research does not support that such instances relatively exist in large- scale.⁵³ The social component can as well be positively affected by FDI. This is true especially when foreign capital is used to build up labor-intensive industry sectors with respected international labor standards. If locals have a job to live from then this will eventually have an adjuvant bearing on other members of society since the money earned needs to be spent again. An economic circuit will be spurred.

When summarizing the different opinions about FDI and its effects on development it should be clear by now that there is not one truth. While some researchers found proof in favor of it others did not or at least with restrictions. It suggests itself that in a world with plenty of countries, different cultures, habits and people, the success of FDI, meaning the extent to which it helps boost economic growth in a host country depends on a variety of nation specific conditions.^{54 55} The framework which is for instance the general level of education, the level of technology in local companies, the level of openness to international trade or inadequate competition policies, determines the magnitude of the outcome from FDI. The two researchers Sanchez-Robles and Bengoa also share the notion that long term benefits from foreign direct capital derive best if the receiving nation provides human capital, liberalized markets, satisfactory infrastructure plus economic and political stability.⁵⁶

The effects of FDI can also be negative if growth prospects entail remittances of profits from local government towards MNE’s or if western organizations receive any kind of concessions for doing business in a certain country. In the end FDI seems to function as a catalyst whereby it amplifies the strengths and weaknesses of the host country’s economic and legal structure.

In the case of the Chinese influence in Africa the following paper will show how China makes use of FDI and what the effects are with regard to what researchers and institutions like the OECD tend to say about foreign direct capital.

Concerning the literature base for this thesis, the author read several articles, studies and books about the topic. The management project will be based on up to date renowned literature from authors like Ian Taylor, Chris Alden, Arthur Waldron, Robert Rotberg as well as from institutions like the World Bank, the IMF, the OECD, the Forum on China Africa Cooperation and others. Besides those sources the three main ones are from Charles Hill, who composed the book “International Business” and who was already used as a reference frequently, from the OECD which published the already repeatedly cited paper “Foreign Direct Investment for Development” as well as from the International Monetary Fund (IMF) with the study “Development Aid and Economic Growth”. These are the author’s basic texts because the first one gives clear information about the diverse theories on economic growth and development plus some knowledge about FDI while the second one provides extensive explanations of the relationship between FDI and growth. The last source was chosen since it sheds light also on one of the pillars of this final project, namely the effect of development aid towards economic growth.

In order to approach the topic in this thesis, especially beginning with chapter four, the author searched for written material providing an overview of the effects of the Chinese presence in Africa. Despite the increasing number of literature sources, including those mentioned above, most authors only touch specific areas of the Chinese African relationship, being it either from a political, economical, developmental, cultural or environmental perspective. There are not many papers with academic content presenting a holistic view and those available are oftentimes a few years old. Therefore, the strategy will be to extract useable information from existing studies but to search for updates and original sources.

Besides books and newspaper articles, mainly chapter four and to a minor extent section five will be based on information also underlined in a set of studies like the one from an Africa consultancy firm with the topic “The impact of the Chinese Presence in Africa” or a paper called “Africa and China” from the OECD. Furthermore existing studies and reports used are from the World Bank with the topic “Building Bridges: China’s growing role as infrastructure financier for Sub-Saharan Africa” or from the magazine “The economist” with “A ravenous dragon” covering the quest for resources or from the German Institute of Global and Area Studies with “Contours of China’s ‘Africa mode’ and ‘Who may benefit’”. Those papers will mainly serve as an introduction and a tool box from which specific content will be utilized. There are two other useful documents which deliver an interesting insight into the subject and these are called “Chinas engagement in Afrika: Chancen und Risiken für Entwicklung” from the German Institute of Development Cooperation plus “China’s return to Africa: Anatomy of an expansive engagement” from Chris Alden. All of those will contribute information for this final project but due to their different prospects there is not one single core study being most important.

3 China’s early reach out to Africa

The People’s Republic of China is fairly young but this should not hide the fact that this large territory was home to plenty of ethnic groups and many kingdoms with a long history. Out of early agricultural societies civilized cultural groups slowly evolved over centuries. With the ascent of emperor Wu in 141 BC within the Han dynasty (202 BC - 220 AD) the first policies mentioning overland trade were passed and a few years later that resulted in indirect trade relations also with Northern Africa.⁵⁷

3.1 Beginning of the Sino African relations

Despite the indirect trade during the era of emperor Wu, relicts like Chinese coins and porcelain that have been found in East Africa only definitely proof an encounter between China and Africa from the eighth century AD on and not necessarily before.⁵⁸ Several other discoveries dating back to the tenth and eleventh century AD, document the early dealings as well.

