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Are Chinese Firms Attracted to Political Risk? Locational Determinants of Chinese Outward Foreign Direct Investment
Presented in partial fulfillment of the requirements for completion of the Bachelor of Arts degree in International Studies at the Croft Institute of
International Studies
Croft Institute of International Studies
Sally McDonnell Barksdale Honors College
The University of Mississippi
University, Mississippi
April 2017
Approved by:
_________________________ Advisor: Dr. Nilufer Ozdemir
_________________________ Reader: Dr. Oliver Dinius
_________________________ Reader: Dr. Gang Guo
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Abstract
This study evaluates the foreign direct investment (FDI) location choices made by Chinese firms from 1996 to 2015 and investigates the extent to which Chinese firms are attracted to investing in countries with high levels of political risk. Using new Chinese data, the study categorizes Chinese firms into Central State-Owned Enterprises and Other Chinese Firms to see the relationship between investment location and political risk for firms with varying levels of Chinese government control. Additionally, the data is divided between investments made from 1996 to 2003 and investments made from 1996 to 2015 to measure the effect that important changes in Chinese domestic policy in 2004 have had on the investment location choices of these firms. After conducting negative binomial regressions, the results show that these two types of Chinese firms have different attractions to political risk across different time periods. Central State-Owned Enterprises’ FDI location choices are not significantly influenced by a country’s political risk regardless of time period, but China’s Other Firms change from being attracted to political risk prior to 2004 to being deterred by it after 2004. These findings show that changes to Chinese domestic policy and level of control by the Chinese central government can have a profound influence on Chinese firms’ views towards political risk, and this reflects the larger ability of Chinese government intervention to enact change in Chinese firms and in the greater Chinese business environment.
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Table of Contents Introduction……………………………………………………….....................1-4 Related Literature Previous Literature on Chinese OFDI…………………………….…....5-6 Defining Political Risk…………………………………………...…….6-7 Influence of Political Risk on Chinese OFDI…………………………..8-9 China’s “Go Global” Strategy…………………………..…………….9-12 Increased Firm Privatization…………………………………………12-14 Effects of Global Financial Crises………………………………………15 Types of Chinese Firms……………………………………………...16-17 Classification of Firms in this Study………………………………...17-18 Hypotheses………………………………………………………………......19-20 Data and Model Data………………………………………………………………….21-22 Dependent Variables………………………………….…………………22 Independent Variables…………………………………….…………22-25 Descriptive Statistics……………………………………..………….26-27 Statistical Model: Negative Binomial Regression...…...……..……..28-29 Results and Discussion Control Variables…………………………………………………....30-35 Political Risk…………………………………………...………...….35-41 Conclusion…………………………………………….………………...…..42-44 Appendix…….………………………………….……………………..……45-46 Bibliography……………….…………………………………………...…...47-50
Pre2004_OreAndMetal, Pre2004_OreRiskInt, Pre2004_CurrentAccount, and
Pre2004_ExRateChange. By including these 10 interaction variables, the effects on
Chinese firms’ OFDI before 2004 can also be seen.
Table 2: List of Variables and Sources
Variables Description Source CentralOFDI Count of Central SOE OFDI China’s Ministry of Commerce OtherOFDI Count of Other Firm OFDI China’s Ministry of Commerce RealGDP Host country’s Real GDP (US$,
constant) World Bank Development Indicator
Distance Distance between China’s capital and the host country’s capital
CEPII
Inflation Host country’s rate of inflation (annual %)
World Bank Development Indicator
Patents Host country’s total patent applications
World Intellectual Property Association
OECD_dummy Dummy variable coded as OECD member = 1, non-OECD member = 0
World Bank’s Governance Indicators
Pre2004_dummy Dummy variable coded as OFDI before 2004 = 1, after 2004 = 0
PolRisk Rule of Law- A measure of the political stability of host country
World Bank’s World Governance Indicators
OreAndMetal Host country’s ore and metal exports (% of total merchandise exports)
World Bank Development Indicator
OreRiskInt Interaction variable of “OreExports” and “PolRisk”
World Bank Development Indicators
CurrentAccount All transactions other than those in financial and capital items (% of GDP)
IMF World Economic Outlook
ExRateChange Host country’s percent annual change in exchange rate
World Bank Development Indicator
Pre2004 * “x” Represents the interaction between “Pre2004_dummy” and each of the independent variables listed above
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Descriptive Statistics:
Table 3 depicts the descriptive statistics of each independent variable used in the
study including the number of occurrences (N), minimum value (Min), maximum value
(Max), average of all of the values (Mean), and standard deviation (Std. Dev.).
