Sample of assignment: Economic analysis of China

Economic analysis of China

1. Introduction of the economy of China

Chart 1 GDP of China against the world total
Source: Maddison (2006)

China, as one of the Four Great Ancient Civilizations , was once one of the most advanced and powerful countries in the world for more than a thousand years before the modern era. Even in the nineteenth century it dominated the world economic landscape. And based on Angus Maddison, the famous economic historian, China accounted for a third of the then global GDP (Gross domestic product) in 1820. But the once largest economy fell when it chose to close its door to the outside world and did not catch up with the Industrial Revolution which happened in the west (Lin 2011, p. 1). The 20th century marked the most difficult time that the Chinese have ever had in the history when key words such as wars, natural disasters, political events, cultural revolutions and class conflicts become frequent in the text book of history, but the once dragon country has been reviving and emerging again in the global arena starting from the reform and opening up in the 1980s. Below we will try to review and discuss the economy history of China since the economy reform.

1.1 1978 to 1990: Reform and opening up

According to Allen Huang (2001, p. 50), economic reform of China in the 1980s proceeded in cycles or waves with each cycle began with a new policy initiative by reform leaders, it was followed by experimental implementation, evaluation, and relevant research by reformist intellectuals and officials and came to an end with the emergence of problems and criticism from the opponents of reforms, requiring a period of readjustment before pressures built or opportunities arose for another reform initiative. In the following we will discuss the two phases of the economy reform in China in the 1980s: Phase One: reform in the countryside & Phase Two: rural industrialization and enterprise reform.

1.1.1 Phase One: reform in the countryside

The reform trail steps began in the farming sector which was still the most influential and fundamental sector of the Chinese economy in the 1970s and 1980s. The basic starting point for rural reform is to motivate the hundreds of millions of farmers who had used to be in a less proactive status in growing their farms because of the socialist economy’s public property concept as everything belonged to the public and there had been no initiatives to work hard. Deng Xiao Ping, who was considered as the designer of the economy reform, observed that “generally speaking, reform in the country side means operating the responsibility system, throwing out the system of everyone eating from a communal pot and motivating the farmers to work for themselves. His reform policies include: instituting the responsibility system; establishing a wholly integrated two-tier management system that combines centralization with decentralization; keeping the system of public ownership as the mainstay while promoting the overall development of a diversified economy (Howe, Kueh & Ash 2004, p. 245). The most important significance of the reform in this stage was the liberalization of people’s mind to encourage them to actively take part in the economy activities rather than focusing on the political conflicts and it also set example for the reform in other sectors.

1.1.2 Phase Two: rural industrialization and enterprise reform

Rural industrialization is a crucial element of post reform development in the countryside. The most remarkable growth in production and employment occurred in the sector frequently referred to as “rural industry” or “township and village industry”. And the restructuring of the whole regional economy owes a great deal to a rapid surge in the rural industry which underscores many distinctive features in population redistribution, migration and settlement reorganization. And it is believed that the rural industrialization has been one of the most dynamic elements of the economy reform (Lin 1997, p. 126). And to support the economy reform and introducing the market economy, the modern banking system had to be established. The reform of the banking system to serve a market economy was progressed gradually in the late 1980s and early 1990s (Chow 2007, p. 54). Prior to 1978, enterprises were almost all owned by the state in one form or another. At the top of each sector were the State-owned Enterprises (SOEs), answerable to the national government. Below these were other enterprises reporting to provincial, municipal, or county authorities. Private enterprises, meaning family-run shops, were not allowed until after 1978, and even then they were limited to seven employees (Ahmad, Gao & Tanzi 1995). In this stage of the enterprise reform, ownership issues were not touched but enterprises were given more autonomy to make their own decisions rather than following the arrangements from the governments. The enterprise reform made significant progress in the period but it continues and deepens in the 1990s and lasts even to date.

1.1.3 Economy performance
Table 1 The national income ranging from 1978 to 1993
Source: State statistical bureau, Statistical year book of China (1994: 33-34)

The good performance of the economy performance of China during this period of economy reform could be reflected in the national income as shown in the table above. The country’s national income achieved an average year on year growth of 9.5 percent from 1978 to 1993 which was the beginning stage of the economy reform and opening up.

