The Giant Sucking Sound: Is China Diverting Foreign Direct Investments from Other Asian Economies?

Is China taking direct investments away from other Asian economies? Theoretically, a growing China can add to other countries’ direct investments by creating more opportunities for production-networking and raising the need for raw materials and resources. At the same time, the extremely low Chinese labor costs may lure multinationals away from other Asian sites when the foreign corporations consider alternative locations for low-cost export platforms. In this paper, we explore this important issue empirically. We use data for eight Asian economies (Hong Kong, Taiwan, Republic of Korea, Singapore, Malaysia, Philippines, Indonesia and Thailand) from 1985 to 2001 and control for the determinants of their inward direct investment. We then add China’s inward foreign direct investment as an indicator of the “China Effect”. Due to issues of simultaneity, we use a random effects simultaneous equation model to estimate our coefficients. We have three results: (1) The level of China’s foreign direct investment is positively related to the levels of these economies’ inward direct investments; (2) the level of China’s foreign direct investment is negatively related to the direct investments of these economies as shares of total Asian foreign direct investments; (3) The China effect is not the most important determinant of the inward direct investments of these economies. Policy and institutional factors such as openness, corporate tax rates and corruption can be more important.