The Nexus between Export Diversification and Foreign Direct Investment: Empirical Evidence from China

The transformation of the Chinese economy into a high-tech manufacturing hub spurred a heated debate among policymakers and academia. The large-scale market-friendly reforms have resulted in massive FDI inflows and high export diversification along with the extensive as well as intensive margins. By using the ARDL and VECM approaches, this paper revisits the theoretical and empirical connection between export diversification and FDI inflows in the framework of the Melitz model. The cointegration outcomes indicate a long-run relationship between export diversification and FDI, where the later has a diversifying effect on Chinese exports. The estimated coefficients show that export concentration has negatively related to FDI in China. Conversely, the results validate the presence of a positive spillover effect on export diversification. The reverse effect also holds, and the results indicate that export concentration has a negative effect on FDI or in other words, export diversification can attract foreign capital. It means that the diversifying capabilities of firms' allure FDI inflows. Further, the granger causality analysis confirms the short- and long- run bidirectional causalities between the variables of interest. Overall, the results confirm the validity of the Melitz model and spillover theory. The inclusion of control variables is robust to our analysis. The study advocates several policy implications for the stakeholders.