The Determinants of Foreign Direct Investment Choice in Chinese Automotive Industry

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UPPSALA UNIVERSITY Department of Business Studies Master Thesis Spring Semester 2012

The Determinants of Foreign Direct Investment Choice in Chinese Automotive Industry

-How Swedish firms invest in Chinese market?

Authors: Cai Xingyu & Li Yongliang Supervisor: Olivia Kang Date of submission: 2012-05-23

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Abstract

Since China entered WTO, the multinational corporations (MNC) increased the foreign direct investment (FDI) in Chinese market because China is famous for its huge market volume and low labor cost. However, the knowledge of Chinese market is still limited. This paper analyses the determinants of automotive MNC's FDI choice made in Chinese market based on the study of Chinese FDI environment and the investment behavior of Swedish firms. The determinants are tested through three variables: industry development, cultural distance and the government policy. In this thesis, data related to FDI in automotive industry is collected mainly from 13 provinces or municipalities. The results show that: (1) The regions with larger market size will attract more FDI; (2) The larger cultural distance will create more obstacles when MNCs invest, thus has the negative impacts on FDI choices; (3) MNCs will give priority to those areas with lower tax burden. Besides, this thesis also describes the detailed cultural distance at firm level between China and Sweden based on the interview with a Swedish firm. The results suggest Swedish firms need to focus more

on the partner selection and management adaption when investing in Chinese market.

Key Words: FDI; industry development; cultural distance; government policy

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1. Introduction and research proposal

1.1 Introduction

1.1.1 Overview of MNC and FDI

Multinational Corporation (MNC), also known as multinational enterprise (MNE), means a corporation or enterprise that market production or delivers services in several different countries (Pitelis, 2000). The International Labor Organization (ILO) has defined an MNC as "a corporation that has its management headquarters in one country, known as the home country, and operates in several other countries, known as host countries."

One of the most important influences of MNC is creating the economic development which usually involves structural and institutional changes. It can also increase the employment and improve social welfare (Liang, 2003).

It is complicated and not always logical to determine the position (in favor or against) of countries towards MNC. In general, most developed countries can make more profit with lower labor cost from other countries with the help from MNC. It is not very clear about developing nations’ position. Some of them will favor MNC because it can boost the economy and infrastructure. Therefore, delegates must contemplate a lot of economic factors that would help explain why they support or oppose MNC, and have to establish sales agencies in order to figure out whether that particular developing country has competitions or not. (Jagdish, 2004)

Bruce has defined that “there is increasing recognition that understanding the forces of economic globalization requires looking first at foreign direct investment (FDI) by multinational corporations (MNCs)”. (Bruce, 2006)

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Foreign direct investment (FDI) is direct investment by a company in distribution located in another country either by sharing a company in the country or by expanding operations of an existing business in the country (Borensztein, 1998, p116). FDI has been one of the most discussed topics in the development for economic globalization.

MNCs consider FDI as an important means to reorganize their production activities across borders, in accordance with their corporate strategies and the competitive advantages of host countries. Host countries regard inflow of FDI as a significant opportunity for integrating their economies into the global market and promoting their economic development. To maximize FDI’s benefits in economic development, host country governments employ a variety of policies and measures (Chuang, 1999).

1.1.2 Emerging Market Introduction

Most MNCs search for ways to gain and sustain competitive advantages in growing global business surroundings, focus more and more on the new emerging markets.

In driving global economic recovery and growth, the emerging economies begin to play an important role. Moreover, instead of the developed countries like UK, some of the fastest growing countries in the world are represented by Brazil, Russia, India and China.

“Emerging Markets” were created in 1981 by Antoine W. ban Agtumael, the deputy director of the capital markets department of the World Bank’s International Finance Corporation (Wharton, 2008). According to the Business Dictionary, emerging market means a new market structures arising from digitalization, deregulation, globalization, and open-standards, which are shifting the balance of economic power from the sellers to the buyers. Investments in these markets are usually characterized by a high level of risk and possibility of a high return (Sigrun, 2009).

Compared to developed economies, emerging economies have many unique

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advantages, such as high GDP potentials, young working populations, growing middle classes and relatively lower-debt economies.

Generally speaking, the emerging market economies have young, expanding working populations. For example, the average age in Japan, Germany and Italy is 43 while in the UK around 40. Compared to the developed countries, the average age of China is 34, 29 in Brazil and 25 in India. (Nigel, May 2010.)

After 1978, China’s government put all their efforts into changing the economy to a market-oriented one, and output had quadrupled in 2007. This is a country that has natural resources such as coal, iron ore, petroleum, natural gas and hydropower potential. Since 2008, China has become the second-largest economy in the world behind the US with GDP of $ 7.5 trillion (NBSC, 2011).

1.1.3 FDI situation in China

China has become the largest recipient of FDI among developing countries. More and more MNCs enter Chinese market through FDI for the purposes of cost saving, market share possessing and sales expansion (Huang, 2008). According to China's Ministry of Commerce, FDI distribution in China is quite unbalanced and the majority of FDI are invested in the coastal area which is the most developed region in China (China Statistical Yearbook, 2011). However, the government is trying to encourage MNCs to invest in those areas with worse investment environment through carrying out some incentive policies. But the growth rate of FDI in coastal area is still higher than other areas (China Statistical Yearbook, 2011). According to China's Ministry of Commerce, the main reason is that many MNCs believe that the cultural distance will greatly increase the institutional cost and managerial difficulties and a developed infrastructure can help minimize this negative impact (Huang, 2008). As a result, industry development, cultural distance and government policy are convinced to be the three main factors to help MNCs formulate the FDI plan in Chinese market.

