Policy Uncertainty and Foreign Direct Investment: Evidence from the China-Japan Island Dispute

Tatsuro Senga and Cheng Chen

No 1268, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Can a temporary uncertainty shock generate long-lasting effects on economic activities? To show causal evidence, we utilize data from Japanese multinational corporations (MNCs) and explore the economic impact of the unexpected escalation of an island dispute between China and Japan in 2012. Our difference-in-differences estimation substantiates that a sharp, but temporary fall in local sales of Japanese MNCs in China led to persistent downward deviation of foreign direct investment (FDI) from its trend. Moreover, despite the quick recovery of local sales, Japanese MNCs in China have continued to underestimate their local sales, which generates pessimistic and more dispersed forecast errors after the island crisis. We view this as evidence for a belief-driven channel through which a large and unexpected shock leads agents to revise their beliefs and start tail risk hedging.

Date: 2017
New Economics Papers: this item is included in nep-cna
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Working Paper: Policy Uncertainty and Foreign Direct Investment: Evidence from the China-Japan Island Dispute (2016)
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