Distance of doing business and outward foreign direct investment: An empirical study of China

• Published date: 01 August 2022
• Author: Xinbei Qian,Dexue Liu,Liangxiong Huang,Hanchao Li
• Date: 01 August 2022
• DOI: http://doi.org/10.1111/rode.12890

Rev Dev Econ. 2022;26:1411–1437. wileyonlinelibrary.com/journal/rode

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1411

© 2022 John Wiley & Sons Ltd

Received: 9 January 2020

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Revised: 17 February 2022

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Accepted: 10 March 2022

DOI: 10.1111/rode.12890

REGULAR ARTICLE

Distance of doing business and outward foreign

direct investment: An empirical study of China

XinbeiQian1

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DexueLiu1

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LiangxiongHuang2

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HanchaoLi3

1College of Economics, Jinan University,

Guangzhou, China

2School of Economics and Finance,

South China University of Technology,

Guangzhou, China

3The Faculty of EEC, Coventry

University, Coventry, UK

Correspondence

Liangxiong Huang, School of Economics

and Finance, South China University

of Technology, Building B10, 510006,

Higher Education Mega Center,

Guangzhou, China.

Email: hlxiong@scut.edu.cn

Funding information

Guangzhou Philosophy and Social

Sciences Planning Project, Grant/Award

Number: 2021GZYB01; National Natural

Science Foundation of China, Grant/

Award Number: 72073047; Guangdong

Soft Science Research Project, Grant/

Award Number: 2018B070714013

Abstract

Differences between the business environment in the

home country and the host country are an important fac-

tor when enterprises consider their location choice with

regard to outward foreign direct investment (OFDI).

However, this is ignored by much existing literature. Based

on the trade- off framework of international firms between

exporting and participation in OFDI under the condition

of heterogeneous enterprises, this paper constructs a theo-

retical model of the impact of distance of doing business

(DDB) on OFDI. We take China's OFDI as an example

and use the World Bank Group's Ease of Doing Business

Index to construct the DDB indicator, as well as test the

impact of the DDB on China's OFDI by combining the

macro- location panel data of China's OFDI between 2004

and 2017. The results showed that increasing DDB signifi-

cantly reduces the scale of China's OFDI. The effect is ro-

bust. The mechanism is that DDB significantly decreases

the success rate of OFDI and increases the cost of OFDI,

thereby decreasing the scale of OFDI. Further analysis

then finds that official acts, such as building partnerships,

and folk acts, such as increasing cultural identity, can sig-

nificantly reduce the negative effect of DDB on OFDI.

KEYWORDS

cultural identity, distance of doing business, outward foreign

direct investment, partnership

JEL CLASSIFICATION

F21; F23; G18

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QIAN et al.

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INTRODUCTION

Outward foreign direct investment (OFDI) is an important factor for economic globalization.

Institution quality of the nation (region) is strongly connected to competitiveness and devel-

opment. Institution quality is also a key factor affecting OFDI (Blonigen,2005; Schwab,2009).

Measurement of the institution quality generally adopts the World Bank's Global Governance

Indicators (WGI) and The Heritage Foundation (THF) economic freedom indicators (Acemoglu

etal., 2005; Estrin etal.,2009; Globerman & Shapiro,2003; Miniesy & Elish, 2016; Roelfsema

& Zhang, 2012). However, these indicators are more complicated and involve a wide range of

fields, and they often have a relatively weak correlation with the daily business activities of en-

terprises. To accurately measure the business environment, which closely relates to the daily

business activities of enterprises, the World Bank conducted a survey in 2003, comprising busi-

ness projects in nearly 200 countries (regions). The business data objectively reflect the sum of

various surrounding conditions that accompany the entire company business process, including

all links from start- up through operation, and bankruptcy. Concurrently, the business data can

more accurately reflect the institutional environment that enterprises are facing in their business

activities from a micro- perspective. The Doing Business Report publication has not only caused

widespread concern about enterprises but also ignited increased interest among researchers.

Some scholars use the World Bank's doing business data to measure the institution quality and

test the impact of the business environment on OFDI. The empirical results show that overall the

ease of doing business ranking and subindicators have a positive effect on OFDI (Jeong,2014;

Piwonski,2010; Shahadan etal.,2014).

Most existing literature centers on institutional quality, and OFDI focuses on the impact of

home- country institutional quality (business environment quality) on OFDI. However, these

analyses ignored the differences between the home and host countries, for example, differences

in institutional distance between the host and home countries. These differences increase the

risk of cross- border investment, and the cost of transnational operations, thus impacting on

the choice location of OFDI (Mudambi & Navarra,2002). Existing literature mainly captures

the differences in institutional distance between the home and host countries. Most institutional

distance indicators have been based on indicators such as the WGI or the THF economic free-

dom indicators. The study of the impact of institutional distance on OFDI can be divided into

three categories: (1) institutional approach theory (Habib & Zurawicki,2002), which holds that

firms tend to invest in countries close to their own institutions; (2) institutional escape theory

(Aleksynska & Havrylchyk,2013), which believes that firms are more inclined to invest in coun-

tries a large distance from their home country's institution; and (3) comprehensive view (Xu &

Shenkar,2002), which argues that the influence mechanism of institutional distance on OFDI is

diversified and cannot be explained by a single theory. However, no existing literature employs the

business index to analyze the impact of distance of doing business (DDB) on OFDI and present a

moderating factor (e.g., building partnerships and increasing cultural identity) to reduce the neg-

ative effect of DDB on OFDI. Compared with other institution quality indicators, business data

can more fully reflect the regulations and difficulties encountered by firms involved in OFDI. In

addition, existing literature has not built a clear mathematical model to explain the impact mech-

anism of business environment distance on OFDI scale. Considering these research deficiencies,

this paper first refers to Cezar and Escobar (2015), which integrates the export choice model of

heterogeneous firms (Melitz,2003) and the trade- off framework of international firms between

exporting and participation in OFDI (Helpman etal.,2004; Yeaple,2009). This paper constructed