Dependent Variables: (1) Central SOE OFDI, (2) Other Firms OFDI- Sum of Local SOE and Private OFDI ϕ p < 0.10, * p < 0.05, ** p < 0.01, *** p < 0.001
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suggests that before 2004 both types of Chinese firms were attracted to depreciation in
host country exchange rate.
Chinese firms’ indifference to inflation and attraction to currency depreciation
before 2004 could be the result of Chinese firms seeking to acquire cheap foreign assets
in countries with currency depreciation. High inflation rates often lead to currency
depreciation which subsequently causes the cost of production, wages, and assets in that
country to decrease relative to foreign currency. This is consistent with results of past
studies on OFDI that show that as host country exchange rate depreciates, “more
profitable opportunities for OFDI occur since foreign currency denominated assets
become cheaper.” (Buckley et al., 2007). Chinese multinational firms before 2004 could
have seen opportunities to cheaply enter new markets due to foreign currency
depreciation and influenced the location choice of their OFDI.
Political Risk:
While the results both support and oppose the findings of many past studies, in
analyzing Chinese OFDI’s relationship to political risk, the empirical results yield mixed
outcomes. The original results in Table 3a show that political risk (PolRisk) for Central
SOE’s is not significant, but Other Firms’ political risk is significant and positive. This
positive value indicates that the OFDI from China’s Other Firms is actually attracted to
countries with low political risk, not supporting the claims of many previous studies
(Buckley et al., 2007; Cui & Jiang, 2009; Kolstad & Wiig, 2009; Ramasamy et al., 2012,
Quer et al., 2012). In fact, according to the results, a one unit decrease in host country
political risk is associated with approximately a 16% increased chance in the likelihood
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of a Local SOE or Private firm investing there. Therefore, these empirical results do not
support Hypothesis 1, which claims that Chinese firms are attracted to political risk.
However, when the Pre2004 interaction variables are also factored into the model,
the effect that political risk has on Chinese OFDI is complicated. Table 3b depicts the
results of the model that includes the Pre2004 interaction variables. The results in Table
3b show that for Central SOEs before 2004, political risk (Pre2004_PolRisk) is not
significant in determining where Central SOEs engage in FDI. Therefore, the results do
not support Hypothesis 3a which claims that China’s Central SOEs are attracted to
political risk across all years of the study. For Other Firms, on the other hand, political
risk before 2004 is significant and negative. This shows that before 2004 Local SOEs and
Private firms were attracted to investing in countries with high political risk, but when
looking at the years 1996 to 2015 as a whole, these firms display the opposite behavior,
actually being attracted to countries with low political risk. This suggests that China’s
Local SOEs and Private firms’ attention to political risk significantly changed after 2004,
and they changed from being attracted to political risk to being deterred by it. These
results support Hypothesis 3b that China’s Other Firms are not attracted to political risk
after 2004.
Several explanations can be found for China’s Other Firms’ change from
attraction to political risk to deterrence from it. First, the increased implementation of
China’s “走出去” or “Go Global” domestic policy helped begin a rapid increase in
Chinese OFDI after 2003 that was coupled with increased Chinese firm privatization.
Recall that previous studies have found that China’s Private firms are more market-
seeking than its state-owned firms (Ramasamy et al., 2012); therefore, an increase in the
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number of private multinational firms as a proportion of total Chinese multinationals
would likely cause the overall trend of Chinese investment to become more market-
seeking and deter from investments into politically risky countries.
Second, Chinese firms appear to be turning to more developed countries for
investment rather than continuing to invest in developing and likely politically riskier
countries. Membership in the Organization for Economic Cooperation and Development
(OECD_dummy) is used in this analysis as a proxy for classification as a developed or
developing country, and for both Central SOEs and Other Firms, OECD membership was
significant and positive from 1996 to 2015. This shows that both types of Chinese firms
are generally attracted to investing in developed countries. However, OECD membership
before 2004 (Pre2004_OECD) for both types of firms is not significant. This implies that
before 2004 a country’s status as developed or developing did not have a significant
effect on where Chinese firms chose to engage in OFDI. Moreover, previous studies have
found that the bulk of Chinese FDI has historically been engaged in developing countries
that, as a group, record higher levels of political risk (Buckley et al., 2007). This study’s
data supports this claim, showing that the mean value for political risk for OECD
countries is 1.266 while the mean value for non-OECD countries is -.3192 where higher
values denote less political risk. Based on this data, it can be seen that as Chinese firms
become more attracted to investing in developed countries, they would similarly become
more attracted to investing in less risky host countries.