1.2 1990–2000

1.2.1 Rapid economy growth
Chart 2 China GDP from 1990 to 2000
Source: 2011

Table 2 The FDI trends in the East Asian countries (billion US dollar)
Source: Sussangkarn, Park & Kang 2011

With the deepening of the economic reform, the Chinese economy during the 1990 and 2000 experienced one of the most fast growing periods, as the chart above shows the GDP (Gross Domestic Product) was increasing rapidly from only 356.937 billion US dollar to 1083.278 billion US dollar suggesting the economy scale had almost increased by three times during the decade.
As mentioned above, the Chinese economy development had been left far behind since the industrial revolution, without the necessary startup capital, the Chinese government has adopted an economy mode which continues to date which is the attraction of foreign direct investment (FDI) and export oriented growth mode. As illustrated in the table above, in term of the attraction of foreign direct investment (FDI) in the 1990s, ASEAn occupied a fairly high proportion of 8.1 percent to East Asian countries and since the 1990s, China’s FDI flows have been rapidly increasing and occupied percent of the East Asian FDI in 1995 (Sussangkarn, Park & Kang 2011). As a matter of fact, between 1992 and 1997, the total inflow was a whopping 196.8 billion US dollar which made China as the largest recipient among the developing countries and second only to the United States (Appendix 1.0). And by the mid 1990s, the foreign investing enterprises had become a significant force in the China economy.

1.2.2 Uneven economy development in different regions

Though the economy reform was on the way and the central planning role of the government was one of the major targets to be removed from the economy, the government planning still played an important part in designing the economy development and influencing the major direction. One of the key decisions influencing the major economy development status that we see today is the establishment of special economic zones (SEZs). August 1980s saw “Regulations Governing the SEZs in Guangdong Province” authorized at the fifteenth meeting of the Fifth People’s Congress Standing Committee. Shortly afterwards came the promulgation establishing four SEZs in Shenzhen, Zhuhai, Shantou and Xiamen (Yue & Bifan 1989, p. 302). The setting up of the special economy zones become more popular in the 1990s as the government encouraged “a proportion of people and regions could become rich first and help the lagged behind areas”. But this policy directly contributes to the uneven development of economy in different regions which leads to various social and political problems that the government still struggle to tackle to date.

1.2.3 State owned enterprises (SOEs) reform

In the beginning stage of the state owned enterprises (SOEs) reform, the Chinese government had used a variety of strategies which did not involve ownership restructuring. Reform programs under such strategies mainly focused on the expansion of the enterprise rights and autonomy, the building of managerial incentives, and the introduction of the competition from the non-state sector to the state sector. At a later time, around the middle of the 1990s, the government started to experiment with new strategies that started to address the ownership reform of the SOEs, mainly via partial or comprehensive privatization (Leng 2009, p. 39).

1.3 2000 to present

Entering the new century, the Chinese economy seems to keep a fast pace in the economy development among the globalization trend in term of being the world’s factory. But problems are emerging while the economy of the country has not been built in a healthy mode and many economies had been suspecting the long term effectiveness and functioning of the investment and exporting oriented growth mode, these problems include but not limited to: Dispute over the under value of Yuan; High inflation; Property bubble; Lack of protection for private property rights and High cost of living among the common people.

2. Economy policy objectives

In the Fourth Session of the 11th National People’s Congress (NPC) at the Great Hall of the People in Beijing, Premier Wen Jia Bao announced the Government Report 2011, establishing the below targets to be achieved in year of 2011 ( 2011):

 GDP will grow by around 8 percent.
 Consumer Price Index (CPI) increase will be kept around 4 percent.
 Over nine million jobs will be created for urban residents. The registered urban unemployment rate will be kept at 4.6% or lower.
 China will accelerate the transformation of economic growth mode; boost domestic demand; greater help to agricultural, farmer and rural areas; greater efforts in social progress and people’s livelihood.
 A deficit of 900 billion yuan is projected, consisting of 700 billion yuan in central government deficit and 200 billion yuan in local government bonds.
 The central government will allocate 42.3 billion yuan to stimulate employment.

From government report and also taking into the consideration of the actual policies taken by the government, we can conclude four kinds of policy objectives to be achieved by the government polices: Maintaining a rapid and stable growth rate (it is said that China could not afford to slow down its economy due to a number of issues such as the flooding of the migrant workers into the cities); Life improvement (through job creation, CPI control); Economic transformation (industrial upgrading and adjustment) and Proactive government spending (to lead the direction of the economy development and also resolve the various social issues such as uneven economy development in different areas).