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1.2 Research proposal

When considering of the Swedish MNCs international business relationship with China, current research shows that Swedish firms' mainstream of business relationship with Chinese market still stays at the level of import and licensing (Bruce, 2006).

When considering of the Chinese automotive market situations, the current research shows that the automotive industry development varies in different areas in China and so far the FDI approach in this industry is still restricted to joint venture (Zhang Xiujuan, 2007). The Chinese market has abundant qualified labor force and the government is encouraging local firms to improve the competitiveness through international cooperation (Chen Fang et al., 2007 ). As a consequence, it is feasible and attractive for Swedish firms to think about investing more in Chinese market because the complementary of the two parts is obvious and both sides have the possibility to make an improvement through the FDI behavior. In this thesis, industry development, cultural distance and government policy are considered to be the three determinants to affect MNC's FDI choice in Chinese market.

Our research question is: How can the determinants of Industry development, Cultural distance and Government policy affect the Swedish automotive MNC's FDI in Chinese market?

The aim of the thesis is to analyze and try to figure out how these three factors mentioned above affect Swedish automotive MNC's FDI choice in Chinese market.

The testing part will base on three hypotheses raised out in the literature review part.

The conclusion will be given based on the testing results of the three hypotheses to figure out the suitable way for Swedish firms in automotive industry to engage FDI in Chinese market and offer a basic guideline from aspects of Chinese automotive industry, main cultural difference and the government policy towards FDI.

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Figure 1: The outline of the thesis

Research problem: Swedish FDI determinants in Chinese market

Sub factor 2: cultural distance

Sub factor 3: Chinese FDI environment and policy

Sub factor 1: automotive industry development

Theoretical Framework:

Emerging market Features Cultural distance

Industrial agglomeration Government policy

Empirical test:

Location quotient Government policy analyze

Conclusions

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2. Literature review

Because of the increasing importance of Chinese market, many MNCs are considering about entering Chinese market in order to gain more profit. Many Swedish firms are considering it as well. Therefore, how to choose different approaches of foreign market development and establishments becomes a crucial topic. The location, control, and internationalization process has become MNCs' core research topic of the business research (Eden & Lenway, 2001). In order to perform our research, it is necessary to understand what research related to this study has been done. In this chapter, research on different determinants which affect MNCs' foreign investment style will be introduced in the following parts.

2.1 Development status in China and Sweden

From the aspect of China, China's manufacturing industry has been integrated into the global value chain and truly becomes a "world Factory" because of the huge manufacturing industry (Jia Sun, 2011). However, China's manufacturing industry is at the low-end link of global value chain and there are problems of R&D capabilities, lack of self-marketing brand and scarcity of highly-skilled human resource. Even though the labor cost is getting higher in China, most parts in coastal area, middle area and western area still have a wide range of space to develop from Economic structural adjustment. Moreover, many investments choice should not only focus on the cost but also the integrity of the related industries and supporting services.

For example, many small countries cannot offer a entire service of the product manufacturing while China can do. Meanwhile, China has a large inner market which forms the economies of scale. However it's not possible and proper to only rely on export to enlarge the business scale in China. If Chinese firms can work with foreign companies, the business scale may have a better development. (Jinping Zhao, 2010).

From the aspect of Sweden, based on recent study, the main business partners of

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Swedish firms are USA, UK, Germany and France. They are the countries which over a long period have dominated both quantitatively and qualitatively in the Swedish global production (Bjarne, 2008). Although Chinese market is growing fast, the main approach of trade is through import and export. Hofstede (1983) coined four dimensions to describe the cultural distance between different markets. Sweden has the characteristic of low power distance and high uncertainty avoidance, which explains why Swedish firms prefer entry mode with less commitment. As the development of international business environment, the market in that 4 countries nearly saturated and the BRIC countries become the market with most potential (Bjarne, 2008). Therefore, establishing business network in this market becomes increasingly crucial.

2.2 Internationalization process and FDI

The increase in international co-operation and business relationship lead to rapid changes in competitive environments in the global market (Beamish and Delios, 1997). So, more and more firms are thinking about investing in foreign markets through FDI.

2.2.1 Internationalization process and relevant theory

The motivation of internationalization has been studied by many scholars. Hymer (1976) first raised the concept of market imperfection and explain the internationalization as behavior to pursue the monopolistic advantage in the target market. As a result, MNCs can get above-normal profit by their firm-specific advantage. Peter J. Buckley & Mark Casson (1976) explained the internationalization behavior as a way of decrease the transaction cost. They argue that the interaction among different counterparts will create the risks and uncertainties for MNCs, which will influence the institutional efficiency and profitability. So MNCs choose to invest in the foreign market in order to minimize these negative factors through turning the external business relationship into the internal cooperation. By doing that, MNCs can

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reduce the uncertainty and risk during the production process and keep high level of profitability. Johanson and Vahlne (1979) studied the internationalization process while researching Swedish firms' internationalization behavior. Johanson collected the data from Swedish-owned subsidiaries in the foreign market and applied

"establishment chain" to describe the different steps of investment. Figure 2 illustrates the internationalization mechanism -- as compiled by Johanson and Vahlne:

Figure 2: The basic mechanism of internationalization: state and change aspects (Johanson &

Vahlne, 1977: 26).

