Title
The Determinants of Chinese
Outward FDI to Developing
Countries
Bachelor Thesis Within Economics
Authors: Linda Thilén and Lisa Hellblom Tutors: Börje Johansson and James Dzansi
Bachelor‟s Thesis in Economics
Title: The Determinants of Chinese Outward FDI to Developing Countries Author: Linda Thilén and Lisa Hellblom
Tutors: Börje Johansson and James Dzansi
Date: 2010-05-29
Subject terms: F21, P45
Abstract
Outward foreign direct investment has increased significantly in recent years and a con-siderable part is going to developing countries. This thesis examines the determinants of Chinese outward FDI to developing countries. Data from 2003 to 2008 has been col-lected from 104 developing countries which have received Chinese FDI.
The analysis is based on the results of a semi-gravity model. The variables included in the regression are resource-richness, GDP, openness to trade, bilateral trade with China, and distance from Beijing. As expected by the authors, Chinese FDI was found to be strongly correlated with resource-richness and the existence of trade ties between China and the recipient country. Quite disturbingly, the results show a strong relationship be-tween Chinese FDI and corruption. A negative correlation was confirmed for the level of GDP, openness to trade, and distance to Beijing, along with the authors‟ expecta-tions.
Kandidatuppsats inom nationalekonomi
Titel: Avgörande faktorer för Kinas direktinvesteringar i utvecklingsländer Författare: Linda Thilén och Lisa Hellblom
Handledare: Börje Johansson och James Dzansi
Datum: 2010-05-29
Ämnesord: F21, P45
Sammanfattning
Kinas utländska direktinvesteringar har ökat anmärkningsvärt de senaste åren och en stor andel har gått till utvecklingsländer. Målet med denna uppsats är att bestämma de faktorer hos utvecklingsländer som attraherar kinesiska direktinvesteringar, med ett sär-skilt fokus på naturresurser. Data har samlats från 104 stycken utvecklingsländer som har mottagit kinesiska direktinvesteringar under åren 2003 till 2008.
Analysen baseras på resultaten från en semi-gravitationsmodell. De följande variablerna är inkluderade i modellen: naturtillgångar, BNP, öppenhet gentemot internationella marknader, handel med Kina, det fysiska avståndet från Beijing samt korruption. Som förväntat visade resultaten ett starkt samband mellan direktinvesteringar och naturtill-gångar samt volymen av handel mellan Kina och mottagarlandet. Mer oväntat är det funna positiva sambandet mellan korruptionsnivån i landet och direktinvesteringar. Ett negativt samband hittades mellan kinesiska direktinvesteringar och BNP, öppenhet samt avståndet från Beijing.
Abbreviations
BNP Bruttonationalprodukt
CPI Corruption Perception Index
FDI Foreign Direct Investment
GDP Gross Domestic Product
IDP Investment Depelopment Path
IMF International Monetary Fund
MNE Multinational Enterprise
MOFCOM Ministry of Commerce, People‟s Republic of China
OECD Organization for Economic Co-operation and Development SITC Standard International Trade Classification
Table of Contents
1
Introduction ... 1
1.1 Purpose ... 3
1.2 Outline ... 3
2
Background ... 4
2.1 FDI and Chinese FDI ... 4
2.2 The Investment Development Path ... 5
3
Previous Research ... 7
4
Theoretical framework ... 9
4.1 Internalization Theory ... 9
4.2 Dunning’s eclectic paradigm ... 10
5
Method ... 12
5.1 Hypotheses ... 12
5.2 The Gravity Model ... 15
6
Results ... 18
7
Conclusion ... 22
List of references ... 24
8
Appendix ... 27
8.1 Appendix 1 ... 27
8.2 Appendix 2: The 15 largest receivers of Chinese FDI ... 29
8.3 Appendix 3: Partial Correlation Diagrams ... 30
8.4 Appendix 5: Outward Chinese FDI ... 32
8.5 Appendix 6: The 15 largest host countries of Chinese FDI 2003-2006 ... 33
1
Introduction
Outward foreign direct investment from China has increased significantly in recent years. From being an almost non-existent phenomenon in the beginning of the 1980‟s, China was in 2008 the world‟s 20th
largest country in terms of outward FDI (CIA Fact-book 2010). Measured in billions of US Dollars, Chinese outward FDI increased more than tenfold between 1980 and 2008 (MOFCOM and China Statistics Bureau). Accord-ing to the 2008 Statistical Bulletin of China‟s Outward Foreign Direct Investment, a to-tal of 157 countries world wide received Chinese FDI in 2008. The recent increase in Chinese outward FDI has caught the attention of the world and the motives for it have been questioned. This is especially true for investments in host countries classified as developing countries. But what in fact determines which developing countries China in-vests in?
The Sino-African relationship is relevant to look at to understand the complexity of China‟s new role in the developing countries of the world. The presence of Chinese in-vestors in Africa has raised both concern and hope, and has led to debates on economic as well as political levels. In a debate in the 2010 February issue of The Economist, George Ayittey, (Distinguished Economist, American University) and Calestous Juma, (Professor of the Practice of International Development, Harvard) share their different views on the consequences of the increased Chinese activity in the African continent. Ayittey is skeptical and regarding the objectives of China he concludes: “Its real inten-tions are well known: to elbow out all foreign companies and gain access to Africa's re-sources at cheap prices”. Ayittey is concerned that China will act as a second colonizer and exploit Africa‟s resources. Juma on the contrary considers China as a positive force in promoting African growth: “China's rising demand for Africa's natural resources helped to re-establish Africa as a source of valuable commodities for the global mar-ket”.
