Overseas Chinese and foreign investment in China : an application of the transaction cost approach

A striking feature of the foreign investment in China is that Hong Kong and Taiwan in particular, overseas Chinese in general, have been the dominant supplier of foreign direct investment in China for the almost last two decades. This paper employs the transaction cost approach to provide an explanation for the observed phenomenon. Specifically, overseas Chinese have two competitive advantages in investing in China. First, most obviously, the commonality of culture and language reduces the communication cost of business transactions. Second, the experience of many overseas Chinese’s doing business in relationship-based trade system, or the GuanXi system, provides them with the knowledge in operating their business in a “dual track system” of the Chinese economy, and reduces the cost of their dealing with the governmental officials and local firms in the GuanXi system in China. The flexible contractual form, particularly joint ventures, reduces the cost of investing in China. However, overseas Chinese again have a cost advantage in interacting with their Chinese partners within joint ventures. Finally, that Hong Kong, and to a lesser extent Taiwan, have played a particularly important role in the foreign investment in China can be explained by the consideration of transportation cost and the application of the product cycle theory