Johanson and Vahlne explained that the reasons MNCs change the way of investment in the foreign market are due to the market knowledge accumulation and commitment making. Moreover, Johanson (1994) combined his updated theory with the business network approach. The theory considered foreign market as a network, internationalization process can be judged as a behavior that the firm commits and obtains a position in this network which will have impacts both on the firm and its partners. Based on the business network theory, Johanson and Vahlne (2009) revisited the Uppsala Model and made an extension. He used incorporating learning, trust building and opportunity creation as the variables to analyze the commitment to the foreign markets.

State Change

Market Knowledge

Market Commitment

Commitment Decision

Current Activity

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2.2.2 FDI effects on MNCs and local market

FDI has become one of the main strategies for MNCs to enter a foreign market and, therefore, it has been widely studied by many scholars. Dunning (1980) developed Buckley and Casson's theory. He added three factors to explain the incentives of MNC:

ownership advantage, location advantage and internalization advantage. Then he compared different entry modes and concluded that FDI can help MNCs acquire all these three advantages. Haddad and Harrison (1993), Chuang and Lin (1999) and Branstetter (2005) all studied effect of FDI through empirical analyses. They found out that FDI can not only help MNCs to establish firm-specific advantage in the foreign market, but also create positive effect on the domestic-owned firms through technology spillover. Also some scholars found the negative effect on the local firms.

Aitken and Harrigan (1999) found out the consequence through the study of Venezuela that FDI will have the "Crowding out Effect" for the local firms if the technique gap is too large between MNCs and domestic firms. Borensztein, Gregorio and Lee (1998) used the data from 69 developing countries to analyze the FDI effect on the host countries. They concluded that only when human recourse capital of the country reach a critical level can FDI create the positive effect on the local industry.

Besides, many Chinese scholars also study FDI effect on both the market and local-firm development. Chen Taotao (2003) analyzed the FDI and its effect in different areas in China and concluded that FDI effect on local industry depends on three variables: the gap of firm size, capital intensity and technology level. Zhang Guoqiang (2008) studied the effect of FDI based on the Nash-counot Model and found the consequence that the technology gap between MNC and local level had a break-even point. If the gap is getting bigger, the positive effect of FDI will decrease.

2.3 Industry development

The eclectic paradigm theory developed by Dunning (1993) provides an explanation that how MNC's internationalization plans are processed. MNC will first think about the location with higher level of development in order to establish value chain with

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less risk and communicating costs. Kostova and Zaheer (1999) argue that MNCs will think about investing firms at the location with high economic efficiency because this efficiency can help MNCs successfully minimize the transaction cost. Many scholars use industry agglomeration to measure the industry development. Crozet (2004) studied the location determinants of FDI in France and found out that the investors of the same nationality will give priority to "co-locate". That is to say, the followers of FDI will give more priority to the place that the first-mover invested. Besides, Head's (1995) studied about the Japanese investment in the US market and also made similar conclusions. Wheeler and Mody (1992) studied the location strategy of US companies and tried to find out the most important determinants. They conclude that industry development, market size and transportation become critical factors of MNCs' decision-making. Lu Minghong (1997) used the FDI data from 29 Chinese provinces and regions to analyze the key factors that influence MNC's investment strategy. He concludes that industry development, export dependence and the specialization of labor force all have the positive effect in encouraging MNCs to invest in those areas.

Liang Qi (2003) analyzed the FDI intensity in the coastal areas in China. She studied the MNCs' investment motivations through interviews in provinces of Jiangsu, Guangdong, Zhejiang, Shandong and Fujian. She concludes that the development of industry has replaced the government policy and has become the most important factor for MNCs when thinking about investing in China.

2.3.1 Industry development in International Process

The concept of industry development is essential to IP model and it is important that the multinational firms learn from different business partners in order to create valuable business networks and sustainable operations abroad (Johansson and Vahlne, 2003; 2009 ).

Industry development in target market will offer different aspects of knowledge which are critical to MNCs.

Industry development includes information about firm number, firm size and number of

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upstream and downstream enterprises etc. This information is seen as the most important part of relevant knowledge for MNCs according to the IP model. Higher level of industry development always related with more active market activities. This makes firms easier to learn from each other and they will find opportunities by which they both can improve their business operations (Johansson and Vahlne, 2009). Besides Learning from each other, new knowledge can also be created through the interactions within a network.

However, higher level of industry development also relates to more fierce competitions and less privilege which will create higher entry cost (Williamson, 1979). High level of competition will create obstacles when MNCs are considering about FDI. Besides, Chetty and Agnal (2007) argued that high level of industry development leads to the

"over-embedded network" which will create barriers for MNCs to share knowledge with external environment. So industry development also possibly has negative impact on FDI.

Hypothesis 1: The high level of industry development in a region will make it easier to attract FDI from MNCs.

2.4 Cultural distance and psychic distance

Hofstede (1983) first raise the concept of cultural distance and give the valuables to measure it. He argues that national cultural difference is the key issue for management and organization science. He emphasizes on the importance of nationality based on three reasons: (1) Political reason: this reason create the institutional differences between two countries; (2) Sociological reason: nationality is the identity of people, so different nationalities result in the different social environments; (3) Psychological reason: different level of psychological ability will lead to the different learning skills and the different ways of doing things. Hofstede uses the gaps of different nationalities to measure the cultural distance between different countries. He uses four dimensions to describe the national cultures: (1) "Individualism versus collectivism".

People with the character of "individualism" tend to be more independent and

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self-centered. They are willing to do things on their own and prefer taking risks and trying new things. On the contrary, "collectivists" prefer working in-groups and tend to think about the members in the groups and sometimes will give first priority to the mutual benefit of the group. (2) "Power distance". This dimension is mainly used to describe people's attitude towards inequality. The big power distance always leads to the high level of centralization. People in this environment will be more accustomed to the hierarchical management and automatic leadership. (3) "Uncertainty avoidance".

