Abstract
The transformation of the Chinese economy into a high-tech manufacturing hub spurred a heated debate among policymakers and academia. The large-scale market-friendly reforms have resulted in massive FDI inflows and high export diversification along with the extensive as well as intensive margins. By using the ARDL and VECM approaches, this paper revisits the theoretical and empirical connection between export diversification and FDI inflows in the framework of the Melitz model. The cointegration outcomes indicate a long-run relationship between export diversification and FDI, where the later has a diversifying effect on Chinese exports. The estimated coefficients show that export concentration has negatively related to FDI in China. Conversely, the results validate the presence of a positive spillover effect on export diversification. The reverse effect also holds, and the results indicate that export concentration has a negative effect on FDI or in other words, export diversification can attract foreign capital. It means that the diversifying capabilities of firms’ allure FDI inflows. Further, the granger causality analysis confirms the short- and long-run bidirectional causalities between the variables of interest. Overall, the results confirm the validity of the Melitz model and spillover theory. The inclusion of control variables is robust to our analysis. The study advocates several policy implications for the stakeholders.
Highlights
During the past couple of decades, China has experienced unprecedented economic development, which in turn favored a substantial amount of foreign direct investment (FDI) and, it became the world's second-largest FDI destination after the United States in 2017 with remarkable inflows of $136 billion (UNCTAD, 2018)
The miraculous transformation of the Chinese economy during the past several decades triggered academic research and policymakers to investigate the possible drivers of its industrial revolution in the form of export growth and export diversification
The massive FDI inflows in China may be attributed to market-friendly reforms
Summary
During the past couple of decades, China has experienced unprecedented economic development, which in turn favored a substantial amount of foreign direct investment (FDI) and, it became the world's second-largest FDI destination after the United States in 2017 with remarkable inflows of $136 billion (UNCTAD, 2018). Being the leading export-oriented economy, China has made significant progress in export diversification and product differentiation. The recent increasing trends in export diversification and FDI in China gain the attention of the policymakers and academicians and trigger the debate regarding the FDI and export diversification nexus. Literature evidenced that countries with over-dependence on the export of primary goods fail to attain sustainable economic growth (Majerova et al, 2020). The dependence on exports of primary goods may entail both long as well as short-term vulnerabilities to the economy. To reduce such vulnerabilities, the best strategy is the horizontal diversification in exports across markets and products (Harrison and Rodríguez-Clare, 2010). Various factors can help in export diversification and offer considerable developmental benefits of export diversification
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