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Policy Uncertainty and Foreign Direct Investment: Evidence from the China-Japan Island Dispute

Author

Listed:
  • Cheng Chen

    (University of Hong Kong)

  • Tatsuro Senga

    (Queen Mary University of London)

  • Chang Sun

    (Princeton University)

  • Hongyong Zhang

    (RIETI)

Abstract

Can a temporary negative shock generate long-lasting effects on economic activities? To show causal evidence, we utilize data from Japanese multinational corporations (MNCs) and explore the economic impact of the unexpected escalation of an island dispute between China and Japan in 2012. Our difference-in-differences (DID) estimation substantiates that a sharp, but temporary fall in local sales of Japanese MNCs in China led to persistent downward deviation of foreign direct investment (FDI) from its trend. Moreover, despite the quick recovery of local sales, Japanese MNCs in China have continued to underestimate their local sales, which generates pessimistic and more dispersed forecast errors after the island crisis. We view this as evidence for a belief-driven channel through which a large and unexpected negative shock leads agents to revise their beliefs and start tail risk hedging.

Suggested Citation

  • Cheng Chen & Tatsuro Senga & Chang Sun & Hongyong Zhang, 2016. "Policy Uncertainty and Foreign Direct Investment: Evidence from the China-Japan Island Dispute," Working Papers 803, Queen Mary University of London, School of Economics and Finance.
    • Handle: RePEc:qmw:qmwecw:803
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    File URL: https://www.qmul.ac.uk/sef/media/econ/research/workingpapers/2016/items/wp803.pdf
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    Cited by:

    1. Belke, Ansgar & Volz, Ulrich, 2018. "Capital flows to emerging market and developing economies: global liquidity and uncertainty versus country-specific pull factors," IDOS Discussion Papers 23/2018, German Institute of Development and Sustainability (IDOS).
    2. Maria D. Tito, 2017. "Looking Inside the Magic 8 Ball : An Analysis of Sales Forecasts using Italian Firm-Level Data," Finance and Economics Discussion Series 2017-027, Board of Governors of the Federal Reserve System (U.S.).
    3. Yu, Zhen & Xiao, Yao & Li, Jinpo, 2021. "How does geopolitical uncertainty affect Chinese overseas investment in the energy sector? Evidence from the South China Sea Dispute," Energy Economics, Elsevier, vol. 100(C).
    4. Abdalwali Lutfi & Maryam Ashraf & Waqas Ahmad Watto & Mahmaod Alrawad, 2022. "Do Uncertainty and Financial Development Influence the FDI Inflow of a Developing Nation? A Time Series ARDL Approach," Sustainability, MDPI, vol. 14(19), pages 1-11, October.
    5. Geonwoo Park & Heon Joo Jung, 2020. "South Korea’s outward direct investment and its dyadic determinants: Foreign aid, bilateral treaty and economic diplomacy," The World Economy, Wiley Blackwell, vol. 43(12), pages 3296-3313, December.
    6. Luo, Changyuan & Si, Chunxiao & Zhang, Hongyong, 2022. "Moving out of China? Evidence from Japanese multinational firms," Economic Modelling, Elsevier, vol. 110(C).

    More about this item

    Keywords

    Uncertainty; Forecasts; FDI; Geopolitical conflicts; Business cycles;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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