Foreign direct investment in China
Based on Wikipedia: Foreign direct investment in China
The Factory That Ate the World
In 1978, China was an economic island. Foreign companies had essentially given up on the country. Mao Zedong's revolution had driven most of them out, and those that remained operated in a strange limbo—Royal Dutch Shell, for instance, somehow kept pumping oil while the Cultural Revolution raged around it.
Twenty-four years later, China became the world's top destination for foreign direct investment. The transformation was so complete that economists started calling it "the world's factory."
How did this happen? The story involves Communist Party resolutions, special economic zones, Hong Kong entrepreneurs, and a fundamental reinterpretation of what "self-reliance" actually means.
Self-Reliance Doesn't Mean What You Think
During Mao's rule, the Chinese Communist Party championed "self-reliance"—the idea that China should build its economy without depending on foreign powers. This made ideological sense. The country had suffered through a century of foreign exploitation, from the Opium Wars through the Japanese occupation. Why invite more outsiders in?
But self-reliance was never as absolute as the propaganda suggested.
Japan, despite being the most recent invader, became a major trading partner in the 1950s. Chinese leaders quietly studied Japanese industrial methods. They were particularly interested in Japan's state-led development of Manchuria in the 1930s and 1940s—the very occupation that had brutalized the Chinese population also left behind an industrial blueprint that Communist planners found useful.
Even Mao himself wasn't as rigid as his reputation suggests. In 1972, he approved importing foreign goods that would later enable China's opening. This was six years before Deng Xiaoping supposedly invented the policy of economic reform.
The Rebranding of Deng Xiaoping
The standard history goes like this: Mao died in 1976, a transitional leader named Hua Guofeng held power briefly, and then Deng Xiaoping swept in to modernize China. Deng's "reform and opening up" represented a clean break from Mao's isolationism.
This narrative has problems.
Political historians Frederick Teiwes and Warren Sun have argued that Hua Guofeng—supposedly a rigid Maoist placeholder—was actually implementing reforms that Deng would later get credit for. On all the major dimensions—aggressive economic growth, openness to the outside world, management reform—Hua and Deng were essentially in agreement.
Hua even approved the creation of special economic zones, which would become the crown jewels of China's opening. The zones weren't Deng's idea. They were already in the works.
So why does Deng get all the credit? Partly because he outlasted Hua politically, and partly because of a clever piece of political theater: the 1981 Party Resolution.
How to Rewrite History Without Lying
In 1981, the Communist Party adopted a document with a magnificent bureaucratic name: the "Resolution on Certain Questions in the History of Our Party since the Founding of the People's Republic of China." Its purpose was to settle the question of Mao's legacy and justify the new direction.
The resolution performed a delicate operation. It couldn't repudiate Mao entirely—he founded the People's Republic, after all. But it needed to explain why China was now doing things differently.
The solution was to reinterpret self-reliance. According to the resolution, self-reliance had been necessary during the civil war and the early years of the republic. The Party overcame blockades from the Nationalists and the Japanese. Victory came because China "depended on the efforts of the whole Chinese people."
But now—the resolution continued—circumstances had changed. The "shortcomings and mistakes" of recent economic work needed correcting. The influence of "Left errors" (a polite way of referring to the Cultural Revolution's chaos) had to be eliminated. Going forward, "active efforts must be made to promote economic and technical co-operation with other countries on the basis of independence and self-reliance."
Notice the sleight of hand. Self-reliance now meant working with foreign countries, as long as China maintained its independence in doing so. The principle hadn't changed—only its application.
Building the Machine
Starting in 1981, China began constructing an elaborate system to attract foreign capital. The government passed a series of laws with names that read like a legal textbook's table of contents: the Equity Joint Venture Income Tax Law, the Foreign Enterprise Income Tax Law, the Industrial and Commercial Tax Provisions, and many more.
These laws created different pathways for foreign companies to enter China. You could form a joint venture with a Chinese partner. You could process materials or assemble products. Or, if you were brave enough, you could establish a wholly foreign-owned enterprise.
Each pathway came with tax incentives. The government was essentially paying companies to bring their factories to China.
But here's what's interesting: these incentives didn't immediately produce a flood of investment. The initial uptake was slow. Political scientist David Zweig found that rural coastal elites—the people who theoretically had the most to gain from foreign trade—weren't lobbying for more openness.