Developing countries in the role of investors is a relatively new phenomenon, and the early theories about which factors determine where FDI takes place have been realized mostly from the perspective of industrialized countries (Sauvant 2005). However, re-search in more recent years has been conducted to discern whether Chinese FDI is de-termined by other factors, particular to the dosmestic factors of the country. Buckley et
al (2007) have found that Chinese outward FDI is attracted to countries with high politi-cal risk, whereas Cheung and Qian (2008) have found no significant effect of institu-tions. Both studies find Chinese FDI to be attracted by natural resources. While the stu-dies by Buckley and Qian mainly recognize the domestic factors shaping Chinese out-ward FDI, our research focuses on the determinants specific to the host countries. Fur-thermore, we have chosen to only include developing countries in our research, as we believe that the relationship between China and the developing world provides an im-portant aspect on how the economic world hierarchy is changing. The determinants of Chinese outward FDI presented in our research will thus be the influencing factors of developing countries only. In addition to this, the time period analyzed by Buckley et al. comprises data up until 2001. When looking at Graph 5:1 it becomes clear that the dramatic increase of Chinese outward FDI takes place after 2003, the starting point for our research.
The Chinese miracle has without doubt showed that it is possible for a country to rise from poverty to an economic power extremely fast, and this could make China a role model for countries striving for economic growth. For decades, developed countries have attempted to eliminate poverty through development aid. However, this has not led to the results aimed for. As recognized by Ovaska (2003), Western aid has not been successful in promoting economic growth. The major difference between Western and Chinese attitude towards foreign countries is the Chinese non-interference policy (Tull 2006). This policy implies that China is capable of establishing business relations with-out imposing any political constraints.
Is China only making use of the mal-functioning regimes in some countries to be able to appropriate itself with the natural resources? Or is China offering a unique opportunity for countries trapped in poverty to raise? Undoubtedly, the relationship between the fastest growing economy in the world and the countries hoping to follow the same path merits more attention.
„We have turned east where the sun rises,
and given our backs to the west, where the sun sets’
1.1
Purpose
The purpose of this thesis is to examine Chinese FDI to developing countries. The re-search attempts to investigate whether natural resources in developing countries attract Chinese FDI. Our aim is to contribute to the ongoing debate on China‟s intentions in developing countries by providing empirical research on the determinants of Chinese outward FDI.
1.2
Outline
This thesis is outlined as follows: The first section is the introduction and states the pur-pose of the thesis. In the second section, a historical background of Chinese FDI is giv-en. The third section presents a briefing of previous research within the topic. Next, the foruth section provides the theoretical base underlying our research and presents the main theories. In the fifth section the data collected and the regression model are pre-sented. The sixth section consists of the evaluation and analysis of the results. Finally the conclusions drawn are presented in the seventh section. Following this, the list of references and the appendix are given to the reader.
2
Background
According to the OECD foreign direct investment is defined as:
“a category of investment that reflects the objective of establishing a lasting interest by a resi-dent enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor. (…)The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is evidence of such a relationship.”
2.1
FDI and Chinese FDI
A majority of studies on the effects of FDI in developing countries point towards posi-tive effects on growth and development. Foreign direct investment directed towards China played an important role for the development of the Chinese economy. Bo-rensztein et al. (1998) find a positive relationship between FDI and growth in their study on FDI going from developed countries to 69 developing countries over two decades. The results suggest that FDI is an important vehicle for the transfer of technology, and that FDI has relatively larger effects on growth than domestic investment. In the 1970‟s and onwards, more liberal national policies encouraged foreigners to invest in China. The advantage of the lower labor costs in China attracted many foreign companies and this led to a boost of the economy. It also extended the variety of goods produced in China by bringing new technologies and knowledge. China‟s impressive growth rate over the years has been fueled by massive FDI. China eventually became the world‟s largest recipient of FDI.
Outward foreign direct investment from China has been increasing considerably the last decades and many of the host countries are developing countries. Chinese FDI first be-gun in the late 1970‟s with the so-called open door policy but the true expansion of in-vestments started with the go global policy, implemented in 1999. The data on Chinese FDI is consistent with OECD and IMF standards only since 2003 (Cheung and Qian, 2008). Among developing countries, China is the world‟s 3rd largest investor in foreign countries (UNCTAD 2010). From this point on, when referring to „Chinese FDI‟, out-ward Chinese FDI is implied.
Total FDI from China has increased more than tenfold since the 1980‟s (see Graph 5:1). Despite this, Chinese FDI still only accounts for a relatively small part of the Chinese GDP and China was only the 20th largest country in the world in terms of outward FDI in 2008 (CIA Factbook 2010). One explanation for this might be that the prominent growth rate in China has had the effect of making domestic investments more attractive than investing abroad. However, this seems likely to be changing as the increase of Chinese outward FDI since the middle of the 1980‟s has been dramatically increased (see Graph 5:1).
Chinese FDI seems to be spread over the world but has a remarkable majority of its pro-jects taking place in South and East Asia as well as in Africa. Though Africa is only re-ceiving a small share of the total, the African continent is host to more Chinese FDI than Europe, North America or Oceania. Less than a third of all FDI is actually going to developed countries (Graph 5:2) and for instance, 9 among the 15 largest recipients of Chinese FDI between 2003-2006 are developing countries (Graph 5:3). The Chinese companies responsible for the largest FDI share are with only one exception state-owned. State-owned enterprises in China are highly profitable and operate as monopo-listic firms in officially-sanctioned markets, often in sectors such as the natural resource industry or telecommunications (Morck, 2008).
2.2
The Investment Development Path
The investment development path (IDP) was first developed by Dunning in 1979 and later elaborated by various researchers. The theory argues that the FDI position of a country is associated to its economic development relative to the rest of the world (Dunning and Narula 1996). Acccording to the investment development path, countries tend to go through five stages of development before the outward FDI is approximately at the same level as inward FDI. These five stages are:
1. No existence of inward or outward FDI.
2. Emergence of inward FDI while low degree of outward FDI. 3. Slowing growth of inward FDI and an expansion of outward FDI. 4. Outward FDI exceeds inward FDI.
