Host country’s financial condition and FDI inflow: evidence from China

Abstract

PurposeThis paper investigates how the gap between the host country's actual and optimal financial conditions affects foreign direct investment (FDI) inflows through evidence from China.Design/methodology/approachThe authors first employ principal component analysis (PCA) to measure FDI target countries' actual financial conditions and use 30 OECD countries as a reference group to assess the optimal financial condition. The authors then estimate a two-way fixed effect model with panel data of China's outward FDI in 64 countries for the period 2003–2017 to get the regression results. The authors' results overcome endogeneity and are robust.FindingsResults show that (1) the gaps between host countries' actual and optimal financial conditions positively affect FDI inflows from China; (2) there is a heterogeneous effect between low-income and high-income countries. The gaps for high-income countries significantly increase FDI inflows from China, while the gaps are not significant for low-income countries.Research limitations/implicationsThe authors examine how the gap affects FDI inflows from China. An increase of 1% in the target country's gap promotes a 6.3% increase in FDI inflows. However, the authors do not explore what mechanisms are key to these results. The authors will explore these questions in the future.Originality/valueThis paper complements the influence factors of FDI and enriches theories of FDI. The gap between actual and optimal financial conditions plays an essential role in FDI flows across countries for policymakers.