Innovation and FDI in Economic Development of China

Introduction

Foreign Direct Investment (FDI) in the last two decades has become significantly vital in developed and developing countries. Today, an increasing number of these countries experiencing success in the attraction of a substantial and increasing amount of FDI (Lenka & Sharma, 2014). Moreover, today, the innovative performance of any country is a vital determinant of global competitiveness and national progress (economic development of the country) (OECD, 2007). This has also consequently made innovation to be another key determinant of economic growth and development for any country. Without a doubt, the ability of a country to innovate and successfully incorporate its innovations in the marketplace has become a crucial determinant of global competitiveness of the past two decades and is pitted to play an even vital role in the future (OECD, 2007). From such an outlook, it is evident that FDI and innovation have become a vital component of economic development for countries.

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China’s economy for over thirty years has grown at an annual rate of 10%. By 2010, the country had gone above Japan and became the second-largest economy worldwide (Xing & Pradhananga, 2013). FDI has played a vital role for China in internationalizing its economic activities, and its innovative capabilities have made the nation a primary source of technological now how and through FDI a source of technology transfer within the economy (Lenka & Sharma, 2014). These major roles the two factors play in China’s economy have been expressed in various models of the endogenous growth theory.

The existing empirical literature examining the impact of these two factors individually or in combination on the economy have provided consistent findings that affirm a positive association between the two and economic growth and development (Mishra, 2014). The role of FDI and innovations is country-specific and can be positive, negative, or insignificant. This relevance is dependent on the economic, institutional, and technological conditions of the specific country and its economy. This paper, therefore, aims at studying FDI and innovation on economic development with a country-specific focus on China and how these factors have influenced the economic growth and development of the country.

Background of the Study

China, in 1979 started its economic reforms which called for foreign capital involvement in its economy. Since then, the country has received a significant part of the international flows of direct investment that turned away China from special regimes towards the implementation of nation-wide open policies for FDI (Fu, 2008). From the time of introduction of these policies to the economy of China, the economy of China has been growing at a faster rate compared to that of the pre-reform period and for the major part avoided the major economic disruptions that have been existing in the global market (Morrison, 2015). From 1979 when the reforms were made to 2014, the annual real GDP for China averaged about 10% implying that the country has been doubling its economic size in real terms after every eight years (Morrison, 2015). The global financial crisis slowed down the economic growth of China’s economy where the country’s real GDP growth dropped from 14.2% in 2007 to 9.6% in 2008 and further to 9.2% in 2009(Morrison, 2015).

As a response, the government of China in a similar manner to 1979 took measures to cushion these effects through the implementation of a stimulus package and expansion of its monetary policy. These measures did not only boost consumption but also FDI that prevented a sharp economic slowdown for the country (Morrison, 2015). Currently, China is the second-largest receiver of FDI behind the United States of America and it is the first among the developing nations in the absorption of FDI (Azarhoushang, 2013). This is illustrated in the figure below. Low costs of labor, cheap land, incentives from the government, and a huge domestic market make the country attractive for foreign companies to invest. From the existing research studies and data, the Chinese administration has over the years has economically benefited from FDI through the design and implementation of policies that promote FDI (Fu, 2008). However, with the recent declining rate of economic growth and development of China that has a negative growth in its real GDP since 2014, there is a sign that FDI also has an adverse effect on the state as well. This highlights the fact that FDI plays a vital role in the economic development of China.

In addition, technological capabilities are also a vital component of competitiveness at the national, regional, and/or firm levels. Since the economic reforms that took place between 1978 and 1979 in China, the country’s economy has experienced significant growth as mentioned above (Wu, n.d.). However, the growth has been over the years driven by export-oriented and labor-intensive manufacturing activities (Wu, n.d.). This made the country’s economy vulnerable to external shocks as evidenced in the 2008 United States’ sub-prime credit crisis that resulted in the global recession that negatively impacted China’s economy (Wu, n.d.). To safeguard sustenance of China’s economic development in the future, new policies furthermore, to the ones on FDI were introduced to boost the role of innovation in the economic progress of the state (Wu, n.d.). The aim was to transform the economy to become a knowledge-intensive economy and reduce its dependence on exports and external markets (Schaaper, 2009). This is as envisioned in the country’s “Medium-to-Long-Term Plan of National Science and Technology Development (2006-2020)” that was announced in 2006.

It is because of this reason that the Chinese economy is vigorously promoting innovation. This is reflected in indicators such as the development of China’s expenditure on Research and Development (R&D) (Schaaper, 2009). Moreover, there is increased employment of scientists and engineers within the R&D sector to promote innovation. Finally, there is also an increased expansion of R&D inputs that have consequently increased innovation in the country’s economy (Schaaper, 2009). The development of innovative capabilities for a nation has been crucial in the economic improvement and growth of countries. Increasing research has been conducted in the past decade on the innovative systems of countries and their impact on economic development (Wu, n.d.). It is postulated that a distinctive and systematic element concerning innovation a local phenomenon that cannot be forecast by the more accustomed international innovation frameworks.

Previous scholarly research and popular commentary have attributed China’s economic development to its large market and low manufacturing costs. However, more recent accounts have noted that the significant development of China’s economy can be attributed to more than the large market and low production cost. Other factors such as FDI and innovation have been found to play a vital role. This paper will, therefore, highlight the role FDI and innovation have played in the economic development of the country.

Problem Statement of the Study

Increased globalization which has occurred in the past two decades has resulted in an unprecedented growth in FDI flows for many countries including China that has had a significant effect on the state’s economic development. In addition, economists have been interested in identifying the role of innovation in the development and growth of the economy. China is considered the most recent story of economic success in the world experiencing a consistent annual economic growth a phenomenon that can be attributed to the country’s shift from a growth model that is dependent on knowledge and technology (innovation).

This study’s purpose is, therefore, to study the role FDI and innovation play in the economic development of China including the study of the effect of the two aspects (positive or negative) of the country’s economic development. The existing data and statistical evidence indicate that FDI and innovation have more positive effects compared to the negative on China’s performance economically. The country is a classic example of successful FDI absorption and innovation incorporation in sustainable economic growth and development which has today converted the foundation of the country’s economic development. This paper will analyze the origins of FDI and innovation including their relationship and how they link up to promote economic development.

The Rationale of the Study

The pace and scale at which China has undergone an economic transformation have no historical precedent. Before, the introduction of the economic reform policies in 1978, the country was among the poorest nations in the world (Zhu, 2012). Its per capita real GDP was only a fourth of the United States and a tenth of Brazil’s. However, since the introduction of the reforms, the country’s real per capita income has grown at an average rate that is above 8% annually (Zhu, 2012). Currently, the country’s real per capita GDP is almost a fifth of the US and equal to Brazil’s. This rapid growth and development in a sustained manner have occurred in a nation that has over 20% of the global population and nowadays China is the second-biggest economy in the globe after the US.

This economic development has been attributed to FDI and innovations within the Chinese economy. For instance, by the end of 2005, China had accumulated, and FDI of about $622 billion that was way above the gains made in 2002 ($53 billion) a 91% increase in just three years and the FDIs’ contribution to the country’s economy is burgeoned in ways that were not anticipated(Zhang, 2006). For example, in 2004, inflows from FDI constituted of 7% of China’s gross capital formation; 21% of the country’s tax was from Foreign Invested Enterprises (FIEs), 28% of the output from industries came from FIEs; and over half (57%) of the state’s exports coming from the FIEs. This indicates the significant impact of FDIs on the state’s economic development (Zhang, 2006). In addition to FDI, innovations have played an essential role in the state’s economic development.

China, as the largest exporter globally, is mainly dependent on exports for economic growth and development. However, this dependency on exports makes the country prone to the economic fluctuations that exist in the international market, for instance, the 2007/2008 global financial crisis. This, therefore, requires the country to employ strategies that will cushion it from the deleterious effects of negative market changes at the international level, FDIs, and innovation being among the key strategies. Hence, by conducting a study on the role and impact of FDIs and innovations on the economic progress of the state, the Chinese government can turn up with strategies and further relevant policies to ensure consistent and sustained economic development and protection from the consequences of the market fluctuations. Moreover, today, China’s economic development is on a gradual decline. Therefore, by understanding the two elements under study, it is possible to identify the areas that need FDIs and innovations to return China to normalcy.

Research Question of the Study

From the problem statement provided above the research questions that will guide this study will be as indicated below.

  1. What are the primary roles of Foreign Direct Investments and innovation in the economic development of China?

Objectives of the Study

On the basis of the research questions provided above the objectives of this study will include:

  1. To find out the role of FDI and innovations on China’s economic development
  2. To find out the positive impact of FDI and innovations on China’s economic development.
  3. To establish the negative effects of FDI and innovations on China’s economic development.
  4. To determine the origins of FDI and innovations in China’s economy
  5. To establish the relationship between FDI and innovations and how they promote China’s economic development.

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The Methodology of the Study

Research in business is today influenced by two major trends that are occurring in the business field. These are increased globalization and the rapid growth of the Internet and other Information and Communication Technologies (ICTs). These two trends continue to accelerate in the field and; therefore, the methodology for this study will be on the basis of e-research and a review of literature in the area. E-research comprises of activities employing a spectrum of advanced ICT capabilities and includes new methodologies in research that emerge from increased access to research instruments and facilities, sensor networks and repositories of data, software and infrastructure services enabling secure connectivity and interoperability (Sakchutchawan, Hong, Callaway, & Kunnathur, 2011). To ensure comprehensive coverage of FDI and innovations and their impact on China’s economy, any relevant research and literature in the area were reviewed from all e-material with the keywords searched being “China”, “FDI”, “Foreign Direct Investment”, “Innovation”, and “Economic Development.”

Several comprehensive searches will be conducted with a fact-finding objective aimed at examining the role of FDI and innovations and their impact on China's economic development. Journals, books, secondary data, reports, published papers in data banks, government statistics, and other information from internationally recognized scientific research institutes will be reviewed and analyzed.

The Scope of the Study

To ensure the relevance of the study to the current market conditions and country specificity, the study will be conducted on the basis of literature from China’s economy only with references being made to other countries only for comparative purposes. The variables of the data that will be analyzed will be limited to the country’s economic data not more than 10 years old (2006 – 2016).

