Reexamining the determinants of foreign direct investment in China

Abstract

This study examines significant determinants of foreign direct investment (FDI) inflows in China using bounds test approach for the period of 1980–2015. It shows that the main determinants of FDI include labour cost, size of market (gross domestic product, GDP), trade openness, economic policy uncertainty, and real exchange rate. The system of the Vector Auto Regressive (VAR) Model with Impulse Response Function (IRF) and Variance Decomposition Method (VDM) is used to empirically demonstrate the relationship between FDI and its main determinants in China. The study also examines the causality of the relationship, drawing on Granger Causality test and the Toda-Yamamoto-Dolado Lutkephol (TYDL) approach. It is revealed that FDI and its determinants have bidirectional causal relationship in the long-run and also a significant relationship in the short-run. The study finds that the extra volume of inward FDI can be attracted when emerging market economies try to open for external trade. Furthermore, it suggests that the GDP growth is an important determinant of FDI inflow. Such a result implies that policy makers need to establish a more effective, liberal and transparent FDI policy framework, which can help the FDI-based policies lead to stimulating economic growth.