This dimension is mainly used to describe people's view towards change. It is quite difficult for people labeled with "strong uncertainty avoidance" to accept changes.

These people feel anxious about unknown factors and prefer preserving the status quo.

So they always create specific regulations in order to minimize the risks. While people in "weak uncertainty avoidance" always feel excited about new things and are willing to make changes regardless of its potential risks. (4) "Masculinity versus Femininity." Hofstede argues that in different nationalities people will have different attitudes to the job division related to sex. In masculine society, people always have the mutual sense about what kind of job should be done by males and what should be done by females. While in feminine society, actually there is no clear boundary.

Hofstede took 50 countries as research samples and tested their cultural distance in 4 dimensions above and finds out that those dimensions have much higher impact on the management focus and organization structures. So firms from countries with large cultural distance will have quite different management styles.

According to the Uppsala Internationalization Process Model (I-P model), Johanson (1997, 2009) also explained the MNC's internationalization behaviour. He presented his view in the I-P model that an internationally inexperienced firm or a firm has really limited knowledge to one foreign market will choose a low commitment entry mode in order to minimize the uncertainties and risks. Based on the transaction behavior in target market, MNCs will increase their commitment and thus gain more information and knowledge from new market. As a result, MNCs are able to shorten the psychic distance with target market and probably give more investment and

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change the business modes from low-commitment (export, licensing) to the high-commitment (JV or WOS) once they accumulating enough information.

Besides, Eriksson (1997) developed the concept of "experiential knowledge" into three types: internationalization knowledge, business knowledge and institutional knowledge. Internationalization knowledge is gained from the firm's previous international behaviour while business knowledge and institutional knowledge are gained from the experience from particular market and only useful to this market. The internationalization knowledge enables MNCs to expand business into foreign markets with larger cultural distance. The business knowledge and institutional knowledge will help firms accumulate commitment in particular market and shorten the psychic distance.

Hypothesis 2: The cultural distance between China and Sweden will make it more difficult to invest in Chinese market with the approach of joint venture.

2.5 Government policy towards FDI

From 1980s, the government policy towards foreign investment has changed a lot from the restrictive policies to the open policies (Zhang, 2007). According to the report from United Nations Conference on Trade and Development (UNCTAD), from 1990s, the policy changes have been increasingly taking place in many countries.

Based on the proportion of two kinds of policy--- incentive policy and restrictive policy, incentive policy has become absolutely the mainstream. The Chinese government has been increasingly concerned about how to attract and acquire more investment from foreign countries and sometimes even create the competition with neighbor countries (Zhang, 2007).

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Year

Country with policy change

Number of policy change

Incentive policy

Restrictive policy

1991 35 82 80 2

1992 43 79 79 0

1993 57 102 101 1

1994 49 110 108 2

1995 64 113 106 7

1996 65 114 98 16

1997 76 151 135 16

1998 60 145 136 9

1999 63 140 131 9

2000 69 150 147 3

2001 71 208 194 14

2002 70 248 236 12

Figure 3: Global policy changes to FDI (World Investment Report, UNCTAD, 2005)

UNCTAD also introduces the main policies that government frequently employs to attract FDI. There are two categories: tax incentive and non-tax incentive. The former one mainly attracts FDI through tax reduction. It includes import and export tariff privilege, profit tax privilege, capital tax privilege, sales tax privilege and value-added tax privilege. The latter one includes subsidy, equity participation and currency insurance.

Many scholars present their point of view about whether these policies can successfully attract FDI. Bond and Samuelson (1986) argue that in some countries with high level of information asymmetry, the tax privilege policy in developing countries can be judged as a signal from government to show the sincerity and eager to invite FDI. These policies are used to strengthen investors' confidence. Spar (1998) studied the tax incentive policies in Costa Rica and concludes that those policies can reduce the investment risks and provide a sense of safety to those investors. Coyne (1994) compared firms' responses to the incentive policies and their investment scales.

Coyne concludes that firms with less HR recourse and capital need to benefit from those policies to minimize their costs while some large investors always reach agreements with host country before entering. As a result, small-scale investors will

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be more sensitive to the incentive policies.

However, some scholars also have the opinions that the government tax incentive policies have little influence on the foreign investors. Ahmed (1978) interviewed 52 MNCs about most important factors they have to consider in the process of investment. Based on the survey, the tax incentive policy is only in the 7^th place in developing countries and 8^th in developed countries. Some other scholars with similar opinion think that market and the political environment are the most important factors while tax privilege is just a method to reduce some disadvantages for the foreign investors.

As China is aiming for the international standards, foreign policy has been unable to adapt to the changing international situation. In the process of the development of China’s market economy, multinational corporations constantly enlarge their scale of investment and they are having a big impact on Chinese foreign policy based on their firm-specific advantages. The impact that the multinational corporations have includes 5 main points, which are proposing policy issues, agenda setting, policy-making, policy implementation and policy evaluation (Chang Liu, 2011). Xia Wang mentioned that, the effectiveness that the adjustments of foreign policy showed includes four main points. (1) It won’t make a big effect on the scale of foreign investment. (2) It is good to meet the foreign company's requests in order to attract foreign capital (3) It’s good to improve the efficiency of using foreign investment. (4) It is good to optimize the industrial structure and regional economic structure (Xia Wang & Liuqin Chen, 2008). Li Zonghui and Lu Minghong (2004) use the Panel Data Model to test the effectiveness of government tax incentive policies to attract FDI.

