Editor's note: The Chinese mainland has become one of the world's most popular investment destinations, as its economy continues to open and becomes increasingly market-oriented. With this, overseas investment is playing an increasingly pivotal role in determining the nation's economic progress. The Chinese Academy of International Trade and Economic Co-operation, a think-tank of the Ministry of Commerce, recently completed a report on overseas investment trends from 2005 to 2007 after six months of research in order to gain an insight into trends related to foreign direct investment (FDI) in China, as well as local investment policies.

More investment expected

The report mainly covers multinationals listed in the Business Week Top 1,000, from Europe, the Americas, Japan, South Korea and China's Hong Kong Special Administrative Region and Taiwan Province, representing the information technology, automobile, chemical, biology and pharmaceutical industries.

The Chinese mainland is set to welcome even more overseas investment in the years to come, with 82 per cent of the multinationals surveyed indicating that they will boost their spending. Their production, sales and technological development are growing gradually along with this increased investment.

Around 35 per cent of multinationals say they are at the stage of consolidating their investments in the Chinese mainland.

Initially, multinationals normally form joint ventures with local partners but only hold a token stake. This is in order to gain the right to do business in China.

When multinationals reach the consolidation stage, they increase their stakes by taking advantage of their competitive edge in terms of capital, networks and information. This will normally see an increase in investment in real terms, which will see multinationals either take a controlling stake or take absolute control of the venture at a later date.

Although multinationals reap dividends from their investment at this stage, they have to re-invest heavily in order to adopt to the mainland market and strengthen their global strategy.

This will usher in a new investment boom in the Chinese mainland and offer local governments opportunities to attract more overseas capital.

Several tendencies will be displayed over the next three years in terms of investment by multinationals at the consolidation stage:

First, a sustained technological edge. While accelerating the shift of primary industries to the Chinese mainland, high-end products and technological development will be retained in their home countries, with investment in manufacturing continuing to rise.

Second, multinationals will increase their investment in sales and after-sales services in order to sharpen their competitive edge. Some regions have already welcomed significant amounts of this investment and the demand for services is soaring.

Third, some manufacturing giants will speed up their transfer of technology to China, after transferring assembly procedures to the nation. For example, some software and system integration giants have realized that China has a huge pool of potential talent and have started to shift application-oriented research projects to the Chinese mainland to cultivate local technological and management skills.

Size matters

The key to the expansion of multinationals' investment is their market scale and the high growth of the Chinese mainland's industries, with IT and automobiles being two typical examples.

The mainland IT market accounted for 30.8 per cent of the Asian market (excluding Japan) in 2003, with this share expected to reach 38 per cent as the sector's growth rate continues to outstrip the global IT industry's average.

The mainland's car production will hit 8.5 million units in 2005, up 30 per cent year-on-year. The size and growth rate of the two industries have become key factors influencing multinationals' investment strategies in the Chinese mainland.

Policies, effective industrial chains and labour costs will also be major factors determining multinationals' investment in the coming three years.

China is set to open up its market to an unprecedented extent and has created many new opportunities for overseas investment in this period, thanks to the government's fulfilment of its pledges made upon joining the World Trade Organization (WTO) in 2002.

Many multinationals say they will establish product retail terminals as the mainland frees up the commercial distribution sector.

This would stimulate growth of investment from distribution enterprises.

The concentration of a certain industry in one region has attracted more suppliers and manufacturers in the industry chain to enter the market.

The integration of upper- and lower-reach industries enables manufacturing enterprises to consolidate their operations in the mainland more effectively, and increases the appeal of the mainland market to multinationals.

Labour costs in the Chinese mainland are also an attractive factor for overseas investors, being around the same level as India and less than one-third of Brazil and Mexico.

More R&D expenditure

The next three years will see most multinationals in China -- 61 per cent -- increasing their R&D spending. The trend has the following characteristics:

First, most multinationals will retain their core R&D functions in their home countries, although some will be transferred overseas.

Second, the approach of R&D investment is shifting from technological alliance towards international mergers and acquisitions.

Third, multinationals' R&D in the Chinese mainland mainly focuses on the local application of their products, rather than on elementary studies. Such fundamental research and development requires more skilled professionals and is critical to companies' future development. Multinationals are reluctant to move basic R&D outside their home countries, also for the fact that it is easy to keep the secrets in their headquarters.

Overseas companies had established 700 R&D centres in the Chinese mainland by the end of last year, according to statistics from the Ministry of Commerce.

