Does bilateral political relations affect foreign direct investment?

Abstract

This article employs the bootstrap Granger full-sample and sub-sample rolling window estimation to explore the time-varying property between bilateral political relations and foreign direct investment based on Sino-Japanese relations. The result identifies a one-way causal nexus running from bilateral political relations to foreign direct investment. Bilateral political relations have both positive and negative influences on foreign direct investment inflows in different sub-stages, but merely negative impacts on outflows. However, the reverse causality has not been proven, which is inconsistent with the model of Polachek et al. that the increased foreign direct investment is conducive to improving bilateral political relations. We also divide the BPR into two dimensions: leader’s visits and diplomatic conflicts to examine the role of specific political actions. Leader’s visits can significantly increase FDI inflows and outflows, but diplomatic conflicts have less impact on FDI. China and Japan should increase dialogue to ensure bilateral relations’ stability and seek common ground in economic interests, ultimately providing investors with a favorable political environment.