China’s Open Door Policy towards Foreign Direct Investment: A Game Theoretic Interpretation

Since the Reform and Open Door Policy Initiative launched by Deng Xiaoping in 1978, the Chinese government gradually undertook the open door policy towards foreign direct investment (FDI). First, the government created Special Enterprise Zones (SEZ) in the selected coast cities. A set of preferential treatment is granted to the foreign enterprises invited in SEZs with a restriction on the transfer of profits to home. Then in the second phase of the open door policy, the government lifted the regulation on the participation of foreign capital in the domestic enterprises and the ban on profit transfer. FDI surged and became to assume a significant portion of the manufacturing sector in China. Throughout the two phases of the open door policy the Chinese government reduced the tariff rate consecutively and pledges to lower it even further as precondition of China's accession to the World Trade Organization. The purpose of this paper is to argue in the framework a simple game theory that the key to the success of the open door policy must have been the political liberalism among the Chinese public. We will show this by modeling the process of the open door policy as a game between the Chinese government and the foreign capital, and show that if it were not for liberal political atmosphere a reduction in the tariff rate would not have resulted in further deregulation and increase in FDI.-1