Limitations of the Study

Similar to all secondary data, limitations in finding the exact necessary information and data will be experienced. In addition, previous studies have attempted to conduct the impact of FDI and innovation in specific sectors and have experienced limitations in finding information and data on certain sectors of the economy. These same limitations will be experienced for this study and, therefore, for most of the part, the overall data in all the country’s sectors and the economy will be employed.

In addition, the study takes a case study approach as it addresses a contemporary societal issue. Consequently, it will experience the limitations inherent in a case study method of research. These are, for example, the lack of rigor and minimum foundation for scientific generalizations owing to the lesser sample size where in this regard a single country (China) is. This makes it difficult to generalize the findings to other nations. Finally, the study can only be exploratory and descriptive, and the implication is that the findings cannot be generalized to other countries.

Literature Review

This chapter covers a review of the literature that is relevant to the topic under study. The review is based on the research objectives highlighted above this is with the aim of ensuring that the objectives formulated in the previous chapter can be represented in more measurable terms. The chapter begins by reviewing Foreign Direct Investment (FDI) and innovation and takes a look at its definition and some of the theories of FDI. It also reviews the relevant literature on Economic development and later highlights the relationship between FDI, innovations and economic development hence provide a clear indication of the role of FDI and innovations in economic development. The chapter also covers a review of the positive and adverse effects of FDI on the economic development of China and also highlights the origins of FDI in China. Finally, this section establishes through a review of the relevant literature the relationship between FDI and innovations and how they link up to promote economic development.

China’s Economic Development History

The Economy before the Reforms

Before the economic reforms of 1979, under Mao Zedong’s leadership, the country had a command or centrally planned economy. The greater portion of outputs produced in the country was under the control of the government that was then responsible for setting up the goals of production, controlling the prices, and allocation of the relevant resources in most of the nation’s economy (Lin, 2012). In the ’50s the individual household farms were collectivized into large communes. Large-scale investments in physical and human capital were undertaken by the central government during the 60s and 70s to support industrialization.

By 1978, approximately, three-quarters of China’s production from industries was done state-owned enterprises (SOEs) according to the output targets that were centrally controlled as a result of large-scale investments. Private enterprises, entities, and foreign-invested firms were banned with the aim of making the economy self-sufficient (Lin, 2012). During the period foreign trade comprised of only acquiring goods and/or services that could not be produced domestically or obtain within the country (Morrison, 2015). Moreover, China also had no mechanisms for allocating resources efficiently due to the centrally run and managed economy (Lin, 2012). Therefore, the domestic firms, workers, and farmers had little or no incentives at all to increase the productivity or quality of their products as the focus was on the production targets set by the central government.

As per China’s governmental statistics, the country’s real GDP grew at an average rate of 6.7% annually between 1953 and 1978. The data’s accuracy during this period has, however, been doubted by many economic analysts who argue that the officials of the Chinese government at the time especially those at the sub-national level exaggerated the levels of production for political purposes (Wang, Fan, & Liu, 2007). According to Angus Maddison, an economist, the country’s average real GDP growth rate during the period was approximately 4.4% annually. Moreover, the country’s economy experienced several significant economic depressions and recessions during Mao Zedong’s leadership (Wang, Fan, & Liu, 2007). These included the Great Leap Forward that lasted two years (1958 – 1960) that resulted in a massive famine and death of about 45 million people and the Cultural Revolution that occurred between 1966 and 1976 (Wang, Fan, & Liu, 2007). This revolution resulted in the widespread political chaos that significantly disrupted the economy of the country. The per capita GDP on the basis of Purchasing Power Parity (PPP) of the country doubles from 1950 to 1978, the living standards dropped by 20.3% from 1958 to 1962 and by 9.6% from 1966 – 1968.

After Chairman Mao’s death in 1976, the Chinese government in 1978 made a decision to break away from the Soviet form of economic policies. This was achieved through gradual reforms in the economy according to the principles of the free market and opening trade and investment to the western nations hoping that this would increase the growth of the economy and raise the standards of living of the people.

 

Introduction of the Reforms

At the start of 1979, several economic reforms were put in place by the Chinese government. The existing central government initiated incentives on price and ownership for farmers that allowed them to sell part of their produce in the free market (Morrison, 2015). Moreover, four special economic zones were established by the government and these were set-up along the nation’s coastline so as to attract FDIs, increase exports, and import products of high technology into the country (Morrison, 2015). More reforms were made and these were done in stages and aimed at decentralizing policymaking in various sectors most importantly trade (Lin, 2012). The provincial and local governments were given economic control these were allowed to operate and compete under the principles of the free market instead of the direction and guidance of the state planning.

Moreover, the population was also encouraged to engage in entrepreneurship. More regions and cities at the coast were designated to be open cities and development zones that allowed them to experiment with the free-market reforms and offer incentives (tax and tariffs) for attracting foreign investments (Morrison, 2015). Furthermore, price controls by the state were eliminated gradually on various products. Another success in the Chinese economy was the liberalization (Morrison, 2015). Barriers to trade were eliminated that increased competition and attracted inflows of FDIs. The implementation of these reforms was aimed at the identification of the policies that produced favorable economic outcomes and which did not for implementation in different regions of the country that is “crossing the river by touching the stones.”

Foreign Direct Investments (FDIs)

There are several definitions of FDI. Among the definitions is that provided by the International Monetary Fund (IMF) that defines FDI as an investment that is made to gain long-term interest in enterprises operating outside the investor’s economy (Apte, 2010). As highlighted in World Bank (2010), FDI is the sum of equity capital, earnings that have been reinvested, long-term capital, and short-term capital as contained in the balance of payments (World Bank, 2010). Varying definitions of FDI also exist within the Balance of Payments Manual. As per the BPM5 FDI is a category of international investment that provides a reflection of the objective of one economy’s resident (direct investor) acquiring a lasting interest in an enterprise resident in a different economy (direct investment enterprise) (Alcacer & Ingram, 2013).

In this regard, the lasting interest refers to the existence of a long-term relationship between the direct investor and investment enterprise and a high degree of influence by the investor of the enterprises’ management (UNCTAD, n.d.). A direct investment relationship is formed after the acquisition of 10% or more of the normal shares and voting powers by straight investors (UNCTAD, n.d.). The investment, in this case, is regarded as direct since the investor who may be a foreign national, company, or entities seeks to control, manage, or significantly influence the foreign enterprise.

Once the identification of a directly invested venture has been done, the definition of the capital flows amid the venture and entities in other states must be categorized as FDI. The long-term interest of the direct investor is considered to be the key characteristic of FDIs, consequently, the only element that can be classified as FDI is the capital provided directly or indirectly by the investor (UNCTAD, n.d.). These investments are those aforementioned that are equity capital, earnings reinvestment, and provision of intra-company loans (short/long-term). Finally, as per BD3 of OECD, a direct venture is a combined or unincorporated enterprise where a single investor from a foreign nation has at least 10% of the enterprises' ordinary shares or the enterprise’s voting powers or has less than ten percent of the firm’s ordinary shares and powers to vote but has significant influence in its management. This is the former case is unless there is proof that the investor’s percentage shares do not permit effective powers in the enterprise (Apodaca, 2010). An effective managerial voice simply means the investor can influence the enterprise’s management and not having absolute control.

Moreover, FDI can also be in the form of a Greenfield entry or Mergers & Acquisitions (M & As). A Greenfield investment is also considered to be an FDI and from this perspective, an FDI can be defined as a subsidiary company created by a parent company in a foreign country from the ground up by one or more non-resident investors (Harms & Méon, 2011). It may also include the establishment of new channels of distribution, offices, and staff quarters. M & As as FDIs occurs where a foreign investor acquires the existing assets of a company that is the transfer of ownership from a domestic investor to a foreign one (Harms & Méon, 2011). The key characteristic that differentiates FDIs from Foreign Portfolio Investments (FPIs) is that the intention of the FDI is to exercise control over the enterprise undertaken.

It is well documented in the currently existing literature that companies owned by foreigners have great levels of productivity compared to their domestic counterparts. However, this is often related to investment in more productive sectors and companies by foreign investors (Masso, Roolaht, & Varblane, 2010). The positive role, impact contribution of FDI in a country’s economy occurs in varying ways that are through the firm’s effect on productivity levels, or other spillover effects (Masso, Roolaht, & Varblane, 2010). For the purpose of this study, long-term investments are considered those that last for five years or more, and anything below 5 years are considered a short-term FDI. To comprehend the influence of FDIs on economic development, it is vital to understand the theoretical foundations of FDI. Cost allocation plays a significant role in the effectiveness of the cost accounting system used by the organization. Businesses require capital expenditure, which comes at a cost; it is not free. Cost allocation helps in the determination of the amount that will be used in the production of a product. It helps in keeping the costs within the budget allocated to business operations, ensure that goals set regarding the target profit margin are reached, and to track any inefficiencies in business operation. Firms operate within their budgets and spend on necessary products and consumers are interested in buying. Cost allocation helps in cost control within an organization. It ensures that low costs allocated to the production of goods and services do not end up being overpriced goods. The profit targets of an organization form part of the objectives of the firm, and they should be attained.

Companies have all set the goals in profit-making through which they can achieve by the sale of services and goods. According to companies, profit is less the cost of the item. If one divides the result with the sale price, the company will give its gross profit margin based on each term. Most companies will reduce costs or sale price to increase the profit margin. If a company does not use proper allocation practices, it may not reduce the cost of the product. The company can have inefficiency and operations, which raises the costs immediately. For example, the company should not use many workers to make a single product (Klein, 1983). The additional workers will add the production cost because they will receive wages hourly. The company should remove the inefficiencies from the system since this will improve the operations for the company and will allow the maximization of profit.

Additionally, microfinance is a type of banking services, which is provided to a low-income individual or group or unemployed who could otherwise have no means of accessing financial services. More importantly, the primary aim of microfinance is to offer low-income individuals a chance to become self-sufficient by providing a way of saving money, insurance, and borrowing money. However, microfinance is not a novel concept. The small microcredit activities have existed since the 1700s. Even though most contemporary microfinance institutions function in developing countries, the tempo of payment default for the loans is astonishingly low hence more than 90% of the given loans are paid. Like any other conventional banking operation, microfinance institutions have to charge lenders interest on the loans offered.