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Figure 4: Average Annual Amount of OFDI by Other Firms
Another interesting conclusion that can be derived from the results is that recent
changes to China’s overall business environment seem to affect the investments of
China’s Local SOE and Private firms more than those of firms directly controlled by the
central government. Figure 4 shows the average amount of OFDI projects engaged by
China’s Other Firms annually, and it shows that after 2004 significantly more OFDI by
China’s Other Firms went to developed countries than to developing countries and this
trend even persisting until 2015. This supports previous findings that China’s Private
firms are generally more market-seeking and would likely turn to stable countries with
large markets for investment (Ramasamy et al., 2012).
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However, when compared to Figure 5, which shows the annual number of OFDI
projects by Central SOEs, this trend is not shown. Instead, the investment trend by
Central SOEs into developed and developing countries is almost the same across all years
of the study. Central SOEs invested in developed and developing countries at about the
same rate from 1996 to 2015. This indicates that the observed changes to Chinese firms’
investment behaviors in the year 2004 apply to China’s Local SOE and Private firms but
do not apply to Central SOEs. Huge domestic policy changes such as the “Go Global”
strategy and China’s rise to become one of the largest economies in the world still did not
influence Central SOEs to invest more in developed countries over this time period.
Figure 5: Average Annual Amount of OFDI by Central SOEs
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This poses interesting questions regarding why over a period of time where
Chinese firms and China itself changed so drastically did China’s Central SOEs not
similarly change. Strict supervision of these firms by the Chinese central government
could push Central SOEs to support China’s national agendas at the expense of profit.
For example, China is one of the largest importers of natural resources in the world. With
such a need for natural resources, the Chinese government could utilize these large firms
to enable its acquisition of natural resources despite the level of political risk in host
countries. Figure 6 depicts the levels of political risk in countries where more than 30%
of exports are ore and metal exports, and of these countries, the vast majority rest to the
left of center and are considered countries with higher political risk. In pursuit of
investing in countries with abundant natural resources, the Chinese central government
could encourage Central SOEs to invest in higher risk countries such as these.
Figure 6: Political Risk in Natural Resource-Abundant Countries
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Moreover, for the natural resource-abundant countries shown in Figure 5, the data
shows that only 8.5 percent of these countries are OECD members while 91.5 percent are
not. This could also help explain the phenomenon shown in Figure 5 where Central SOEs
invested in developed and developing countries at very similar rates from 1996 to 2015.
Central SOEs could be pushed by the Chinese central government to prioritize the
acquisition of natural resources, limiting the pool of potential investment targets to those
dominated by developing countries and those with higher political risk. The results show
that China’s Other Firms and Central SOE’s OFDI displays different relationships with
political risk over time, and 2004 marked a significant year in the change from Local
SOE and Private Firms being attracted to political risk to being deterred by it.
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Conclusion:
Chinese investment into other countries has been increasing at an incredible pace
in recent years, and this is especially true for Chinese outward foreign direct investment.
As China’s OFDI policy has liberalized and its private sector become larger, it has
become easier for Chinese firms to engage in OFDI, and the year 2004 served as a critical
year in this development.
Utilizing new data on Chinese OFDI, this study shows that two different stories
emerge with regards to Chinese firms’ relationship to political risk from 1996 to 2015.
For China’s Local SOEs and Private firms, limited investment opportunities prior to the
implementation of the “Go Global” strategy in 2004 likely drove them to invest in
countries with high political risk. However, after Chinese OFDI policy liberalized, these
firms began turning to more developed countries for investment and their attraction to
political risk similarly changed. On the other hand, political risk did not have a significant
influence on the OFDI of China’s Central SOEs both before 2004 and after. With their
relatively large size and tight control by the Chinese central government, they are
expected to follow national economic imperatives and potential political agendas that
might lead Central SOEs to make investments regardless of the target country’s level of
political risk.
This study also supports and contradicts various aspects of past research on what
country-level factors influence Chinese OFDI. The results of this study are similar to
those found by past studies with regards to Chinese OFDI’s relationship with market size,
distance, technological innovation, and current account balance. Inflation, exchange rate
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change, and political risk on the other hand do not exhibit results consistent with past
studies.
For countries that seek to attract Chinese FDI, this research suggests that targeting
specific types of Chinese companies would be most effective. Countries with large
markets, technologically developed economies, and abundant natural resources can
approach any type of Chinese firm for investment, but countries that suffer from high
political risk or a looming financial crisis should target Chinese Central SOEs whose
large size and backing by the state could allow them to take on riskier investments.
