Foreign direct investment (FDI), signifies capital invested in a country that provides manufacturing and service capabilities for both native consumers and world markets. Not only does this capital signal investor confidence in a specific business and in the geopolitical climate of the host country, but it can also link national economies—benefiting both the capital suppliers and the host regions. Nowhere is this phenomenon more apparent than in China. According to China's commerce ministry, FDI in 2010 surpassed $100 billion for the first time, climbing 17.4% from the year prior, to reach a whopping $105.74 billion.

A myriad of factors contribute to foreign investment in China—either positively or negatively. Here are some of the biggest influences:

Key Takeaways

  • Foreign direct investment (FDI), signifies capital invested in a country that provides manufacturing and service capabilities for both native consumers and world markets.
  • According to China's commerce ministry, FDI in 2010 surpassed $100 billion for the first time, climbing 17.4% from the year prior, to reach a whopping $105.74 billion.
  • A host of factors influence FDI in China, such as stability, availability or world investment capital, and government regulatory policy.

1. Capital Availability

FDI is mainly dependent on the available investment capital that may be put into circulation. And in the early 2000s, a thriving global economy resulted in large swaths of investable capital across many nations, that proportionately overwhelmed the number of viable local investment ideas in a given country. Consequently, institutional and individual investors looked to emerging and developing markets for investment opportunities, and China happened to greatly benefit from this global surplus in investment capital.

2. Competitiveness

China has outpaced India and many other emerging countries when it comes to nurturing the elements necessary for business growth. The development of infrastructure has been a key driver in this area. After all, roads, highways, and bridges are essential for employee commutes and the transportation of goods. China also boasts a strong workforce, both in terms of numbers and aptitudes. Advances in these areas dramatically lower transaction costs and increase profits, letting investors earn robust returns.

3. Regulatory Environment

National government policies can be a double-edged sword—especially those that favor state entities at the expense of privately-held firms, as is the tradition in China. This has historically made China a less favorable investment destination, where investors looking to set up manufacturing facilities there have encountered high start-up costs, heavy legal exposure, and other compliance entanglements.

On the other hand, the Chinese government promotes investment in commercial and entrepreneurial activities by providing attractive financial incentives in the form of tax breaks, grants, low-cost government loans, and subsidies. Such government-sponsored inducements can ultimately boost profitability, and help businesses succeed quicker.

4. Stability

Political and economic stability can facilitate an influx of FDI. Contrarily, acts of instability such as blackmail, kidnapping, rioting, rebellion, and social unrest are bad for business and can contribute to hyperinflation, which renders a country’s currency virtually obsolete. Therefore, in order to encourage FDI, citizens, workers, and entrepreneurs should strive to respect Chinese law, while the Chinese justice system should employ effective mechanisms for reducing crime and corruption.

5. Local Chinese Market and Business Climate

The sheer size of China’s population makes it an attractive nation for investors to commit capital to higher-end industries like healthcare, information technology, engineering, and luxury goods. Furthermore, economic growth and FDI can start a "success domino effect." In essence, the more FDI a region attracts, the more it grows, which in turn stimulates more FDI, to create overall sustained growth.

6. Openness to Regional and International Trade

FDI tends to find its way to nations who can sell goods both to local and foreign consumers. Trade barriers such as tariffs discourage investors, who realize that artificially inflated prices will depress demand abroad. Furthermore, such actions can prompt retaliatory tariffs from the U.S. on Chinese products, or trigger an outright ban on certain goods. Contrarily, export-friendly policies like regional and international free trade agreements encourage FDI in China--especially for enterprises with substantial market share outside the local Chinese market.

The Bottom Line

For a developing nation like China, foreign investment is crucial to spurring development and pulling the country's economy toward a competitive spot in the global marketplace. But the right set of circumstances must be in place for FDI to occur.