Fighting Trade War with FDI Policy Reforms

Abstract

China accelerated FDI policy reforms since the presidency of Donald Trump. We evaluate how multinational enterprises (MNEs) respond to such reforms amid rising trade policy uncertainty. Applying difference-in-differences approach on monthly bilateral FDI from 2015 to 2019, we find that reforms increase FDI to China significantly after their implementation in July 2017. The increase in FDI concentrates in industries such as the manufacture of automobile and machinery equipment that have undergone intensive reforms. In addition, the rising FDI is mainly underpinned by economies that have substantial export exposure and investment experience in China, such as Germany, South Korea and Japan. Further analysis reveals that FDI from economies and industries that are more exposed to the reforms through trade networks, increases more aggressively. We find no evidence that FDI responds to the tariff hikes or trade policy uncertainty arisen from the US-China trade war.