The analysis shows that the tax incentive policy is one of the main factors to attract FDI in Chinese market.

Hypothesis 3: The Chinese government tax incentive policy will have a positive impact on firm's FDI in automotive industry.

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3. Research Methodology

3.1 Research Approach

In this thesis, both qualitative and quantitative approaches are used to analyze the investment environment of Chinese market. The aim of the research is to find out if it is feasible for Swedish firms to enter Chinese market through investment approach of joint venture. Theories show that the industry development, cultural distance and government policies are quite important for MNCs when planning to enter foreign market in the world. How these determinants will affect MNC's choice in Chinese market still needs to be analyzed. For the determinants of industry development and government policy, we need to collect data from National Bureau of Statistics which can describe the industry development and incentive policy intensity and then try to use data to find out the connection with FDI intensity. As a result, a correlation testis best suited for the test of industry development. Besides, a quantitative regression analysis is suited best for the test of government policy. Cultural distance is treated as a determinant which will create obstacles during FDI activities. This factor is based on social studies so that it is impossible to be represented by numbers or formulas.

Based on this reason, a qualitative research is suited for this purpose. In this paper, the data for the qualitative research is gathered from website and through our interview.

Qualitative analysis based on interview will help analyze Swedish firm-specific advantage and automotive industry current situation to identify the motivation of Swedish firms to enter Chinese market. Besides, qualitative analysis based on the data from website is also used to help describe the general situation of automotive FDI distribution and government policy support in main provinces in China. Moreover, quantitative analysis of cultural distance based on Hofstede's Cultural Distance Model is used to describe the cultural distances between China and some other important countries in the world. This mainly strives to provide a clear picture on how large the differences between China and Sweden are compared with other countries.

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To analyze international FDI flows and intensity, there are two essential statistical sources namely the OECD and UNCTAD. The former publishes some flow data while the later publishes world FDI flows annually in early autumn covering the previous year in the World Investment Report. It contains not only data but also commentary and the information is collected from a wide range of countries. Both sources base their figures on national statistical sources.

3.2 Research Method and Model

3.2.1 Research data selection

In this thesis, the MNC's FDI strategies are convinced to be influenced by three determinants: industry development, cultural distance and government policy. In order to analyze how these three determinants affect the FDI strategies, both primary data and secondary data are used in this thesis. To find the relationship between industry development and FDI, the data about FDI intensity in automotive industry and the total output in each area in China are necessary. In consequence, the secondary data are mainly gathered from National Bureau of Statistics. Besides, the tax burden in each area is needed to analyze the relationship between FDI and government policy.

So the secondary data are also gathered from National Bureau of Statistics. The aim of the research is to study the Swedish automotive firm's FDI strategy in Chinese market.

And the cultural distance is the main determinant to show the obstacles to create joint venture between Sweden and China. As a result, primary data are collected through interview with Swedish automotive firm. In this thesis, Scania is chosen as our research sample and database to evaluate the cultural distance between Sweden and China. Scania is one of the world's leading automotive manufacturers and has established business relationship with China. However, the approach is still stagnated at the level of import. Even though Chinese market is of great potential, Scania only established sales agencies in China and the only business interaction with China is the relationship with Chinese dealers to offer its after-sales service (Scania annual report, 2010). At the same time, Scania is also looking for partners to establish a joint venture

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in China. As a result, the study can effectively figure out the main factors for Swedish firms to think about when entering Chinese market and the main barriers in building up business relationships.

Credentials of the Interviewee: Peter Sjöblom is the CEO of Scania Chinese Sales

& Service Company since October, 2010. Before 2010, he was in charge of sales business in South East Asia. Peter Sjöblom joined Scania in 1982 and has abundant knowledge about Scania and sufficient experience in Asian market.

Operationalization: As the main purpose of the interview is to find out the main cultural difference between Swedish firms and Chinese firms in automotive industry.

The questions are designed to help authors research on the core values of Scania in selecting Chinese partners and the main obstacles they think would emerge during the creation of joint venture. First of all, we need to have a clear image about Scania's business and its activities in China. So questions 1-3 as Appendix 1 shows are mainly focused on the current situation of Scania. Through these three questions, we can have a better understanding of both Scania and Chinese market environment. After that, the following questions focus on the different steps during FDI process. Question 4 focuses on the main standards of Scania to select partners. This question aims to research different values between Swedish and Chinese firms when thinking about co-operation. Question 5 strives to examine Scania's attitude to the ownership structure in joint venture. This question is quite practical especially in China. It aims to investigate the attitude about the importance of control and final saying. Questions 6-9 mainly focus on the cultural gap in human recourse management in order to find out the obstacles in leadership part. These questions mainly focus on the attitude about cultural adaptation. Last two questions mainly ask Scania's future expectation in the future.

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3.2.2 Variables and methods selection

In this thesis, three hypotheses will be tested in the empirical part to evaluate the investment environment in Chinese market at the province (or regional) level.

Quantitative analysis will be involved in testing the hypothesis 1 and 3. The following section will explain the variable selection and the mechanism. Hypothesis 2 will be tested both quantitatively and qualitatively. First, quantitative analysis will be used to test the relationship between FDI and cultural distance at the global level. Afterwards, a qualitative analysis based on the interview to the Swedish automotive firm will be used to understand the main cultural difference between Sweden and China.

3.2.2.1 Test on the relationship between industry development and FDI

In this thesis, industry agglomeration is used to describe the industrial development.

