Editor's note: The Chinese Academy of Foreign Trade and Economic Co-operation, a think tank for the Ministry of Commerce, recently published the 2005 Report of Transnational Corporations in China. Following are excerpts:

I. New trends of multinationals' operations in China

China's investment environment has greatly improved since the country joined the World Trade Organization (WTO) in 2001, with the nation bucking the global trend of falling foreign direct investment (FDI). China now is attractive to foreign investors not only in terms of preferential policies, but also thanks to its stable and increasingly transparent investment environment. China is now a competitive manufacturing base as well as a lucrative and promising market. This has made China an important destination for multinational investments.

Annual global FDI dropped from US$1,388 billion to US$560 billion from 2000 to 2003. But over the same period, FDI in China grew steadily from US$40 billion in 2000 to US$53 billion in 2003. Last year, the figure topped US$60 billion.

Since 2001, major multinationals have been adjusting China's position in their global strategies.

New trends were seen during these processes.

Increased investment

Many multinationals have considerably increased their investments in China over the past three years.

Japanese companies are the best example of this trend. Nine major Japanese companies doing business in China have established 200 new enterprises in the nation since 2001.

They now not only regard China as an export base, but also a key market and site for research and development (R&D).

Many other big companies from the United States, Europe and the Republic of Korea have also joined this trend to set up new firms in China.

Putting China in more positions in multinationals' industrial value chain

Multinationals operating in China concentrated on manufacturing in the 1990s.

But intensifying competition among multinationals and also from Chinese companies have prompted foreign firms to extend their value chain in China. For the upstream, they have started to set up R&D centres and key component manufacturing bases; for the downstream, they began to greatly increase their inputs into sectors like sales and logistics.

Between June 2003 and June 2004, foreign companies established 200 R&D centres. By the end of last year, foreign companies had set up more than 750 R&D centres in the country.

Chips are the core components of the electronics industry. Although multinationals' investment in chip projects in China used to be small, this is no longer the case, with investment gradually growing to US$730 million in 2003 from US$91 million in 2000.

Consolidation activities

Multinationals have been adjusting the management structure of their China-based operations. But their methods are somewhat different. Some, such as Japan's Matsushita, put previously independent business units under the umbrella of the company's head office in China. Some, like Finnish company Nokia, merged their manufacturing bases. While others, such as French telecommunications firms Alcatel, grew by acquiring stakes in other IT companies.

But the common thread that binds all of these activities is the creation of group companies where independent ventures had previously operated. At the end of the day, these firms will operate according to a single goal, a single strategy, a single brand and operations co-ordinated by the group. Such practices are expected to significantly improve the multinational firms' overall competitiveness in China.

II. Multinationals' contributions

China has absorbed huge amounts of resources from foreign investment. Since China started its reform and opening in the late 1970s, the country has attracted more than US$550 billion in FDI. Annual FDI currently accounts for 10 per cent of the country's fixed asset investment;

Foreign-funded enterprises' exports and imports both account for more than half of the nation's total; The taxes they pay make up 20 per cent of the total; And they employ about 22 million workers.

On the industrial front, foreign companies' participation has spurred the development of many industries, such as home appliances, packaging and logistics.

On the micro-economic level, Chinese companies have grown thanks to co-operation and competition with foreign firms. Chinese companies have learned many new concepts from multinationals, such as corporate governance and unfair competition.

Multinationals in China also helped change Chinese people's mindset and the structure of Chinese society.

With the development of the modern manufacturing and modern service industries, modern industrial workers and professional managers have become new social forces. Now people have broader perspectives, and they pay more attention to national and global developments. People's values are more pragmatic and diversified.

Foreign companies, especially multinational ones, are an important force in bringing about these changes.

III. China's debates on FDI

There have been discussions and debates among researchers and in the media on problems related to China's introduction of foreign capital.

The major issues of concern are as follows:

Gap between GDP and GNI

Foreign investment has contributed to China's prosperity by driving up growth of gross domestic product (GDP). But the country's gross national income (GNI) has failed to grow at such a rapid rate. This means the country is more prosperous, but not necessarily richer. Some claim that foreign investment is a factor behind this phenomenon.

China's GNI lagged behind its GDP every year between 1993 and 2003. This indicates that a part of the value generated in China - we believe about 100 billion yuan (US$12 billion) every year - did not end up being the income of Chinese nationals. It actually flew out of the country and became the wealth of foreign citizens.

As an increasing number of foreign enterprises have begun to reap profits in China, their earnings from the country will only grow.

