China has been the developing world's leading recipient of inward foreign direct investment (IFDI) since 1992 and has consistently ranked in the top five IFDI destinations (developed or developing) over the past three years. Last year, China's IFDI hit a record $105.7 billion. China's accumulated $1.0574 trillion of IFDI entails investment in tens of thousands of projects in sectors as diverse as automobiles, banking, electronics, real estate and textiles.

Initially, foreign investors were attracted to China because of the low costs, especially the labor costs, of operating in China. China's impressive growth rates, preferential policies for foreign investors such as much reduced import duties, cheap land, special economic zones, proximity to the dynamic East Asian economy, political stability and opening of an increasing number of sectors and geographic regions made the country very attractive to foreign investors.

China's accession to the World Trade Organization (WTO) in 2001 served as yet another spur to increased flows of foreign capital into the country. Diverse observers are asking, though, if the golden years of IFDI are over, because investment inflows reflect a slower rate of growth and even decline in some cases. This question has arisen primarily because the operating costs of foreign multinational corporations in China are increasing owing to the rising labor cost.

According to one Chinese government report, minimum wages has soared 22 percent this year. Rising labor cost is part of China's efforts to ensure the fruits of the country's economic growth are more equitably shared to promote domestic consumption and encourage higher value production. They are also linked to new social welfare schemes such as modified social security programs.

Some foreign companies have opted to deal with perceived rising costs by moving to Pakistan or Vietnam, where supposedly the cost of production is lower. Such a response, though, may be myopic because the overall operating cost is a function of many factors, including worker productivity (which requires good education, sustained training and a strong work ethic), quality of infrastructure, integration into the global supply chain, availability of distribution and logistics system, technology, and ready access to clients and parts' suppliers.

If one considers this "total package" when comparing the costs of operating in China with other countries, it is quite possible that the gains from shifting production and service delivery elsewhere may be nowhere as high as believed.

Farsighted investors recognize that a strong presence in China allows them to access the large Chinese domestic market, which is the first, second or third largest for many companies such as Agilent Technologies, BMW and Walter AG, and represents a path to diversification for others such as Gap Inc.

China is also an extremely profitable market for some as proved by the remarks of GM Vice-Chairman Steve Girsky who told one Wall Street publication: "We make a lot of money here." For other companies such as Federal Express, China is an invaluable regional headquarters.

Yet for others, among them AstraZeneca, Microsoft and Siemens, a presence in China allows them to leverage the country's science graduates, prestigious academic institutions, and proliferating research and development facilities. Eventually, astute investors can find ways to reduce operating costs by seeking economies of scale, economies of scope, and pursuing new efficiencies in their use of inputs and production and service delivery processes.

There is no doubt that inbound investors do have some legitimate concerns about non-labor related costs. But even here, there is considerable misunderstanding. Vice-Premier Li Keqiang said in January during his visit to Germany that China would "enlarge its openness" to IFDI. In addition, numerous government representatives have emphasized China's receptiveness to foreign investment.

Furthermore, there should be an appreciation of the fact that some of China's measures such as income tax law changes or creation of M&A and anti-trust laws represent a leveling of the playing field or the adoption of Western-style legal and regulatory regimes rather than a sign of aversion to foreign investment. Foreign companies would welcome greater fairness and transparency on the operation of these new regimes, though.

All multinational corporation managers must pay attention to the bottom line. The rising cost of operating in China is causing some to wonder about the merits of investing in China, others to worry about maintaining profitability in the country, and yet others to ponder moving their investments elsewhere. The preceding discussion reveals, though, that the issue of cost is not simple. Above all, foreign companies need to think beyond labor costs.

Moreover, even if labor costs are critical, there are multiple benefits for operating in China that need to be considered. Ultimately, foreign investors need to be careful lest they fall victim to the adage that the "stingy person pays the most".

The author is associate director of Center for US-China Policy Studies, and associate professor of international relations, San Francisco State University.

(China Daily 11/12/2011 page5)