Institutional distance and China's horizontal outward foreign direct investment

Abstract

Using a theoretical model, we develop an institution-based version of the Linder hypothesis for horizontal FDI; FDI is more likely to occur among countries with smaller institutional distance. We then use firm-level data to estimate the effect of institutional distance between China and the countries that host its FDI on horizontal outward FDI (OFDI) of Chinese multinational enterprises (MNEs). High-dimensional fixed effects (HDFE) estimation shows that the overall institutional distance has a positive effect on China's OFDI, which does not support the institution-based version of the Linder hypothesis. The positive effect of institutional distance on OFDI does not vary significantly across China's state-owned enterprises (SOEs) and private-owned enterprises (POEs). Further analysis based on four sectoral institutional distances shows that the effect of public sector and labour market institutional distances on OFDI of MNEs is negative and this effect is stronger for POEs than SOEs, which supports the institution-based version of the Linder hypothesis for horizontal FDI. However, the effect of the goods and services sector institutional distance and capital market institutional distance on horizontal OFDI is positive. The impact of the goods and services sector institutional distance on OFDI of SOEs is stronger than for POEs. While unravelling the black box of institutional effects, we find significant asymmetries in the effect of sectoral institutions on OFDI. We also find that the effect varies in size across ownership structures.