3. Adopted macro economy policies after the global financial crisis

Given the changes in GDP growth in China, it is clear that the financial crisis is indeed negatively affecting China’s macro economy. The previous high-speed growth rate maintained over several years has fallen by around 3 percent from 11 per cent to 8 per cent. These worsened economic conditions are mainly due to the shrinkage of import and export trade, with a consequent impact on other economic sectors (Forrest & Yip, 2011, p. 231). Soon after the happening of the global financial crisis, the Chinese government issued a serious of macro economy policy to inject power into the impacted economy with the hope that the economy would not slow down significantly which the both the government and the people would not accept. Below we will see into the detailed policy in term of monetary policies, fiscal policies and supply side policies and evaluate their effectiveness and impacts after the implementations.

3.1 Monetary policies of the Chinese government

3.1.1 Monetary expansion

Chart 3 The M2 money supply of China
Source: 2011

Monetary policy refers to the policies made to propose change in the money supply or the rate of growth of the money supply to achieve the particular macro economic goals (Arnold 2010, p. 116). Soon after the happening of the global financial crisis, the Chinese government adopted a monetary expansion policy before which the government was still targeting at combating the overheat economy using a tightening monetary policy. Since 2009, the People’s Bank of China (PBOC) has adopted a very expansionary monetary policy to support the expansionary fiscal policy. In the first half of 2009, bank credit increased by 7.3 trillion RMB, which was above the official target for the full year. Credit growth was surprisingly high, and the same was true of the broad money supply, M2, which grew at a record rate relative to GDP. As illustrated in the chart above, the M2 supply of China was maintained in an average 17% or 18% since 2005 until the outbreak of the global financial crisis. The M2 supply increased dramatically throughout the whole year of 2009. And as a result, the inter-bank money market has been inundated with liquidity. In contrast, the annual increases in bank credit in 2006 and 2007 were 3.18 trillion Yuan and 3.63 trillion Yuan respectively ( 2010).

3.1.2 Tightening monetary policy in the post crisis era

As the figure above indicates, since the beginning of 2010, when the Chinese government believed that the economic crisis was not creating a major impact in the economy, it began to tighten the monetary policy. As a matter of fact, China’s central bank moved to tighten monetary policy in January by raising the bank reserve requirement ratio by 0.5 percentage points and slightly increasing the interest rate on its one-year bill by 8 basis points to 1.84 percent. The adjustment in the amount of money banks are required to keep on reserve and it was the first change in the rate since June 2008 ( 2010). And later in the starting of the 2011, the M2 supply growth already resumed to the pre-crisis level.

3.1.3 Consequence of the loose monetary policy Positive consequence:

Chart 4 The GDP growth rate of China from 2007 to 2011
Source: 2011

It is obvious that the immense and timely fiscal and monetary expansion was having a large effect. The Chinese economy growth remained strong during the global financial and economic crisis, reflecting the massive fiscal and monetary stimulus and strong underlying momentum related to the size of its domestic market the robust fundamentals (The World Bank 2010, p. 47). As shown in the chart above, since the first half of 2009 marked the worst impacts of the global financial crisis, and under the stimulation of the ambitious fiscal policies and expansionary monetary policies, the trend of the worsening economy conditions was stopped and it bounced back strongly since the second half of 2009 though still later it could not recover to the pre-crisis growth rate which was more than 10 per cent. Hence in general the loose monetary policy did play an effective role in controlling the spreading of the financial crisis in the country. Negative consequence: Money supply is turning into inflation

According to Andy Xie (2011), China’s inflation picture remains unstable as when the price of a product or service rises, it often goes up by 20 or 30%, and this is because of the high level of money supply growth which is rare in a normal inflationary environment in which prices tend to rise in line with CPI. The government is taking some administrative measures to cool inflation. Cutting highway tolls, decreasing import tariffs, and jawboning businesses from raising prices could cool inflationary pressure for the time being. But, these measures only delay, not reverse the trend. If one interprets any cooling from such measures as victory over inflation and begins to loosen up again, a catastrophe will follow. And when the surplus of money supply is turning into too much inflation, it could cause disastrous consequences to both the life of people and the economy activities of the business entities. Negative consequence: A credit squeeze

When the government later adopted a tightening monetary policy in the post crisis era, there has been a credit squeeze that severely affected the business practices of the medium and small companies in China. The city of Wenzhou in Zhejiang has been the focus of complaints by small businesses that they face a credit squeeze after the government tightened monetary policy to cool inflation and the property market. According to the news in November this year, more than 80 businessmen in Wenzhou have disappeared, committed suicide or declared bankruptcy to avoid repaying debts to informal lenders since April. Wenzhou’s 400,000 businesses are facing financial hardship because of rising costs, soaring black market interest rates and a sudden credit squeeze. Similar problems are happening across China because private enterprises rely on underground borrowing rather than banks to operate.