Why not? Two reasons. First, ordinary farmers and managers of township enterprises had no way to influence policy. There were no formal channels, and the cost of trying to create informal ones was too high. Second, the state controlled foreign currency. Even if you exported goods and earned dollars, you couldn't spend those dollars freely.
The incentive structure was broken.
The Zones
In 1980, China designated four special economic zones: Shenzhen, Zhuhai, and Shantou in Guangdong province, and Xiamen in Fujian province. If you've ever seen photographs of Shenzhen's transformation from fishing village to gleaming metropolis, you've seen what the zones could accomplish.
The special economic zones were laboratories. They operated under different rules than the rest of China—lower taxes, fewer regulations, more freedom to deal with foreigners. Foreign companies could set up joint ventures there without navigating the full complexity of Chinese bureaucracy.
The design was deliberate. Economist Barry Naughton argues that the zones fit perfectly within China's "dualistic system"—a rigid planned economy alongside experimental market spaces. If the experiments succeeded, leaders could expand them. If they failed, the damage stayed contained.
This wasn't a new idea. Export-processing zones existed throughout Asia. But China's version offered more liberalization than most.
Conservative factions within the Communist Party weren't happy. They compared the special economic zones to the foreign concessions that had humiliated China in the late Qing and Republic periods—territories where foreigners operated outside Chinese law. The reformers saw commitment to change. The conservatives saw capitulation to imperialism.
In 1984, the government opened fourteen more coastal cities. In 1988, Hainan island became both a separate province and a special economic zone. By 1992, special zones dotted the inner cities as well.
The China Circle
Where did all this foreign investment actually come from?
Not from where you might expect.
The largest source of foreign direct investment in China wasn't the United States or Japan or Europe. It was what economists call "the China Circle"—Hong Kong, Taiwan, and Macau.
Hong Kong dominated from the beginning and has remained the largest source ever since the mid-1980s. Investment from developed countries like Japan and the United States formed a secondary tier.
This pattern makes sense when you understand the economics of East Asian manufacturing in the 1980s. Hong Kong and Taiwan had both experienced sustained economic growth in the 1960s and 1970s, largely through manufacturing. But success breeds its own problems. As their economies developed, local production costs rose. Wages went up. Land got expensive.
Just across the border, China was opening special economic zones with cheap labor and minimal regulations. For a Hong Kong or Taiwanese factory owner, the math was obvious.
The advantages went beyond cost. Within the China Circle, transaction costs were low. People spoke the same language. They understood the same business customs. Hong Kong entrepreneurs could navigate Guangdong province in ways that American executives couldn't.
The result was a massive migration of manufacturing capacity. Hong Kong and Taiwanese owners brought capital, management expertise, and technology. Their new Chinese factories absorbed labor from the rural countryside. The workforce in Guangdong and Fujian nearly doubled between 1985 and 2001.
Historian Peter Hamilton argues that Hong Kong's role predated the official opening. Even before 1978, business interests in Hong Kong were attempting to engage with China through trade ventures and distributing international publications. They were laying groundwork, building relationships, and convincing Chinese officials that export-oriented policies could work.
The Recycled Capital Problem
Here's a puzzle: some of the "foreign" investment coming into China wasn't really foreign at all.
Economist Nicholas Lardy identified what he called "the phenomenon of recycled capital of Chinese origin." Chinese companies would move their money outside the country, then reinvest it back into China as "foreign direct investment."
Why go through this elaborate dance? Because foreign investors got preferential treatment. Better tax rates. Fewer restrictions. By round-tripping their capital through Hong Kong or elsewhere, Chinese companies could access benefits reserved for foreigners.
This recycled capital accounted for roughly one quarter of investment flows in 1992. It complicates any analysis of how much genuine foreign interest existed in China's economy.
Tiananmen and After
Foreign direct investment into China was rising steadily through the late 1980s. Then came June 1989.
The Tiananmen Square protests and massacre briefly disrupted the trend. Foreign companies pulled back. International criticism intensified. China's reformers worried that the opening might close.
It didn't.
