Determinants of Foreign Direct Investment in East Asia: Did China Crowd Out FDI from Her Developing East Asian Neighbours

Li-gang Liu, Kevin Chow and Unias Li
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Li-gang Liu: Research Department, Hong Kong Monetary Authority
Kevin Chow: Research Department, Hong Kong Monetary Authority
Unias Li: Research Department, Hong Kong Monetary Authority

No 617, Working Papers from Hong Kong Monetary Authority

Abstract: This paper applies a gravity model to investigate the determinants of foreign direct investment (FDI) in East Asia. We find that economic fundamentals (such as market size, per capita income, and country risk indicators), economic and cultural ties, and information asymmetry are important determinants for FDI. Of the sub-components that measure country risks, we find that both the level and the volatility of exchange rate matter in attracting FDI, as do some institutional quality indicators such as government stability and the degree of corruption in recipient countries. Globally, it appears that inward FDI among high-income OECD economies declined substantially on average over the sample periods under investigation. Meanwhile, inward FDI of the high-income OECD economies in emerging market economies, particularly those in Latin America and Asia, gained substantially relative to their economic fundamentals. Our empirical results indicate that the ASEAN-4 (Indonesia, Malaysia, the Philippines, and Thailand) received above-average inward FDI from the high-income OECD economies, even over the period of the 1997-98 Asian financial crisis, after controlling for their economic fundamentals. By contrast, China¡¦s FDI from the high-income OECD economies was below-average relative to its economic fundamentals. Thus, it is difficult to establish that China has crowded out FDI from her developing ASEAN neighbours. Both Hong Kong and Singapore have received more FDI on average from the European Union (EU), the US, and Japan. The FDI from these three economies in ASEAN-5 (Singapore plus ASEAN-4) was above the average over the sample periods studied. In contrast, only Japan invested more than the average in Greater China (Mainland China plus Hong Kong) in the 1990s. However, this was not the case for either the EU or the US.

Pages: 23 pages
Date: 2006-11
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