Where to Direct Foreign Investment in China

Following the United States, China has become the second largest foreign direct investment (FDI) recipient in the world since 1993. FDI from the rest of the world has contributed to a substantial portion of China's promising economic growth. However, previous analyses on this phenomenon often treat China as a whole and pay little attention to the sub-national differences within such a big country. Another limitation of these studies is that they tend to exclude or at least overlook the impacts of political considerations, which are critical to foreign investment in China. This dissertation applies John Dunning's eclectic location theory, which recognizes both economic and political characteristics for international firms to determine their optimal investment locations in China at the sub-national level. The stock of accumulated FDI is examined along with the inflows of FDI to provide more comprehensive advises to international enterprises and policy makers. Based on the panel data containing 26 Chinese provinces and 4 municipalities from 1996 to 2007, the empirical results show that relative political capacities (RPC) of local governments do have significant positive impacts on attracting more foreign capital to the region in the short run but not on the stock of FDI in the long run. However, there is an inverse U shape relationship between government capacity and FDI activities, meaning RPC has diminishing return on attracting more FDI once the optimal level has been reached. Also, even though the special economic zones (SEZs) have been drivers of China's foreign capital influx for decades, this research argues that most provincial level of such economic zones have failed to attract enough FDI to the region due to the lack of capable local governments to implement policies and suitable environment for investments.