The investment development path illustrates the different stages a country goes through in opening up to the international market. All 104 developing countries used in our study experience inflows of FDI in the period 2003-2008 (Table 2:1) except six.1 This implies that the majority of the countries are around the second stage on the investment development path.
1
3
Previous Research
As the world‟s largest recipient of FDI, much focus has been on China receiving FDI from other countries while its outward FDI has been given less attention. Two recent studies, Buckley et al (2007) and Cheung and Qian (2008) investigate the effects on Chinese outward FDI to both developed and developing countries and include natural resources in their analysis. Both studies find China to be resource-seeking. However, Cheung and Qian do not find support for China‟s investments in African oil-producing countries to be primarily driven by natural resources. The studies differ in their conclu-sion about institutions; Buckley concludes that China is attracted to bad institutions whereas Cheung does not find institutions to be significant. A detailed description of the studies follows.
Buckley (2007) examines the determinants of outward Chinese FDI to 49 countries be-tween 1981 and 2001. The research is divided into an early period (1981-1991) and a later period (1992-2001). The results show that in the later period, Chinese firms have moved from close foreign markets towards riskier ones in order to secure natural re-sources. This suggests that China‟s need to secure natural resources have become more important in recent years. Their results also suggest that Chinese FDI is attracted to countries with bad institutions, estimated by an index of political risk. Both institutions and natural resources appear to become more important for the later period 1992-2001 which is explained by the market liberalization by Deng Xiaoping in 1992. Further-more, Buckley finds Chinese FDI to be positively correlated with GDP, inflation, trade and cultural proximity to China. Cultural proximity is estimated by the percentage of the population speaking Chinese. Distance from China, however, was not found to be of significance.
Cheung and Qian (2008) examine FDI flows from China to 31 countries, 21 developing and 10 developed which were separated in the research, in the period 1991-2005. Natu-ral resources were estimated by the ratio of fuel, metal and ore exports as part of total exports. For the developing countries, the results showed resource-seeking motives. The researchers found evidence that China has increased its efforts to secure natural re-sources in both developing and developed countries since 2002. Furthermore, it was found that China is increasing its involvement in developing countries and appears to be insensitive to the risk associated with developing countries. In addition to this, Cheung
and Qian find Chinese FDI to be attracted by the GDP of the host country as well as by low wages.
Another important researcher in the field of FDI in developing countries is de Mello who analyzes the effects on FDI in selected Latin American countries in the time period 1970-1991 by using Granger causality (de Mello 1996a). A stronger correlation is found between FDI and output growth in small open economies than in larger ones. In addi-tion, de Mello (1996b) concludes that there is a stronger positive relationship between FDI and domestic investment in non-OECD countries, so-called technological laggers which are less technologically developed than the leaders. This would imply that devel-oping countries would benefit more from the positive effects of FDI on domestic in-vestment than developed countries. Both developing and developed countries were found to benefit from FDI in terms of increased output growth.
The link of causation, whether FDI promotes growth or vice versa, has been debated. de Mello (1997) suggests that the direction of causality depends on the determinants of FDI. If the determinants of FDI appear to be strongly correlated to FDI, then growth is considered to cause FDI. However, in the research by Chowdhury (2003) it is found that the link of causation runs both ways. Three developing countries2 were studied in 1969-2000 and presence of unidirectional causality from economic growth to FDI was found, indicating that there was feedback between the two variables.
2
4
Theoretical framework
Foreign direct investment existed in the nineteenth century in the form of lending by Britain to finance development in foreign countries. However, it was no until the 1960‟s that FDI flows became prominent on a larger scale (Moosa 2002). Ronald Coase pub-lished „The Nature of the Firm‟ in 1937. This paper, where Coase argues that the exis-tence of firms is a result of market imperfections, has served as a basis for the further research within the field. Although Coase focused on the firm at a domestic level, his arguments have been applied in the later research in the field of FDI, for example in the Internalization theory by Buckley and Casson (1976).
4.1
Internalization Theory
The internalization theory was conceptualized by Buckley and Casson (1976) and is in-volved in the analysis of the multinational enterprise. The theory explains the function-ning of the multinational enterprise (MNE) in terms of the firm‟s interaction with the external environment, its organizational design (Rugman 2007). Internalization is the concept of performing activities inside the MNE in order to overcome market imperfec-tions, i.e. firms tend to create their own internal markets (Buckley 1976). The theory demonstrates that the MNE organizes activities internally in order to develop and ex-ploit firm-specific advantages in knowledge and in other types of intermediate products. According to Buckley (1988), the internalization theory rests on the premises that firms will choose the least costly location and also that firms continue to internalize markets up till the point where the costs outweigh the benefits. As a result, firms will choose lo-cations with particular benefits such as low tax rates. In Dunning‟s eclectic paradigm, ownership advantages are added as a third factor influencing the behavior of the firm in an international context.
Internalization is an alternative to the external market for developing and exploiting knowledge. In more general terms, Buckley and Casson (1976) demonstrate that any type of market imperfection, across both goods and factor markets, can lead to pressure for internalization by the MNE.
4.2
Dunning’s eclectic paradigm
The theory of Internalization inspired John Dunning‟s eclectic model of foreign direct investment, also known as the OLI model. It states three different reasons for companies to invest abroad (Dunning 1988).
Ownership advantages such as organizational advantages, trademarks, produc-tion techniques, entrepreneurial skills, returns to scale, human capital and repu-tation.
Locational advantages are the existence of raw materials, low wages, special taxes or tariffs.
Internalization advantages arise when an internal organization of activities is a more efficient way of organizing transactions than in the market
In addition to the fact that ownership specific advantages as well as internalization ad-vantages are necessary, it must be in the firm‟s interest to use these in combination with a least some factor inputs located abroad - so called location specific advantages. By combining ownership specific advantages, internalization specific advantages and loca-tion specific advantages, we obtain the eclectic paradigm of FDI.
