A panel data analysis of locational determinants of Chinese and Indian outward foreign direct investment.

• Author: Duanmu, Jing-Lin

INTRODUCTION

The rise of China and India is one of the defining events of the 20th century. While China has captured the world's attention by its phenomenal FDI inflows and impressive GDP growth, India is swiftly developing its offshore IT outsourcing and other service sectors with its language and institutional advantages. The sheer size of the two countries, along with their rapid growth, means that some of the most important impacts are likely yet to be seen. With significant deregulation within the two countries on FDI abroad, those companies that have gained more confidence and accumulated more financial capital are now spreading their wings and investing overseas. Table 1 shows that from 1982 to 1992, Chinese FDI rose from 44 US$ million to 4000 US$ million, while India's outward FDI, beginning at only 1 US$ million in 1982, rose slowly to 24 US$ million in 1992 and then grew steadily from 82 US$ million to 2222 US$ million in 2004.

The upsurge of Chinese and Indian FDI raises an unanswered question about the locational determinants of direct investment from the two countries. It is important to pursue such an understanding for several reasons. First, FDI from developing countries, especially big economies such as China and India, becomes a new source, alongside FDI from developed nations. MNEs from developing countries may foster positive spillovers because of narrower technological gaps between them and firms in developing nations (Battat and Aykut 2005). They are less corporatized and more informal than western models, and are often more appropriate to the host country context (Gelb 2005). In the light of significant decline in investments from developed nations, FDI from developing countries plays an important role in sustaining FDI flows to developing nations. Host country governments and agencies have an incentive to learn what attracts this type of investment in order to design their investment promotion policies. Furthermore, their investments may or may not have different determinants vis-a-vis FDI originating in developed nations. A systematic investigation will give us empirical evidence to take part in this debate. Third, a comparative study will enable us to explore whether Chinese and Indian FDI react to host characteristics differently and why they do so.

Using unbalanced panel data, we find that Chinese and Indian FDI are attracted to countries with large market size, low GDP growth, high volumes of imports from China or India, and low corporate tax rates. We also find important differences between China and India. While Chinese FDI is drawn to countries with open economic regimes, depreciated host currencies, better institutional environments, and English speaking status, but deterred by geographic distance and OCED membership; none of these factors are important for Indian FDI.

The remainder of the paper is set out as follows. Section 2 reviews literature on the locational determinants of FDI and studies on FDI from developing countries. Section 3 presents our research hypotheses. Section 4 explains the data, measurements and methodology. Section 5 reports the results. Finally, we summarise our findings, discuss policy implications, and acknowledge the limitations of the study.

LITERATURE REVIEW

LOCATIONAL DETERMINANTS OF FDI

As an important component of globalisation, FDI has grown far more rapidly than international trade during the last two decades (Gaston and Nelson 2002). Accordingly, there has been a vast amount of empirical literature developed around the issue of the forces attracting FDI. The literature is not only massive but also 'chaotic' (Chakrabarti 2001) because it has not been possible to arrange location-specific decisions of companies into a uniform theoretical pattern (Baniak et al 2003). However, according to Dunning's (1993) categorization, most FDI can be classified into three types: resource-seeking, efficiency-seeking and market-seeking. As a result, most previous empirical studies have investigated the impact of the availability of natural resources, typically minerals, raw materials and agricultural products; the costs and quality of particular factor endowments; and the size and growth of domestic markets. recently, scholars contend that FDI is also subject to basic macroeconomic trends, which bring some 'less conventional' variables, such as exchange rates, inflation rates, and debt levels, into the general framework. In addition, Dunning (2006) stressed the importance of the host institutional environment, such as: taxes, fiscal incentive structure, legal, and macroeconomic infrastructure, to inbound FDI.