Investment recovered quickly after 1990, and exploded after Deng Xiaoping's Southern Tour in 1992. The elderly leader traveled to the special economic zones, publicly endorsing continued reform at a moment when the political direction seemed uncertain. His tour signaled that China remained open for business.
Several factors drove the surge. Globally, foreign direct investment to developing countries was increasing everywhere—China was riding a larger wave. China's economy was growing rapidly, creating attractive opportunities. The policy environment kept liberalizing.
Perhaps most importantly, a decade of institution-building was finally paying off. The legal frameworks, the tax incentives, the special economic zones—all the infrastructure that China had been constructing since the early 1980s was now mature enough to support massive capital inflows.
And the government opened new sectors. Before 1992, foreign investment focused mainly on export manufacturing—making goods in China for sale elsewhere. After 1992, the domestic marketplace opened up. Real estate. Consumer goods. Services. Foreign companies could now sell to China, not just manufacture in China.
The Inequality Engine
Foreign investment transformed China. But transformation is not the same as improvement—at least not for everyone.
Inequality existed during the Mao period despite all the Communist rhetoric about equality. The coming of foreign capital didn't create inequality. It intensified it and changed its form.
Scholars Ching-kwan Lee and Mark Selden identify three durable hierarchies that shaped who benefited from the opening: class, citizenship, and location.
Location mattered enormously. The special economic zones were coastal. The foreign investment concentrated there. Rural industrialization in these areas created new opportunities, absorbing workers from agriculture into manufacturing. But what about the interior provinces? What about people who couldn't migrate to where the factories were?
Citizenship mattered too. China's household registration system—the hukou—divided the population into rural and urban residents. Rural migrants who moved to coastal factory towns remained classified as rural residents, with limited access to urban services. They built the products that made China the world's factory, but they remained second-class citizens in the cities where they worked.
Class distinctions emerged and hardened. Lee and Selden describe "an emerging bureaucratic-business elite wedding regulatory power with capital." Officials who controlled permissions and approvals could partner with business interests—including foreign capital. During the privatization of state-owned enterprises in the 1990s, this elite captured much of the value. Workers who had enjoyed minimal protections under the old system found themselves redundant.
The inequality wasn't entirely new. It was a manifestation of hierarchies that had existed under Mao, now amplified by market forces and foreign money.
The Long Arc
From 1992 until at least 2023, China remained either the number one or number two destination worldwide for foreign direct investment. The factory that foreign capital built kept expanding.
Some things changed along the way. In 2008, China eliminated the preferential corporate tax rates that had favored foreign enterprises. The implicit message: China no longer needed to offer discounts to attract investment. The investment would come anyway.
The special economic zones that once symbolized reform became ordinary parts of a transformed economy. Shenzhen is now a global technology hub, no longer a laboratory but an established center of innovation. The dualistic system—rigid planning alongside experimental markets—gradually gave way to something more uniformly market-oriented.
And the sources of investment shifted. Taiwan, despite political tensions with the mainland, sent the majority of its foreign investment to China between 1991 and 2020—over 54 percent. The economic integration that began in the 1980s created ties that survived decades of political hostility.
The Meaning of Self-Reliance, Revisited
The story of foreign direct investment in China is ultimately a story about ideas—specifically, about how a revolutionary ideology adapted to economic reality.
Self-reliance never meant what outsiders assumed it meant. Even at its most isolated, China traded with Japan and studied Japanese methods. Even Mao approved technology imports. The principle was always more flexible than the propaganda suggested.
What Deng Xiaoping and his predecessors accomplished was a reinterpretation, not a repudiation. Self-reliance could mean attracting foreign capital on Chinese terms, maintaining ultimate control while accepting outside resources. Independence didn't require isolation.
This ideological flexibility proved remarkably durable. It allowed China to become the world's factory without abandoning its revolutionary identity. Foreign companies brought capital and technology; China provided labor and land and eventually, a massive consumer market. Both sides got what they wanted.
The costs were real—inequality, displacement, environmental destruction, labor exploitation in the factory zones. The benefits were real too—hundreds of millions lifted from poverty, infrastructure built, technology transferred.
Whether the exchange was worth it depends on who you ask and what you count. What's undeniable is that the exchange happened, on a scale and at a speed that reshaped the global economy. The world's factory is still running.