This paper uses the prevailing approaches found in the literature examining the foreign ownership structure of FIEs in China with an emphasis of Chinese firms seeking to form alliances with foreign firms.6 Our interest revolves around the institutional environment for local firms and is premised on the idea that the relevant host-country factors for examining foreign ownership question go well beyond the traditional focus on FDI policies and political risks.Each FDI project requires contributions from both foreign and local firms.In view of analytical tractability,we have chosen firms-joint ventures-that have explicit contributions from local firms.?The prevailing approach in studies of ownership structure of FDI projects is to view the equity structures as an outcome of bargaining between foreign and host firms(or host governments).Bargaining,in turn, is treated as a function of the preferences for forming alliances and the capabilities to make resource contributions to the alliances on the parts of foreign and host firms.8 We adopt the same approach here,except for the fact that we pay closer attention to those factors that affect the preferences/capabilities of local firms. Approaching the foreign ownership question from a local perspective leads us naturally to a consideration of some of the institutional factors that have been featured prominently in the 6 It is explicitly acknowledged in previous studies that the capabilities and resources of local firms affect the ownership structures of FDI projects.For example,Asiedu and Esfahani(2001)incorporate several measures of local resource contributions.However,these variables are not critical in their conceptual framework. 7 This framework applies equally to wholly-owned foreign subsidiaries which do not have explicit contributions from local firms.We then want to determine the host-country factors that reduce the local contributions to zero. s The theoretical underpinning that links these industrial characteristics with bargaining power dynamics is the transaction cost framework.Theoretical literature includes Sveinar and Smith (1984),Hennart (1988)and Kogut (1988).For empirical applications,see Krobin(1987),Gomes-Casseres(1990)and Asiedu and Esfahani(2001). 6
6 This paper uses the prevailing approaches found in the literature examining the foreign ownership structure of FIEs in China with an emphasis of Chinese firms seeking to form alliances with foreign firms. 6 Our interest revolves around the institutional environment for local firms and is premised on the idea that the relevant host-country factors for examining foreign ownership question go well beyond the traditional focus on FDI policies and political risks. Each FDI project requires contributions from both foreign and local firms. In view of analytical tractability, we have chosen firms—joint ventures—that have explicit contributions from local firms.7 The prevailing approach in studies of ownership structure of FDI projects is to view the equity structures as an outcome of bargaining between foreign and host firms (or host governments). Bargaining, in turn, is treated as a function of the preferences for forming alliances and the capabilities to make resource contributions to the alliances on the parts of foreign and host firms. 8 We adopt the same approach here, except for the fact that we pay closer attention to those factors that affect the preferences/capabilities of local firms. Approaching the foreign ownership question from a local perspective leads us naturally to a consideration of some of the institutional factors that have been featured prominently in the 6 It is explicitly acknowledged in previous studies that the capabilities and resources of local firms affect the ownership structures of FDI projects. For example, Asiedu and Esfahani (2001) incorporate several measures of local resource contributions. However, these variables are not critical in their conceptual framework. 7 This framework applies equally to wholly-owned foreign subsidiaries which do not have explicit contributions from local firms. We then want to determine the host-country factors that reduce the local contributions to zero. 8 The theoretical underpinning that links these industrial characteristics with bargaining power dynamics is the transaction cost framework. Theoretical literature includes Svejnar and Smith (1984), Hennart (1988) and Kogut (1988). For empirical applications, see Krobin (1987), Gomes-Casseres (1990) and Asiedu and Esfahani (2001)
more recent studies of FDI flows but have so far not been extended to the analysis of ownership structure.Many of the institutional studies of FDI have focused on FDI flows rather than on foreign ownership of existing FDI projects.These two questions may be related to each other but are sufficiently distinct to warrant separate approaches.We believe that incorporating institutions into the analysis of foreign ownership is a contribution to the FDI literature We use a unique dataset containing over 2,000 joint ventures located in Jiangsu and Zhejaing to get at the two central questions in this paper.First,how do institutions affect the ownership structures of FDI projects?Second,how does one potential mechanism-the domestic firms as joint-venture partners-illuminate the institutional determinants of the ownership structures of FDI projects?Using the bargaining framework,we set out to test the hypothesis that an institutional environment more nurturing of domestic private firms is associated with greater bargaining power-arising from weaker FDI preferences or stronger capabilities-of Chinese joint-venture partners and,all else being equal,greater Chinese Note the underlying presumption in such an analysis.Our paper presumes that a country's institutional environment,first and foremost,affects the host firms anchored there and that the institutional environment affects the ownership structures of FDI projects via its primary effect on the capabilities and resource constraints of local firms. 1The most detailed institutional analysis is on the connections between corruption and FDI(Wheeler and Mody, 1992:Wei.2000:Hellman et al.,2002).. For example,one can envision a scenario in which foreign investors invest in many projects but only retain small equity interests in each project,and a contrasting scenario in which foreign investors invest in one single project but retain all the equity interests in it.The relationship between FDI flows and foreign ownership would differ between these two scenarios. 7
