The Role of the Joint Venture mode of Foreign Direct Investment in the development of the Chinese automobile Industry

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Conference Paper


Clive Collis


Gerpisa colloquium, Paris (2011)





This paper discusses the role of Foreign Direct Investment, via joint ventures, in the development of the automobile industry in China. It starts with an examination of theories which explain the motives for international production and places joint ventures in the context of a range of modes of entry. It then discusses the development of the Chinese automobile industry and the contribution of joint ventures and conclud s that, nevertheless, China’s automobile industry is not yet ready to compete globally.

Theories of Foreign Direct investment (FDI) 

A number of theories of the multinational enterprise and of international production have been particularly influential. Hymer's  specific advantage theory suggested that a firm investing overseas faced additional costs compared to a domestic competitor, for example those costs entailed in managing a distant operation. In order to cover these extra costs the firm would need to possess internal specific advantages over domestic rivals, for example, economies of scale or superior technology. However, Hymer's theory does not explain why a firm possessing internal specific advantages does not exploit them through exporting or licensing rather than through international production. Vernon developed product life cycle theory by adding a spatial dimension in order to explain a shift from exports to direct investment. Graham argued that oligopolistic rivalry may lead to direct investment as competitors threaten each other by investing in each other’s home markets. Buckley and Casson argued that for direct investment to take place there must be internalisation advantages present. Dunning's eclectic paradigm draws on key elements of some of these earlier theories, notably the concepts of specific (ownership) advantages and of internalisation, adding a strong role for location advantages. Ownership advantages are those advantages specific to a company and dependent on its ownership of particular assets, such as technological capability or ownership of a brand name. Internalisation factors are those benefits that derive from a firm managing activities internally such as making its product in a foreign location rather than licensing its production abroad. Location factors are those advantages which are present in a particular geographical location, e.g. cheap labour.
There are numerous host country benefits associated with FDI. Direct effects comprise additions to capital stock, to employment and to exports. Indirect effects arise from input purchases from local firms. Dynamic impacts include technology spill-overs and demonstration effects in management and working practices.
Dunning has incorporated the notion of Stages of Growth into his analysis by applying the paradigm to explain the changing level and pattern of MNE activity into and out of a country as it proceeds along its development path. The extended Dunning framework, incorporating the notion of stages of growth, is relevant to China because the investment development path identifies a number of stages through which a country might pass. In the third stage identified by Dunning, location specific advantages will be improved through the development of government policy towards direct investment, the development of agglomeration or cluster type economies and growing markets.
FDI takes a number of forms:  MNEs building production facilities in countries other than their own country, expanding or reinvesting in such facilities, engaging in cross border mergers and acquisitions (M&As), and establishing international strategic alliances such as joint ventures (JVs) with companies from a different country. The geographical restructuring of the world’s automotive industry has taken place through the process of FDI undertaken by the industry’s major corporations. Ford, for example, used all FDI entry modes to globalise its market reach: it pioneered USA overseas direct investment through factory building in the UK in 1911 and 1931; reinvested in existing operations (Bridgend factory in Wales in 2000); acquired Aston Martin (1987), Jaguar (1989), Volvo (1999) and Land Rover (2000); and entered into JVs with state-owned companies in China.
The Chinese Automobile Industry and Joint Ventures (JVs)           
From 1947 until 1978, China followed a Marxist-Leninist style command economy, but following Chairman Mao Zedong’s death, the incoming government embarked on what was called the Open Door Policy. Under the premiership of Deng Xiaoping, China recognised that it could not solve its domestic economic problems without inward Foreign Direct Investment (FDI) . By 2003, almost all of the world’s leading automobile producers had opened a JV production facility in China on terms shaped by the Chinese Government. No foreign entity could own more than half of the rights to a JV with a Chinese firm. The norm was for the Chinese partner to hold a 51% majority.
The reasoning behind the desire of western firms to establish themselves in China was predicated more on market potential in the long term rather than to leap over tariff barriers or to take advantage of the availability of relatively low cost labour. Though market size of itself was a sufficient driver to push for market penetration, this has to be seen within the confines of government policy. Initially, one might have considered that the sheer strength of the automotive multinationals gave them an enhanced bargaining power in firm-government negotiations. However, China had no intention of being controlled by foreign firms.
Essentially, the multinationals, whose advantages lay in their products, technology, competences and brands, sought market entry and to incorporate their potential Chinese operations into their wider global portfolio. In contrast the government, knowing the strength of China’s market potential and its low cost labour base, sought to increase the economic and social welfare of its citizens through attracting inward FDI. Using its JV requirements, government policy was sufficiently strong to force aspiring overseas entrants to compete against each other for the privilege of entering China. Beijing chose where foreign firms would be located, who their partners would be, what vehicles would be produced and what degree of local content would be used. In essence Chinese state’s terms of engagement with foreign entities was designed to ensure that China would be the main beneficiary of their activities in the country rather than anyone else. In encouraging industrial development the Beijing government never intended that its industries would be dominated by foreign multinationals, rather there would be a parallel growth of JV firms and indigenous firms.
In total there are roughly 120 car producers in China, consisting of: wholly-owned state enterprises, led by the First Autoworks (FAW), Donfeng and SAIC; various JV firms; and Chinese independents such as Xiali, Brilliance China, Geely, Chery and Great Wall. In terms of output, the JVs dominate. For instance, FAW’s JV produced just under a million units in 2006 and SAIC’s almost 900,000. In contrast, the combined total output of all the other domestic firms was only 700,000, with many producing only a couple of thousand units annually. With respect to capacity utilisation, even the best JV plants are fortunate to operate at 65–70%; many state owned firms operate at somewhere between 40 and 50% and many others at as low as 20% . The case for rationalisation was strong and recognised as such by government.
From the late 1990s onwards, policy statements down to 2009 have repeatedly called for rationalisation, but seemingly the Chinese state has found it difficult to force mergers due to the decentralised power structure in the industry. As an alternative to simple mergers and take-overs, the national and provincial authorities have encouraged stronger state firms to either absorb their weaker counterparts or at least take them under their wing. This approach has serious shortcomings in that although the stronger firms can supply capital to their acquisitions often they can provide little in much-needed managerial or technological improvement since they themselves are often weak in those areas. The flaws in this policy were identified eventually and current ‘policy’ is moving gently to allow international firms to participate in the rescue process. For instance, SAIC-GM was persuaded by Shanghai City Council to take over the ailing Wulung Automobile Company in Guangxi Province The Chinese hope that more widespread participation of MNEs in this process will occur.
Other problems within indigenous firms which foreign JV partners have been expected to help resolve have been in the areas of technology, R&D, design, safety and quality. Relying on protective tariffs until joining the WTO, Chinese firms did not invest in R&D and product development and had been reliant on JVs. However, in early days of JVs, overseas firms fearing possible infringements of intellectual property rights, were reluctant to bring their latest cutting edge technologies or their key R&D research and design capabilities to their Chinese operations. But given that national government policy was insistent that this should occur, there has subsequently been progress on this including demonstration effects and spill-overs to Chinese independent firms.
China is now an established player in the automobile industry having made considerable progress over the past 25 years. FDI in the Chinese automobile industry through joint ventures has made an important contribution to the industry there. However, China’s automobile industry is confined mainly to its domestic market and is not yet ready to compete globally.
i) Clive Collis and Darren Webb, Inward Investment, IED, London, 2000.
ii) Tom Donnelly, Clive Collis and Jason Begley, Towards sustainable growth in the Chinese
automotive industry: internal and external obstacles and comparative lessons, Int. J. Automotive Technology and Management, 2010.

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