In the beginning of the 15th century under the rule of emperor Yongle, the general Zheng He led seven expeditions with destinations also being on the African continent. In 1418 he first landed in Africa in the region of the present state of Somalia and debarked therewith a few decades before the Portuguese sailor Vasco da Gama.⁵⁹ Zheng’s voyages are of particular importance for the Chinese because in the course of Sino African meetings for instance on economic summits they like to highlight the peaceful ambitions for their early explorations. While Europeans settled in Africa mainly for reasons of economical exploitation, Zheng’s missions were supposed to serve only for “friendly exchanges”.⁶⁰ Especially Chinese politicians and diplomats emphasize that this early contact with the two cultures can be seen as the beginning of a long traditional friendship which lasts until today.

After seven excursions between 1418 and 1433 the Chinese administration stopped the voyages Zengh He’s into the Indian Ocean because in relation to the high costs the return of investment or the value of goods brought back to China was not as lucrative as initially hoped. The focus of foreign policy generally changed then towards the far eastern area since the Mongolians threatened the country. With the exception of Chinese workers being enslaved mainly in British foreign colonial parts of Africa and Madagascar during the opium wars in the 19th century, a long era of intermission of the Sino-African relations followed.⁶¹ Whereas in the end of the 15th century the Portuguese initiated the colonization of Africa the Chinese African bilateral relationship was resumed only circa 500 years after Zheng He’s adventure trips.

3.2 Sino - African relations from 1949 - 1989

In the first years after the foundation of the People’s Republic of China in 1949, Africa did not play an important role in the Chinese foreign affairs. The communist government in Beijing experienced from its coming into power a growing international isolation which especially after the Korean War was further enforced by the United States of America. China only maintained diplomatic ties to some states of the Eastern Bloc and the Soviet Union and from this it followed that Africa gained in significance.

3.2.1. Chinese Diplomacy serving ideological aims

The Chinese foreign policy towards Africa in the 1950’s and 60’s was dominated by ideological goals. In the eye of China the US and in the 1960’s the Soviet Union too were seen as hostile nations. During the cold war it was the strong Chinese attempt to escape international isolation initiated by the “imperialist” US and supported by the Soviet Union. In the search for options the African continent with a rising number of countries postulating their independence, seemed to be promising for assisting China in obtaining international recognition plus backup. The Bandung conference on the Indonesian island Java in April 1955 was the first occasion where Non- Aligned Nations like China met amongst others with six African countries to discuss ways for an own political course without the interference of the two hostile forces and other colonial powers.⁶² This symbolic south-south dialogue marked the beginning of the approach towards Africa and very soon China perceived the strategic opportunity behind the growing movement of non-committal countries.

In order to realize its ideological ambitions to spread communism and fight capitalism, China set its diplomatic apparatus in motion and visited five African nations in 1956. The attention towards its new potential partners on the southern continent did not only happen to strengthen the international proportion of power but to provide assistance for oppressed governments in their fight against the imperialistic rulers. China itself has experienced repression and abasement during the Opium Wars and the Japanese invasion between 1938 and 1940. Therefore, Mao Zedong announced on the eights congress of the communist party in 1956:

“…To achieve a lasting peace in the world, we must further develop our friendship and co-operation with the fraternal countries in the camp of socialism and strengthen our solidarity with all peace-loving countries. We must endeavour to establish normal diplomatic relations on the basis of mutual respect for territorial integrity and sovereignty, and equality and mutual benefit, with all countries willing to live together with us in peace. We must give active support to the National Independence and Liberation Movements in Asia, Africa and Latin America, as well as to the Peace Movement and righteous struggle in all countries throughout the world...”⁶³

This speech clearly underlines the strategy to establish diplomatic ties based on the consideration of national sovereignty among socialist countries on the one hand and also to call for liberation movements because both actions will assumedly lead to global (socialist) peace. In the following years China turned its desire into action and actively supported resistance movements which increased the reputation of the country among certain target groups. Some political activists even traveled to China in order to learn more about battles for independence.⁶⁴

China’s ideological power struggle was best demonstrated on the African continent when it distanced itself from its former ally, the Soviet Union in the 1960’s and 70’s. Both parties diverged in the question who was the true socialist and linked to that who truly supported the African liberation movements. China adjudged its neighbor country of striving for hegemony in Africa, hence being counter-revolutionary. As a result it took a more rigid position in the ideological matter which influenced the relation to the new enemy and to its potential African partners simultaneously. In the years following 1960 China refused to accept several cooperation requests from African states just because of their attitude towards the Soviet Union.⁶⁵ Therewith, the Asian nation limited itself with respect to its general foreign policy goal to break out of the international isolation.