As a result, microfinance has emerged amidst the problems and rethought banking to the poor. Practitioners and policymakers have often skipped the ideology of assessing failures in early experience and coming up with innovation and new ideas. Consequently, income difference is not clarified away by talent difference hence it leaves credit rationing as the primary candidate. The high informal sector rates of interest are insufficient for the poor to borrow. Moneylenders offer loans with high-interest rates making it difficult for the villagers to repay. However, microfinance institutions have come to the aid of the villagers to offer loans at affordable rates. Banks cannot discriminate between risky and non-risky borrowers hence the interest rate will be exceedingly high. The analysis of adverse selection and moral hazard provides tools for analyzing market imperfections.

The informal experiment grew to the Grameen Bank that has branches all over Bangladesh. However, Yunus had to battle against the conventional wisdom of financial institutions and large international donors. He had taken a risk to lend poor people even though they had no collateral to offer. Yunus had seen the micro-borrowers were serious in their obligation since they had only one chance to rise from the poverty trap. Furthermore, the success of the Grameen Bank was in arranging the micro-borrowers in groups of five. They were given further instructions concerning the procedures of the program. Additionally, Yunus concludes by arguing that he understands the dichotomy and insists we should emphasize the social consciousness driven in the private sector.

Moreover, banking institutions should take risk and associate with poor people to understand their needs. Although practitioners and policymakers do not see the significance of helping the poor, one should analyze a situation and come up with the best plan. Banks do not have the capacity to interact with the poor on a financial level. In the same way, banks have lost many of their resources because they do not know the risky and non-risky borrowers. As a consequence, poor people have been edged out with high-interest rates by the banks. For poverty to be eliminated, banks should be willing to take risks because most of the poor people are determined to pay back the loans. The banks should borrow a leaf from Grameen Bank since more than 90% of the micro-borrowers are repaying back the loan. The finance institutions should be stern in the loan instructions are procedures to make sure they edge out risky borrowers. Yunus portrayed the perfect example by helping the poor despite the absence of collateral. Policymakers and practitioners should carry out research before they come up with conclusions about discriminating against the poor. Yunus tried to show that Bangladesh can eradicate poverty if the financial institutions followed in his steps.

Policymakers should be ready to take risks because of the huge returns it can have to a financial institution. Furthermore, they should understand that information from their peers can be used as collateral even if they do not have material wealth. Incentive contracts can be devised to ensure local lenders are hired as agents for the banks. More importantly, policymakers should understand that raising the interest rates will undermine the quality of the institution’s loan portfolio hence reducing the profitability of the firm.

Summary of FDI theories

There are two major theories on Foreign Direct Investments (FDIs) that are international trade theories and international production theories. International trade theories attempt to explain the motives of trade, the underlying patterns of trade and the benefits to nations, and enable firms and governments to act on the basis of the benefits gained from the systems of trade (Brakman & Garretsen, 2008). On the other hand, international production theories highlight the reasons and patterns underlying a foreign country’s production activities (Brakman & Garretsen, 2008). The theories suggest that any firm’s propensity in engaging in foreign production is dependent on several factors within the target market that works in combination (Brakman & Garretsen, 2008). They further elude that trade and investment should be conducted with similar principles to those of comparative costs and be contributed to the division of labor at the international level.

Innovation

Similarly, to have a meaningful discussion on the role and impact of innovation on the economic development of China, it is vital to have an understanding of the term innovation from an economic perspective. This allows the establishment of the framework with which the objectives of this study can be discussed and easily highlight how it is tied to FDI, and they combine to stimulate the economic growth of any state, and this case China. Innovation is today widely used; however, the term has been ill-defined (Greenhalgh & Rogers, 2010). Innovation can be described as the act of applying new and novel ideas to products, processes, and other aspects of a firm’s activities resulting in increased value (Greenhalgh & Rogers, 2010). The value is broadly defined to include high-value addition for the firm and consumer or other firms’ benefits.

The vital definitions of innovation are product and process innovation. While the former can be defined as the introduction of a new product or a change in the quality of an existing product that is significant, the latter is defined as the introduction of new production and delivery process for goods and services (Greenhalgh & Rogers, 2010). Within the definitions of innovation provided above is the element of novelty as innovation is defined as being new to both the firm and the market.

Moreover, the product or process must be introduced to the market for the benefit of the consumers a feature that distinguishes innovation from inventions or discoveries. The process of innovation comprises various stages s illustrated in figure 4 below, and each of the stages contains activities that require knowledge input and Research and Development (R&D) (Greenhalgh & Rogers, 2010). These are contained in skilled personnel and specialized equipment and time investment in the utilization of these resources. Each successful stage results in the production of outputs that were initially intangible into a tangible form for sale in the marketplace or may remain intangible if it is a service (Greenhalgh & Rogers, 2010). The introduction of innovation in a firm and consequently a country’s economy involves a risk (Sahin, 2006). Therefore, an innovation-decision is required that involves a process. The process can be described as an activity for seeking and processing information with the aim of reducing risk and uncertainty regarding the advantages and disadvantages of innovation.

Basic Features and Measurement of Innovation

This study is targeted at exploring the existing relationship between economic development and innovation in China and innovation is discussed as one of the key determinants of economic development. Innovation is discussed in regard to the term as a concept and characteristics and the main indicator of innovation in the nation. An additional definition of innovation to the ones provided above is the initial attempt to carry out a new idea for a new product or process into practical use (Fagerberg, 2005). It could also be considered to be the commercialization of new products and processes. A country’s capability to innovate is considered as among the main elements of economic development (Fagerberg, 2005). As aforementioned, the paper aims at highlighting the relationship between innovation and economic development from a quantitative approach and establishes the levels of regional contribution and differences in innovation and consequently economic development within these regions.

To highlight the relationship, the elements of innovation require quantification for regression analysis. Innovations were measured in the form of patents which are simple and conventional ways of quantifying innovations (Breznitz & Murphree, 2011). Today, policies and protective laws related to innovations are more complete and perfect. Therefore, registration of patents and protection of the benefits of innovators is emphasized by the innovators and policymakers (Breznitz & Murphree, 2011). Systems of patenting, keep detailed records of information for new market inventions and individuals apply for patents for their innovations to allow their use without copying or cheating (Breznitz & Murphree, 2011). Due to the simplicity and regardless of the drawbacks patent measurement is globally used for quantifying the level of innovation. The other traditional measure for investment is the expenditures made on research and design (R&D). The efforts made by a nation in investing in R&D have a direct relationship with its levels of innovation (Breznitz & Murphree, 2011). Research and design expenditure measurements provide a more detailed classification of different types of innovations compared to patents as there are different divisions of the R&D concepts.

The faster the rate of development of any nation, the greater the knowledge and recognition of innovation. Therefore, there is an increasing number of parameters for measuring innovations. Innovation is considered among the main generators of economic development in China with a large number of patents. The government changed its policies to ensure the speedy processing of traditional agriculture and production into innovative businesses. Patents registration will be used as an indicator of innovation.

Economic Development

Finally, before setting out to highlight the role and impact of FDIs and innovation as described above on the economic development of China including addressing the other objectives and answering the research questions of this study, it is vital to understand the meaning of economic development as will be used in this paper. Given the broad nature of the field of study and its application, it is obvious that the term has a variety of meanings. Economic development is a concept, activity, and professional practice hence the difficulty in defining the term and the lack of a single universal definition of it.

In economic theory, the first step in understanding economic development is differentiating it from economic growth. Economic growth is mainly theoretically based and simply quantified as the aggregate increase of a country’s output (Nafziger, 2012). Economic growth on the basis of the theory is considered to be like an engine that produces yields as a purpose of inputs (labor, equipment, and land) (Nafziger, 2012). Economic growth is, therefore, said to occur when a nation’s outputs increase. The increase in output may be attained by the incorporation of technology or innovation in the production processes to promote efficiency or injecting more inputs (Nafziger, 2012). Partly due to this straightforward nature, the emphasis placed by economic growth on increased population, levels of employment, and output dominate debates (Nafziger, 2012). This is despite the element that such increases could be tied to improvement and/or depreciation in affluence and the people’s value of life.

Economic development, on the other hand, can be termed as the growth of a country’s capacities contributing to the improvement of the country by realizing the perspective of the country’s individuals, firms, and the community at large (Karlsson, Andersson & Norman, 2015). It is the economic progress of a country or the qualitative measure of this progress and the adoption of new technologies, movement from an agricultural-based economy to one that is industrial-based accompanied by a general improvement of the populace’s living standards (Nafziger, 2012). The level of development is determined by the affluence and value of life through innovation, reduced costs of transactions, and the usage of capabilities for the responsible manufacture and diffusion of the goods and services (Feldman, Hadjimichael, Kemeny, & Lanahan, n.d.). It requires institutions that are effective founded on openness, risk tolerance, appreciation of diversity, and a high level of confidence that there will be mutual gains for both the public and private sectors (Feldman, Hadjimichael, Kemeny, & Lanahan, n.d.). It is vital for the creation of growth of the economy and ensuring a prosperous economic future hence; economic developments also include economic growth (Feldman, Hadjimichael, Kemeny, & Lanahan, n.d.).Therefore, in my discussion of the roles and impact of FDI on economic improvement, economic growth will be considered as an element of economic development and not an isolated term as economic advance as mentioned above is part of development.

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Role of FDI and Innovations in China’s Economic Development

Since establishing economic reforms and call for foreign involvement in the economy of China in 1979, the country has become the second main receiver of global direct venture inflows. It is also currently the biggest host country among the developing nations (Buckley, 2012). Along this rapid process of increased FDIs inflows, there is an accompanying significant development and growth of China’s economy (Liao, 2009). FDI has, therefore, played a vital role in china’s economy. For example, has been one of the primary determinants of the opening up of the country’s economy and hence strongly promoted the domestic market’s competition and determined the evolution of foreign trade (Liao, 2009). In addition, FDI in China has been seen to boost investments domestically. An open economy like China finances investments by both domestic savings and foreign flows of capital (Liao, 2009). FDI promotes economic development through physical stock expansion in host countries and the increase of domestic investment efficiencies via the creation of competition.

