The relationship between foreign direct investment and foreign trade in China : evidence from a provincial leval

The relationship between foreign direct investment (hence forth noted as FDI) and foreign trade can be both theoretically and empirically ambiguous depending on the assumptions and methods undertaken. Some suggest that FDI may be complementary to bilateral trade (i.e. increase the source or host nation's exports and imports) while others may believe FDI to be a substitute for trade (i.e. replaces trade as a method of transaction). Either way, the result can have significant influence on the source (FDI sending country) and host (FDI receiving country) country's economic development potential. As China is the world's largest recipient of FDI, and also a major participant in global trade, this paper analyses the empirical relationship between trade and investment using provincial level trade and investment data from China. The finding of this thesis shows that while import and FDI flow have a positive relationship, indicating a complementary relationship, the significance level drops after 1998. This is consistent with Kojima's view using a neoclassical framework that foreign investment causes more imports in the initial stages of investment, as the infant subsidiary relies on the source country for the necessary inputs and technical support. The relationship decreases in the long run as the firm becomes more independent and can find reliable suppliers of inputs in the host nation. Exports however, were mostly insignificant (although remaining positive). This indicates the possibility that contrary to the popular view that investors in China are mostly efficiency seekers with the intention to utilize China as a cheaper production base for exports, a growing number of FDI since the mid-nineties, were actually aimed at targeting China's large domestic market.