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Foreign direct investment under weak rule of law : theory and evidence from China

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  • Wang, Xiaozu
  • Xu, Lixin Colin
  • Zhu, Tian

Abstract

This paper develops a self-enforcing contract model to show that better economic fundamentals can help when there is weak rule of law -- but with order -- to attract foreign direct investment, whereas lowering taxes does not necessarily help. Using a cross-region Chinese dataset, the analysis finds evidence consistent with the theoretical analysis. Regional variations in tax rates and the perceived quality of formal contracting institutions are not correlated with regional inflows of foreign direct investment, but leadership characteristics are. Most conventional economic factors have the predicted effects on foreign direct investment. The finding that foreign direct investment is lower in locations where domestic private firms have better access to finance and where the air quality is poor is new to the literature.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5790.

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Date of creation: 01 Sep 2011
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Handle: RePEc:wbk:wbrwps:5790

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Keywords: Debt Markets; Emerging Markets; Investment and Investment Climate; Bankruptcy and Resolution of Financial Distress; Access to Finance;

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  1. Laura Alfaro & Sebnem Kalemli-Ozcan & Vadym Volosovych, 2005. "Why Doesn't Capital Flow from Rich to Poor Countries? An Empirical Investigation," NBER Working Papers 11901, National Bureau of Economic Research, Inc.
  2. Yingqi Wei & Xiaming Liu & David Parker & Kirit Vaidya, 1999. "The Regional Distribution of Foreign Direct Investment in China," Regional Studies, Taylor & Francis Journals, vol. 33(9), pages 857-867.
  3. Li, Hongbin & Zhou, Li-An, 2005. "Political turnover and economic performance: the incentive role of personnel control in China," Journal of Public Economics, Elsevier, vol. 89(9-10), pages 1743-1762, September.
  4. Dees, Stephane, 1998. " Foreign Direct Investment in China: Determinants and Effects," Economic Change and Restructuring, Springer, vol. 31(2-3), pages 175-94.
  5. La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert W., 1998. "Law and Finance," Scholarly Articles 3451310, Harvard University Department of Economics.
  6. Cletus C. Coughlin & Eran Segev, 1999. "Foreign direct investment in China: a spatial econometric study," Working Papers 1999-001, Federal Reserve Bank of St. Louis.
  7. Bruce Blonigen, 2005. "A Review of the Empirical Literature on FDI Determinants," Atlantic Economic Journal, International Atlantic Economic Society, vol. 33(4), pages 383-403, December.
  8. Moenius, Johannes & Berkowitz, Daniel, 2011. "Law, trade, and development," Journal of Development Economics, Elsevier, vol. 96(2), pages 451-460, November.
  9. Stein, Ernesto & Daude, Christian, 2007. "Longitude matters: Time zones and the location of foreign direct investment," Journal of International Economics, Elsevier, vol. 71(1), pages 96-112, March.
  10. Huang Yasheng, 2007. "Ownership Biases and FDI in China: Evidence from Two Provinces," Business and Politics, De Gruyter, vol. 9(1), pages 1-47, May.
  11. Mailath, George J. & Samuelson, Larry, 2006. "Repeated Games and Reputations: Long-Run Relationships," OUP Catalogue, Oxford University Press, number 9780195300796, September.
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