Theories on FDI suggest that FDI’s role in the economy of the host country can be approached within economic development’s theoretical frameworks. Investigations on the impact of FDI on economic growth and development as will be conducted later in this paper should take into consideration both the direct relationship between FDI and a country’s output and its impact on the economic development conditions and determinants that indirectly affect economic development (Wei, 2010). From this point of view, a study on the role of FDI in a country’s economic development can be discussed from various perspectives with complementary or contradictory conclusions.

Propositions contained in neoclassical theories indicate that FDI aids economic development by promoting economic growth due to several factors. These include the inward flows of FDI that enhance the formation of capital and augment employment (Wei, 2010). This is achieved because the expansion of FDI-related industries grows the host country's economy (Grivoyannis, 2012). It also results in the creation of employment within the sectors and activities that are indirectly tied to the original FDI (Wei, 2010). As an empirical example from a study conducted by the OECD in 2000, the overall employment in foreign-owned companies had significantly increased between 1991 (4.8 million) and 1999 (18.38 million) a rate that is even higher today as will be demonstrated in the impact section (Wei, 2010). The increase in employment is achieved through the employment of Chinese people in the invested industries through the backward and forward linkages created by the investments. For example, the suppliers, service providers, and/or subcontractors.

In addition, FDI naturally attracts within the host economies special resources, for instance, relevant know-how in management, access to international production networks; skilled labor and established brand names; and technological transfers and spillovers. The acquisition of such modern technology was among the greatest reasons for China’s goal to attract FDIs (Fu, 2008). The government at the time the aim was to promote industrialization. Advanced technology is promoted in two ways, through the direct introduction of advanced technologies to their subsidiaries and spillover effects as mentioned above (Fu, 2008). Initially, FIEs in China were mainly labor-intensive and export-oriented with minimal technological content, for instance, within the garment industry. At this point, the Multinational Companies (MNCs) regarded China as a place for digesting their outdated technology (Chen, 2012). However, the intensification of competition that came with the opening up of the Chinese market, Chinese firms FIEs have increasingly adopted advanced technologies to maintain their market shares.

Spillover transfers of innovation and technology in China have been generated mainly through education and training of Chinese locals and learning-by-doing by the domestic companies. Local suppliers in China acquire technological assistance need by the FIEs to meet the current technological requirements (Abraham, Konings, & Slootmaekers, 2006). Local partners to the FIEs have also learned new technologies through cooperation with MNEs. The spillover effects have been significantly felt in China’s electric and telecommunications industry where today the domestic competitors have caught up with FIEs that in the past dominated the country’s markets (Abraham, Konings, & Slootmaekers, 2006). In regards to the development of human capital, Wei (2010) highlights that 85.4% of the 442 FIEs in China engage in trade procession trained their local employees within China while 21.3% trained them abroad and 8.9% did not offer any form of training to their employees.

Summary of the Section

While FDI is seen to have a direct function in the economic progress of China, innovations affect the economic progress of the country indirectly as a “by-product” of FDI. FDI has played a vital China’s development through economic reforms that opened up the country to foreign investment inflows augmenting employment in the country, increased investments especially in fixed assets, and promotion of trade that has converted China into a great exporting nature that is industry-based (Zhang, 2006). Innovations also played a vital role through the FDIs through research and development of the industries and of the people and spillovers generated from FIEs to local companies (Fu & Soete, 2010). Furthermore, through the competition effect generated between the local firms and FIEs as an outcome of the implementation of modern innovations by domestic firms that have eliminated the traditional FIE monopolies in the country. Finally, through the FIEs training provided to locals, there have been advanced regional innovations through better practices and knowledge in innovation management that have produced greater effectiveness in innovation in China.

The Impact of FDI and Innovations in China’s Economic Development

Impact on GDP

The most obvious impact of FDI on China’s economy is the impact on the GDP of the country. While it may be difficult to ascertain whether the increased number of FDI comes from increased GDP or vice versa, FDI has significantly contributed to China’s GDP growth directly or indirectly (Stohldreier, 2009). Following the adoption of Open Door Policies by China, the country has experienced significant GDP growth between 1978 and 2007 from 364.5 billion RMB Yuan to 24’953 billion (Stohldreier, 2009). This increased to 39’798 billion Yuan in 2010 as illustrated in the figure below.

This growth in GDP has been occasioned by the adoption of initiatives that have encouraged inward FDIs. China perceives the attraction of FDIs as a vital element for development and this has made China the second-largest country attracting the inflow of FDIs following the United States (Chartas, 2010). This is illustrated in figure 1 and figure 2 in the previous chapter. This has been attributed to revenues generated from tax, earnings from FIEs and tariffs, enhancement of capital formation that has resulted in the accumulation of capital for China, and the augmentation of the country’s total productivity levels (Chartas, 2010). Moreover, its due to the spillovers as explained above that include innovations because of the adoption of new and advanced technology and knowledge from the foreign investors and finally, through the generation of opportunities for employment as indicated in the table below.

Impact on International Trade

Participation in trade at the international level and driving economic growth and development via exports is considered among the main policies for opening up China’s economy. Consequently, there has been a tremendous increase in China’s international trade. China’s external trade has been tremendously growing over the years (Chartas, 2010). For example, the exports increased from 0.5 US$ to1442.8 billion US$ between 1979 and 2008 and by 2014 it stood at $ 2.3 trillion (Wei, 2010). This is attributed to the increased levels of FDI in the country and the resultant expansion of the country's expansion in the manufacturing of exports (Wei, 2010). Export promotion via FDI has been the major reason for FDI attraction by China. FIEs in China have produced this improvement in China’s export performance making it the lead exporter globally (Chartas, 2010). Through exportation, the local industries have benefited from spillovers and technological transfers. The increased exports also raise produce an increase in imports hence improving overall trade balance since 1998.

Innovation also has had a significant impact on the country’s trade. In the export market today, China is gaining a much larger share of high-tech products in the export market. Figure 8 below the trend in the country’s exports since 2002 (Xing, 2011). The high-tech exports have been growing by about 30% annually, and this is a higher rate compared to the overall export growth. In 2009, the growth in high-tech exports reached US$ 376.9 billion and this comprised 31.4% of the nation’s total exports (Xing, 2011). China had trade deficits of high-tech products before 2004, but the rise in exports turned the deficit into a surplus and in 2009 the surplus rose to US4 67 billion that represent 34% of China’s total trade surplus.

Impact on Economic Transition

Finally, FDIs and innovation have had a significant impact on China’s economic transition as part of economic development. The neoclassical theories in economics indicate that markets are a better approach for the organization of the economy compared to central planning (Wei, 2010). FDI inflows and its spillovers of innovation and technology have significantly contributed the economic transition of the country’s economy to a market-oriented economy that has positively impacted several areas of the economy that have improved the economic performance of the country (Stohldreier, 2009). These are first the diversification of the structure of ownership that has transformed the country into a mixed ownership structure of state institutions, private, and collective businesses (Stohldreier, 2009). This diversification has increased FIEs in the country which has increased effectiveness in the domestic market and encouraged a market-oriented economy.

In this regard, FIEs today account for the more vital part of the production to meet the local demands compared to imports. The ownership structure diversification from FDIs has consequently produced product diversification as a result of the increased competition (Stohldreier, 2009). Product diversification despite having its extra costs in the production process has produced products that meet the needs and demands of different consumers in the Chinese market (Shen, Wang, & Su, 2011). This has improved both the value of the life of the Chinese people and promoted the performance of firms hence economic development (Shen, Wang, & Su, 2011).

Second FDIs and innovations directly or part of FDIs have played a significant role in the establishment of institutions that are market-oriented. FDI attraction exerted constant pressure on creating legal frameworks in China in regard to IPR and the creation of reforms in the systems of accounting (Stohldreier, 2009). Third, they have facilitated the much-needed reforms in State-Owned Enterprises (SOEs) that allowed them to jointly venture into business with FIEs. The SOEs have in turn benefited from various better systems of management, incentive schemes, and risk management methods that have improved the overall performance of these enterprises hence promoted economic performance and ultimately economic development (Stohldreier, 2009). Lastly, they have promoted competition in the country as the FDIs and innovations have overall improved the country’s competitiveness as they have broken the oligopolistic structures and state monopolies that existed in the country (Stohldreier, 2009). Therefore, through FDI and innovation, there is a highly competitive manufacturing sector not only domestically but also in the international market.

The Origins of FDI and Innovations in China's Economy

The trade and investment incentive and reforms in China have played a part in the growth of foreign direct investments in the country. These flows have been a significant source of productivity gain as well as rapid trade and economic growth in China (Indian Economic Association, 1953). According to Morrison (2015), approximately 445,244 foreign-invested businesses had been registered in China by 2010, employing over50 million employees. Since 1990, levels of foreign investment enterprises (FIE) have risen significantly; rising from 2.3 percent to 25.9 percent as of 2011 (Morrison, 2015). In fact, this accounts for a substantial share of the industrial output of China as well as foreign trade.

The yearly FDI inflows to China rose from USD 2 billion in 1985 to a high of USD 128 billion in 2014; making China the largest destination for foreign direct investment (Whalley & Xin, 2010). The global FDI has risen exponentially over years; growing from approximately USD 200 billion in the 1980s to approximately USD 1.2 trillion in 2014 (UNCTAD, 2014). In discussing the source of FDI in China, it is important to note that this global phenomenon is largely a north-north affair (Porth, 2003). The developed nations accounted for a significant proportion of FDI outflows while they were also recipients of the largest proportion of FDI inflows. However, the structure of external financing in China is quite distinct from that of most emerging economies in Asia or Latin America. In China, the FDI share is quite large and the proportion of a foreign loan is quite small as opposed to other Asian countries. Furthermore, the significance of portfolio investment is low as opposed to other emerging economies. Presently, the FDI stock in China is relatively large since income earned from investments is growing and re-invested earnings are increasingly coming an integral component of the FDI inflows.