Industry agglomeration reflects the level of geographical concentration. These variables can also describe the development of relevant industries and the specification of labor force. In this thesis, model of location quotient is used to test the industry agglomeration in main automotive manufacturing areas in China.

Location quotient (LQ) is a index to quantify that how concentrated a certain industry;

cluster or demographic group is in a region as it is compared with the national average level. The formula of LQ is as follows:

1

1 1 1

/ /

m

ij ij

j

ij n n m

ij ij

i i j

e e

LQ

e e



  





 

In this formula, i means the particular region i (i=1,2,3...n), j means the particular industry j(j=1,2,3...n) and e_ijmeans the total output of industry j in the region i. LQ_ij here means the location quotient of industry j in the region i. If the LQ_ijis larger than 1, it means that the agglomeration of industry j in region i is higher than the national level. Besides, larger LQ value means higher level of industry agglomeration. Then the LQ value will be compared with the FDI growth rate to test out how LQ will have

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the impact on FDI inflows. As a result, the correlation test will be used. The formula is as follows:



 







 

) 1 /(

) ( ) 1 /(

) (

) 1 /(

) )(

(

2

2 n y y n

x x

n y y x r x

Here ^x means the first variable (LQ change in this thesis). x refers to the average value of ^x. ^y refers to the second variable (FDI growth in this thesis). The value of r is from -1 to 1. The positive value of r means that the two variables have positive

correlation while the negative of ^r means the negative correlation. Besides, if ^r closes to 1 means that these two variables are closely related.

3.2.2.2 Test on the cultural distance

In this section, the study will analyze the cultural distance index between China and Sweden and some other countries or areas. Then the comparison of FDI and the FDI modes will be applied to test the importance of cultural distance factor to the MNC's FDI strategy. Cultural distance index is to test the cultural distance in quantitative way based on the 4 dimensions of Hofstede's cultural distance model. The formula of cultural distance index is as following:





 ⁴ 

1

i iu

iu ij

j I

I CD I

Here CDj represents the cultural distance between country j and home country. Iij

represents the index of CD dimensions i in country j and Iiu represents the index of CD dimension i in home country.

Besides, the detailed information on cultural distance will be gathered from the interview to Scania about the cultural barriers which will institutionally affect the investment strategy making in Scania. We contacted Peter Sjöblom. Due to his limited availability and occupied schedule, we finally conducted a telephone interview to ask him about the details in communication, negotiation and business relationship building in China.

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3.2.2.3 Test on the effect of government incentive policy

As an emerging market, China’s economy is growing at a double-digit growth rate.

So the capital shortage is a common phenomenon to almost every industry (Xu & Tan, 2003). So far, the FDI incentive policy offered by Chinese government mainly has been focused on the tax privileges (Zhu & Fu, 2008). In this thesis, the hypothesis 3 suggests that the FDI will be influenced by both government tax incentive policy and the regional business scales. So the following model is used:

^FDI ^ ^f⁽^PV^,^SV⁾

PV represents the variable of tax privilege because there are many different types of tax privilege in China and it isn’t shown on the National Bureau of Statistics. So

"tax bearing rate (TBR)" is used to measure this variable.

TBR = TAX_f/ Output

TAX_frepresents the income tax from foreign-funded enterprises. This value reflects the tax cost for foreign-funded enterprises in different areas. Low value in TBR means high level of policy privilege.

SV represents the size of the market. In this thesis, the total output is used to measure the market size because larger market size always relates to more opportunity and ability to acquire FDI.

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4. Empirical data

4.1 World FDI development

From the UNCTAD data published in July 2011, one may conclude the following: In general, the overall world inflows of FDI increased, among which FDI flows into developing countries increased the most. Moreover, total FDI flows into developed countries in 2010 fell and it indicates that MNCs are transferring investment focus from developed countries to developing countries.

Figure 4 illustrates FDI inflows to developed and developing major world economies since 1970, as well as inward stocks in 2010. In 2010, the highest level of inflows belong to US ($228 billion), followed by China ($105 billion) and Hong Kong ($68 billion). The same as the stocks of inward FDI, US has the highest level of stocks at ($3.5 trillion), followed by Hong Kong ($1.1 trillion).

Compared with 2010, the global FDI inflows increased by 17%. In the recipient of FDI, US was again the largest, receiving $77 billion, but China just $11 billion.

($ millions) Flows Stocks

1970 1980 1990 2000 2009 2010 2010

Developed economies

9,491 46,576 172,526 1,138,032 602,835 601,906 12,501,569

(EU) total 5,158 21,279 97,309 698,279 346,531 304,689 6,890,387

United States 1,260 16,918 48,422 313,997 152,892 228,249 3,451,405 Developing

economies

3.854 7,479 34,853 257,625 510,578 573,568 5,951,203

China N/A 57 3,487 40,715 95,000 105,735 578,818

Hong Kong, China

50 710 3,275 61,938 52,394 68,904 1,097,620

World 13,346 54,078 207,455 1,402,680 1,185,030 1,243,671 19,140,603 Figure 4: World inward FDI 1970-2010, (World Investment Report,UNCTAD, 2011 )

Figure 5 mainly illustrates the outward flows and the stock of outward FDI in the past

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40 years. In 2010, 70% of world FDI outflows were made up by developed countries while 25% was contributed by developing countries. Among all the outflows, the EU member states made up 31% of outflows. The US was the largest investor ($329 billion) in the world, compared with the entire EU ($407 billion) and China ($68 billion). The US also holds the highest outward stocks of FDI in terms of stocks at

$4.8 trillion.

