Discussion Paper

No. 2019-54 | November 07, 2019
Financial development and FDI inflows in China


In this paper, the authors revisit the nexus of financial development and FDI inflows in Chinese perspective, incorporating the vital role of institutional quality and other important variables in this paradigm. Using ARDL bound testing and VECM procedures, they establish causality by exploiting variations in financial development and FDI. To unmask the shortcomings in the previous literature, the authors use a composite index of financial development, recently developed by the IMF, since it provides a more fine-grained analysis. The results show that there is a long-run relationship between FDI and financial development. Bidirectional causality is confirmed by using VECM. The inclusion of control variables, e.g., institutional quality, transport infrastructure, per capita GDP, trade openness, domestic investment, natural resources rent, is robust in the analysis. The positive role of financial development in FDI inflows is of utmost importance for policymakers and the Chinese government. Several policy implications are given in this study.

JEL Classification:

C22, F23, F38, G21, G32, O17


  • Downloads: 213


Cite As

Hameed Khan and Umair Khan (2019). Financial development and FDI inflows in China. Economics Discussion Papers, No 2019-54, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2019-54

Comments and Questions

Anonymous - Referee Report 1
January 09, 2020 - 07:59

General comment

This paper examines empirically the financial development (FD) and foreign direct investment (FDI) nexus in China. The authors use conventional time-series techniques (ARDL and VECM) to address causality. They find a short-run and long-run positive bidirectional causal relationship between the two variables. The paper is well executed ...[more]

... and the authors exhibit good command of the technical procedures. Unfortunately, I find no novel features in the dataset, the econometric techniques or the key findings. In addition, the paper is poorly written. My opinion is to reject the paper.

Specific comments
a)A key contribution of the paper is the use of a new variable to measure FD: the financial development index developed by IMF. The authors do not spend any effort presenting this key variable. Why not to use the “Global Financial Development” indicator elaborated by the World Bank? The WB GFD contains four dimensions: Access, depth, efficiency and stability. A contribution to the literature would be to identify exactly which dimensions are the ones that explain most of the expected connection between FD and FDI.

b) In the abstract the authors say “… incorporating the role of institutional quality and other important variables to the paradigm”. They construct a composite index of institutional quality using many institutional characteristics from ICRG data. Since they emphasize the importance of institutional quality, they should explain why their composite index is superior to other ready-to-use measure of institutional quality (for example, the one provided by the World Bank).

c) Section 2 (Overview of financial development in China) provides a vague and incomplete description of FD. In addition, there is no connection between FD and FDI, so the entire section can be eliminated.

d) Besides my concerns related to the empirical analysis, the reason that critically affect my decision to reject this piece of research is that the document is poorly written. There are too many grammar mistakes and lack of attention to detail. Various examples are provided below.
1. You use FD and FDI in the text before you define the labels.
2. Table 1 presents the variables as labels when they have not been defined yet).
3. I did not find in the paper information about the time window of analysis or the number of observations in the regressions.
4. Third, the authors talk about “sectoral” FDI but it is unclear that they perform any sectoral analysis.

Hameed Khan - Reply to Referee Report 1
January 16, 2020 - 07:55

see attached file