While the FDI in China is high, a handful of economies account for the financial and non-financial resources invested. Hong Kong emerges top as a single investor though the newly industrialized economies (NIEs) are the largest sources of FDI inflows in China. Since 1991, Hong Kong has been the largest supplier in China. Of the total FDI inflows to China, Hong Kong contributed approximately 50 percent (Wei, 1996). This is an exemplary pattern. Hong Kong's contribution to the aggregate FDI in China has been significantly high since the enactment of the open door policy (United Nations, 2007). Nonetheless, it should be noted that the Hong Kong Investment is indeed the Taiwanese FDI outflow in disguise; to avert any political difficulties with the government of Taiwan. Some parts of declared Hong Kong investment is purported to originate from mainland China; local investors want to benefit from the preferential treatment given to foreign investors by the mainland.

It is also worth noting that other East Asian nations, especially those with a significant number of the Chinese diaspora, for instance, Singapore, Macao, Indonesia, Malaysia, and Thailand, have also provided a significant volume of foreign direct investments to China. These Asian countries collectively account for an immense share of FDI inflows to China: over half of the total FDI in China. In essence, this situation is attributed to the still principal part of Hong Kong; which accounts for more than half of the total FDI inflows (Ho, n.d.). Over the past years, Taiwan has consistently ranked the second behind Hong Kong, amongst foreign investing nations. The relevance of Taiwanese and Hong Kong investors reacted to the preliminary strategy of the Chinese government that was intended to draw "overseas Chinese" to do commerce in mainland China.

The Special Economic Zones set up in the province of Guangdong; particularly Zhuhai and Shenzhen, next to Macao and Hong Kong, the Special Economic Zone of Xiamen, in the Fujian province, next to Taiwan, was evidently intended to attract finances from overseas Chinese. This strategy proved to be successful. Despite the restrictions levied FDI in China by Taipei, investment by the Taiwanese increased speedily in the early nineties; though it has since declined after the imposition of the restrictions (Chantasasawat et al., 2004). Nonetheless, this turnaround might well reflect an underestimation of the real flows of FDIs from Taiwan since Taiwan businesses are not permitted to make direct investments in the Mainland China but can do so by investing in another nation. Foreign investments from Taiwan and Hong Kong may be said to be specific because it profited from the special policies formulated by the Chinese authorities and it was enriched by strong family and cultural relations with the mainland.

Among the industrialized nations, the United States and Japan have been the most significant investors in China. In fact, Japan is China’s second-largest FDI inflow source; after Hong Kong. Japan's FDI's outflow to China has risen over the past years; growing from approximately 12 percent in 1991, to slightly over 20 percent in 2014 (Morrison, 2015). The other two primary investors in the Chinese economy are the U.S. and Germany. In 2014, U.S. FDI outflows to China were valued at USD 65.77 billion while the total U.S. FDI outflows stood at USD 4.2 trillion dollars (Morrison, 2015). Although the figures are significant, it is apparent that U.S. businesses or investors account for a relatively small share of FDI in China. Germany, on the other hand, is China's most significant trade partners within the European trading block; ranking sixth globally (Rodrik, 2003). German firms have been significant investors in the Chinese economy; in fact; they have been the top European investors (German Chamber of Commerce in China, 2015).

Negative Effects of FDI and Innovations on China’s Economic Development

Foreign Direct Investment (FDI) and innovation have ensured the economic growth of China enabling it to realize substantial space in the world’s economy (Rajan & Rongala, 2007). China’s market size, labor cost, quality infrastructure, and favorable government policies are suitable for foreign investors. These investors seek to make a lot of profits from their investments and critically analyze the security of the investment (Alfaro et al., 2004). FDI and innovations have fueled its growth by empowering its business sector. This has made China rise into a superpower with a much stable economy, higher investments, productivity growth, more jobs, and a more dynamic export sector. It has made China realize a better position in the world market as many investors are willing to establish their businesses in China. However, FDI and innovation have negative effects that cannot be assumed. It poses a great threat to the economy and it is much reason to respond to these negative effects (Zhang, 2001).

The increased openness of China and the incredible FDI has led to an increasingly complex and biased tax incentive system. The tax system was well structured and allowed collection revenue in the domestic funded enterprises (Bartels & Crombrugghe, 2009). This ensured that enough money is raised to ensure the smooth running of the government. It also ensured that the resources are well maintained and the domestic traders are exposed to all that they need to run their investments (Szirmai, NaudeĢ, & Goedhuys, 2011). With increased FDI and innovation, new laws have been structure in order to accommodate foreign investors. They are subjected to a different treatment that leads to chaos and confusion. It destabilized the tax system making it complex and more biased. This does not only lead to the loss of government revenue but also promotes foreign investments at the expense of the domestic enterprises.

The structuring of new rules in the tax system has also made China realize a conflict with the WTO principles of national treatment and the prohibition of export and import-replacement subsidies. It has forced China to amend its laws in order to conform to universally accepted laws (Bartels & Crombrugghe, 2009). This has weakened the tax system of China since it is exposed to constant changes. It has lost its original grip and hence developed flaws that weaken the revenue collection process. This has led to huge losses in revenue and weakens the government’s ability to grow.

Increased FDI and innovations have also lead to the growth of regional inequalities. FDI and innovation constitute investors with a primary objective of raising profits. They engage in investment for economic reasons (Farole & Winkler, 2014). They are attracted to resources, cheap labor, reliable market, quality infrastructure, and favorable government policies. These factors ensure that the investment serves their main objective-to make a lot of profits. Therefore, investors critically analyze the environment before choosing a toe to establish the investment. Foreign investors take quality time to analyze the suitability of the environment and establish if it is worth making the investment (Rajan & Rongala, 2007).

China is divided into regions that have different capacities of resources and favorable factors that favor investment. This imbalance allows investors to concentrate on some regions and ignore the others. The focus on specific regions has led to the growing income disparity between the coastal and inland provides (Bartels & Crombrugghe, 2009). The Chinese government is forced to reduce the regional income disparity by constituting measures that will open up the western and central regions to investment. This directive imposes an expenditure on the government and pressure that diverse the effort of the government that will otherwise be used to empower other weakening sectors of the economy.

The effort to correct the regional income disparity leads to conflicts between the government, the foreign stakeholders, and domestic traders. The domestic traders feel ignored and the government seems preoccupied with impressing FDI and innovations. They therefore often fail to cooperate in embracing the foreign investors and giving the support they need in order to run their business (Bartels & Crombrugghe, 2009). This conflict disrupts economic activities leading to reduced production and underutilization of the available resources by both the domestic and foreign enterprises.

Many foreign investors check in to exploit the rich resource available in China. They are interested in the market size, quality infrastructure, and the low cost of production due to cheap labor. This has led to the exploitation of China as foreign investors siphon away their returns in order to develop their own home countries. They do not engage in manufacturing and infrastructure development but rather export their products to realize income. This has opened up China to modern-day economic colonialism where foreign companies expose the host country and leave its resource vulnerable to the exploitation by other foreign enterprises. Many foreign enterprises also violate the established laws and fail to realize the taxes that they are entitled to. This makes it hard for the government to maintain its economic climate. It puts a lot of pressure on the domestic enterprises and the government-owned production lines to finance the government. It denies it a chance to realize a surplus in revenue collection that can be used to fuel economic growth.

With increased FDI and innovations, a lot of foreign companies have been established in China. These establishments come with a surge in the number of foreign nationalities in China (Zhang, 2002). These had led to the introduction of foreign culture in China. It is eliminating the rich Chinese culture in the quest to promote diversity and modernity. This has led to the conflict between the Chinese and foreign nationalities. The conflict does exist due to the different ad contradicting cultural values appreciated by each of the groups. The foreign investors find it hard to conform to the Chinese culture while the Chinese nationalities find it hard to put up with the new and weird foreign culture. This destabilizes the economic sector, as the Chinese prefer to sell and buy from fellow Chinese and shun away from foreign investors. It has led to a bad economic environment marked with resentment and hate that deters economic development. Ideas from foreigners are not appreciated and never considered to be in line with the generally accepted code of conduct.

FDI and innovation are saturated in the traditional sectors and the minimum investment is made in the chemical and automobile sectors. China denies foreign investors the ability to fully claim the ownership of their investments. This shows a big mistrust of foreign investment which is never appreciated by the investment (Goldberg et al., 2008). China is afraid to take the risk of fully engaging a foreign company in leading a certain part of their economy. The enterprises, therefore, fail to realize their full potential since they are denied the opportunity. The laws are structured in a way to discourage the ventures of the investors and encourage those of domestic enterprises. This unfair competition leads to a less productive economic environment where quality is never appreciated. The foreign companies’ ideas and quality of products are never bought by domestic companies. It leads to the exportation of low-quality goods and services that could otherwise be improved through the creation of and competitive economic environment. It has made Chinese products to lose the grip of its market, as many prefer to get products from other countries. The Chinese are also forced to sell their products at cheap rates in order to retain their large market.

GDP and FDI

FDI can stimulate the economy of China through expanding exports to the foreign states, increasing capital formation, generating employment, enhancing the industrial output of China, and expanding the exports to foreign states. By the finish of 2008, the ratio of FDI to the gross fixed capital had developed in 1990 from 3.45% to 6% (Xing, 2011). The world rankings of the Chinese exports had dramatically increased from fifteenth in 1990 to third in 2008 with volume sales of $1,429 billion3, where more than half contributed to foreign-invested enterprises (FIE). Additionally, the share industrial output by the FIE in sum was thirteen times more than in 1990. Moreover, from 1990 to 2008, on average yearly about one percent of the total employment and sixteen percent of the total income was contributed by FIE. The indicators can suggest the positive influence of the FDI in China’s economy. It is apparent in figure 8, before 1990, the FDI percentage of the GDP on average was less than 1% yearly, thus, the causal associations cannot be assessed. During the 1990s, the FDI as the percentage of real GDP and GDP growth were positively correlated (Adegbite & Ayadi, 2011). However, it seems that the real GDP growth leads to FDI. It was similar to the findings of a few empirical researches on the causal association between economic growth and FDI that suggested it was a fast developing economy that attracted FDI inflows. On the contrary, after 2000, it became rather negatively correlated. As a result, the link between FDI and GDP remains unclear. Additionally, the scatter plots in the (figure 9) Provincial data show that FDI as the percentage of real GDP and GDP were weakly and positively correlated.

