China is one of the most popular investment destinations in the world. For a number of years in the 1990s China accounted for 50 percent of foreign direct investment (FDI) going into developing countries, and China was the second largest recipient of FDI in the world. Government officials, business practitioners, and economists hail China's large FDI absorption as a celebrated achievement of the reform era.

The central claim of this book is that the large absorption of FDI by China may be a sign of some substantial weaknesses in its economy. The book starts from the premise that FDI is, fundamentally, a microeconomic phenomenon rather than a macroeconomic phenomenon. At a given level of macroeconomic fundamentals, such as an expanding market or low labor costs, whether a country gets more or less FDI – relative to domestic investments and relative to contractual arrangements between foreign and domestic firms – depends on the relative competitiveness of foreign versus domestic firms. FDI inflows into China surged in the 1990s because of the combination of some substantial problems in China's corporate sector and China's promising macro fundamentals.

Three sources of problems in China's corporate sector are identified in this book. One is a political pecking order of firms that allocates China's financial and broad economic resources to the least efficient firms – SOEs – while denying the same resources to China's most efficient firms, that is, private firms.