Economic Growth, Foreign Investment and Regional Inequality in China

Over the past three decades, China’s economic miracle has featured an open-door policy, most notably in the absorption of foreign capital. One of the downside effects of economic reform, however, has been ever-rising inter-regional inequality. As foreign direct investment (FDI) is distributed unevenly across regions, many scholars and policymakers have blamed inflows of FDI as one of the main factors in driving the Chinese regions apart. By this logic, controlling the scale of FDI could be a solution to regional inequality; however, it is difficult to reconcile the positive effect of FDI on economic growth with the potentially ‘negative’ effect on regional inequality. This is a controversial and provocative issue in developmental economic literature. Using the largest panel dataset covering all the Chinese regions over the period 1979–2003 and employing an augmented Cobb-Douglas production function, this chapter provides evidence that FDI has been an important factor responsible for regional growth differences in China. However, it suggests that FDI cannot be blamed for causing regional inequality; it is the uneven distribution of FDI instead of FDI itself that has caused regional growth differences. The key policy issue is that FDI should be guided towards inland areas with preferential policies implemented in order to improve the spatial allocation of investments as a means to reduce regional inequality.