2.12. Regional Differences in Capabilities for FDIs and Innovation

Differences in regions, cities, and provinces in China exist in regards to FDIs and innovations. This explains the differences in the level and speed of economic development in the country. On the basis of previous research conducted in China, the level of inequality in the nation at the provincial level reduced during the 80s but has since then been on the rise (Qu et al., 2013). The inequality can be attributed to factors that include differences in labor density, locations, infrastructure, and politics. For instance, the rising levels of investment, improved factor mobility, decentralization, openness, agglomerations, and capital input (Peilei, Guanghua, & Ming, 2012). There is significant inequality in the levels of innovations and capability to innovate in different regions in China. This is mainly observed within the east-central-west regions with the inequalities between the provinces exhibiting a V-pattern that is increasing and oscillated starting from 2004 to 2006.

In relation to FDIs, the eastern, western, central, and south-eastern regions were previously examined in a study by Cheng (2000) that revealed that FDI and the growth of GDP that is a determinant of economic development are positively correlated in all of China’s provinces. The study also revealed that FDIs act as a stimulant to economic growth and development of the coastal provinces compared to those located in the western areas of China (Chartas, 2010). In a similar manner, a related study conducted by Wei Hou-Kai in 2002 also revealed a highly significant and positive relationship between the same variables in China’s eastern provinces (Chartas, 2010). On the other hand, the study also indicated that FDIs located in China’s western regions have no significant impact on the growth and development of the country’s economy.

FDIs inflows significantly affect the growth of China’s income. According to Zhang (2006), the growth in income increases over time with the coastal provinces experiencing greater growth compared to the inland provinces (Zhang, 2006). Regional disparities exist in China and are correlated to FDIs in every region. These affect the income inequalities of the country’s various provinces. While the FDIs appear to have a significant impact on the development of the coastal provinces, the same is absent within the inland provinces.

Regional FDIs Distribution and Division of Cities

Regional FDIs Distribution

The differences in the attraction of FDIs have created regional differences in economic development. This due to the fact that certain leaders in the nation have promoted FDIs attraction to certain regions, geographical location, market size, and labor productivity (Zhang, 2006). These were distributed unevenly. The disparities are significant among the provinces. At the start of the reform era at about 1985, Guangdong and Fujian were the main FDIs recipients (Zhang, 2006). These comprised of the initially create special economic zones that already had a geographical upper hand in regards to their location. Moreover, Beijing and Shanghai had a good economic environment and better infrastructure. Consequently, there was a skyrocketing of FDIs in Shanghai that was up to approximately US$10 billion (Zhang, 2006). Furthermore, Jiangsu, Zhenjiang, and Shandong in east China received a huge amount of FDI with notable progress. On the other hand, Hainan and Guangxi provinces had minimal development with low-level economic development (Zhang, 2006). Also, western provinces such as Guizhou, Yunnan, Guasu, Xinjiang, and Sichuan have minimal FDI shares. Therefore, about 90% of the country’s inward FDI was received by the country’s eastern provinces (Zhang, 2006). While a few of the provinces in the west had modest progress, most had no tremendous development compared to those in the east.

Division of Cities for Innovations

In China, the division of cities is vital and is based on factors of competition such as financial power, geographical influence, political status, and standing, and geographical size just to mention a few. On the basis of such a standard, the cities of China are divided into five levels with the first level cities being towns such as Beijing, Shenzhen, and Shanghai (Wang, Fan, & Liu, 2007). Second level cities comprise Nanjing, Chongqing, Wuhan, Xian, and Tianjin among others. This, therefore, suggests that disparities exist in levels of innovation between the different cities (Wang, Fan, & Liu, 2007). The differences result in disparities in the presence and availability of innovations hence differences in the levels of economic development.

However, despite the differences, they all add up to ensure the overall development of the country’s economy. This paper highlights these disparities and provides insight into the fact that there are regional differences exist, however, they all combine to ensure the development of the entire nation.

The Gap

As highlighted above, over the last thirty years, China’s market has been gradually opening up and hence attracted trade, FDI, and innovations. From 2001, the increased outward orientation of China has been cemented by the country’s entry into the WTO. This has further supported its exports, imports, and inward flows of investments. Especially the great increase of inward FDI over the years and the effects it has had on the domestic economic development has received significant academic and policy attention. FDI and innovations have significantly developed China, however, the major concern that will be the key focus for this study is the fact that the external opening of the economy has created disparities in the countries regional development where certain regions are more economically developed compared to others. This aspect has been rarely addressed in research, therefore, this paper as part of highlighting the impact of FDI and innovation on economic development focuses on the regional disparities.

Research Methodology

This chapter discusses the research methodology that was used in this study. It highlights the research design, research philosophy, research approach, and research methods. It also discusses the data collection and analysis methods that were used, the accessibility issues experienced, and finally the limitations of the study.

Research Design: Descriptive ad Explanatory

The research design refers to the strategy selected for the integration of the different components of the study in a coherent and logical manner. It, therefore, ensures that the research problem of a particular study is effectively addressed (Vogt, Gardner, & Haeffele, 2012). It is an articulation of the data required for the study, the data collection methods, and the means of answering the research questions (Vogt, Gardner, & Haeffele, 2012). For this study both a descriptive ad explanatory approach were used to answer the research questions and meet the objectives of the study. A descriptive approach to this study was considered as the study attempts to provide an accurate description of certain phenomena and existing conditions. A descriptive approach supports comprehensive analysis and provides the findings of the research with ease (Vogt, Gardner, & Haeffe, 2012). An explanatory approach where there is a causal relationship that requires a causal explanation to ensure that the research questions are answered as unambiguously as possible (Vogt, Gardner, & Haeffele, 2012). The descriptive nature of the study allows any reader to comprehend FDI, innovations, and economic development as separate concepts. In addition, it is effective in gathering data that can be easily quantified and used for statistical inference to the target audience. Furthermore, there appears to be a causal relationship between FDI and innovations and economic development. Therefore, the explanatory approach provides insight to the reader on the causal relationship that exists between FDI and innovations and economic development in China.

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Research Philosophy: Positivism

The research philosophy is the belief regarding how data in a particular study should be collected, analyzed, interpreted, and utilized. It is related to the development of knowledge and the nature of this knowledge developed and the means for gathering, analyzing, interpreting, and using such knowledge (Mkansi & Acheampong, 2012). Research philosophy in a dissertation involves awareness of the study’s assumptions and the formulation of the researcher’s beliefs ad assumptions. The choice of philosophy is influenced by the practical implications of the study (Mkansi & Acheampong, 2012). The positivist philosophical approach was selected for this study. The assumption in this approach is that phenomena can be studied as facts and the relationship between the facts established as laws in science (Crossan, 2003). Positivism is, therefore, scientific in nature with the belief that observations of the world can be objectively made due to the stability of the world’s reality.

From an economic point of view, it takes into consideration the impact of certain factors on the economy. Positivism is used where the study is highly structured ad contains large samples and the measurements often are quantitative but qualitative ones can also be used. The researcher’s role under positivism is limited to the collection, analysis, and objective interpretation of the data (Crossan, 2003). For this study, the researcher highlights the relationship between FDIs and innovations and economic development in China and the regional differences in the levels of development in the country. Only secondary data was collected. Therefore, it is analyzed quantitatively with the relevant statistical methods to establish the impact of FDIs and innovations o economic development in China and the regional differences that exist.

Research Approach: Deductive

A research approach is a plan and procedure for undertaking a study. Research approaches begin from the assumptions made for the study of the data collection, analysis, and interpretation methods (Kaufmann & Panni, 2014). There are two main types of research approaches that are inductive and deductive. An inductive approach starts with the observation of phenomena followed by the formulation of theories to explain the observations. It also involves the search for certain patterns from the observations made and the development of theories to explain the observed patterns (Kaufmann & Panni, 2014). The deductive approach, on the other hand, begins from a general point of view to a more specific point that is a ‘top-down’ approach (Kaufmann & Panni, 2014). As mentioned earlier and discussed in Chapter 2, there seems to be a causal relationship between FDIs and innovations and economic development in China. Therefore, the deductive approach was undertaken in this study. The approach was used to allow the results to develop from a general perspective to a specific one that is from the general theories and concepts of FDIs, innovations, and economic development to how the former two impact the later in China as a whole and regionally.

Research Methods: Quantitative

The study has used the quantitative research method. Quantitative research is described as the numerical representation and manipulation of observations made in a study with the aim of providing a clear description and explanation of the phenomena under study (Creswell, 2003). Quantitative research involves the isolation of certain variables (FDIs, innovations, and economic development) as contained in the study ad seeking an existing correlation, relationships, and causality (Creswell, 2003). These are sought through statistical, mathematical, and numeral data analyses. It also involves the representation of findings in pictorials that promotes an easy understanding of the matters under investigation and derivation of the appropriate inferential information (Creswell, 2003). Therefore, due to the descriptive nature of this study, the data on the impact of FDIs and innovations on China’s economic development can be obtained and analyzed and interpreted.

Method of Data Collection: Secondary Data

For this study, the secondary data collection approach was utilized. Information was gathered from a previously done research sourced from online libraries. The area under study has minimal literature; therefore, the data used was from two sources as it provided the best information and the most reliable data for drawing conclusions and making inferences in the study. The keywords used for selecting the most appropriate sources of secondary data include, “FDIs,” “innovations,” and “Economic development in China.” From these sources, the impact of FDIs and innovations on China’s economic development and the regional differences in development were evaluated.

Data Analysis: Regression Analysis

The statistics are evaluated based on the regression analysis of variables under study. FDIs and innovations are taken to be separate variables and their impact on China’s economic development and the regional differences analyzed separately. The independent variables in this regard are the FDIs and innovations while the dependent variable is the economic development of China.

Analysis of the Impact of FDI on Economic Development

For the analysis of data within this section, an endogenous growth model is taken into consideration and is briefly described and used to estimate the existing relationship between FDIs and innovations at the provincial level. These will be achieved by starting from the Cobb-Douglas production function:

Y=AKaLb,

Where Y represents the level of output of GDP, A is the production efficiency, K is the capital used or available, and L is the labor force. The function of production indicates that provincial outputs are dependent on the inputs and the productivity parameter.

