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How does corporate investment respond to trade policy uncertainty in China? The role of political connections

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  • Yin, Doudou
  • Si, Deng-Kui
  • Wang, Yun

Abstract

This paper investigates how political connections affect the relationship between trade policy uncertainty and corporate investment by utilizing Chinese non-financial firm-level data from 2003 to 2022. We find that trade policy uncertainty inhibits corporate investment by decreasing expected cash flows, increasing cash flow uncertainty, and lowering investment returns. Political connections mitigate the adverse impact of trade policy uncertainty on corporate investment by increasing government subsidies, alleviating financing constraints, and improving investment inefficiency for firms. The results are robust to changing variables measurements, alternating econometric model settings, and addressing endogeneity concerns. We also find the adverse impact of trade policy uncertainty on corporate investment is more pronounced for non-state-owned firms and small-sized firms, and the positive role of political connections benefits firms with higher financing constraints, lacking bank-firm relationships, and regions with lower institutional quality. Our findings highlight that optimizing the business environment and strengthening the communication between firms and governments are crucial for coping with unexpected policy uncertainty shocks.

Suggested Citation

  • Yin, Doudou & Si, Deng-Kui & Wang, Yun, 2024. "How does corporate investment respond to trade policy uncertainty in China? The role of political connections," Economic Analysis and Policy, Elsevier, vol. 82(C), pages 1429-1445.
    • Handle: RePEc:eee:ecanpo:v:82:y:2024:i:c:p:1429-1445
    DOI: 10.1016/j.eap.2024.06.002
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