($ Millions) FDI Flows Stocks

1970 1980 1990 2000 2009 2010 2010

Developed economies

14,100 48,397 229,584 1,094,728 850,975 935,190 16803536

(EU) total 5,063 21,902 130,572 813,119 370,016 407,251 8,933,485

United States 7,590 19,230 30,982 142,626 282,686 328,905 4,843,325 Developing

economies

51 3,192 11,914 134,194 270,750 327,564 3,131,845

China N/A N/A 830 916 56,530 68,000 297,600

World 14,151 51,590 241,498 1,232,117 1,170,527 1,323,337 1,323,337 Figure 5: Outward world FDI 1970-2010, (World Investment Report, UNCTAD, 2011)

In considering FDI flows, the developed countries made an important role, which is illustrated by the data relating to outflows and stocks. The situation that FDI flows mainly occur between developed countries still remains. However, in recent years the flows to developing countries have been growing and are expected to continue to grow in the future.

4.2 Current situation of Chinese automotive industry

Chinese automotive industry has been developing during recent years even when financial crisis happened in the year 2008. In Figure 6 it illustrates that the total output of Chinese automotive industry increased from 1571.49 billion CNY in year 2005 to 4173.03 billion CNY in year 2009. The annual growth rate is kept above 20%, which is quite attractive to MNCs from other countries. The increase of import and export volume as well as the FDI intensity described below will also show the same situation that Chinese market is becoming a hot spot of FDI in automotive industry.

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Figure 6: The Chinese Automotive industry output in year 2005-2009 (Source: China Statistical Yearbook, 2010)

According to Figure 7, both import and export of automotive in China have been increasing (except the export volume in the year 2009 decreases because of the financial crisis). From year 2001 to 2008, the import volume increases from 71.90 billion CNY to 407.5 billion CNY and the export volume increases from 24.50 billion CNY to 641.1 billion CNY. Based on the time flow, the export growth is faster than the import growth.

Figure 7: The import and export of Chinese automotive in the year 2001-2009 (Source: China's Automotive Industry Development Research, 2010)

One of the main reasons why China's export increases so rapidly is because many MNCs invest in Chinese market to establish the business relationships mainly through the way of joint venture ("Chinese Automotive Industry Research", 2010). Based on the data from China National Bureau of Statistics, there are 19,441 firms in Chinese automotive industry in year 2009 and 3,637 of them are foreign-funded enterprises.

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The total capital of foreign-funded enterprises is 1478.52 billion CNY while the total capital of automotive industry is 3809.57 billion CNY. The foreign-funded enterprises' capital has reached the proportion of 38.81%. Besides, the total industry output is 4173.03 billion CNY and the foreign-funded enterprises create the output of 1853.32 trillion, up to 44.41% of the total output.

4.3 Industry development test

4.3.1 Regional automotive industry status

China has vast territory and there are many provinces and municipalities which has different features. These areas are categorized as three main areas based on the geographical conditions: Coastal area, Middle part and Western area. The industry development in each area is quite different from each other. According to the China Statistical Yearbook (2010), the total output of automotive industry in China reached 4173.03 billion CNY. The Figure 8 shows the output of automotive industry in top 13 provinces/municipalities in year 2009 and their locational distribution. Jiangsu Province ranks the first by having the 452.36 billion CNY in total, reaching 10.84% of the total output. Shanghai and Jilin Province follow and rank at 2^nd and 3^rd place with output of 324.62 (7.78%) and 311.12 (7.46%) respectively. Other places also have good output performance such as Zhejiang (6.90%), Hubei (6.25%), Chongqing (5.57%), Tianjin (3.51%). The top 5 provinces' output reaches 1637.13 billion CNY which is 39.23% of the total output in Chinese automotive industry.

(Billion in CNY)

Output (2009) Percentage Location

Jiangsu 452.36 10.84% Coastal area

Shanghai 324.62 7.78% Coastal area

Jilin 311.12 7.46% Middle part

Zhejiang 288.09 6.90% Coastal area

Hubei 260.95 6.25% Middle part

Chongqing 232.31 5.57% Western area

Tianjin 146.58 3.51% Coastal area

Anhui 122.85 2.94% Middle part

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Guangdong 109.91 2.63% Coastal area

Sichuan 99.06 2.37% Western area

Shandong 98.68 2.36% Coastal area

Hebei 79.28 1.90% Coastal area

Fujian 50.31 1.21% Coastal area

China in total 4173.03

Figure 8: Top 13 provinces or municipalities in output of automotive industry and their locations (Source: China Statistical Yearbook, 2010)

From the locational distribution, the majority of top ranking provinces/municipalities in China are at coastal area. As Figure 8 outlines, only Jilin, Hubei and Anhui are from middle part and Chongqing, Sichuan from western area. Other provinces/

municipalities outlined in Figure 8 are from coastal areas. The total output of coastal area in Figure 8 reaches 37.13% of total output while middle area and western area are much smaller (16.65% and 7.94%).

4.3.2 Industry agglomeration and its impacts on FDI

In this part the location quotient index (LQ) will be used to analyze the automotive industry development. Due to the different statistic standards in each province in China, bureau of statistics in some provinces/municipalities does not publish the data of the industrial output of foreign-funded enterprises in automotive industry. As a result, 12 provinces / municipalities are chosen as the test sample (Shanghai bureau of statistics only publish the data of manufacturing industry, not specific in automotive industry). As Figure 9 illustrates, only 7 provinces/municipalities have the above-average index of location quotient (LQ > 1). Based on the data of 2009, Tianjin has the highest index of LQ (4.53), which means the automotive industry development in Tianjin is quite centralized and the relevant service is well-constructed. Chongqing follows Tianjin, occupying the 2^nd place. Jilin, the province which focuses on the automotive production since the establishment of People's Republic of China, ranks the 3^rd. Hubei as an emerging market for automotive industry has strengthened the capital input since 2000s and its LQ index ranks 4^th place. The LQ of other provinces are all around 1, most of which are large

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manufacturing provinces. There are many foreign companies invested in different industries which lead to the decentralization of the automotive industry development.

