Much of this adulation of FDI is wrong. To appreciate this point, it is necessary to point out that China's dependency on FDI is already extraordinarily high. Between 1993-97, on average, FDI financed about 15% of China's capital formation, compared to 6% in the United States. Furthermore, much of the conventional argument for FDI does not apply to China.

Contrary to popular belief, China is a net capital-exporting country. China has one of the world's highest savings rates and its current account has been in surplus every year in the l990s, except for 1993. So has its capital account. This means that China has accumulated a massive foreign exchange reserve, much of which, according to international press reports, has been invested in U.S. Treasury bonds.

The idea that FDI is an efficient mechanism for technology transfer is similarly flawed because a large portion of the FDI has gone into low-tech industries. It reflects foreign firms' provision of standard machinery and equipment as equity stakes. There is no reason why China has to obtain these capital goods via FDI; they are easily available for purchase on International markets.

It is also not clear why China has to resort to FDI to import managerial expertise. To be sure, some of the FDI has gone to large-scale and complex operations that Chinese managers are ill-equipped to run. But lots of FDI has gone to finance the operations of extremely small firms -- some with less than 10 employees -- in industries the Chinese have practiced for thousands of years, such as traditional handicrafts. It stretches common sense to argue that an economy capable of growing at 8% to 9% a year is short of entrepreneurs to run these small operations.

Finally, a much touted benefit of FDI -- that it promotes China's exports -- is exaggerated. Yes, foreign-invested firms have created exports but they have also taken over export-oriented Chinese firms. Foreign-invested firms both created and diverted exports away from Chinese firms.

China's FDI is not a sign that its economy is strong and healthy. Rather, it underscores some fundamental distortions. There are two complementary components to this claim. First, much of the export-oriented FDI -- mainly originating from ethnic Chinese firms in Hong Kong and Taiwan -- materialises because of the severe liquidity constraints on the part of export-oriented Chinese firms. These liquidity constraints arise not because export-oriented Chinese firms are inefficient, but because they are private. Until 1998 the four big state-owned banks were explicitly prohibited from lending to private firms. Private firms have no choice but to raise financing in the only way they can -- selling their claims on future cashflows to foreign firms. FDI rises as a result.

Second, a large portion of the domestically oriented FDI -- mainly in capital-intensive industries -- does not go toward financing creation of new capacity but toward acquisition of existing assets from state-owned enterprises. The insolvency of the SOEs is a familiar story. What is not familiar is the fact that SOEs have built up a potentially valuable asset base during the reform era, which was financed by a generous infusion of subsidised credit from the banking system. On top of a good asset base, SOEs have generated a thin or close to negative cashflow, rendering them potential acqisition targets. Because Beijing explicitly shuns privatisation, the only viable acquirers end up being foreign firms. FDI rises again.

To be sure, some of the FDI materialises in China because the investors are globally competitive firms with proprietary assets, a deep capital base and technological dynamism. But Chinese firms have ceded market and equity positions not only to Fortune 500 firms but to small- and medium-sized overseas Chinese firms in industries characterised by perfect competition (thus no technological proprietary edge on the part of investing firms) and industries-- such as traditional handicrafts, garments and shoe-making -- in which Chinese firms ought to be quite competitive.

(From The Asian Wall Street Journal. Mr Huang is an associate professor at the Harvard Business School.)