An exploratory investigation of international pharmaceutical firms' FDI decision into China: a comparison between eastern-firms and western-firms.

ABSTRACT

This paper investigated the determinants of international pharmaceutical firms' foreign direct investment (FDI) into the Chinese pharmaceutical manufacturing industry during the period from 1980 to 1998. The analysis of 43 cases showed that international pharmaceutical firms' FDI into China were predominantly driven by China's specific location factors. China's market size with its great potential played the most important role. China's rapid economic development & growth and its open-door policy were other two important determinants. Relative stable political conditions and incentive policies provided by China were also considered as important factors. The impact of relatively stable political conditions in China on western pharmaceutical firms' FDI into China was significantly greater that that on eastern firms'. Incentive policies provided by China received more attention from eastern firms.

1. INTRODUCTION

China has attracted substantial FDI since the passage of the Chinese-Foreign equity joint venture law by the National People's Congress of China in 1979. FDI grew from a modest amount of a few hundred million dollars annually in the late 1970s and early 1980s to almost US$ 3.5 billion annually in the late 1980s. Beginning with an over 25% growth in 1991, China has since attracted greatly increased amounts of FDI. An approximately 152% increase for 1992 based on the previous year, an almost 150% increase from 1992 o 1993, a further 20% growth in 1994, over 10% growth for both 1995 and 1996, and an over 8% increase to reach US$45.257 billion in 1997. China recorded FDI inflow worth US$ 45.463 billion for 1998 (SSBPRC, 1999). The country had been second only to USA as the major recipient of FDI from 1993 to 1997, and ranked in the third position in 1998 in the world (UN, 1996-1999). During the period from 1992 to 1998, China had hosted almost 10% of total FDI inflow in the world, and absorbed over 28% of the total FDI inflow to developing countries and over 46% of total FDI inflow to Asian countries or regions. South East Asian countries or regions attracted about US$480 billion FDI flows from 1992 to 1998, and about 50% of this went to China (UN, 1996-1999). China had approved and signed 324,134 FDI agreements and contracts with foreign investors from 1979 to 1998, and almost 20,000 projects for 1998 (SSBPRC 1999). Large proportion of the FDI inflow received by China came from Hong Kong, Taiwan, Singapore, South Korea and other developing countries/regions. During the period of 1978~1998, over 70% of total FDI inflows to China were from Asian/developing countries/regions including Hong Kong (53.89% of the total ranked as 1st) Taiwan (4th), Singapore (5th), South Korea (6th), and Thailand (11th). With the exception of Japan (8.03%, ranked as 2nd) and USA (7.91%, ranked as 3rd), other industrialized countries played a minor role (refer to TABLE 1).

The popularity of FDI activities in China also applies to the pharmaceutical industry. A significant number of American, European, Japanese and other Asian pharmaceutical groups had been actively pursuing and evaluating avenues of access to the Chinese pharmaceutical manufacturing industry and established over 1,500 pharmaceutical companies during the period from 1980 to 1998. Foreign invested pharmaceutical companies were distributed in almost every part of China (CCPIE, 1995). This paper was to explore why foreign pharmaceutical firms' made their FDI in China, and further to compare FDI decision patterns between eastern and western pharmaceutical firms. Most of current FDI theories revealed from the research studies that were conducted mainly based on western firms' FDI activities. A comparison of the FDI decision patterns between eastern and western pharmaceutical firms would be expedient and meaningful, and contribute to a better understanding of FDI theories in general.

2. FDI LITERATURE

The theories of foreign direct investment have traditionally emphasised market imperfection (Hymer, 1960; Kindleberger, 1969), location specific advantage (Franko, 1971; Vernon, 1977), internalization theory (Buckley and Casson, 1976), and transaction cost theory (Williamson, 1975 and 1979; Buckley and Casson, 1976; Caves, 1982; Anderson and Gatignon, 1986). Dunning's (1988) "eclectic paradigm" denoted that a firm's FDI decision is influenced by three types of factors: ownership-specific factors of a firm, location-specific factors of a market and internalization advantages of integrating transactions within the firm. Taggart (1993) suggested that the three main divisions of FDI theory (three-division theory), via approaches based on domestic market imperfections, firm specific advantages, and location specific advantages were generally more appropriate reasons for explaining why multinational pharmaceutical firms invest abroad. Location specific advantages including market size, stage of economic development, host country's incentive policies, labour cost considerations, trade barriers, openness of the economy, etc. have recently attracted considerable research attention in explaining why FDI occurs in China. Zhang and Yuk (1998) asserted that FDI pattern in China is most likely to be determined by the location specific advantages.