The modes of setting up these R&D centres differ to some extent, with 46 per cent of the multinationals saying they would like to set up independent research facilities, while 24 per cent say they will work with local partners to develop technologies. Some 33 per cent of these big companies say they will introduce more R&D projects to China for local development and 33 per cent will increase their R&D staff in China.

Sole ownership favoured

The survey reveals that 57 per cent of multinationals prefer to establish solely-funded manufacturing facilities in the Chinese mainland, while 37 per cent say they are willing to co-operate with local enterprises, 28 per cent said mergers with and acquisitions of local companies cannot be ruled out.

Overseas companies entering the Chinese mainland generally used to establish joint ventures with local firms in order to circumvent the policy restrictions imposed on foreign investors in many Chinese industries.

The government revised its WFOE (wholly foreign-owned enterprise) Implementation Regulations in 2001 before its accession to the WTO.

The revised WFOE rules now provide that "the establishment of WFOEs must benefit the national economy" and that China "encourages the establishment of technologically advanced WFOEs."

Before the revision, the rule stated that WFOE applications would only be approved if the WFOE committed itself to using advanced technology or annually exported at least 50 per cent of its products.

The government lifted restrictions in many industries, especially the service sector, after the nation joined the WTO.

Overseas companies have obtained a better understanding of mainland markets through their long-term participation.

Bigger say for overseas HQs

The survey finds that large-scale production investment is decided by multinationals' overseas headquarters or their Asia-Pacific headquarters.

The mainland headquarters decide investment in local R&D and sales.

The overseas headquarters will decide what kind of products should be manufactured in China according to the firm's global strategy.

Based on that, the local company in the mainland will decide the production capacity and total investment. The local company is also responsible for choosing investment destinations, government relations and human resources.

The mainland operations of software and pharmaceutical companies, in which R&D has a more important role, generally have less power.

As a result, the report says local investment promotion departments should keep contact with multinationals' overseas headquarters and deliver more information to their investment planning departments.

So far, 30 multinationals have established their regional headquarters in the Chinese mainland.

Vital to keep promises

The Yangtze River Delta will be the most popular investment destination for multinationals over the next three years, with 47 per cent indicating that they will invest in this region.

It is followed by the Bohai Economic Rim, including Shandong, Shanxi, and Hebei provinces, and Beijing and Tianjin municipalities, with 22 per cent saying they plan to invest in this area.

While the Pearl River Delta, which was previously the most popular investment destination, comes third, with 21 per cent of multinationals opting to invest there.

Northeast China and western and central China are still at the bottom of the list, with 9 per cent and 8 per cent of the multinationals favouring them, despite the government's move to promote investment in the two regions.

Meanwhile, 92 per cent of the multinationals say they will invest in development zones.

According to the report, both the stability of investment promotion policies and how many of them can be practically applied are major issues for multinationals when they choose investment destinations in the mainland.

The efficiency and transparency of the local governments is also a factor.

Local governments have a major influence in the mainland's economic development. Local governments fiercely compete with each other in attracting foreign direct investment, offering all kinds of favourable policies in terms of land use and income tax.

But the multinationals often have concerns about whether these promises can be kept because of change of local leaders or the adjustment of the central government's macro-economic policy. Sometimes the favourable policies offered by local government are too good to be true.

Almost all the multinationals hope local governments can improve their working efficiency, which should not slow the company's working progress.

They say they want to operate and compete in a fair and stable environment.

Sufficient information key

Most of the multinationals say the cost of obtaining useful information regarding industry, markets, human resources and policies in the Chinese mainland is high.

They also say they have little knowledge about regions outside eastern China.

The survey indicates local governments do not achieve much from their publicity and promotions. Their departments responsible for attracting investment have no clear targets and have bad understanding about how an investment decision is made, which means that their promotions are generally ineffective.

As a result, local governments should take the following steps.

First, they should improve their information delivery to multinationals, including more detail and useful content.

Second, they should gain more knowledge about multinationals' latest investment trends, updating investment promotion policies for their reference.

Third, they should have an idea about the latest features of multinationals' investment and choose the relevant investment.

Fourth, they should have knowledge of how different multinationals run to decide their investment and formulate diversified investment promotion policies.

Fifth, the local government should have a clear picture about the region's advantages and disadvantages in investment attraction and formulate its specific positioning, which enable the governments to improve their work accordingly and improve the supporting environment.

Actual FDI in the Chinese mainland increased moderately by nearly 13 per cent to US$60.6 billion last year.

Total contracted FDI reached US$153.5 billion in 2004, up 33.4 per cent year-on-year.

By the end of last year, nearly 509,000 foreign-funded companies had been set up in China.

The accumulated FDI reached US$562 billion and the contracted investment totalled US$1.1 trillion.