Foreign Direct Investment in China, the Factors Determining a Preference for Investing in Eastern or Western Provinces

Abstract

Why do foreign enterprises invest in certain provinces of China? This study started with five possible factors that could influence the decision of multinational corporations: 1) Economic growth; 2) Labor costs; 3) Domestic investments; 4) Agglomeration advantages; and 5) Innovation. The Eastern and Western provinces are slowly converging in terms of foreign direct investments (FDI) and growth rates. Especially after the 11th and 12th five year plans, which were primarily aimed at opening up the Western part of China. Based on a data for the time period 1992-2012 for each of the 30 provinces we analyzed the hypotheses derived from Dunning [1]. After checking for normality and multi-collinearity we estimated the coefficients of the independent variables and their statistical significance. To find different determinants across China, this study opted to do the analysis for the Eastern and Western provinces of China separately. GDP Growth is found to be positively related to FDI in both cases. The wage level is only found to be significant in the Eastern provinces. A reason for this can be that the Eastern China is a step ahead of the Western China, higher educated people are needed and hence higher labor costs are accepted. Domestic investments are found to have a positive effect on FDI in both models. Finally the indicator for agglomeration has a positive significant coefficient: already existing businesses pull MNEs. This effect is found to be stronger in the Eastern provinces; this can be due to the fact that more MNEs have already established their businesses over there. Lastly, the variable patent has the wrong coefficient in both models. These results have policy implications and confirm the importance of certain location factors as suggested in the Dunning model. The government can stimulate FDI in the western provinces by promoting domestic investments in these provinces. Also agglomeration attracts FDI and can be promoted.