Foreign direct investment flows and domestic investment in China: A multivariate time series analysis

This paper explores the effects of inward and outward foreign direct investment (FDI) on domestic investment in China using annual time series data over the period of 1982-2016. The empirical analysis is performed using ARDL bound testing procedure and fully modified OLS technique to get robust estimations. The causality analysis is also conducted by estimating a VECM based Granger causality test to reveal the direction of the relationship among the concerned variables. Overall results reveal that inward FDI substitutes domestic investment while outward FDI complements it. Moreover, the complementary effects of outward FDI on domestic investment are greater than those of inward FDI, implying that the former has the potential to offset the substitutional effects of the latter on domestic investment. The results remain robust across alternative specifications and estimators. Our study contributes to the worldwide debate on development finance by providing new econometric evidence on the linkages between capital flows and domestic investment. The findings suggest that FDI flows can contribute to the sustainable economic growth in China if pragmatic policies are framed to encourage local firms to engage in cross-border investment.