The eclectic paradigm suggests that in the case of existence of the three types of advan-tages, the greater those are the more FDI will be undertaken. When firms possess consi-derable organizational and internalizational advantages but the locational advantages are favourable in the home country, domestic investment will be preferred to FDI. In this case, the foreign market remains an export market instead of hosting FDI.
Dunning‟s eclectic paradigm leads to the classification of FDI into three different cate-gories based on the motives of the firms: market-seeking, efficiency-seeking and
re-source-seeking. FDI is considered to be market-seeking when the investing firms are
looking for an expansion of their market and to profit from the global market. Efficien-cy-seeking FDI occurs when firms allocate abroad in order to benefit from lower pro-duction costs. FDI is resource-seeking when investments take place in order for the firm to benefit from resources specific to the host country. Natural resources as well as hu-man capital are considered as resource endowments. This implies that firms seeking low
labor costs or a large pool of skilled workers as well as firm searching for natural re-sources fall into this category.
5
Method
The analysis is conducted on 104 developing countries around the world in the time pe-riod 2003-2008. After identifying South Africa as an outlier, the country was excluded from the research. The year 2003 was chosen as a starting year for two reasons. Firstly, after 2003 the level of outward FDI from China increased as it became legal for private firms to invest abroad (Buckley 2007). Also, it was not until 2003 that the Chinese gov-ernment started to publish data on outward FDI which was consistent with the standards of the IMF and OECD (Cheung and Qian 2008). Taken together, 2003-2008 was consi-dered an interesting time period for analyzing the Chinese outward FDI, and it had not been done in previous research. Buckley (2007) and Cheung and Qian (2008) mainly focused on domestic factors shaping Chinese outward FDI to both industrialized and developing countries, such as capital market imperfections and China‟s international re-serves. In contrast, our research focuses on factors in the host countries which attract Chinese FDI. In addition to this, the research is limited to include only developing countries.
Problems associated with the data used were encountered. Firstly, all data on Chinese FDI are from the Ministry of Commerce of the People‟s Republic of China. Although the FDI data presented by the Chinese government is in accordance with international standards, it is difficult to evaluate the quality of the data. Also, data on Chinese FDI was missing in some years for several countries, mostly in the early period of the re-search. This was especially true for smaller and less developed countries such as Belize and Dijibouti, which could be explained by less structured and reliable data sources in those countries.
5.1
Hypotheses
According to the World Bank, Chinese imports of fuels and energy amounted to 169.109 million dollars in 2008 and China‟s total primary energy consumption is esti-mated to more than double between 2000 and 2020 (World Bank 2010). China‟s eco-nomic growth has increased its demand for natural resources. This thesis attempts to ex-amine whether China‟s increased demand for natural resources is reflected in its out-ward FDI. To estimate resource-richness, export of primary commodities was used as a proxy. Exact information on the supplies of natural resources was not accessible due to
the fact that much of the oil supply for example is based on predictions. Primary com-modities include the following products, classified according to the Standard Interna-tional Trade Classification (SITC) system; (0) food and live animals, (1) beverages and
tobacco, (2) crude materials, inedible, except fuels, (3) mineral fuels, lubricants and re-lated materials, (4) animal and vegetable oils, fats and waxes, (68) silver and platinum group metals, (667) pearls, precious and semi-precious stones, (971) gold non-monetary (Department of Economic and Social Affairs 2006).
Consistent with what is proposed in the eclectic paradigm, firms can choose to locate in areas with special advantages, for example an existence of natural resources. A positive relationship between Chinese FDI and natural resources is expected in accordance with the Internalization theory which claims the importance of control of the exploitation of scarce resources.
Hypothesis 1: Natural resources are positively correlated with the level of out-ward Chinese FDI.
Data on GDP was retrieved on UNCTAD‟s Handbook of Statistics 2009 (UNCTAD 2010). According to the gravity model, GDP is regarded as an estimate of the size of an economy. GDP is considered as a “pulling factor” which positively reinforces FDI flows. In the study of 23 developing countries, Basu (2003) finds a long-run relationship between FDI and GDP.
Hypothesis 2: The level of real GDP in a country is positively correlated with the level of outward FDI from China.
The openness to trade variable measures how open a country is towards the interna-tional market. To calculate an estimate of the openness to trade, imports and exports were added and then divided by the country‟s real GDP. In the research by Aizenman and Noy (2005), FDI flows to 205 countries were investigated in relation to trade and it was found that the openness to trade was an important factor in accounting for FDI flows. A country which has received a high openness to trade is believed to be easier to trade and invest in, indicating that more FDI will be present.
Hypothesis 3: Openness to trade is positively correlated with the level of out-ward FDI from China.
The presence of trade indicates that business relations have been established and that the trading countries are not completely unfamiliar with one another. Data on each coun-try‟s trade with China was obtained from the statistical trade database International Trade Centre (ITC 2010). Data on Chinese imports and exports in each country were added to obtain the total trade value. Research by Aizenman et al. (2005) has shown that there are positive feedback effects between FDI and trade and that the two enforce one another. Moreover, Brainard (1997) concludes that FDI between two countries is more likely to take place the more similar the two countries are which further suggests that trade and Chinese FDI will be positively correlated.
Hypothesis 4: The level of bilateral trade with China is positively correlated with the level of Chinese outward FDI.
The distance was measured in kilometres from Beijing to the capital of each country3. Distance does not only impose higher transport costs, but also costs in the form of tar-iffs or increased cultural differences. In our study distance is considered to capture both the effects of familiarity and the transportation costs. The internalization theory predicts that firms are more likely to locate in closer locations and that distance will have a nega-tive effect on FDI flows (Buckley and Casson 1981).
Hypothesis 5: The distance from Beijing is negatively correlated to the level of outward Chinese FDI.
