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Forschungsarbeit

International Trade, FDI and Productivity in China

By Lei Hou (28.01.2013)

China is rising as a substantial trading and investing power in world economy. A research on Chinese trade and Foreign Direct Investment (FDI) is attractive and is a hot topic. It is strongly supported theoretically and empirically that productivity is a key determinant on firm’s export and foreign investment. More recently, the credit crisis starting in 2008 and simultaneous collapse in export and FDI suggest the link between financial conditions and firm’s internationalization. Therefore, I base my research on a heterogeneous firm setup and pay more attention to the effect of financial factors on firms’ internationalization. Both the general theory on financial development and firm internationalization and the specific case in China are investigated in my research, which consists of the following four chapters:

Chapter 1. Capital Endowment, Credit Constraint and FDI

There are emerging literatures on financial constraint and firms’ internationalization. Theory on this topic concludes that both real factor (productivity) and financial factor (bank credit) affect firms’ internationalization strategy. Specifically, the more productive the firm is, the more likely it engages in export or FDI, and the more developed its financial system, the more export or FDI a country does. These predictions are confirmed by empirical evidences using either country level or firm level data (Manova 2007, Muuls 2008, Berman and Hericourt 2008, Li and Yu 2009, Buch et al. 2009, Arndt et al. 2009). But when we go to Chinese outward FDI data, what we observe is inconsistent with the above theory predictions. As we know, China has a not well functioning financial system but China’s outward FDI flow increases dramatically from 5 billion in 2002 to 55.9 billion in 2008. 71% of the flow goes to Asian countries. More surprisingly, this increase is dominated by Chinese State-Owned Enterprises (SOEs) while these SOEs are less productive compared to private firms. These inconsistencies motivate my first work.

By comparison of SOEs with private firms in China, I find that these two types of firms differ not only in productivity, but also in initial capital endowment and access to external credit. Under state dominated financial system and partly for the existence of policy loans, Chinese SOEs have a relatively larger size of initial capital endowment and better access to external finance. Based on these facts, I develop a model which introduces initial capital endowment and external credit to explain the particular Chinese case. With this model, I investigate how capital endowment and external credit affect FDI. What explains the location of Chinese investment abroad?

Chapter 2. Multiple Finances, Margins of FDI and Aggregate Industry Productivity

An emerging body of literature documents the impact of financial development on facilitating firm internationalization. While its function through providing a larger scale of external finance and relaxing firms’ financial constraints is widely accepted, it is not clear whether the diversification of financial channels and access to alternative finance accompanied by financial development play a role. In this chapter, I address the question of whether the availability of alternative financing sources could help reduce the size of the collapse of FDI during the recent crisis and influence welfare.

The contribution of this research is threefold. Firstly, it complements the quickly growing literature on credit constraint and firm internationalization by firstly proposing the impact of alternative financing and differentiating firm responses to the worsening financial condition. Secondly, this chapter contributes to the work on financial systems by analyzing the complementary and substitution effects of bank finance and bond finance. Thirdly, I propose FDI-induced aggregate productivity gains for the parent country through the selection effect in the capital market. I show that FDI could bring aggregate productivity gains for the parent country through the reallocation of financial resources towards more productive firms.

Chapter 3. Financial Structure, Productivity and Risk of FDI

Risk is an important element in the theory of capital structure. Firms have incentives to reduce the costs associated with various risks by adjusting their capital structure (Desai et al. 2008). Meanwhile, risk is a key driving force for the volatility of investments and returns, which is particularly the case for FDI comparing to domestic investment. When comparing the FDI performances in countries with different financial systems, I find that outward FDI flows from countries with the market-based financial system like U.S. and U.K. are more volatile than those from countries with bank-based financial system like Germany and Japan. Hence in this chapter, I investigate the question that facing business risks in foreign direct investment, how multinational firms choose their sources of financing and whether financial structure influences the volatility of foreign direct investment. Answering this question will illuminate the potential link of financial system and volatility of FDI, and further provide policy implications about how to structure the financial system to stabilize FDI and assist firms’ internationalization.

What distinguishes this research is the investigation on the structure effect of financial development. Besides reproducing the results that reduction of financing cost facilitates FDI as discussed in existing literatures, I set up a link between financial structure and FDI locations and volatilities based on the fact that foreign investment faces significant risks and firms have incentive to reduce such risks by choosing different financing instruments. By doing so, I suggest a new direction of policy on reforming the structure of financial systems to promote firm’s internationalization.

Chapter 4. Financial Underdevelopment, Distortional Lending and Export Market Survival: Evidence from Chinese Manufacturing Firms

An emerging stream of literature focuses on the role of finance in fueling trade performance. While it is well recognized that finance is a key determinant of firms’ export participation and trade volumes (Beck 2002; Beck 2003; Muuls 2008; Berman and Hericourt 2010; Manova 2007; Demir and Dahi 2011), the impact of finance on exporter’s survival is largely neglected. This chapter aims to fill the research gap of linking domestic financial development and export market survival. I use the data for Chinese manufacturing exporters during 1998-2008 to examine how the Chinese financial system, in transition toward a marketized one, shapes the dynamics of Chinese exporters in foreign markets. I study whether the financial development as a result of financial system reform unleashes Chinese exporters’ financial constraints and facilitates their survivals in foreign markets as well as whether this effect is homogeneous across industries, regions and different types of firms.


Educational Background
  • 09/1998—07/2002
  • School of Economics, Jilin University, P.R.China, B.A. in Economics (International Trade), with distinction
  • 09/2002—07/2005
  • School of Economics, Jilin University, P.R.China, M.A. in Economics (International Trade), with distinction
  • since 09/2006
  • School of Economics, Jilin University, P.R.China, Candidate for Ph.D. Degree in Economics (World Economy)
  • 09/2007—08/2008
  • Munich Graduate School of Economics, University of Munich, Chinese-German Program Student
  • since 09/2008
  • Munich Graduate School of Economics, University of Munich, Candidate for Ph.D. Degree in Economics (International Economics)

Scholarships and Awards
  • 1998-2002
  • Undergraduate Scholarship for Academic Excellence
  • 1999-2002
  • Student Leadership Award
  • 1999-2002
  • Dong Rong Award
  • 2002-2005
  • Postgraduate Scholarship for Academic Excellence
  • 09/2007-08/2008
  • Scholarship for Studying Abroad sponsored by China Scholarship Council
  • 05/2009-04/2012
  • Bavarian Elite Research Grants (Bayerisches Eliteförderungsgesetz) through the project ‘International Trade, FDI, and Productivity in China’, supervised by Prof. Dr. Dalia Marin.
  • 09/2011
  • Hanzekovic Best Paper Award (National Bank, Ministry of Finance, Institute of Public Finance, Croatia)

Research Report by Lei Hou - Long Version