Region 2003 2004 2005 2006 2007 2008 2009

Jiangsu LQ 0.58 0.6 0.61 0.66 0.69 0.81 0.68

LQ

change 0.02 0.01 0.05 0.03 0.12 -0.13

FDI

growth 18.72% 22.13% 25.40% 15.34% 11.47% -2.03%

Zhejiang LQ 0.74 0.73 0.76 0.88 0.92 0.89 0.83

LQ

change -0.01 0.03 0.12 0.04 -0.03 -0.06

FDI

growth 2.78% 3.03% 6.87% -4.79% -8.00% -2.31%

Hubei LQ 2.05 2.08 2.18 2.33 2.37 2.58 2.77

LQ

change 0.03 0.1 0.15 0.04 0.21 0.19

FDI

growth 5.75% 1.18% 14.06% 2.14% 17.43% 9.12%

Chongqi ng

LQ 4.01 4.15 4.78 4.21 4.54 4.24 5.41

LQ

change 0.14 0.63 -0.57 0.33 -0.3 1.17

FDI

growth 45.13% 99.71% 7.72% 162.58

% 65.00% 31.15%

Tianjin LQ 3.83 3.93 4.05 5.31 5.3 4.72 5.03

LQ

change 0.1 0.12 1.26 -0.01 -0.58 0.31

FDI

growth 14.14% 19.24% 12.14% -20.91% 50.98% 21.18%

Anhui LQ 0.97 1.01 1.04 1.08 1.17 0.97 1.21

LQ

change 0.04 0.03 0.04 0.09 -0.2 0.24

FDI

growth 79.21% 169.72

%

133.81

% 10.30% 25.36% 17.31%

Guangd ong

LQ 0.71 0.68 0.67 0.73 0.67 0.56 0.65

LQ

change -0.03 -0.01 0.06 -0.06 -0.11 0.09

FDI

growth 8.83% 10.65% 0.52% 8.91% -2.48% 7.17%

Shandon g

LQ 1.18 1.24 1.43 1.82 1.37 1.11 1.13

LQ 0.06 0.06 0.19 0.39 -0.45 -0.26 0.02

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change FDI

growth 3.84% 5.67% 6.50% -41.86% -2.12% 0.18%

Fujian LQ 0.7 0.71 0.7 0.96 0.98 0.94 1.42

LQ

change 0.01 -0.01 0.26 0.02 -0.04 0.48

FDI

growth 16.41% 15.18% 41.12% 5.27% 4.05% 22.12%

Figure 9: Location quotient change and FDI growth rate of top 9 provinces or municipalities in output of automotive industry.^①

In order to test the correlation between FDI inflows and the LQ index, the FDI growth and LQ change are chosen as the variables. Figure 9 illustrates the FDI growth rate and the LQ change from year 2004 to 2009. Correlation test is chosen as the quantitative method here to test the correlation between these two variables. The formula is as following:

  







 

) 1 /(

) ( ) 1 /(

) (

) 1 /(

) )(

(

2

2 n y y n

x x

n y y x r x

This test is processed in 9 provinces mentioned above respectively in order to figure out the correlation in different regions. The outcome of correlation test is as following:

Region r value

Jiangsu 0.61

Zhejiang 0.63

Hubei 0.78

Chongqing 0.22

Tianjin -0.33

Anhui -0.08

Guangdong 0.19

Shandong 0.82

Fujian 0.63

Figure 10: Correlation test of LQ change and FDI growth

One can figure out that there are two regions (Tianjin and Anhui) that have the negative r value and other regions have the positive r value. The absolute values

① The data of FDI in automotive industry in Shanghai, Jilin and Sichuan is not available.

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in four regions (Chongqing, Tianjin, Anhui and Guangdong) are close to 0 while others are close to 1.

From the result we can get the conclusion that from national wide, the LQ and FDI may have positive correlation, although we cannot determine whether the correlation is linear or not. Two of the r values are negative but the negative relation is very weak (r value close to zero) and we also get some result strongly support the position that the relationship is significant(r value close to 1). For the regions with large FDI adoption and good industrial basis, the relationship is strong. For less develop areas, the FDI base is very low, the variance shall be much higher than average, thus appear to be different from normal.

4.4 Cultural distance test

The cultural distance and its effects on FDI strategies of Swedish MNCs will be tested in this section. The first sub-section deals with the general cultural distance test to figure out the main difference between Chinese and Swedish. The second sub-section aims to find out which factors Swedish automotive firms care when thinking about investing in China through the data collection from the interview with the CEO of Chinese service company of Scania.

4.4.1 General cultural distance with China

In this part, Hofstede's cultural distance model will be used to evaluate the cultural distance based on four dimensions: power distance (PDI), individualism (IDV), uncertainty avoidance (UAI) and masculinity/femininity (MAS). In order to find some connections between cultural distance and FDI intensity, this study aims to analyze not only the cultural distance between China and Sweden but also other countries / areas which have close business connections with China.

The Determinants of Foreign Direct Investment Choice in Chinese Automotive Industry