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How does financial system efficiency affect the growth impact of FDI in China?: Evidence from provincial data 1999-2006

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  • Ying Xu
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Abstract

Purpose–In spite of being the second largest recipient of foreign direct investment (FDI) in the world, China shows limited evidence of considerable FDI benefits on growth (Fan and Hu; Luo; Ran et al.). Motivated by Alfaro et al.'s model, the purpose of this study is to test whether poor financial market development might be responsible for the relatively low benefits of FDI on growth in China. Design/methodology/approach–The author applies Blundell-Bond system GMM estimators to a panel of Chinese provinces. Findings–The results indicate that poor financial intermediation does indeed limit the transmission of FDI benefits within the Chinese economy. Moreover, the study reveals preliminary evidence that banks' credits to unproductive state-owned enterprises (SOEs) constitute poor financial intermediation with negative growth implications. In contrast, credits to small private enterprises are associated with a positive impact of FDI on growth. Research limitations/implications–The study is constrained by data availability especially for private credit data across provinces. Practical implications–Two policy implications can be drawn from the empirical findings. First, the direct policy implication is that to ensure positive benefits from FDI in China, domestic financial reforms are crucial. This is an important perspective for making FDI policies. The results also reveal some key priorities of financial reforms. More credits to small private enterprises are an indication of good financial intermediation, while more loans extended to unproductive SOEs signal poor financial intermediation. The priority of reform comes down to tackling the difficult problem of credit misallocation. Originality/value–This paper provides an alternative perspective to address the weak FDI-growth relationship found in China. Inspired by Alfaro et al.'s model and the understanding of the problem of Chinese financial markets, the study examines the role of the financial system in the FDI-growth linkage and reveals how financial market conditions could influence FDI benefits in China.

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Bibliographic Info

Article provided by Emerald Group Publishing in its journal China Finance Review International.

Volume (Year): 2 (2012)
Issue (Month): 2 (August)
Pages: 406-428

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Handle: RePEc:eme:cfripp:v:2:y:2012:i:2:p:406-428

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Related research

Keywords: China; Credit misallocation; Economic growth; FDI spill-overs; Financial development; Financial markets; Foreign direct investment;

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  1. Alfaro, Laura & Chanda, Areendam & Kalemli-Ozcan, Sebnem & Sayek, Selin, 2004. "FDI and economic growth: the role of local financial markets," Journal of International Economics, Elsevier, vol. 64(1), pages 89-112, October.
  2. Bond, Stephen Roy & Hoeffler, Anke & Temple, Jonathan, 2001. "GMM Estimation of Empirical Growth Models," CEPR Discussion Papers 3048, C.E.P.R. Discussion Papers.
  3. Richard Blundell & Steve Bond, 1995. "Initial conditions and moment restrictions in dynamic panel data models," IFS Working Papers W95/17, Institute for Fiscal Studies.
  4. Albert Park and Kaja Sehrt & Albert Park and Kaja Sehrt, 1999. "Tests of Financial Intermediation and Banking Reform in China," William Davidson Institute Working Papers Series 270, William Davidson Institute at the University of Michigan.
  5. Blomstrom, Magnus & Kokko, Ari, 1998. " Multinational Corporations and Spillovers," Journal of Economic Surveys, Wiley Blackwell, vol. 12(3), pages 247-77, July.
  6. Sylviane GUILLAUMONT JEANNENEY & PING HUA & ZHICHENG LIANG, 2006. "Financial Development, Economic Efficiency, And Productivity Growth: Evidence From China," The Developing Economies, Institute of Developing Economies, vol. 44(1), pages 27-52.
  7. Thorsten Beck & Ross Levine & Norman Loayza, 1999. "Financial Intermediation and Growth: Causality and Causes," Working Papers Central Bank of Chile 56, Central Bank of Chile.
  8. James Laurenceson & Kam Ki Tang, . "The FDI-Income Growth Nexus: a review of the Chinese experience," EAERG Discussion Paper Series 0905, School of Economics, University of Queensland, Australia.
  9. Boyreau-Debray, Genevieve, 2003. "Financial intermediation and growth - Chinese style," Policy Research Working Paper Series 3027, The World Bank.
  10. Mankiw, N Gregory & Romer, David & Weil, David N, 1992. "A Contribution to the Empirics of Economic Growth," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 407-37, May.
  11. Luo, Xubei & Zhu, Nong, 2008. "Rising income inequality in China : a race to the top," Policy Research Working Paper Series 4700, The World Bank.
  12. King, Robert G & Levine, Ross, 1993. "Finance and Growth: Schumpeter Might Be Right," The Quarterly Journal of Economics, MIT Press, vol. 108(3), pages 717-37, August.
  13. Richard Podpiera, 2006. "Progress in China's Banking Sector Reform: Has Bank Behavior Changed?," IMF Working Papers 06/71, International Monetary Fund.
  14. Selin Sayek & Laura Alfaro & Areendam Chanda & Sebnem Kalemli-Ozcan, 2003. "FDI Spillovers, Financial Markets and Economic Development," IMF Working Papers 03/186, International Monetary Fund.
  15. Gabrielle Lipworth & Tamim Bayoumi, 1997. "Japanese Foreign Direct Investment and Regional Trade," IMF Working Papers 97/103, International Monetary Fund.
  16. Fan, C. Simon & Hu, Yifan, 2007. "Foreign direct investment and indigenous technological efforts: Evidence from China," Economics Letters, Elsevier, vol. 96(2), pages 253-258, August.
  17. Hao, Chen, 2006. "Development of financial intermediation and economic growth: The Chinese experience," China Economic Review, Elsevier, vol. 17(4), pages 347-362.
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