Financial Development, Foreign Direct Investment, and the Efficiency of Capital Allocation in China

Kevin Huang (), Chun Jiang, Qingyuan Li, Qiwei Zhao, Jia Wang and Kai Sheng
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Qiwei Zhao: School of Economics and Management, Wuhan University, Wuhan 430072, China
Jia Wang: World Financial Group, 3300 Holcomb Bridge Road, Norcross, GA 30092-5405, USA
Kai Sheng: School of Mathematical Sciences, Peking University, Beijing 100871, China

Frontiers of Economics in China-Selected Publications from Chinese Universities, 2013, vol. 8, issue 2, 165-185

Abstract: We study the roles of local financial development and foreign direct investment, and more importantly, their interaction with one another, in local capital allocation, based on Chinese industrial and regional data. Our main finding is that, although local financial development and FDI each individually tended to improve the efficiency of local capital allocation during the sample period, they tended to compete and crowd out each other¡¯s effect, so that one impaired the individual function of the other. In particular, there exists a threshold value for local financial development, above which an increase in FDI reduces the efficiency of local capital allocation, rather than improve it. On the other hand, there exists a threshold value for FDI, above which further development in the local financial system lowers the efficiency of local capital allocation, rather than increase it. Our estimations suggest that the levels of FDI and local financial development in some relatively more developed Chinese regions have already surpassed such threshold values. We provide some interpretations of our findings and we discuss potential policy implications.

Keywords: foreign direct investment (FDI); local financial development; capital allocation efficiency (search for similar items in EconPapers)
JEL-codes: F23 F36 F43 O16 (search for similar items in EconPapers)
Date: 2013
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