2.1 Market Size

A number of studies (Kwack, 1972; Ahmed, 1979; Agarwal, 1980, OECD, 1983) revealed that foremost among the determinants of inwards FDI is the attractiveness of the market. Tesai's (1994) study showed that market size is one of the key determinants of FDI, though economic growth and labour cost are also important. Milner & Pentecost (1996) also noted that for a given location if it had advantages of a large market size it would expect more inward investment. Broadman and Sun (1997) claimed that the size of China's market explains, in large part, the massive FDI flows it has attracted since 1980s. A number of studies reported that China's market size and growth played an important role in attracting FDI inflows into the country (Kueh, 1992; Lardy, 1995; Wang and Swain, 1995, 1997; ODI, 1997; Fittock and Edwards, 1998; Wu, 1999; Yan, 2000), and it is particularly true when foreign investors with new technology and new management and marketing skills were primarily attracted by China's huge potential domestic market and geared mainly towards long-term strategic considerations (Li and Li, 1999). However, Wu, (1999) argued that large size and low labour cost are not unique to China, India, for example, is also a large nation and cheap labour is also accessible in other developing countries.

2.2 Incentive Policy

The Chinese government frequently encourages FDI by offering incentives for foreign investment including tax concessions, etc. Most of the empirical evidences (Hartman, 1984; Boskin and Gale, 1987; Newlon, 1987; Slemrod, 1990) revealed that specific incentives such as lower tax have no major impact on FDI decisions. However, to take advantage of investment incentives offered by the Chinese Government to foreign investors is one of the aims of Hong Kong's investors in Mainland China (NRI and ISAS, 1995; Zhang and Yuk, 1998). Li and Li (1999) also suggested that the tax incentives and preferential policies in China form an attraction for foreign investors.

2.3 Low Labour Cost

Cheap labour used to be cited as the key factor attracting manufacturing operations to China (Broadman and Sun, 1997). Empirical research also found relative low labour costs to be statistically significant, particularly for foreign investment in labour-intensive industries and for export-oriented subsidiaries (ODI, 1997). The benefits being sought by Taiwanese small and medium sized companies who had FDI in China were abundant labour supply and low production cost (Wei and Christodoulou, 1997). The decision to invest in China for Hong Kong investors was heavily influenced by the prevailing low wage rate. The cost factor--lower labour and capital costs, lower rent and land prices--therefore was the dominant motivation of Hong Kong investment in Mainland China (NRI and ISAS, 1995). Zhang and Yuk's (1998) study also confirmed that cheap labour was one of the important determinants of Hong Kong manufacturing investment in China. Foreign investors who made investments in labour intensive production geared towards export were mainly aiming for China's cheap labour cost (Li and Li, 1999).

2.4 Openness of Host Economy

While access to specific markets, judged by their size, growth rate, etc. is important, host country's domestic market factors are predictably much less relevant to export-oriented foreign firms (ODI, 1997). A range of surveys indicated a widespread perception that 'open' economies encourage more foreign investment. One of the indicators of openness is the relative size of the export sector. Singh and Jun (1995) suggested that exports, particularly manufacturing exports, are a significant determinant of FDI flows and that tests show that there is strong evidence that exports precede FDI flows. China, in particular, has attracted much foreign investment into its export sector.

