This research examines the role of foreign direct investment (FDI) in Chinese economic growth. Foreign investment to China mainly coming from the Asian countries has been centered on 2nd and 3rd industries such as manufacturing, utilities, real estate, and has been geographically concentrated on the eastern coastal area. Foreign investment began to make a significant and increasingly regular impact on Chinese economic growth from 1992 onward. For example, FDI to China has contributed to the increase of 11.2% in fixed capital formation, 20.7% of industrial output and 51.8% of volume of trade. Given that net exports contributed to about 2.1% to Chinese economic growth in 2001, FDI is understood to contribute directly to economic growth through capital formation rather than trade.

This study has found several features from the empirical study that takes into account these facts. First, labor input is found to have only a slight role to Chinese provincial economic growth, and in some provinces even takes on a negative role. The main reason for this minor role of labor input in spite of its higher distribution rate than those of domestic capital and foreign capital is that employment has rather decreased despite of rapid each provincial economic growth. Employment has been decreasing in many provinces with the continuous rationalization process of enterprise (specially state owned enterprises) despite the steady increase in the demand for labor as a result of new investment and foreign investment businesses in China.

Second, Chinese economic growth is mainly dependent on capital accumulation. The high economic growth rate has induced domestic capital accumulation, but foreign capital accumulation has not been that high. However, high economic growth has greatly encouraged the increase in the contribution rate of domestic capital as well as foreign capital formation. This relation between economic growth and capital accumulation signals that foreign capital inflow has assumed a major role in Chinese economic growth.

Third, the role of total factor productivity (TFP) growth has been impressive in some provincial Chinese economies. However, some regions with higher TFP growth rate did not achieved high economic growth.

Because TFP is composed of various factors, we divided it into four parts: technological change, economies of scale, technical efficiency change and allocative inefficiency. Each is examined and interpreted appropriately.

Generally provinces that achieved higher economic growth rate had only a slightly higher TFP change. Despite the high economic growth, some provinces record negative TFP growth because decreasing scale economies and increasing allocative inefficiencies countervailed technological change and efficiency enlargement. Specifically, some areas such as Shanghai and Peking recorded lower TFP growth due to the complex factor of allocative inefficiency, unmeasurable and unexplained factors, as well as decreases in scale economies arising from government’s intervention in the process of economic development: All in spite of high economic growth rates, high domestic and foreign capital accumulation.

The areas that have higher economic growth rates have lower technical efficiency change. The marginal change of technical efficiency in these areas decreases because already high technical efficiency has been achieved in these areas, which have also experienced continuous economic growth. However, Chinese economic growth was possible due to the rapid capital accumulation areas with high capital accumulation achieved high economic growth and attained much efficiency improvements. Reflecting this, the areas that have higher stock of domestic and foreign capital tends to also have higher technical efficiency level.

Broadly speaking, Chinese provinces that accomplished higher economic growth achieved higher technological change. Higher economic growth was induced by higher capital accumulation as well as higher technological change. Chinese economic growth, it may be claimed, was mainly achieved by capital accumulation that was achieved by planning of strong government intervention rather than by market principles. The relationship between Chinese economic growth and technical inefficiency change shows that allocative inefficiency increases in provinces that show high economic growth heightened the effect of a negative TFP.

Aggravation of allocative inefficiency in areas having high economic growth indicates a controversial point that seems latent on high economic performance. Specifically, a drastic decrease in technical inefficiency in Shanghai and Peking areas illustrate many hidden problems behind the high economic growth of China.

The above analyses on the role of FDI in China gives several implications about Korea’s economy as well.

First, the positive contribution to economic growth of FDI in China will encourage China to utilize their invitation of much continuous foreign investment to act as a principal resource of growth. There is therefore the possibility of relative difficulties in Korea to attract FDI due to the stiff competition from China.

Second, FDI to China may heighten the general efficiency level of the Chinese economy thereby contributing to the increase of Chinese goods' competitiveness in the world markets. Specifically, an increment of continuous FDI and export increment may gradually increase the role of the foreign sector in China’s economic growth. This should contribute to magnify the rival relation in the export market between Korea and China.

Third, Chinese economy growth that depends greatly on capital accumulation may act as an affirmative role in the development of China’s manufacturing industry. Industry upgrading and rationalization policy may succeed as long as there is will for China government’s capital accumulation, particularly at the Chinese 10th 5 year economic development plan. This means that China will achieve a fortitude production base in industries such as semi-conductor, automobile, petrochemicals, steel and ship building which are traditionally key industries in Korea. Korea economy will thus face pressure for industrial rationalization and restructuring.

Fourth, Chinese economic growth is gradually losing the effect of scale economies as continuous economic growth is dependent greatly on the input of capital accumulation and where the contribution rate of labor input remains low. Mass construction social overhead capital for the provisions of the Peking Olympic Games and development of Western parts of China will allow scale economies, which will be magnified further extending the period of possible high economic growth. Therefore, China will continuously offer an affirmative opportunity to Korea as an export and investment market. It is expected that China will also enlarge its concurrence with Korea in the world market.

Fifth, one of the salient features in Chinese economic growth is that the distribution rate of labor income in GDP is higher than other developing countries, yet the contribution rate of labor input in economic growth remains low. This implies that labor input does not greatly increase in spite of sustainable economic growth. The pattern of economic growth is one where economic growth does not seem to induce the enlargement of employment; thereby unemployment tends to increase continuously. The latent instability of the Chinese economy in this respect may be increased by the accelerated opening up to outsiders and the enlargement of people's consciousness largely stimulated by upcoming Olympic Games in 2008.

The artificial enlargement of government investment can become a hindrance according to the extension of the insolvent scale in state-owned companies. If it is magnified further becoming uncontrollable, China’s continuous economy growth, which depends mainly on the capital investment, may become interrupted. Nonetheless, even though China’s economy has been confronted by this crisis, the competitive relation with Korea may not be damaged greatly in the export markets. Largely because of joint venture companies located in China that takes charge of half of Chinese foreign trade, competition will not be between Korea and China in the export market but rather with foreign companies in China. These affirmative or negative features of FDI in China may heighten the importance of the role of FDI in Chinese economic growth.