Does Foreign Direct Investment Provide Desirable Development Finance? The Case of China

Yan Liang

China & World Economy, 2007, vol. 15, issue 2, 104-120

Abstract: Foreign direct investment (FDI) is often considered as a cost‐effective and risk‐reducing source for development finance. This paper, however, shows that FDI finance often entails underestimated risks and costs. FDI might react sensitively to business cycles and might not be as “permanent” as conventionally believed. FDI might also accelerate other forms of capital flow in times of financial difficulties and, hence, destabilize financial order. In addition to the risks, compensations to FDI and the high import‐dependency of FDI‐related trade lead to a considerable drain on the balance of payments. Moreover, the reliance on foreign capital for development finance is equivalent to building a Ponzi financing scheme and, therefore, is unsustainable. Given the fact that FDI financing is risky and costly and China does not lack savings, it is suggested in the present paper that China's efforts in attracting FDI should not aim at external capital provisioning.

Date: 2007
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