We believe the country's GNI being less than its GDP is an unavoidable situation when China is a recipient of huge amounts of foreign investment. But we do not regard this as a cause for concern. The gap between GNI and GDP will narrow as Chinese companies increase their overseas investments and operations.

Multinationals' negative impact on domestic enterprises' technological innovation

Foreign investment has long been regarded as a means of upgrading the nation's technological level. But many Chinese academics and managers now complain that this goal has not been met.

Although many multinationals introduced state-of-the-art technology to their China operations, many Chinese employees cannot get to grip with the core technology.

Chinese enterprises and employees working with foreign companies have not gained much in terms of their research and development capabilities.

Foreign auto makers, for example, are even accused of discouraging research and development activities in their joint ventures in China.

FDI's negative impact on China's technological development can also be attributed to the lack of an institutional framework and policies that support fair and orderly competition in the market. With the rise of domestic companies, this issue has become more pressing.

Multinationals' alleged suppression of competition

Some multinationals were accused of monopolizing the market. Although some of the reports were inaccurate, this issue requires attention.

We should not neglect the fact that some multinationals won their position in the Chinese market after making contributions here.

But as China's business environment becomes increasingly relaxed and multinationals input into the nation's market increases, the ability of these companies to suppress competition will become stronger.

The construction of a mechanism safeguarding a healthy competitive order has emerged as a significant issue. Monopolies should be avoided by introducing new competitors, to protect small competitors to ensure market players compete fairly.

An anti-trust law is necessary. Of course the law will target all monopolistic activities, both by domestic and foreign companies.

Local governments' unreasonable competition for foreign investment

Some local governments offered excessively preferential treatment to foreign investors; some built unnecessary development zones to attract foreign companies and have ended up wasting huge amounts of farmland; and some blindly introduced energy-consuming or pollution-generating projects.

The aim of introducing foreign investments is to promote sustainable development. But the local government officials regard attracting foreign investment purely as a way to show off their performance.

These practices should be rectified.

IV. New approach in dealing with multinationals

We should not limit the scale of foreign capital influx.

We should maintain the stability and continuity of the policy of encouraging foreign investment.

China is not overtly dependent on foreign investment, as indicated by the ratio of foreign investments to GDP and the ratio of foreign investments to total fixed assets investment.

For the first indicator, China is on par with the average level of the developing world. If China's GDP is calculated by Purchasing Power Parity (PPP), the ratio for China is just half of the global average.

FDI's percentage in fixed asset investment is also below the global average. With the growth of domestic investment, this figure is expected to fall further.

In fact, we believe China still has a good opportunity to absorb external resources.

With the progress of globalization, many multinationals are regarding China as a link in their global value chain. China is now a market for them. For many of them, China is also a manufacturing base, and to some it is an R&D and service centre.

The rapid growth in FDI in China over the past few years contrasts dramatically with the fall in global FDI.

As China's economy continued to grow and the country further implements its WTO commitments, the nation has a good chance to attract even more foreign investment.

The current round of macroeconomic adjustment is a chance to optimize the structure of foreign investment

The central government's tightened controls on land use have prompted foreign companies to invest more in inland areas of the country and up their investment in the service and high-tech industries, both of which require less land.

But we should also try to maintain the stability of our foreign investment policy during the cycle of economic adjustment. We should also try to rely more on market-based measures in the adjustments in order to strengthen foreign investors' confidence.

Increasing competition from neighbouring countries for FDI justifies the maintenance of some preferential policies for foreign investors

China should keep some favourable policies for foreign investors because more countries are competing for foreign investment.

Viet Nam levies an corporate income tax of just 10 per cent on foreign-funded companies. And Ho Chi Minh City promised to exempt foreign companies from paying corporate income tax for eight years after they begin to make a profit.

The Republic of Korea has established three special economic zones and offers preferential financial policies to companies operating there.

We should bear in mind that China is a country short of natural resources. We have to use the resources we have rich supplies of, such as low-cost manufacturing capabilities and markets - to exchange with other economies for the resources that we lack, such as technology and raw materials.

Foreign investment is a key vehicle for this exchange.

Maintaining the stability of foreign investment policy does not mean preferential treatments cannot be adjusted at all. Some policies should indeed be adjusted to improve the quality of foreign investment.

We suggest that the universal preferential tax rate for foreign companies should be changed into different rates for different industries, regions and projects. In other words, preferential treatments should be maintained for the areas and sectors where more foreign investments are encouraged.