Gradual Financial Liberalization, Fdi, and Domestic Investment: Evidence From China's Panel Data

We argue that how inward foreign direct investment (FDI) affects domestic investment (DI) depends on the degree of financial deregulation. Utilizing the Chinese experience and its panel data, instrumenting FDI with weather indicators (validity supported by over-identification tests), our limited-information maximum likelihood (LIML) results suggest that both FDI and its interaction with financial deregulation have a significant negative effect on DI. It means FDI significantly crowds out DI in China, and higher degree of financial deregulation reinforces the crowding-out effect. The results are robust even after controlling for other growth factors, and time and province effects.