7 more recent studies of FDI flows but have so far not been extended to the analysis of ownership structure.9 Many of the institutional studies of FDI have focused on FDI flows rather than on foreign ownership of existing FDI projects. 10 These two questions may be related to each other but are sufficiently distinct to warrant separate approaches.11 We believe that incorporating institutions into the analysis of foreign ownership is a contribution to the FDI literature. We use a unique dataset containing over 2,000 joint ventures located in Jiangsu and Zhejaing to get at the two central questions in this paper. First, how do institutions affect the ownership structures of FDI projects? Second, how does one potential mechanism—the domestic firms as joint-venture partners—illuminate the institutional determinants of the ownership structures of FDI projects? Using the bargaining framework, we set out to test the hypothesis that an institutional environment more nurturing of domestic private firms is associated with greater bargaining power—arising from weaker FDI preferences or stronger capabilities—of Chinese joint-venture partners and, all else being equal, greater Chinese 9 Note the underlying presumption in such an analysis. Our paper presumes that a country’s institutional environment, first and foremost, affects the host firms anchored there and that the institutional environment affects the ownership structures of FDI projects via its primary effect on the capabilities and resource constraints of local firms. 10 The most detailed institutional analysis is on the connections between corruption and FDI (Wheeler and Mody, 1992; Wei, 2000; Hellman et al., 2002). . 11 For example, one can envision a scenario in which foreign investors invest in many projects but only retain small equity interests in each project, and a contrasting scenario in which foreign investors invest in one single project but retain all the equity interests in it. The relationship between FDI flows and foreign ownership would differ between these two scenarios
bargaining power may lead to a decrease of share of foreign ownership of production assets in joint ventures. We choose to focus on Jiangsu and Zhejiang for both methodological and substantive reasons.First,we impose some implicit restrictions on the supply side of FDI.After satisfying a number of our criteria,most of the surviving joint ventures in these two provinces turn out to be quite small.This characteristic,together with the availability of the detailed industrial classifications,reduces the variance of prominent FDI supply variables such as market positioning of firms,intangible assets,and R&D capabilities.Second,we ensure to maximize the variation on the demand side.These two provinces exhibit substantial-and well-documented- variation in the institutional environments for domestic private firms.This makes it easier for us to examine the institutional determinants of the ownership structures of FDI projects.During the studied period,the two provinces pursued very different policies towards domestic private sector, with Jiangsu imposing financials and legal constraints on domestic private firms and Zhejiang adopting a more supportive policy.The contrast between these two provinces has long been familiar to Chinese scholars (although far less to foreign scholars),but our paper is among the first to systematically explore the effect on FDI caused by the difference in their policies towards domestic private sector These two provinces make as ideal a natural experiment as one can find.Both provinces started out in the early 1980s with similar levels of economic and social development and with a similar domestic private sector size.Both are open to foreign trade and FDI and have a long history of entrepreneurship.Their geographic conditions are almost identical.Both are coastal provinces and are located next to each other.The substantial similarities between these two provinces in many respects and their well-documented policy differences furnish us with a 6
8 bargaining power may lead to a decrease of share of foreign ownership of production assets in joint ventures. We choose to focus on Jiangsu and Zhejiang for both methodological and substantive reasons. First, we impose some implicit restrictions on the supply side of FDI. After satisfying a number of our criteria, most of the surviving joint ventures in these two provinces turn out to be quite small. This characteristic, together with the availability of the detailed industrial classifications, reduces the variance of prominent FDI supply variables such as market positioning of firms, intangible assets, and R&D capabilities. Second, we ensure to maximize the variation on the demand side. These two provinces exhibit substantial—and well-documented— variation in the institutional environments for domestic private firms. This makes it easier for us to examine the institutional determinants of the ownership structures of FDI projects. During the studied period, the two provinces pursued very different policies towards domestic private sector, with Jiangsu imposing financials and legal constraints on domestic private firms and Zhejiang adopting a more supportive policy. The contrast between these two provinces has long been familiar to Chinese scholars (although far less to foreign scholars), but our paper is among the first to systematically explore the effect on FDI caused by the difference in their policies towards domestic private sector. These two provinces make as ideal a natural experiment as one can find. Both provinces started out in the early 1980s with similar levels of economic and social development and with a similar domestic private sector size. Both are open to foreign trade and FDI and have a long history of entrepreneurship. Their geographic conditions are almost identical. Both are coastal provinces and are located next to each other. The substantial similarities between these two provinces in many respects and their well-documented policy differences furnish us with a
