Last week, the Vale Columbia Center at Columbia University published a new report on China’s inbound FDI. Titled “The Unbalanced Dragon: China’s Uneven Provincial and Regional FDI Performance”, the report points out some important trends which illustrate in detail how the country’s next phase of economic development is going to be different than what has characterized inbound FDI over the last twenty years. For companies frustrated at the crowded markets and expensive costs related to operating in and selling to China’s Tier 1 cities, the report shows how China’s economy is shifting from being almost exclusively a phenomenon of the eastern seaboard to one experienced more broadly across the entire country, starting with provinces in the middle of the country and ultimately working its way westward.
In support of this conclusion, the Vale report notes that regarding the eastern seaboard “its share in China’s total FDI inflows declined from 89% in 1987-1990 to about 75% in 2007-2010.” What is driving this? As we have written about previously, China’s eastern Tier 1 cities (Beijing, Shanghai) are becoming increasingly expensive places to conduct business in. At least one major American retailer, Best Buy, has signaled that its strategic retreat from the Chinese market is because of this fact, but that it intends to make another approach at the Chinese consumer, this time through less competitive and costly Tier 2 cities. Count me as someone uncertain this is likely to help Best Buy be more successful; however, that is a point for another day.
The much more important point the Vale report shows is that while China’s 
eastern seaboard is still the preferred destination for FDI (as it says, “the share of the Coastal Region in total FDI inflows remains higher than its share in China’s GDP [84% vs. 56%]”), the middle section of the country is becoming increasingly important. The report notes that one area of needed improvement that will likely further accelerate this trend is more favorable implementation of special economic zones for provinces in-land. As the report says, “while China’s overall regulatory framework is the same for all provinces, the Coastal Region benefitted from early economic liberalization and the establishment of Special Economic Zones; this created an enabling environment for export-oriented and market-seeking FDI.” Another way of looking at that is that while Beijing may articulate formal economic development regulations, in China the question is always how these are implemented at the local level; thus far, implementation has been much smoother along the coast. But, this is changing. What is important to take away from this observation is also that foreign companies are likely to find more receptive and aggressive provincial and municipal-level leaders with respect to offering tax incentives and other economic benefits for companies expanding in the middle section of the country.
For companies who view China primarily through the lens of a sourcing economy, the role of China’s middle provinces is going to become increasingly important. China’s eastern seaboard is experiencing high wage inflation that is unlikely to abate any time soon; consequently, hedging strategies need to start looking at whether identifying vendors further inland is a smart trade. The exchange for lower wages is going to be higher transportation costs and some additional time in your supply chain. For companies who view China as a market to sell into, the growth of China’s inland provinces is an opportunity to further refine your sales and marketing approaches, keeping in mind that in China distribution channels and tastes are likely to be highly fragmented and regionalized. As such, give yourself some time and space to reconfigure what worked in Tier 1 cities for what will work within Tier 2 cities. Overall, the growth of China’s inland cities and provinces is an exciting opportunity that will be necessary if China is to become an economy with a vibrant middle class.