While most empirical studies included 'conventional' variables, the inclusion of 'less conventional' ones differs from one to the other depending on the specific focus of the research. For example, Clegg and Scott-Green (1999) investigated the determinants of US and Japanese FDI into the European Community (EC) 1984-89 and found that the effects of conventional host characteristic variables demonstrated considerable varieties between groups of member countries. For example, throughout those countries in the EC with low labor costs, higher labor costs are positively associated with US and Japanese FDI; yet in countries with high labor costs, this effect diminishes. Both US and Japanese FDI react strongly to the market size of new entrants to the EC, but less so for existent EC member countries. Japanese FDI reacts more strongly to the EU integration compared to the US FDI due to its less established position in the EU. Corporate tax levels are less important in explaining FDI flows into the EC from outside. Focusing on the annual bilateral flows of FDI in the EU-15 members, Janicki et al. (2005) found the host market size and relative size of the two economies significantly increase FDI flows, and distance significantly reduces FDI flows. European convergence variables, such as equalisation of financing costs, convergence of government fiscal policy and the similarity of government debt, all increase bilateral FDI flows. In contrast, low labor cost is not an attractive factor of EU FDI.

Biswas (2002) also found that low wage is not a significant factor in attracting US MNEs, using FDI data from the Bureau of Economic Analysis (BEA) on forty-four countries during the period 1983-1990. Instead, many institutional factors, such as the regime type of the host country, regime duration and property rights index, are statistically significant, suggesting the importance of a healthy institutional environment in attracting US FDI. Sethi et al. (2003) studied the changing trends in the US FDI into the Western European and Asian regions over the period 1981-2000. During 1981-1982, their results show that US FDI has gone to Western Europe because of its high political and economic stability and high GNP. Cultural proximity to the USA is a strong determinant, with cultural distance being negative and highly significant. However, the data between 1981 and 2000 show that US FDI was attracted by low GNP countries and that the negative impact of cultural distance on US FDI diminished. This historical pattern indicates that once US MNEs confronted the declining profits in Western Europe, the resulting cost reduction pressures impelled them to start making much more efficiency-seeking FDI into Asia, although Asian countries do not provide the best mix of the traditional determinants of FDI. Moreover, the high-wage differential between West Europe and Asia is the most significant factor contributing to the restructure of US FDI during 1981-2000, suggesting that low labor costs do matter, but only in the long-term and within countries with heterogeneous labor costs or quality.

As a result of the transition of several Central and Eastern European and the Chinese economies from communism to a market-based economic system, there has been growing attention paid to the impact of the country-specific risks and institutional and political environments on FDI inflows. Bevan and Estrin (2004) reported that, based on a panel data of bilateral flows of FDI from Western countries in eleven Central and Eastern European (CEE) countries, key announcements on progress in EU accession had a significant and positive impact on FDI inflows, but FDI flows to transition economies are not influenced significantly by market evaluations of country-specific risk. Brada et al. (2006) investigated the impact of political factors on FDI flows into seven transition economies in Europe from 1993 to 2001. They found that the initial cumulative inflation rate, the cumulative GDP decline, the share of the private sector in GDP, and change in the unemployment rate significantly reduced FDI inflows. The index of infrastructure reform of a country, lending minus deposits, and change in current account (percentage of GDP) increased FDI inflows, and therefore confirmed the benefits resulting from reform policies.

Egger and Winner (2006) studied the impact of corruption in a panel of bilateral outward FDI stocks of twenty-one OECD countries in fifty-nine OECD economies between 1983 and 1999. They found a negative impact of corruption on FDI. In addition, corruption is important for intra-OECD FDI but not for extra-OECD FDI and overall the impact of corruption has declined over years, suggesting that other factors have become relatively more important than corruption. Similarly, Aizenman and Spiegel (2006) used the index of corruption based on Davoodi and Tanzi (1997) to indicate the level of institutional inefficiency in ninety-seven countries from 1990 to 1999 and found it significantly and negatively related to the ratio of inward FDI to gross fixed capital formation, confirming their hypothesis that MNEs are more sensitive to institutional inefficiency in the host country than domestic firms. Similarly, despite the overall phenomenal FDI into China, Hsiao and Hsiao (2004) found that from 1986 to...