2.5 Other Variables

For a variety of political reasons--mainly to "protect" home industry owners, managers, and employees, but sometimes on ostensibly national security grounds--governments do erect barriers to international commerce. The most notable are tariffs, quotas, domestic content restrictions, and reciprocity rules. In a 1991 survey, 45% of U.S. firms reported that trade barriers imposed by other countries presented the greatest impediment to selling abroad. US companies, therefore, were circumventing trade barriers by establishing plants in other countries, buying local companies and setting up joint ventures with local producers (Weidenbaum and James Jr, 1993). The infrastructure of a host country may be an important element in attracting FDI inflows. ODI (1997) reported that the extent of transport facilities and the proximity to major ports as having a significant positive effect on the location of FDI within the country. In the case of European companies' investment in China, most German companies believed that their investment strategies were part of their corporate re-engineering and restructuring thrusts (Lipman, 1994). Wei & Christodoulou's (1997) study suggested that that language and culture similarities played important roles on Taiwan manufacturing companies' FDI in Mainland China.

Earlier research paid much attention to the FDIs between developed countries such as USA and European countries. Most of the recent studies have focused on location specific factors of the host country and research interests have shifted towards FDI flows from developed countries such as US or European countries to developing countries like China. However, the theories of FDI are still incomplete in their application to China's recent experience, especially in the context of international pharmaceutical firms' FDI in the Chinese pharmaceutical manufacturing industry. China is a complex society, by virtue of its deeply embedded and multi-layered cultural heritage, its long history, its diverse social and political development, and its vast geographical scale which encompasses both national common characteristics and strong local identities, traditions, and so on (Li and Li, 1999). Therefore, this study took an exploratory approach to investigate the determining factors that drove international pharmaceutical firms' FDI into China.

3. RESEARCH METHOD

3.1 Population Definition

A total of 117 international-pharmaceutical-firm-invested pharmaceutical companies (IPFIPCs) in Mainland China were defined as the population for the research based on the following four sources: 1) Catalogue of Chinese Pharmaceutical Enterprises with Foreign Investment which was published by the China Centre for Pharmaceutical International Exchange, an agency of State Pharmaceutical Administration of China. It contains necessary information on over 1,310 FIPCs in China (CCPIE, 1995); 2) Market Reports of National Trade Data Bank of the United States of America (NTDB, 1996); 3) MIMS Asia (1998); 4) The report of Shanghai Pharmaceutical (Group) Corporation (SPGC, 1999). Pharmaceutical companies that had capital investment by non-pharmaceutical firms such as business trading companies, investment development firms, etc. Medical devices or machinery manufacturers that were historically classified as part of pharmaceutical industry in China were not defined as part of the population for this research.

3.2 Sample Size

Over 84% of IPFIPCs were located in east China's 13 provinces and municipalities including Hainan, Guangdong, Fujian, Zhejiang, Shanghai, Jiangsu, Anhui, Shangdong, Hebei, Tianjin, Beijing, Liaoning and Hellongjiang. Less than 16% of IPFIPCs were distributed in China's middle and west areas. A total of 98 IPFIPCs that were distributed in the three major regions in east China and accounted for 83.76% of the population were defined as the sample size for this research. These IPFIPCs in the sample include 29 in South East Region (SER), 38 in Middle East Region (MER) and 31 in North East Region (NER). The SER comprises of Guangdong and Fujian provinces. The MER covers Shanghai municipality, Jiangsu, Anhui and Zhejiang provinces. The NER consists of Beijing and Tianjin municipalities, Liaoning, Shandong and Hebei provinces.

3.3 Data Collection

A questionnaire was designed with both English and Chinese versions and was pretested with six pretesting respondents for the data collection. The research fieldwork was mainly conducted in China between early April and late June in 1999. The data was collected mainly through personal interviews, and a mail questionnaire survey was also adopted as a complementary method. Personal interviews were conducted with senior executives of foreign business partners in IPFIPCs in China, and the posted questionnaires were addressed to foreign general managers/representatives in IPFIPCs in China. In total 44 companies participated in this research, and 82% of answered questionnaires were obtained through personal interviews. Of the 44 responding IPFIPCs, 43 firms provided useful data for the research question. These include 21 IPFIPCs that had investment by eastern pharmaceutical firms including 4 Japanese and 17 Non-Japanese Asian pharmaceutical firms, and 22 IPFIPCs had western firms' investment including 13 from USA and 9 from European countries or regions. In the sample, 3 companies including 2 in Guangdong and 1 in Jiangsu were found to have ceased operations during the fieldwork. Also 1 company in Guangdong had the foreign partner's share sold to its Chinese partner before this survey was conducted. Therefore the real sample size was reduced from an estimated 98 to 94 IPFIPCs, which means that a 45.74% response rate was achieved.