Together with the harsh ideological position China strongly fostered militant support for independence movements across the continent in the form that it supplied mainly weapons, uniforms, food and medicine.⁶⁶ In addition, military trainings under Chinese leadership were organized in the military academy in Nanking as well as in camps in Ghana and Tanzania.

[...]

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¹ (Michael, 2002, p.113 et seq.)

² (Wolf, 2003, p.21)

³ (Saunders et al., 2009, p.136 et seq.)

⁴ (Yin, 2002, p.13)

⁵ (Yin, 2002, p.5)

⁶ (Suranovic, 2009)

⁷ (Suranovic, 2009)

⁸ (Anon., 2004)

⁹ (Hill, 2007, p.169)

¹⁰ (The concise encyclopedia of economics, 2008)

¹¹ (Hill, 2007, p.172)

¹² (Hill, 2007, p.174)

¹³ (Krugman, 1987, pp.131-44)

¹⁴ (Dornbusch et al., 1977, pp.823-39)

¹⁵ (Balassa, 1963, pp.231-38)

¹⁶ (Hill, 2007, p.181)

¹⁷ The Nobel Prize winner Leontief found out that despite the US having plenty of capital and should therefore export capital intensive products and in turn import labor intensive goods, the reality was vice versa. Since this result was at odds with the predictions of the Heckscher-Ohlin model, it has gained fame in the field of economics as the Leontief paradox.

¹⁸ (Trefler, 1995, pp.1029-46)

¹⁹ (Davis & Weinstein, 2001, pp.1423-52)

²⁰ (Panagariya, 2008)

²¹ (Peet & Hartwick, 2009, p.73 et seq.)

²² (Hill, 2007, p.184 et seq.)

²³ (Hill, 2007, p.185)

²⁴ (Deraniyagala & Fine, 2001, p.809 et seq.)

²⁵ (Tybout, 2001, p.2 et seq.)

²⁶ (Grant, 1991, pp.535-48)

²⁷ (Boyer, 2001)

²⁸ (OECD, 2001)

²⁹ (Encyclopedia, 1999)

³⁰ (Vernon, 1966, p.192 et seq.)

³¹ (Schätzl, 1993, p.199)

³² (Barclay, 2000, p.23 et seq.)

³³ (Buckley & Casson, 1991, p.78 et seq.)

³⁴ (Dunning, 1988, p.39)

³⁵ (Dunning, 1980, p.9 et seq.)

³⁶ (Schanz, 1995, p.133 et seq.)

³⁷ (Schanz, 1995, p.136 et seq.)

³⁸ (Braun, 1988, p.338 et seq.)

³⁹ (Choe, 2003, pp.44-57)

⁴⁰ (Carkovic & Levine, 2005, p.195 et seq.)

⁴¹ (de Mello Jr., 1997, pp.1-34)

⁴² (Eller et al., 2005, p.8 et seq.)

⁴³ (Borensztein et al., 1998, pp.115-35)

⁴⁴ (Olofsdotter, 1998, pp.534-47)

⁴⁵ (Bengoa & Sanchez-Robles, 2003, pp.529-45)

⁴⁶ (Greenaway et al., 2007, pp.206-08)

⁴⁷ (OECD, 2002, p.10 et seq.)

⁴⁸ (Al-Iriani, 2006, p.5)

⁴⁹ (OECD, 2002, p.9 et seq.)

⁵⁰ (OECD, 2002, p.13)

⁵¹ (OECD, 2002, p.16)

⁵² (OECD, 2002, p.17)

⁵³ (OECD, 2002, p.20)

⁵⁴ (Buckley et al., 2002, pp.637 - 655)

⁵⁵ (OECD, 2002, p.21 et seq.)

⁵⁶ (Bengoa & Sanchez-Robles, 2003, p.529 et seq.)

⁵⁷ (Tanner, 2009, p.98 et seq.)

⁵⁸ (Freeman-Grenville, 1962, p.185)

⁵⁹ (Fan & Cohen, 1996, p.303)

⁶⁰ (Xiaoying, 2006)

⁶¹ (Jäger, 1994, p.10)

⁶² (Leonard, 2006, p.139)

⁶³ (Tse-tung, 1956)

⁶⁴ (Snow, 1988, p.72)

⁶⁵ (Li, 2007, pp.33-40)

⁶⁶ (Snow, 1988, pp.78, 79)

• College: Grenoble Ecole de Management
• Course: International Business
• Grade: 1,0
• Author: Christian Baumann (Author)
• Publication Year: 2010
• Pages: 153
• Catalog Number: V156469
• ISBN (eBook): 9783640699872
• ISBN (Book): 9783640775101
• Language: English
• Tags: Chinese, Africa, Nigeria, China, resources, southern continent, southern Africa