Corruption is defined as “the abuse of entrusted power for private gain” by Transparen-cy International. The corruption perception index (CPI) ranges between 0 and 10, with a higher value representing lower corruption. The index is presented by Transparency In-ternational and is based on surveys and shows the perceived level of public-sector ruption in a country in a given year. This value is used as a proxy for the level of cor-ruption as well as the condition of public institutions. Since a high level of corcor-ruption is associated with mal-functioning institutions, the CPI index is considered to capture the qualities of institutions. As the CPI illustrates the perceived level of corruption it is a broad measurement with limitations in the form of not capturing all types of corruption
3
which may be present. Several studies obtain evidence on the negative economic effects of corruption, for example Smarzynska et al. (2000) where corruption is investigated in realtion to FDI. Also, in the study by Habib and Zurawicki (2002), corruption is found to have a negative impact on the level of FDI and seen as a serious obstacle for invest-ment.
Hypothesis 6: The level of corruption is negatively correlated to the level of outward
Chinese FDI.
5.2
The Gravity Model
Newton‟s law of gravitation inspired the earliest theories on trade flows which were lat-er elaborated to fit FDI flows. The gravity model was developed in the 1960‟s by Lin-nemann (1966), among others. The model predicts that trade will be proportional to the sizes of the two economies and will be negatively related to the distance between them. The model shows trade flows between two countries, from an origin i to a destination j. The sizes of the economies are measured by the country‟s GDP and the distance be-tween the capitals is included as a proxy for transportation costs. Variables such as fa-miliarity or shared official language are sometimes used to account for costs associated with cultural differences (Nilsson 2007). The extent of familiarity depends on which two markets are analyzed. It is implied that not only geographical but also cultural dis-tance matter.
The gravity model has been accused of lacking theoretical foundation as Newton‟s law, within the field of physics, possibly lacks legitimacy in explaining international trade (Polak 1996). However, the use of the gravity model is vindicated by its generality; it can be used within different theoretical frameworks such as in the Ricardian model (Ea-ton & Kortum 1997) or in the Heckscher-Ohlin model (Deardoff 1998). As FDI shares many features with trade, the gravity model can also be applied for the case of FDI. In earlier studies (Brenton et al. 1999), the gravity model has been used to obtain results on FDI flows. The gravity model was modified so that FDI instead of trade flows were captured so that the model could be applied.
In the gravity model used in our research, the FDI from country i (China) to country j is determined by the six previously defined independent variables. The gravity model in-cludes the combined factors from both country i and j which determine the flow of FDI. However, we have used GDP only from the host countries since we are interested in discerning the factors attracting FDI specific for the host countries. Thus, our model is a semi-gravity model. In the research by Ismail (2009), this type of gravity model has been used to depict the determinants of FDI to ASEAN countries. A description of the independent variables is presented in Table 5.1 together with the abbreviations used in the regression analysis.
The data on Chinese outward FDI was retrieved from the 2008 Statistical Bulletin of China‟s Foreign Direct Investment which showed all the countries receiving Chinese FDI in 2003-2008. From there, all countries defined as developing countries by the World Bank were included in the research. As the data was provided by the Chinese government, problems associated with the reliability of the data were present. However, no other available data on Chinese outward FDI could be found which is why this par-ticular data has been used.
By conducting this research, we wish to establish whether there is a relation between the included variables and FDI, expecting strong results for resource-richness. The follow-ing equation was used to measure the impact of the variables on Chinese outward FDI:
lnFDIcit = i + 4PRIMij + 1lnGDPit + 2lnOPENit + 1lnTRADEcit + 2lnDISTci + 3CPIit + uijt
Based on the hypotheses presented in Section 5.1, the authors expect to find positive coefficients for resource-richness, GDP and openness to trade as these will be positively correlated to FDI. Negative correlation is expected for distance and corruption, which implies a negative coefficient for distance and a positive coefficient for the corruption proxy CPI.
Table 5.1 Definition of Independent Variables
Variable Code Definition
Resource-richness PRIM
GDP GDP
Openness to trade OPEN
Trade with China TRADE
Distance DIST
Corruption CPI
All data is from the time period 2003-2008 and expressed in millions of US dollars, ex-cept for distance and corruption
The export of primary commodities from country i to China.
The real GDP.
The sum of exports and imports divided by GDP.
A country‟s total trade with China measured by imports plus exports.
The distance from China to country i, meas-ured in the number of kilometres from Beijing to the capital of country i.
The level of corruption present in a country. Estimated by the Corruption Perception Index by Transparency International.
6
Results
In the log-linear regression all six variables included in the model appear significant at the five percent level. A summary of the results found are presented in Table 5.1. The adjusted R2, which accounts for the degrees of freedom, is 0.471 meaning that almost half of the variation in FDI can be explained by the independent variables included in the model. Furthermore, the F value is 14.774, a high value which indicates that at least one of the variables included in the model is significant. The t-values presented in Table 5.1 provides more information regarding the significance and the strength and direction of influence.
Table 5.1 Empirical Results
Explanatory Variable Coefficient Estimate t-value P-value
Constant 5.384 2.383 0.019 Resource-Richness 0.721 3.332 0.001 GDP -0.625 -2.393 0.019 Openness to trade -0.316 -2.776 0.007 Trade 0.472 3.194 0.002 Distance -0.250 -2.907 0.005 Corruption -0.204 -2.397 0.019
R2 Adjusted R2 Standard Estimate F
0.505 0.471 1.44813 14.774
The strongest relationship is found between FDI and resource-richness with the lowest p-value of 0.001 and with the highest coefficient estimate of all variables; 0.721 which is displayed in Table 5.1. The estimate coefficient indicates that a 0,721 percent increase in resource-richness is followed by a one percent increase in FDI. As can be seen in Graph 3:1, there is a clear positive relationship between FDI and resource-richness with the most resource-rich countries Russia and Brazil indicated in the graph. These results confirm the first hypothesis, that Chinese FDI is positively correlated to resource-rich
countries. As discussed previously, China‟s demand for natural resources is increasing and new sources are needed to secure this demand; a reasoning which is supported by the results.