solution to a nagging problem in research on this topic-how to precisely measure the institutional environment for domestic private firms. This paper is organized as follows.It begins by our tale of the two provinces to show how the institutional environment for private sector differs from each other.In the second section,we formulate four hypotheses about the institutional determinants of the equity structures of FDI projects.The third section explains the dataset and the construction of the variables and describes the findings from the statistical analysis.The last section is devoted to concluding remarks. 2.A tale of two provinces It is well recognised in the studies of Chinese economy that there is considerable institutional heterogeneity at the regional level in China.The Chinese reforms are often described as"federalism,Chinese style"following a prominent formulation of the Chinese reform model in which local governments are endowed with substantial discretion in economic decision making(Qian 1999).Our two provinces are good illustrations of"federalism,Chinese style".In the 1980s and up to the mid-1990s,Jiangsu imposed more stringent legal and financial constraints on private sector than Zhejiang did.This well-documented difference between the two provinces allows us to test the effect of the institutional environment on the ownership structures of foreign affiliates in China. 2.1.Profiles of Jiangsu and Zhejiang Table 1 presents some basic statistics about the two provinces.In terms of geographic location,both provinces are located on the eastern coast of China.Jiangsu is larger in terms of 9
9 solution to a nagging problem in research on this topic—how to precisely measure the institutional environment for domestic private firms. This paper is organized as follows. It begins by our tale of the two provinces to show how the institutional environment for private sector differs from each other. In the second section, we formulate four hypotheses about the institutional determinants of the equity structures of FDI projects. The third section explains the dataset and the construction of the variables and describes the findings from the statistical analysis. The last section is devoted to concluding remarks. 2. A tale of two provinces It is well recognised in the studies of Chinese economy that there is considerable institutional heterogeneity at the regional level in China. The Chinese reforms are often described as “federalism, Chinese style” following a prominent formulation of the Chinese reform model in which local governments are endowed with substantial discretion in economic decision making (Qian 1999). Our two provinces are good illustrations of “federalism, Chinese style”. In the 1980s and up to the mid-1990s, Jiangsu imposed more stringent legal and financial constraints on private sector than Zhejiang did. This well-documented difference between the two provinces allows us to test the effect of the institutional environment on the ownership structures of foreign affiliates in China. 2.1. Profiles of Jiangsu and Zhejiang Table 1 presents some basic statistics about the two provinces. In terms of geographic location, both provinces are located on the eastern coast of China. Jiangsu is larger in terms of
population,size of areas,and GDP.In 2001,Jiangsu had a population of 74 millions,compared with the 46 millions in Zhejiang.Jiangsu's GDP reached RMB 951.2 billions (approx.US$115 billions by then),compared with Zhejiang's RMB 674.5 billions(approx.US$81.3 billions). Both provinces are far more affluent than the rest of China.In 2001,the GDP per capita of the two provinces exceeded RMB 12,000,while the national average of GDP per capita stood at RMB7,543. As a whole,both provinces did quite well during the reform era,but Zhejiang,the initially poorer and less well endowed of the two,clearly had an outstanding performance During the reform,its progress of growth was faster and by 2001 it became richer than Jiangsu. Between 1978 and 1995,real GDP grew by 14 percent per annum in Zhejiang but only 12.9 percent in Jiangsu.In 2001,the per capita GDP of Jiangsu was RMB 12,922;that of Zhejiang RMB 14,655.The external sector of Zhejiang's economy also outperformed that of Jiangsu. Starting on a smaller share of foreign trade in GDP,Zhejiang grew much faster in export, averaging 27.9 percent annually between 1978 and 1995,compared with only 9.3 percent in Jiangsu.In 2001,the size of industry and foreign trade was almost identical in the two economies. [Insert Table 1 here] 2.2.Two contrasting development models One of the substantial differences between the two provinces is brought about by the status of domestic private sector development in China.In 1980,the size of the domestic private sector-non-state-owned sector minus collective firms,such as township and village enterprises 10
10 population, size of areas, and GDP. In 2001, Jiangsu had a population of 74 millions, compared with the 46 millions in Zhejiang. Jiangsu’s GDP reached RMB 951.2 billions (approx. US$ 115 billions by then), compared with Zhejiang’s RMB 674.5 billions (approx. US$ 81.3 billions). Both provinces are far more affluent than the rest of China. In 2001, the GDP per capita of the two provinces exceeded RMB 12,000, while the national average of GDP per capita stood at RMB 7,543. As a whole, both provinces did quite well during the reform era, but Zhejiang, the initially poorer and less well endowed of the two, clearly had an outstanding performance. During the reform, its progress of growth was faster and by 2001 it became richer than Jiangsu. Between 1978 and 1995, real GDP grew by 14 percent per annum in Zhejiang but only 12.9 percent in Jiangsu. In 2001, the per capita GDP of Jiangsu was RMB 12,922; that of Zhejiang RMB 14,655. The external sector of Zhejiang’s economy also outperformed that of Jiangsu. Starting on a smaller share of foreign trade in GDP, Zhejiang grew much faster in export, averaging 27.9 percent annually between 1978 and 1995, compared with only 9.3 percent in Jiangsu. In 2001, the size of industry and foreign trade was almost identical in the two economies. [Insert Table 1 here] 2.2. Two contrasting development models One of the substantial differences between the two provinces is brought about by the status of domestic private sector development in China. In 1980, the size of the domestic private sector—non-state-owned sector minus collective firms, such as township and village enterprises