This model is based on Balasubramanyam et al. 1996 and Borensztein et al. 1998 endogenous model of growth. The assumption under this model is that FDI promotes economic development through new technology (innovations) and comes into the production function via the productivity parameter (A). This is through skill and technological transfers from the foreign nations and the augmentation of missing capital. It also promotes development through the enhancement of infrastructure, human capital, and institutions in the nation. Hence, productivity (A) is dependent on human capital.

The objective is to determine the impact of FDI and development, the regression model used contains additional explanatory variables to examine its impact on the growth of GDP as part of development. The assumption made is that the stock of capital is dependent on fixed capital and FDI and this is contained in the regression model as is later highlighted. Therefore, output depends on labor, the input of capital, and parameter A. The assumption being that the production function would be linear, the regression model used to test the causal relationship was specified by the equation:

Growth rate of GDPi,t= α +βXi,t + εi,t

Here X comprises a set of independent variables affecting GDP, I the provinces of China (31) and t the time dimension ranging from 1985-2010. Specifications that were estimated for empirical purposes were as below with the GDP’s rate of growth being the dependent variable.

Growth rate of GDPi,t=a + b1FDIi,t +b2EXPi,t +b3Hi,t +b4GCONSi,t + b4POPi,t + b5FCAPi,t + Y* + ei,t

The explanatory variables in the above equation included FDI; Exports from each province (EXP); human capital stock (H) that includes education and schooling, the provinces’ government consumption expenditure (GCONS); population rate (POP); fixed capital (FCAP), Year (Y*); and province fixed-effects.

Analysis of the Impact of Innovations

The objective inherent in this study was the determination of the impact of innovation on China’s economic development and to highlight the regional differences that exist. Therefore, representative cities were selected and the registration patents ad GRP in these cities taken as measurements of the economic situation. These are compared at the same level to determine whether cities with higher levels of innovation could have greater GRP per capita growth through building a model of regression that as highlighted in the next chapter. Data within the cities is where innovation made most of the contribution to the economy is also presented as percentages and the government’s role highlighted based on the review of the literature.

The figures used are from the National Bureau of Statistics to provide insight into the economic development of different cities through their GRP. The basic figures cited include those of Beijing, Shanghai, and Guangzhou with the growth trend of Beijing between 2004 and 2012 employed as an example. The cities are divided into two that are first level (Beijing, Shanghai, and Guangzhou) and second-level cities (Chongqing, Wuhan, ad Tianjin). These were compared to determine the relationship between innovation and the economic situation. To exclude the effects of other variables on the economy, the variables (GRP and patents registered) were included in the regression model so the results will be purely a representation of the effects of innovation on economic development.

After highlighting the economic situation and innovation among the selected cities other variables’ (economy, population, high-tech enterprises output, and education) measurements were determined. The economic situation was determined by the City’s GRP, education by Educational Funds statistics as they contribute to the economy of the city and the country at large and output of high-tech companies that are registered.

The hypothesis is as aforementioned that innovation plays a vital role in the economic development of the cities and country. This hypothesis was tested using an econometric regression model where the four factors (innovation, educational expenditure, the output from high-tech industries, and population) are considered as labor input and capital-output. The population was taken to be the labor input while the rest were taken to be capital inputs. As mentioned above the level of education was measured by Educational Funds statistics while R&D was measured by the number of high-tech industries that directly contribute to the country’s development economically. The notion here was that at the regional level there is a relationship between innovation and economic development. The econometric equation was as below:

Y (GRP) =Education +αX (Innovation) + High-Tech Enterprises’ output+ C+Population

The regression model that was used as a multi-variant least-square lag model as there are multiple variables that impact GRP (Y) and also the need to include a time lag to determine the effect of time on the economy.

Accessibility Issues

Accessibility is how easy it is to attain or obtain relevant information for conducting a study. For this study, the main accessibility issue was finding the relevant secondary data sources about the subject under study. This is because this study aims at highlighting the impact of FDIs and innovations on economic development as separately while in economic terms innovations are often seen as spillovers of FDIS. Therefore, finding the relevant sources covering especially innovation in isolation proved challenging. Moreover, the sources were complex and required simplification to promote understanding by any reader. Furthermore, studies on regional differences in economic development as influenced by FDIs and innovations are minimal hence difficult to access.

Research Limitations

Research limitations are the characteristics of a study design or methodology that impact or influence the interpretation of research findings (Labaree, 2010). They are considered to be the constraints experienced in relation to the generalizability of the findings, application in the market sector, and the utility of the study's findings (Labaree, 2010). These originate from the choice of the study design and/or method for establishing the validity (internal/external) of the study (Labaree, 2010). For this study, the limitation was the lack of sufficient secondary data in the area; therefore, the findings cannot be generalized and applied to other countries.

Findings and Analysis

This chapter provides the empirical findings and analysis of the regression analyses of the impact of FDIs and innovations on the economic development of China. It also provides explanations and interpretations of the findings. It provides an exploration of the impact of FDI and economic growth hence its impact on economic development bearing the fact that growth is part of development as aforementioned. The sample as used in the secondary data was 31 provinces in China based on data of a range of 25 years (1985-2010). The main regression model provided is as provided above. The robust standard errors are presented in parenthesis while the year ad provinces fixed effects are omitted from the table but were included in the regression analysis. Finally, the asterisks ***, **and * respectively indicate significance levels at 1%, 5%, and 10%.

For the findings and analysis of the impact of innovations on the country's economic development, the data used was that from between 1995-2011. Interpolation or the calculation of the rate of growth was done to fix the missing data point. The data was theoretically smoothened by the regression analysis to eliminate bias and promote validity and reliability. However, due to the shortness of the time series, unexpected results were found, for instance, the levels of insignificance. The data were analyzed with interpolation and growth rate calculation this was followed by establishing the logarithm and calculation of the rate of growth for each variable. The regression analysis was conducted by the E-views software and this followed the following process: smoothening of the original data, checking each variable’s stationery, and regression analysis.

Impact of FDIs on China’s Economic Development

The dependent variable was the lagged rate of growth of Ln (GDP) and GDP divides all the explanatory variables that include FDI, government expenditures, exports, and fixed capital. Education (primary, secondary, or higher) was considered to be a share of the total population and the rate of this total population referred to as Ratepop. The year and province effects were also included but omitted from the presented tables below. GDP data was expressed in 100 million Yuan while FDI in 10,000 US$. The GDP including exports, fixed capital, and government expenditures were all converted into US$ (10,000) and the latter were divided by the GDP and in ration calculated.

The findings indicated that FDI positively impacts economic growth and essentially economic development as in all regression analyses it was found a positive and significant influence at a level of 5%. Therefore, a 1% increase in the ratio between FDI and GDP results in a 0.00768% growth in the GDP and hence the development of the economy.

Other variables affecting development through growth are government expenditure ad rate of population growth; however, this aspect is not relevant for this study hence is not discussed. As discussed in the literature review FDI impacts the development of the economy through capital creation and this is both fixed and human capital. From the data, fixed capital has a positive coefficient and was found to be significant statistically at the level of 5% and 10%. This was expected, as the formation of capital is key in the economic development of any nation. In regards to human capital, the first regression analysis is the only one that indicates higher levels of education have a negative and significant correlation to economic growth (Stohldreier, 2009). This is a highlight in Chapter where it is indicated that the economy of China had developed through manufacturing and highly educated individuals are not employed in the manufacturing sector. Higher education that in this regard was considered to be the student population divided by the total population is indicated to have minimal or no effect at all as it is a poor standard for determining the actual level of human capital. There was no data on the average years of schooling.

From the table, there is a positive and significant correlation between exports and GDP and GDP per capita rates of growth. These are in line with the empirical studies in the literature review. These studies argue that FDI promotes economic development through physical stock expansion in host countries and the increase of domestic investments efficiencies via the creation of competition (Liao, 2009) and similar arguments as indicated in Abraham, Konings, & Slootmaekers (2006), Fu (2008), and Chen (2012). They're increasing the number of exports consequently leads to economic development.

FDI from the review of literature is indicated to supposedly have a positive and strong correlation to economic growth hence development. However, as mentioned earlier, the correlation from these findings is weak an attribute that can be tied to the reliability of the studied data. In addition, it may be due to discrepancies of the data that according to Pentecost (2007), was overvalued during the reform era by local governments as they were paid principles depending on their ability to attract FDIs.

Analysis of the impact FDI in different regions (Coastal and Inland provinces)

Since the paper is aimed at filling the existing gap in the field highlighted in Chapter 2, this section involves an analysis of the attraction and its impact in different regions.

At the regional level, education as a spillover of FDI has a positive impact on development. Moreover, fixed capital and consumption by the government respectively impact the positive and negative growth of the economy. The interpretation and analysis of the findings are similar to those provided in the initial section on empirical analysis.

The inland provinces used for this study are as those presented in table 4 below and the regression analysis for the provinces is highlighted in table 5. From the results, FDI was found to have a positive but slight impact on GDP’s growth rate while exports have a positive but insignificant impact on the provinces’ GDP. The inland provinces are dependent on agriculture hence agricultural development ad this is represented with the negative coefficient in education and the level of insignificance. Consequently, any level of education (primary, secondary, or higher education) has supposedly no influence on the development of the inland provinces.

From the results presented, it is evident that there are regional differences in the impact of FDIs economic development on economic development. The data indicated that there FDI strongly impacts the economic development of coastal provinces compared to China’s inland provinces.

Impact of Innovations on China’s Economic Development

To highlight the processes that were involved in the analysis of data from the other provinces or regions used in this section, the data from Beijing is used as an example. The processes include interpolation and growth rate calculation then the establishment of the logarithm and calculation of the rate of growth for each variable (Stohldreier, 2009). Regression analysis using the E-views software and smoothening of the original data, checking each variable’s stationery, and regression analysis. These areas mentioned in the introduction section of this chapter.