The level of GDP is negatively correlated with Chinese outward FDI as the coefficient estimate is -0.625. This is not in line with hypothesis number two which asserted that GDP would be positively correlated with Chinese FDI. And as the p-value of 0.019 is lower than 5%, hypothesis number two is rejected. The results suggest the opposite to previous research on GDP in connection to FDI, for example in the study by Basu (2003). However, the case of China investing in developing countries is believed to create a peculiar framework, with different motives and conditions. As China is as-sumed to primarily invest in resource-rich developing countries and these countries of-ten belong to the group of least developed countries, the atypical correlation occurs. The reasons for this could be that China is investing in countries rich in natural resources but with low GDP which is interpreted as an indication of corruption or weak institutions. For example Sudan which is rich in oil but with an extremely low GDP and corrupt government.
The third variable, openness to trade, is also negative which suggests a negative rela-tionship between the openness to trade and the level of received FDI, illustrated in Graph 3:2. This implies, surprisingly, that China rather invests in countries less open than those well integrated into the world economy. Therefore, the third hypothesis that openness to trade would be positively correlated with Chinese outward FDI, is rejected. One reason for this might be that China itself not long ago belonged to a category of countries unwilling to integrate in the world market. The Chinese experience of opening up towards the world economy and expanding trade successfully might facilitate the ex-change with countries of low openness to trade. While the Western world is unwilling to invest in countries which do not fulfill a minimum of democratic and human right crite-ria, this is not the case for China, which could also be reflected in the results. In the study by Aizenman and Noy (2006) where a positive relationship is found between FDI and the openness to trade, the results are based on developed and developing countries and do not involve the special case of China in relation to developing countries. This further suggests that in the situation of China investing in developing countries, the openness to trade factor may not be as important in determining the level of FDI as
oth-er factors such as future profits associated with new markets. Furthoth-ermore, a low level of openness to trade may not only reflect a country‟s inability to integrate into the world market but could also reflect the Westerns world‟s sanctions towards a country which is considered to be undemocratic or not respecting human rights. As China does not fol-low these recommendations but may rather seizes the opportunities of establishing in emerging markets, the correlation between FDI and openness to trade is negative, as opposed to what previous studies have found.
A positive relationship is found between the fourth variable, trade with China, and out-ward Chinese FDI. The positive correlation between trade and FDI can be seen in Graph 3:4. This implies that trade between the host country and China reinforces FDI flows from China, which is in line with the fourth hypothesis and previous research by for ex-ample Aizenman (2005). A high degree of trade suggests that China has established business relations and knowledge of the particular country which facilitates future busi-nesses. Familiarity and country-specific knowledge provides China with easier and quicker access into markets. The risk of investing increases the more unknown a coun-try is since future prospects and cultural obstacles may be hard to predict. This suggests that China would rather start to invest in countries which are familiar than in unknown markets. As China begun pursuing FDI to developing countries on a larger scale only in the last decade, while having a longer history of trade, one can assume that China in-itiated FDI to developing countries with which they had already established trade rela-tions.
A negative relationship between Chinese FDI and distance was found as can be seen in Graph 3:5. This confirms hypothesis five and shows that China is more probable to in-vest in geographically close countries. This is in line with previous discussion about risks involved in investing in unfamiliar markets. As distance increases, barriers asso-ciated with for example culture and language increase which impede investment. Dis-tance is a proxy for transportation costs which captures costs associated with for exam-ple fuels, customs and increases as distance increases. Therefore, it is not surprising that FDI decreases as distance increases since both the costs and the risks involved will in-crease. This implies that China pursue more FDI in countries which are geographically close. Out of the fifteen countries receiving the most Chinese FDI, ten are located in Asia, which can be seen in Table 2:1.
Corruption is measured by the CPI index, and a higher value of CPI means a less cor-rupt country. As the coefficient estimate for corcor-ruption is negative, this produces a posi-tive correlation between Chinese FDI and corruption which can be seen in Graph 3:6. This indicates that China is attracted to corrupt countries with low transparency and ac-countability. As corruption and the quality of governments and institutions are closely related this also implies that China is attracted to countries with weak institutions. In the study by Habib and Zurawicki (2002), corruption is found to have a negative impact on the level of FDI and seen as a serious obstacle for investment. Again, the study was conducted on a mixture of developed and developing countries and did not capture the effects of corruption on FDI flows between China and developing countries, which could be a special case. Although corruption is an obstacle to investment, one explana-tion for the results could be that China foremost is interested in investing in countries endowed with natural resources and with promising emerging markets rather than al-ready entering well-functioning markets. This would not mean that China per se is at-tracted to corrupt countries but rather that China is not repelled by the fact that corrup-tion is present in a given country. One could view this as a situacorrup-tion where China con-siders the benefits from investing in a country to outweigh the costs associated with for example corruption.
7
Conclusion
The increased Chinese presence in developing countries has caught the attention of many, including the authors. The long-term effects of the Chinese international in-volvement are hard to predict as the level of Chinese FDI in developing countries re-mains relatively low and not sufficient time has passed to evaluate the consequences. This thesis aimed at discerning which factors attract Chinese FDI in the developing world and in particular whether natural resources influence the Chinese choice of loca-tion. By investigating factors believed to influence the direction of Chinese outward FDI, several conclusions were drawn. Firstly, the endowment of natural resources ap-peared as the most significant variable, strongly positively correlated with the level of received Chinese FDI, thus making China resource-seeking.
In addition to this, trade with China was found to be positively correlated with Chinese FDI. This suggests that China is attracted to countries with which they have already es-tablished trade relations, which is in line with what was proposed in the hypotheses and by previous research. Moreover, distance was found to be negatively correlated with Chinese FDI, as expected.