4. DATA ANALYSIS AND RESULTS

Respondents were asked to describe why their parent firms made FDI decisions to invest in China. The responses were scanned many times in the way prescribed by Walsh, Wang and Xin (1999) and summarized and grouped into ten major categories (factors). These ten major categories include China's market size with great potential (for phaemaceutical products), rapid economic development and growth, relatively stable political conditions, low cost of establishment of plant and facility, incentive policies, low labour cost in China, traditional contacts and linkages, similar culture and language, China's open-door policy and continuation of previous business. The descriptive analysis was firstly carried out to summarize the frequency percentages for each factor considered by foreign firms with respect to their FDI decision into China. The results of descriptive analysis are depicted in FIGURE 2 and indicate that over 97% of respondents described China's market size, with its great potential, as the most important determinant of their firms' FDI in China. Over two thirds believed that rapid economic development and growth in China was one of the dominant factors in their foreign investment decisions. The influence of China's open-door policy was ranked in the third position, and about one third of respondents considered that relatively stable political conditions in China also played an important role. Slightly less than a quarter of companies regarded the incentive policies provided by China as an important factor. Only 7% of the responses believed that low cost of establishment of plant and facility, and low labour cost were considered as important factors on their parent firms' FDI in China. Less than 5% of the international pharmaceutical firms took the factors of traditional contacts and linkage, similar culture and language, and continuation of previous business into account when making their FDI decision into China. The primary concerns of the ten factors were strongly associated with China's political, economic, social and culture conditions. The first two most important factors including China's market size with great potential and rapid economic development and growth are connected with China's market and economic conditions, and the second two most important factors including China's open-door policy and stable political conditions concern the government's policy and influence on the business and economic activities. The former seemed to be more important than the later to foreign investors' FDI decision.

The second level of analyses using both phi coefficient test and simple logistic regression to investigate whether or not there are any significant relationships or associations, and the strength and directions of the relationships or associations between the importance of determinant factors and investing firm's country of origin. The results of phi coefficient test and simple logistic regression are presented in TABLE 2 and suggest that there was a significant negative relationship between the variable of relative stable political conditions and parent firm's country of origin ([phi]=-0.3810; p=.0125). This can be interpreted as Western-Firms viewed China's open-door policy as more important than eastern firms. A significant positive relationship was found between the variable of incentive policies provided by China and parent firm's home country of origin ([phi]=0.4533; p=0.0030). Eastern-Firms considered China's incentive policies as an important factor with respect to their FDI decision to invest in China. Phi test also suggested a marginally significant positive relationship between the factor of low labour cost in China and parent firm's country of origin ([phi]=0.2803; p=.0660). Most of the firms who viewed China's low labour cost as an important factor were eastern investors in the sample. The results revealed from Phi coefficient test and simple logistics regression were fairly consistent.

5. CONCLUSION AND DISCUSSION

This research suggested that international pharmaceutical firms' FDI into China was determined by China's location specific factors or advantages. This finding partially supported Taggart's (1973) three-division theory on multinational pharmaceutical firms' FDI activities. The research revealed that four factors namely China's market size with its great potential, rapid economic development and growth, China's open door policy and relatively stable political conditions have been the major motivations in attracting international pharmaceutical firms' direct investment into the Chinese pharmaceutical manufacturing industry during the period from 1980 to 1998. Incentive policies provided by China, cheap labour and social-cultural factors tended to be less important to international pharmaceutical firms' FDI decision into China. Steady GDP growth, increase of income per capita, consistent increase of per capita annual expenditure on medicine and medical service together with over 1.2 billion people make the factor of China's market size with its great potential the most important motivation among the four major factors.

