Financial Distortion And China’s FDI Inflows: Theory And Empirical Research

Since China’s reform and opening up, China has made remarkable achievements in internationalization, a huge amount of foreign direct investment (FDI) inflows in China. In this paper, we will make a new explanation of "Why so much FDI inflows in China" from the perspective of demand,we found Financial Distortions factors can affect China’s FDI inflows.The existing literature on this problem mainly focus on FDI supply angle, Most of the literature thought geographical factors can attract FDI inflows in China, such as market potential, infrastructure level, degree of opening, human capital and so on.In addition, some scholars think the developing countries’purpose of introducing FDI is tooffset domestic saving gap and foreign exchange gap, and thentake advantage of technology spillover ofFDI to enhance the technical level, achieve economic growth at the mean time. Although, in the matter of fact, China’s capital stock and foreign exchange reserves have reached a scale after 90’s, and the FDI’s technology spillover on China’s industry technology upgrade has proved to be very limited, the influence of "Exchange market with Technology" to attract foreign investment was not successful.In this paper, combined with China’s long-standing financial distortions and FDI inflows background, we think financial distortions can explain China’s FDI inflows. In theoretical part, we define financial distortions ascredit discrimination of ownership and financial inefficient, and then analysis the financial distortion on the influence mechanism of FDI inflows. The state-owned bank financial system can’t allocate financial resources efficiently, and artificially lowering interest rates make it below the level of capital market equilibrium, hinder the savings into investment adequately. In the credit resources allocation, highly ownership discrimination makes state-owned enterprises can get rich loans with preferential interest rate,but private enterprises are facing severe credit constraints, they have to pursue FDI to alleviate capital shortage. Therefore, financial distortions make most Chinese enterprises strong prefer to FDI, and thencause a huge amount of FDI into China.In empirical research part, we USES the 1987-2013 panel data of China’s 30 provinces, select and measure the non-state enterprises’credit shre(private) and financial interrelations ratio(fir), respectively agent ownership credit discrimination and financial inefficient, and then empiricallyanalyses whether financial distortions affect FDI inflows in China. The empirical results show that, in time and space range, if the ownership credit discrimination is more serious and the financial efficiency is lower, so the degree of FDI inflows is higher. The empirical conclusions fully demonstrate the financial distortion can cause FDI inflows to China.According to the analysis conclusion of this article, we argue that China should pay more attention to FDI’s quality, and make foreign capital inflow play a good role. More importantly, China should continue to deepen financial reform and SOE(state-owned-enterprise) reform, take efforts to eliminate financial distortions to enhance the competitiveness of domestic enterprises in China, promoting China’s economic growth healthily and rapidly.