3.2 Fiscal policies proposed by the Chinese government
Chart 5 The breakdown of the RMB 4 trillion economic stimulus package
Source: 2010

According to Pablo Lopez-Murphy and Mauricio Villafuerte (2010, p. 13), fiscal policy is the main policy tool that the authorities or governments could turn to for short-term macroeconomic management. In November 2008, China announced an economic stimulus package totaling expenditures of RMB 4 trillion by the end of 2010 – a plan later revised in March 2009. This is expected to raise China’s annual GDP one to two points.RMB 1.5 trillion is to go to constructing infrastructure components such as railways, roads, airports, and water-related facilities. RMB 210 billion is to go to energy-saving measures and environmental conservation, and another RMB 370 billion to innovation and industrial promotion ( 2010). Also a large proportion of money was spend in improving the life of the people in term of attributing 25 per cent (1 trillion yuan) of the total planned budget in the earthquake damage recovery, 400 billion in the construction of the low price housing and 150 billion spent the social welfare such as medical care and education.

According to the budget, in 2009 the total government expenditure (central plus local) would be 7.635 trillion yuan, up 22.1 per cent over the previous year. In 2009, the total government deficit would be 950 billion yuan (US $ 139 billion), the highest in 6 decades compared with 11 billion yuan in 2008. The central government deficit will be 750 billion yuan, 570 billion yuan more than the previous year. The State Council allowed the local governments in provinces to issue 200 billion yuan’s worth of government bonds through the Ministry of Finance. The budget would account for around 3 percent of the year’s GDP value (Shaw & Liu 2011, p. 157).

3.3 Supply side policies of the Chinese government

3.3.1 Theoretical review

Figure 1 The functioning of the supply side policies
Source: Higson (2011, p. 132)

Supply side policy includes any policy that improves an economy’s productive potential and its ability to produce. There are several individual actions that a government can take to improve the supply-side performance. Several types of supply side polices are: improving the productivity of factors, improving the performance of firms (Higson 2011, p. 132). As shown in the figure above, the functioning of the supply side policies could be understood in this way: by improving the supply-side performance, the supply curve would be move from AS horizontally to AS1, suppose the demand curve does not change significantly the equilibrium price would be lowered and yield would be increased. Such changes are good new to both the government and the people because the living cost would be reduced (prices of goods kept in a lower level) and more jobs are created (more output tends to involves more labor inputs whether it is labor intensive or service intensive). Though with a number of benefits, supply side policy also has some disadvantages and the most obvious two are that it is cost to carry out and it takes long term to see the effectiveness of policy. Below we will analyze some of the supply side policies enacted and implemented by the Chinese government especially those adopted since the most recent global financial crisis.

3.3.2 New direction of the state industrial policy

Along with the release of the 4 trillion yuan stimulus package, the Chinese central government successively announced a revitalization plan for ten key industries which include steel, automobile, shipbuilding, petrochemical, non-ferrous metals and equipment manufacturing together with textile, light industry, information technology and logistics. The policy come with 165 detailed plans such as tax incentives, government subsidies and bank loans to support these industries (Yang & Yu 2011, p. 8). For example, in the petrochemical industry, press reports indicated that the government planned to invest RMB 100 billion ($14.6 billion) in petroleum-related project upgrades in 2009 and 2010 and RMB 400 billion ($58.5 billion) for construction of 20 new, large petrochemical projects. And the key measures and policies adopted in the plans include relieving the tax burden on enterprises, supporting financial credit development, launching enterprise-technology-reform projects, encouraging mergers and acquisitions to improve risk forbearance and global competitiveness, fully developing rural markets, expanding exports, and storing energy ( 2010). The root initiative behind the revitalization plan is that the government hoped to utilize the opportunities to change the dilemmas of these industries and hope to finish the upgrade through the adjustment and revitalization plans so as to lay a firm foundation for the further development. Actually these plan do not represent the central government’s first try to revitalize some traditional industries, as early as 2003 the government already had initialized a plan named “Revitalizing The Old Northeast Industrial Bases”. The old industrial bases of the northeast China, mainly involving Heilongjiang Province, Jilin Province, Liaoning, used to be center of China’s industrial development especially the heavy industries. While creating history for the emerging China, starting in 1990s, these Northeast provinces suffered from sharpening structural and system problems such as ageing equipment, backward technology, poor competitiveness and insufficient job opening available to the increasing number of people waiting to be employed (Jing 2007, p. 63). The core of the program is to revitalize the region’s traditional industry, while speeding up development in aspects of structural regulation, regional cooperation, economic reform, the construction of an environment-friendly economy, and increased efforts in education, health care, and cultural projects (Columbus 2007) while at the same time adjusting the industrial structure among the said industries and help reduce the overcapacity in some product categories to fit the demand of the market.