The impact of relatively stable political conditions in China on western pharmaceutical firms' FDI decision into China was significantly greater than that on eastern firms'. Incentive policies provided by China, and low labour cost in China received more attention from Eastern-Firms. Zhang and Yuk's (1998) study also revealed a similar result. However, both eastern and western firms were unlikely to consider China's low labour cost as an important factor to their decision to invest in China. The pharmaceutical industry is a more technology and capital-intensive industry, cheap labour therefore would not have a significant effect on international pharmaceutical firms' FDI decision into China. This finding is consistent with Li and Li's 1999 study on foreign investment in China.

The findings of this research are only applicable for explaining FDI behaviours in international pharmaceutical firms' FDI into the Chinese pharmaceutical industry. Most of the foreign invested pharmaceutical companies in China are firms who had investment by international non-pharmaceutical firms. Therefore, further research on FDI of international non-pharmaceutical firms' and a comparison of determinants between pharmaceutical and non-pharmaceutical firms' FDI in the pharmaceutical industry would be expedient and meaningful. Also future research studies may also extend to other industries rather than just the pharmaceutical industry, as international investors have also been actively engaging in other industries in China.

TABLE 1: SOURCE OF FDI INTO CHINA (1978~1998)

                                     Total FDI Inflows
Countries/Regions                    (US$ Billion)       %

Asian/developing countries/regions   195.029              73.44

  Hong Kong                          143.125              53.89
  Taiwan                              20.356               7.66
  Singapore                           12.675               4.77
  South Korea                          8.337               3.14
  Thailand                             1.791               0.67
  Others                               8.746               3.29

Western/Developed Countries           70.550              26.56

  Japan                               21.332               8.03
  United States                       21.012               7.91
  United Kingdom                       6.903               2.60
  Germany                              4.112               1.55
  France                               2.416               0.91
  Canada                               2.085               0.79
  Netherlands                          1.632               0.61
  Others                              11.067               4.17

Total                                265.580             100.00

Source: Figures attracted from SSBPRC, 1988~1999

TABLE1 2: PHI COEFFICIENT TEST BY EXPLORATORY VARIABLES
DEPENDENT VARIABLE: COUNTRY ORIGIN (EASTERN FIRMS VS. WESTERN FIRMS)

                                                Simple Logistic
                                                Regression

Variables                                        [beta]    Sig.

China's market size with great potential         7.2017   .8443
Rapid economic development and growth            -.9361   .1644
China's open-door policy                          .0800   .8970
Relatively stable political                      -1.792   .0177 *
Low cost of establishment of plant & facility    -.6930   .5838
Incentive policies provided by China             2.7568   .0134 **
Low labour cost in China                         8.4031   .8097
Traditional contacts & linkage                   7.3483   .7768
Similar culture & language                       7.3483   .7768
Continuation of previous business               -7.2017   .8443

                                                   Phi Test

                                           Coefficient
Variables                                    ([phi])       Sig.

China's market size with great potential    .1507        .3229
Rapid economic development and growth      -.2147        .1591
China's open-door policy                    .0197        .8970
Relatively stable political                -.3810        .0125 *
Low cost of establishment of plant &
  facility                                 -.0849        .5775
Incentive policies provided by China        .4533        .0030 *
Low labour cost in China                    .2803        .0660
                                                           ([dagger])
Traditional contacts & linkage              .2261        .1382
Similar culture & language                  .2261        .1382
Continuation of previous business          -.1508        .3229

([dagger]): p < .10; *: p < .05; **: p < .01; ***; p < .001

FIGURE 1: FREQUENCY DESCRIPTIVE FOR EXPLORATORY VARIABLES
(FDI DETERMINANTS)

Factors (Variables)                               Frequency (%)

China's market size with great potential          97.7
Rapid economic development and growth             67.4
China's open-door policy                          41.9
Relatively stable political conditions            32.6
Incentive policies provided by China              23.3
Low labour cost in China                          7
Low cost of establishment of plant and facility   7
Traditional contacts and linkage                  4.7
Similar culture and language                      4.7
Continuation of previous business                 2.3

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Dr. Jiang Fuming earned his Ph.D in The Australian Graduate School of Entrepreneurship at Swinburne University of Technology, Australia in 2002. Currently he is a lecturer in International Business/Marketing and Strategic Management in the School of Business and course convener/coordinator in the Faculty of Commerce at Charles Sturt University, Australia.