These findings ultimately reveal that intervention by the Chinese government can
have an immense influence on the behavior of Chinese firms and the nature of China’s
business environment. Following OFDI policy liberalization in 2004, China’s Other
Firms’ view of political risk changed completely while, for the Central SOEs under the
government’s direct control, political risk was not important and did not become
important after 2004. The common denominator in both of these relationships is Chinese
government intervention. In one, the government enacted change indirectly through
policy and, in the other, through direct control and supervision. Although it is true that
any government can have huge direct and indirect impacts on the business environment
in that country, few governments can match the speed at which China has made these
sweeping changes, doing so only over the span of about two decades. The changes in
Chinese firms’ relationships with political risk shown in this study are, at their root, a
testament to the ability of the Chinese government to quickly manage the Chinese
economy.
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China’s OFDI will only continue to grow in the near future, and this could have
serious implications for China as well as those countries it invests in. Future Chinese FDI
could help stimulate the economies of many developing countries and also increasingly
contribute to the markets of more developed economies. Then, in a world with
increasingly more Chinese intervention in foreign markets, the influence of the Chinese
government will also similarly extend. Domestic Chinese goals and national policies
could begin to have indirect influences on the business environments of other countries.
Globalization has already achieved this to a certain extent in countries such as the United
States and organizations such as the EU which are already intricately linked to the global
economy, but China appears to be a rising player in the field of internationalization.
Chinese firms’ relationship with political risk may change in the future, but those changes
will likely be guided by the direct and indirect influences of the Chinese central
government, and as the amount of Chinese OFDI continues to increase, the role that the
Chinese government’s national policies and imperatives play in the global economy will
also increase.
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Appendix Host Country List: 192 Countries and Territories, 1983-2015
Afghanistan
Albania
Algeria
Angola
Antigua and Barbuda
Argentina
Armenia
Australia
Austria
Azerbaijan
Bahamas
Bahrain
Bangladesh
Barbados
Belarus
Belgium
Belize
Benin
Bermuda
Bolivia
Bosnia and Herzegovina
Botswana
Brazil
British Virgin Islands (UK)
Brunei
Bulgaria
Burkina Faso
Burundi
Cambodia
Cameroon
Canada
Cape Verde
Cayman Islands
Central African Republic
Chad
Chile
Colombia
Comoros
Congo, Democratic Republic
Congo, Republic
Cook Islands
Costa Rica
Cote d’Ivoire
Croatia
Cuba
Cyprus
Czech Republic
Denmark
Djibouti
Dominica
Dominican Republic
Ecuador
Egypt
Equatorial Guinea
Eritrea
Estonia
Ethiopia
Fiji
Finland
France
French Guiana
Gabon
Gambia
Georgia
Germany
Ghana
Greece
Grenada
Guatemala
Guinea
Guinea-Bissau
Guyana
Hong Kong (PRC)
Hungary
Iceland
India
Indonesia
Iran
Iraq
Ireland
Israel
Italy
Jamaica
Japan
Jordan
Kazakhstan
Kenya
Kiribati
Korea, Democratic Republic
Korea, Republic
Kuwait
Kyrgyzstan
Laos
Latvia
Lebanon
Lesotho
Liberia
Libya
Lithuania
Luxembourg
Macao (PRC)
Macedonia
Madagascar
Malawi
Malaysia
Maldives
Mali
Malta
Marshall Islands
Mauritania
Mauritius
Mexico
Micronesia
Moldova
Monaco
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Mongolia
Montenegro
Morocco
Mozambique
Myanmar
Namibia
Nepal
Netherlands
New Caledonia
New Zealand
Nicaragua
Niger
Nigeria
Norway
Oman
Pakistan
Palau
Palestine
Panama
Papa New Guinea
Paraguay
Peru
Philippines
Poland
Portugal
Puerto Rico
Qatar
Romania
Russian Federation
Rwanda
Saint Lucia
Samoa
San Marino
Saudi Arabia
Senegal
Serbia
Seychelles
Sierra Leone
Singapore
Slovakia
Slovenia
Somalia
South Africa
South Sudan
Spain
Sri Lanka
Sudan
Suriname
Sweden
Switzerland
Syria
Taiwan
Tajikistan
Tanzania
Thailand
Timor-Leste
Togo
Tonga
Trinidad and Tobago
Tunisia
Turkey
Turkmenistan
Uganda
Ukraine
United Arab Emirates
United Kingdom
United States of America
Uruguay
Uzbekistan
Vanuatu
Venezuela
Vietnam
Western Samoa
Yemen
Zambia
Zimbabwe
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