After the above two processes, the data for the variables were checked to confirm whether they were stationary. This was to find out whether the data had a particular trend and judge the spurious nature of the data as if the data was spurious it could not be used for the regression analysis. The analysis as aforementioned used the E-views to have the Dickey-fuller test. For this section, the calculations using a single variable was provided as an example. However, it is vital to note that probabilities and critical values are calculated for 20 observations, and this case they were done using only 15 and, therefore, the results may have lacked accuracy.

In cases where the t-statistic was less than the critical value (1%, 5%, and 10% levels), the hypothesis of the study was accepted and the data considered to be stationary. the Durbin-Watson value was 1.953 that is near 2 indicating the data had no auto-correlation problems hence the stationary of other variables of the data could be checked and the DF test for Beijing was as presented below.

Statistical Analysis of China’s First Level Cities

From the regressions results table, Beijing is the only state that attained the stationary value for all tested variables and a significant level of GRP that was at 0.798 with the lagged effect of the impact of innovation on the growth rate being insignificant. For the case of Shanghai, the population variable is not stationary hence the spurious nature of the regression and the result was, therefore, not trustable. On the other hand, in regard to the country’s economic growth in the most recent year, innovation was insignificant for Guangzhou. However, with a one-year lag, the result was significant with a coefficient of -0.53 that implies innovation had a negative impact where there was a year’s lag in Guangzhou’s economy. The results of the relationship were not as expected that not all cities considered to be first-class cities in China have a relationship between growth and innovation that is significant some have a negative relationship but some analysis and conclusions can still be drawn from these results.

Being the Capital city of China, Beijing always holds the leaders' position in political, economical, innovational, and technological development matters. The regression analysis presented, innovation does not have a significant role in the economic growth and development of every city in China. Beijing had a positive and significant relationship between innovations and growth in the regression results since 1995. Different regions have varying innovational capacities and all the first level cities had a positive result in all aspects (significance and coefficient) except Guangzhou that had a negative significance result (-0.53). This inherently implies that innovations are not the only factors that determine the growth and development of a region or nation’s economy, but they are a vital element. In Guangzhou, education has a positive significant relationship in the regression analysis (Apodaca, 2010). This essentially means that education’s capital input in Beijing is more crucial for its economic development. However, the focus for this study was highlighting the relationship and impact between innovation and economic growth as part of economic development, therefore, the other aspects were not taken into consideration, but it highlighted the existing differences in regional development that is dependent on the area of focus of the city to promote development. From the literature review, the government has placed its focus on innovation that has promoted technological enterprises hence plays a role in economic development through innovation (Apodaca, 2010). In addition, by looking at the growth rate and innovation as presented in the results above, within the growth rate of three cities there is no clear trend that the cities that have a higher rate of growth of innovation have a higher rate of economic growth and development. The averaged development rate of the GRP: Beijing - Guangzhou - shanghai; averaged development rate of novelty: Shanghai - Guangzhou - Beijing.

For the first level cities and the different contributions of innovations, the models of utility were found to have the most contributions of innovations for the lagged effect. This was due to the differences focuses on innovation by various cities where when Beijing and Guangzhou are compared; Beijing had higher levels of innovations while Guangzhou had a greater percentage of innovational designs. This could be understood by the argument that inventions are put into the practical production of goods and/or services hence cause a boom for the current year while designs take a longer time for economic activation that is they require more time to be applied to the practical production of goods and/or services. Economic growth and development can also occur through the influence of endogenous factors such as capital and this is as tested for Beijing and Guangzhou.

Consequently, for first stage cities apart from Beijing, there is essentially no linear, positive, and positive link between innovation and economic growth in the three first-level cities. In addition, different cities possess different inputs in labor and capital for ensuring economic growth and the application of utility models comprise of the largest shares of innovations. Finally, on the basis of the different areas of focus in the field of innovation, lagged effects exist between innovation and development among different cities.

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Statistical Analysis of China’s Second Level Cities

In the study, for the cities that were considered to be second-level cities, the variables for Tianjin were found not to be stationary hence the spurious nature of the regression results and, therefore, could not be trusted. Wuhan contains a non-significant positive and negative relationship for the current year and the one lag year respectively (Azarhoushang, 2013). Chongqing possesses both a negative and significant result for the current year but a negative and insignificant outcome with a year’s lag. With the limitations in the data used, the regression results for these cities were not completely outside the expected outcomes.

The results revealed that the relationship between economic growth and hence development is not always positive and significant and this was similar to the results from the analysis of first-level cities. However, in the case of second-level cities, there was a greater indication and trend for higher growth and development where there were higher levels of innovation (innovation: Chongqing >Wuhan > Tianjin; Economic growth rate: Chongqing > Wuhan > Tianjin). The figures attained were compared and averaged within the entire period studied. These findings were, however, not considered to indicate that there is a definite linear relationship between innovation and economic growth because the data utilized was too limited (Azarhoushang, 2013). The only conclusion that was made from the findings for the second level cities is that higher innovation can produce greater growth and development in the economy. Therefore, while different cities and regions may have distinct areas of focus in regards to input in labor and capital for the development of their economies, from the trend observed in the second level cities the higher the levels of innovations the greater the level of economic growth and development.

Conclusions

The Impact of FDIs on Economic Development

China’s economic power has rapidly risen within the last thirty years and is considered the greatest economic success in modern history by most economists. The economic reforms as aforementioned began in 1979 and continued up to 2014 and from the data presented the country’s GDP an indicator of economic development grew at an average annual rate of 10%. Due to this rapid growth and development, the country has today emerged as the largest economy, manufacturer, exporter, and importer of merchandise, and foreign exchange reserves holders.

This study’s purpose was to find out the impact of FDIs and economic development. Economic growth was discussed as it is part of economic development hence an indicator of development. From the literature reviews, the conclusion that can be made is that FDIs play a vital role in economic development as a source of capital and as a complement to private domestic investment through the creation of new opportunities for employment and technological enhancements that boost China’s overall development.

Secondary data was analyzed and it also contained the impact of exports but this was not discussed as it was outside the study’s purpose. The study began by highlighting the trend of FDIs on economic growth. Before the reforms, there were significant restrictions in FDIs in China, for example, the level of FDIs in 1979 was below 0.5 billion US$. To achieve the developmental target, China opened up its market to FDIs through the insertion of incentives that encouraged foreign investments. Several announcements were made by the government such as the introduction of economic zones. China also introduced policies that comprise of the main determinants of FDI that attracted FDIs from different countries hence economic development for China became apparent.

The literature review involved the discussion of previous empirical research which is based on the subject of the study. It was aimed at either assisting or neglecting findings of the empirical findings. Therefore, the findings and analysis in Chapter 4 offer results of the regression investigation which was done for thirty-one provinces using the panel data analysis. As a result, the variables used to signify growth and development were the escalation rate of GDP or the per capita GDP. On the other hand, the other variables were utilized for explanatory purposes. Hence, the findings revealed that FDI has a positive and important connection to economic growth.

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The data was distinguished into two different regions (coastal and inland provinces) and the findings revealed that FDIs have a significant impact on the growth of the economy and hence economic development. This was due to the entrance of better managerial skills and technological know-how to the domestic firms. Finally, the evidence revealed that there are regional differences in the impact of FDIs and economic development where the coastal provinces are more significantly impacted by FDIs compared to the inland provinces as they receive more FDIs.

The Impact of Innovation on Economic Development

The study as aforementioned was aimed at also establishing the impact of innovations on economic development and filling in the gap in research studies by highlighting the regional differences in innovations despite the overall positive development of the economy of China. However, due to the limited data that was used for this study, the findings cannot be generalized (Azarhoushang, 2013). For the first level cities, the conclusions made were that while innovation positively impacts economic development, the relationship is not always linear, positive, and significant (World Bank, 2003). In addition, where innovations existed the utility models comprised of the largest share as they were involved in the production of goods and/or services. Finally, development is affected by lagged effects in its relationship with innovations (Crossan, 2003). On the other hand, for the second level cities, the findings are similar to those of the first level cities (Rajan, Kumar, & Vargill, 2008). However, for these cities, a trend of higher innovation amounting to higher levels of growth was revealed.

Therefore, innovations have a positive and negative impact on economic growth. The regional differences that exist are due to the fact that different cities choose to invest their capital in different areas. However, despite the regional differences, the overall outcome is that each region, province, or city contributes in its own way through FDIs and innovations that result in the overall development of China’s economy.

Recommendations

From the empirical results of the study, FDIs have been indicated to have a positive impact on economic development. Therefore, the policy to maintain the liberal nature of China’s economy as it currently is should be maintained to ensure continuous future development of the country’s economy (Alvstan, Dolles & Strom, 2014). The results have also suggested the existence of a significant and positive relationship in the role of education as part of FDI in economic development (Creswell, 2003). Hence, the government in its efforts to attract such investments should focus on improving the labor quality via education and training within the policy of openness and liberalization of China’s economy. Furthermore, the results reveal a clear disparity in FDIs and FDIs attraction in different regions and cities in China. Consequently, the government should impel the national policies and focus to balance the disparities in FDIs among differences in different regions (Chung, 2001). Finally, the study highlights a clear relationship between FDIs and economic development; however, the role of technology transfer is not clearly highlighted. As a result, policies focusing on technological developments should be geared towards diffusion and absorption of current technology within the domestic sector to allow the new technology to raise the production capacity.

In regards to innovation, the importance of innovation and economic development is known. This study investigated the relationship between the two variables both theoretically in Chapter 2 and empirically in Chapter 3 and the findings analyzed in Chapter 4. From the empirical results, there is also a clear positive significant relationship between innovation and economic development and also an increase. However, despite the significant progress in regards to innovations in China during recent years, there are still significant regional differences in innovation within the country where some cities and provinces are still lagging behind in regards to the incorporation of innovation to promote development. Therefore, to limit this gap, the governments (regional and national) should secure sufficient funds for research and development for their industries especially in cities that are lagging behind and promote linkages between cities that are more developed and those less developed to ensure equality in innovation. In addition, policies that encourage innovation among all cities should be put in place, and these are, for instance, tax instruments, reduction of complications in administrative procedures, and establishing proper technologies for funding innovations just to mention a few. Finally, provinces, cities, and regions that have lagged behind in innovations should invest in capacities to catch-up with the rest of China’s cities.

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