Three findings surprised the authors. Firstly, the level of GDP appears to be negatively correlated with Chinese outward FDI. Furthermore, corruption was found to be posi-tively correlated with Chinese FDI while a negative correlation was found on openness to trade. This would suggest that China is attracted to closed corrupt economies, quite opposite to what previous studies on FDI propose. One explanation given is that China does not follow the regulations and sanctions implemented by the Western society against undemocratic and corrupt governments. Because of political conditions, sanc-tions prevent trade on a larger scale and these countries show low figures on the open-ness to trade variable. As a consequence, China can benefit from emerging markets where no Western companies are allowed. This does not mean, however, that China is seeking corrupt closed economies but rather that China invest in countries where the costs associated with corruption and low degrees of international integration are out-weighed by the benefits of obtaining natural resources and expected future profits.
For future research, the effects of the increased Chinese investment in the third world on growth and development could present information on whether China has provided a way out of poverty or conversely, exploited countries rich of resources but poor in every other aspect. Moreover, the countries included in the research (see Appendix 1) are geographically and culturally spread and do not share the same background or potential for the future. Therefore, a suggestion could be to focus on developing countries be-longing to one particular region or sharing the same prerequisites. Another interesting question is whether Chinese investment eventually will become market-seeking rather than resource-seeking in developing countries as their markets grow.
As China‟s economic situation remains strong and its demand for natural resources con-tinues to rise, one can assume that its international involvement in developing countries will continue. And one can only hope that China provides a better formula for growth and success than Western aid has.
List of references
List of references
Aizenman, J., & Noy, I. (2005). „FDI and trade: Two-way linkages?‟, National Bureau of Economic Research Working Paper 11403. Cambridge, MA: National Bureau of Economic Research.
Basu, P., Chakraborty, C. and Reagle, D. (2003). „Liberalization, FDI, and Growth in Developing Countries: A Panel Cointegration Approach, Economic Inquiry.
Borenzstein, E., De Gregio, J., Lee, J-W. (1998). „How Does Foreign Direct Investment Affect Economic Growth?‟ Journal of International Economics 45.
Brenton, P. Di Mauro, F. Lucke, M. (1999) „Economic Integration and FDI: An Empiri-cal Analysis of Foreign Investment in the EU and in Central and Eastern Europe‟ . Em-pirica, Springer Netherlands.
Brainard, S.L. (1997). „An Empirical Assessment of the Proximity-Concentration Trade-off Between Multinational Sales and Trade‟, American Economic Review 87(4). Buckley, P. and Casson, M. (1976). „The Future of the Multinational Enterprise‟, Lon-don, Macmillan.
Buckley, P. (1988). „The Limits of Explanation: testing the Internalization Theory of the Multinational Enterprise‟. Journal of International Business Studies.
Buckley, P.J., Clegg, J., Cross, A.R., Voss, H. and Zheng, P. (2007). „The determinants of Chinese outward foreign direct investment‟. Journal of International Business Stu-dies.
Coase, R. (1937). „The Nature of the Firm‟, Economica, 4.
Cheung, Y. W. and Qian, X. W. (2008). „China‟s Outward Foreign Direct Investment‟, Paper presented at the Indian Statistical Institute, December 12, 2008.
Chowdhury, A. and Mavrotas, G. (2003). „FDI & growth: What causes what?‟ Paper presented at the UNU/WIDER conference on Sharing Global Prosperity, September 2003, Helsinki, Finland.
Deardoff, A.V (1998), „Does Gravity Work in a Neoclassical World?‟, in Frankel, J.A (ed) (1998) The Regionalization of the World Economy, University of Chicago Press, Chicago
Dunning, J. H (1988). „The Eclectic Paradigm of International Production: A Restate-ment and Some Possible Extensions‟ Journal of International Business Studies, Vol. 19, No. 1, Published by: Palgrave Macmillan Journal.
Dunning, J. H., & Narula, R. (1996). „The investment development path revisited: some emerging issues‟. In J. H. Dunning, & R. Narula (Eds.), Foreign direct investment and governments: catalysts for economic restructuring. London: Routledge.
List of references
Eaton, J. & S. Kortum (1997), „Technology, Geography and Trade‟, NBER, Working papers, No. 6253
Habib, M., and L. Zurawicki (2002), „Corruption and Foreign Direct Investment‟, Journal of International Business Studies 33.
Ismail, N. W. (2009), „The Determinant of Foreign Direct Investment in ASEAN: A Semi-Gravity Approach‟. Vol. 16, No. 3. Springer Wien.
Kolstad, I. and A. Wiig (2009). „What Determines Chinese Outward FDI?‟, CMI Work-ing Paper, No. 2009:3, Chr. Michelsen Institute, Norway.
Linnemann, H., (1966) „An Econometric Study of International Trade Flows‟ North-Holland Pub.Co., Amsterdam.
Moosa, Imad A. (2002). „Foreign Direct Investment: Theory, Evidence and Practice‟. New York: Palgrave.
Morck, R., Yeung, B. and Zhao, M. (2008), “Perspectives on China‟s outward foreign direct investment”, Journal of International Business Studies, 39
Nilsson, D. (2007). „Essays on Trade Flows, Demand Structure and Income Distribu-tion‟. JIBS Dissertation Series, 37.
Ovaska, T. (2003). „The Failure of Foreign Aid‟, Cato Journal 23.
Polak, J. J. (2007). „Is APEC a natural regional trading bloc?‟ The World Economy 534-535.
Rugman, A. M., Verbeke, A. (2007). „Internalization Theory and Its Impact on the Field of International Business‟, Published in International Business Scholarship: AIB Fel-lows on the first 50 Years and Beyond. Volume 14.
Sauvant, K. (2005). „New sources of FDI: The BRICs. Outward FDI from Brazil, Rus-sia, India and China‟, Journal of World Investment and Trade 6 (October): 639–709. Smarzynska, B. and S-J. Wei (2000). „Corruption and Composition of Foreign Direct Investment: Firm-level Evidence,‟ NBER Working Paper.
