Foreign Direct Investment And The Role Of Financial Market Development And Labour Market Imperfections

Since the1978reform and opening up, China has attracted a lot of foreign direct investment and then has become the developing country that absorbed the most actual foreign direct investment around the world for20years since1993. Why there is such a large amount of foreign investment flowing into China? A host of literatures studying the location distribution of foreign direct investment suggest that foreign direct investment prefers areas with a larger size of potential market, the stable economic and political environment, the low labour cost and the perfect infrastructure. Although there have existed a great number of researches focusing on the relationship between foreign direct investment and financial market development, the majority of these studies only pay attention to the location choice theory of foreign direct investment, the influence of foreign direct investment and the development of financial market on economic growth as well as the spillover effect of foreign direct investment. Moreover, the literatures, studying the joint effect of financial markets and labour markets in host countries on foreign direct investment, are rare. Therefore, this paper will study from the perspective of incomplete factor markets. The basic production factors include capital and labour. Incomplete financial markets would affect the available degree of capital and financing costs, the interest rate, and furthermore incomplete labour markets not only affect labour costs, the wage, but also make the difficulties and expenses of laying off workers increase. Thus, this paper begins to study from the most basic production factors, capital and labour, then analyzes financial markets and labour markets that provide capital and labour separately and finally researches the joint impact of financial markets and labour markets in host countries on foreign direct investment under the new perspective of the joint action of financial markets and labour markets. Therefore, this paper connects financial markets and labour markets in host countries together to study the decision-making process of foreign direct investment. Given the status quo of the financial market and labour market in China, this paper would explore the mechanism and function through which the regional financial markets and labour market affect the scale of foreign direct investment flowing into China, and then propose the policy recommendations to improve the financial market and the labour market in China.At first, this paper summarizes the influent mechanism through which financial markets puts impact on foreign direct investment inflows and then sets up the theoretical model based on analyses above. Then, this paper carries on the empirical test, using the provincial regional data and the provincial industrial data in China, to analyze the influent mechanism of the inter-provincial financial market and the industrial financial dependence on provincial, industry foreign direct investment. After that, a search theoretical model is established, linking financial markets and labour markets together, to observe and analyze the joint effect of financial markets and labour markets on foreign direct investment. Then, this paper takes advantage of the provincial regional data and provincial industrial data to empirically study the impact of the inter-provincial financial market, the labour market factors and the industrial financial dependence on inter-provincial, industrial foreign direct investment. Finally, the paper puts forward the relevant policy recommendations based on the conclusions and current situations which China faced with.This paper includes six sections.Section1is the introduction that briefly describes the research background and significance, the research idea and methods, the article structure and innovations and difficulties in this paper. Section2is the literature review that mainly consists of the existing studies about factors influencing foreign direct investment, the linkage of financial markets and foreign direct investment, the relationship of labour markets and foreign direct investment and the interaction between financial markets and labour markets. Section3overview situations of financial markets, labour markets and foreign direct investment in China. This part-firstly describes the basic conditions of the financial market in China, then presents the labour market in China from three aspects of the employment protection system, the labour contract system and the social security system and eventually sketches the conditions of foreign direct investment in China and introduces the development process of it from five stages, including the initial stage, the stable development stage, the rapid growth stage, the wave growth stage and the fifth stage after joining the WTO. Also, this part analyzes the distribution of main source of foreign direct investment, the regional distribution of foreign direct investment and the industry distribution of foreign direct investment in China. Section4studies the impact of financial markets on foreign direct investment. Here, we firstly establish a theoretical model, then carries on the numerical simulation with the model and finally empirically researches the effect of the development of financial market on regional foreign direct investment and on inter-provincial, industrial foreign direct investment. Section5states the impact of labour markets and the financial markets on foreign direct investment. At first, we set up a theoretical model based on the search mechanism under the incomplete labour markets and financial markets, then form the theoretical frameworks about the impact of the financial market as well as the labour market on foreign direct investment separately and eventually empirically research the effect of the regional labour market and the regional financial market on the regional foreign direct investment as well as the impact of the labour market and financial market on the inter-provincial industrial foreign direct investment. Section6concludes this paper and puts forward policy recommendations based on the main empirical findings.Taking the yearly data from each province in China as sample, this paper builds up the theoretical model to regress empirically and reaches the conclusions that labour market protection would inhibit foreign direct investment, and that the high financial market development would promote foreign direct investment inflows after controlling other factors such as labour costs, market potential, nationalization degree, economic openness, infrastructure and so on. Combining region characteristics and industry characteristics together, this paper then takes advantage of the yearly industrial data from each province in China and finds that the relatively small labour-protection regions and relatively high labour-intensive industries would attract more foreign direct investment, and that foreign direct investment would prefer regions with better financial market development and industries with higher financial dependence after controlling the influential factors like human capital endowment, labour costs, market potential, economies of scale and economic openness. In addition, all these conclusions are robust and credible in spite of the different controlling variables, different metrics and the endogenous problem.