3.3.3 Evaluation of the revitalization efforts

The government’s initiatives behind such revitalization efforts are not bad, the government wishes to improve the product efficiency and adjust the industrial structure in term of overcapacity reduction for instance, but many economies and researchers have pointed out some grey and disappointing facts behind such efforts. For instance, Wei Gu, a Reuter’s columnist, suggested on her own opinion that, investors should also bear in mind that Beijing’s top priority is to protect jobs. Any company with plans of cutting more than 20 jobs needs to brief local authorities one month in advance. So far, state-owned companies have largely refrained from staff reduction. But if Beijing does not allow layoffs and closures, then it will be impossible to reduce capacity even after arranged mergers. Therefore she concluded that the market should not expect restructuring plans to lead to much capacity reduction, even though it is desperately needed ( 2009). Based on these view, and also according to my understanding of the relative economy theories and a serious of events reported in the media, I will say that the effectiveness of the revitalization efforts has been discounted because of the reliance of the government direction in the revitalization projects, and because of the government’s set targets which have to be full-filled by the business sector in term of job creation for instance, limitations are there and they should be further improved.

4. Comparing China and India in term of the economy performance
Table 3 Contrasting facts between India and China
Source: 2011
Chart 6 The exports of China
Source: 2011
Chart 7 China GDP annual growth rate
Source: 2011
Chart 8 China inflation rate
Source: 2011
Chart 9 India exports
Source: 2011
Chart 10 India GDP annual growth rate
Source: 2011
Chart 11 India inflation rate
Source: 2011

By looking at some basic facts of China and India, we could see some similarity between China and India, both of them have a large population and labor force and high GDP growth rate and even some similar problems such as high inflation rate, but by contrasting of the two economies we also can see the differences between the countries’ economy growth mode and the future trends. In term of the economy growth mode, China with a much bigger volume of export and foreign direct investment has been focusing on an investment and export driven economy growth mode, while India is relatively more focusing on the development of the domestic demand; and in term of the future trend, as these two giant economies are heavily relying on their low labor cost as a source of competitiveness, India will have a brighter future as it has an increasing number of labor force while China is facing with an aging population.

5. Recommendations given to China’s economy development in the future

5.1 Introduction of exclusive list while adopting the tightening monetary policy

As mentioned above, when the government later adopts a tightening monetary policy in the post crisis era, there could easily be a credit squeeze that severely affects the business practices of the medium and small companies in China causing problems such of those that have been found in the Wenzhou city in Zhejiang province. As also proposed by some economies, the Chinese government while tightening the overall money supply should thinking of the interests of the private medium and small companies which are delicate to the credit squeeze but driving them out of the business will only add to the severity of the unemployment and social unrest. And it would be helpful to introduce an exclusive list to specify some delicate industries and business entities to be exempt from the various restrictions of the tightening monetary policy.

5.2 Balance the economic growth and stable price

As the country’s economy growth remains even during the global financial crisis, in 2010 the country again continued to pick up a high level of CPI growth though the economy at the same time also regained momentum of growth, and with a faster growth in term of the supply of money and a stimulated demand compared to lagged behind aggregate supply, high price again becomes a major concern among the people’s life. Though the government has implemented various measures to stabilize prices and curb inflation and prices began to drop in the second half of the year as prices of Chinese staples: pork, eggs and vegetables fell in the third quarter ( 2011), still the price especially the food price and property price are too high to be accepted by the common people, it is important for the government to find a balancing point between curbing price rises and maintaining economic growth. To recommend in term of the government policy, the government should rely more heavily on the long term based supply side policies rather than the rapidly changing fiscal and monetary policies which tend to have side effects to the normal business activities.


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Appendix 1.0 Measures of FDI inflows in China of projects, values of approved and paid-in FDI from 1979 to 1999
Source: National Bureau of Statistics, 1999 (http://www.moftec.