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Does Foreign Direct Investment Provide Desirable Development Finance? The Case of China

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  • Yan Liang

Abstract

Foreign direct investment (FDI) is often considered as a cost‐effective and risk‐reducing source for development finance. This paper, however, shows that FDI finance often entails underestimated risks and costs. FDI might react sensitively to business cycles and might not be as “permanent” as conventionally believed. FDI might also accelerate other forms of capital flow in times of financial difficulties and, hence, destabilize financial order. In addition to the risks, compensations to FDI and the high import‐dependency of FDI‐related trade lead to a considerable drain on the balance of payments. Moreover, the reliance on foreign capital for development finance is equivalent to building a Ponzi financing scheme and, therefore, is unsustainable. Given the fact that FDI financing is risky and costly and China does not lack savings, it is suggested in the present paper that China's efforts in attracting FDI should not aim at external capital provisioning.

Suggested Citation

  • Yan Liang, 2007. "Does Foreign Direct Investment Provide Desirable Development Finance? The Case of China," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 15(2), pages 104-120, March.
    • Handle: RePEc:bla:chinae:v:15:y:2007:i:2:p:104-120
    DOI: 10.1111/j.1749-124X.2007.00064.x
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    Cited by:

    1. Metaxas, Theodore & Kechagia, Polyxeni, 2012. "F.D.I. through the imitation procedure The case of China: A Note," MPRA Paper 40886, University Library of Munich, Germany.
    2. Metaxas, T. & Kechagia, P., 2013. "FDI Through The Imitation Procedure: The Case of China," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 13(1), pages 145-160.
    3. Nguyen, Vu Hong Thai & Boateng, Agyenim, 2015. "Bank excess reserves in emerging economies: A critical review and research agenda," International Review of Financial Analysis, Elsevier, vol. 39(C), pages 158-166.
    4. Chengsi Zhang, 2009. "Excess Liquidity, Inflation and the Yuan Appreciation: What Can China Learn from Recent History?," The World Economy, Wiley Blackwell, vol. 32(7), pages 998-1018, July.

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