Tull, D. (2006) „China‟s Engagement in Africa: Scope, Significance and Conse-quences‟, German Institute for International Affairs and Security, Berlin.
UNCTAD (2009) World Investment Report 2009: Transnational Corporations and the Internationalization of R&D, United Nations: New York and Geneva.
List of references
Internet Sources
The World Bank (2010) „China and Energy‟, retrieved 2010-03-20 from the webpage
http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/EASTASIAPACIFICE XT/CHINAEXTN/0,,contentMDK:20502907~isCURL:Y~menuPK:318981~pagePK:1 497618~piPK:217854~theSitePK:318950,00.html
OECD (2010) „Definition of FDI‟, retrieved 2010-05-03 from the webpage www.oecd.org/dataoecd/56/1/2487495.pdf
The Economist (2010).„Africa and China‟ News Article Debate, retrieved 2010-04-23 from the webpage
http://www.economist.com/debate/days/view/465#pro_statement_anchor
United Nations Statistics Division (2006). „Standard International Trade Classification‟. Series M No. 34/ Revision 4. United Nations Publication. Retrieved 2010-04-10 from the webpage
Appendix
8
Appendix
8.1
Appendix 1
1. Afghanistan 2. Albania 3. Algeria 4. Angola 5. Argentina 6. Azerbaijan 7. Bahrain 8. Bangladesh 9. Belize 10. Benin 11. Bolivia12. Bosnia and Herzegovina 13. Botswana 14. Brazil 15. Bulgaria 16. Cambodia 17. Cameroon 18. Cape Verde 19. Chad 20. Chile 21. Colombia 22. Congo 23. Côte d'Ivoire 24. Cuba
25. Dem. Rep. of the Congo 26. Djibouti 27. Ecuador 28. Egypt 29. Equatorial Guinea 30. Eritrea 31. Ethiopia 32. Fiji 33. Gabon 34. Gambia 35. Ghana 36. Grenada 37. Guinea 38. Honduras 39. India 40. Indonesia
41. Iran (Islamic Republic of) 42. Iraq
43. Jordan 44. Kazakhstan 45. Kenya
46. Korea, Dem. People's Rep. of 47. Kyrgyzstan
48. Lao People's dem. Rep. 49. Latvia
50. Lesotho 51. Liberia
52. Libyan Arab Jamahiriya 53. Madagascar 54. Malawi 55. Malaysia 56. Mali 57. Marshall Islands 58. Mauritania 59. Mauritius 60. Mexico
61. Micronesia (Federated States of) 62. Mongolia 63. Morocco 64. Mozambique 65. Myanmar 66. Namibia 67. Nepal 68. Niger 69. Nigeria 70. Pakistan 71. Panama
72. Papua New Guinea 73. Peru 74. Philippines 75. Poland 76. Romania 77. Russian Federation 78. Rwanda 79. Samoa 80. Senegal 81. Seychelles 82. Sierra Leone
Appendix
83. South Africa4 84. Sri Lanka 85. Sudan 86. Suriname
87. Syrian Arab Republic 88. Tajikistan 89. Thailand 90. Timor-Leste 91. Togo 92. Tunisia 93. Turkey 94. Turkmenistan 95. Uganda 96. Ukraine
97. United Republic of Tanzania 98. Uruguay 99. Uzbekistan 100. Venezuela 101. Viet Nam 102. Yemen 103. Zambia 104. Zimbabwe 4 Excluded as outlier.
Appendix
8.2
Appendix 2: The 15 largest receivers of Chinese FDI
Table 2:1Based on data from MOFCOM in millions of US dollars
Country 2003 2004 2005 2006 2007 2008 Total 1. South Africa 8,86 17,81 47,47 40,74 454,41 4807,86 5377,15 2. Russia 30,62 77,31 203,33 452,11 477,61 395,23 1636,21 3. Pakistan 9,63 1,42 4,34 -62,07 910,63 265,37 1636,21 4. Kazakhstan 2,94 2,31 94,93 46 279,92 496,43 1129,32 5. Nigeria 24,4 45,52 53,3 67,79 390,35 162,56 922,53 6. Mongolia 4,43 40,16 52,34 82,39 196,27 238,61 743,92 7. Zambia 5,53 2,23 10,09 87,44 119,34 213,97 614,2 8. Indonesia 26,8 61,96 11,84 56,94 99,09 173,98 438,6 9. Algeria 2,47 11,21 84,87 98,93 145,92 42,25 430,61 10. Myanmar --- 4,09 11,54 12,64 92,31 232,53 385,65 11. Cambodia 21,95 29,52 5,15 9,81 64,45 204,64 353,11 12. Viet Nam 12,75 16,85 20,77 43,52 110,88 119,84 335,52 13. Laos PDR 0,8 3,56 20,58 48,04 154,35 87 324,61 14. Sudan --- 146,7 91,13 50,79 65,4 -63,14 314,33 15. Papua New Guinea --- 0,1 5,88 28,62 196,81 29,92 290,88
Appendix
8.3
Appendix 3: Partial Correlation Diagrams
Graph 3:1 Chinese FDI and Resource-Richness
Graph 3:2 Chinese FDI and GDP
Appendix
Graph 3:4 Chinese FDI and Trade
Graph 3:5 Chinese FDI and Corruption
Appendix
8.4
Appendix 5: Outward Chinese FDI
Graph 5:1 Outward Chinese FDI
UNCTAD‟s World Investment Report 2009
Graph 5:2 Number of Chinese projects per destination 2006
Based on data from the World Bank
0 10 20 30 40 50 Australia & New Zealand
Middle East North Korea Japan, HK, S. Korea, Singapore Latin America Eastern Europe & FSU North America Western Europe Africa South and East Asia
Number of Projects
Appendix
