Does ‘Good Government’ Draw Foreign Capital? Explaining China’s Exceptional fdi inflow Joseph P. H. Fana, Randall Morckb, Lixin Colin Xuc, and Bernard Yeungd Abstract

Keefer, 2006, “Governance and Economic Growth in China and India,” 2006. Worldbank working paper

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Keefer, 2006, “Governance and Economic Growth in China and India,” 2006. Worldbank working paper.

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Table 1. Key Statistics for China, the Former East Bloc, and Latin America

Figures are averages over 1990 through 2004, and across all countries in Latin American and the former East Bloc for those regions.

	China	Former East Bloc	Latin American
Economic performance
Per capita GDP (US dollars at PPP)	3292.7	6471.8	5456.9
Average annual GDP growth	8.7%	1.2%	1.1%
Foreign investment
Inward FDI per capita (US Dollars)	$30.38	$83.22	$80.48
Inward FDI as a fraction of GDP	4.3%	3.8%	2.8%
Institutional development
Respect for the rule of law*	4.6	4.4	3.0
Control of Corruption	2.8	3.4	2.8
Responsible Government	-7.0	3.2	7.5
Constraints on executive power	3.0	4.4	6.1

* Respect for the rule of law is the average of 1990 to 2002.

Table 2. Summary statistics China and Comparison Countries

	Weak institution countries				China after 1990
Variable	sample	mean	median	strd dev.	sample	mean	median	strd dev.
Foreign direct investment FDI per capita	1487	21.6	5.28	57.6	13	30.4	33.6	10.4
FDI as fraction of GDP	1455	0.015	0.008	0.032	13	0.043	0.04	0.014
Limits on Executive Power Executive constraints	927	3.4	3.0	2.2	13	3.0	3.0	0
Responsible government	947	-1.2	-4.0	6.9	13	-7.0	-7.0	0
General institutional quality Rule of Law	824	2.6	2.0	1.2	11	4.6	5	0.65
Control of corruption	824	2.67	3.00	1.10	11	2.83	2.00	824
Government track record Predicted growth	1609	0.014	0.016	0.019	14	0.047	0.045	0.01
Star growth	1833	0.178	0.167	0.144	14	0.703	0.707	0.034
GDP growth standard dev.	1609	0.078	0.059	0.059	14	0.048	0.038	0.031
General development Log of per capita GDP	1865	6.66	6.651	1.03	14	6.56	6.59	0.332
Log(mean years of school)	1919	0.819	0.954	0.844	14	1.71	1.70	0.038
Telephones per 1000 people	1242	35.1	13.0	51.7	13	74. 5	56.2	64.6
Other characteristics Log of population	1949	2.31	2.16	1.19	14	7.12	7.12	0.039
Exchange rate	1925	0.403	0.297	0.547	14	0.933	1.00	0.144
Manufacturing share of GDP	1713	26.9	25.2	11.1	14	48.8	49.5	2.76
Services share of GDP	1713	47.7	48.0	10.7	14	32. 7	33.0	1.37
Regime durability	950	2.04	2.20	1.05	13	3.889	3.892	0.08

Table 3. Regressions Explaining FDI Allocation across Countries

Dependent variable in all regressions is log one plus per capita FDI inflow.

Variable	3.1	3.2	3.3	3.4
Limits on Executive Power Executive constraints	0.125
	(2.05)*
Responsible government		0.055
		(1.88)*
General government quality Rule of Law			0.124
			(0.86)
Control of corruption				0.161
				(2.16)**
Government track record Predicted growth	9.172	9.798	9.243	7.792
	(1.73)	(1.83)*	(1.81)*	(1.97)*
Star growth	-0.114	0.190	1.483	0.616
	(0.08)	(0.13)	(1.40)	(0.66)
GDP growth standard dev.	-5.871	-3.874	-4.757	-2.298
	(3.66)***	(1.81)*	(2.37)**	(1.28)
General development Log of per capita GDP	1.346	1.028	0.149	0.572
	(3.97)***	(3.28)***	(0.50)	(2.20)**
Log(mean years of school)	0.023	-0.065	0.478	0.043
	(0.12)	(0.23)	(1.97)*	(0.21)
Telephones per 1000 people	-0.002	0.001	0.008	0.005
	(0.40)	(0.41)	(1.50)	(2.28)**
Other characteristics Log of population	-0.227	-0.182	-0.192	-0.276
	(1.57)	(1.16)	(1.58)	(3.58)***
Exchange rate	-0.181	-0.322	-0.450	0.202
	(0.71)	(1.47)	(0.62)	(0.43)
Manufacturing share of GDP	-0.022	-0.035	0.003	0.035
	(0.78)	(1.16)	(0.14)	(2.23)**
Services share of GDP	-0.020	0.013	0.028	0.008
	(1.52)	(0.55)	(1.54)	(0.38)
Regime durability	0.129	0.067
	(1.31)	(0.58)

Regression fit Observations	411	414	575	569
Regression R-squared	0.63	0.58	0.49	0.68

Fit for China Mean china residual and p-level	2.83 (.000)	1.86 (.000)	-0.73 (.000)	0.68 (.000)

Standard errors are adjusted for country-level clustering and time fixed effects are included, but their coefficients are suppressed.

Figure 1. Foreign Direct Investment Inflows to China, the US and the World

Foreign direct investment inflow is expressed as a percentage of gross domestic product in the left-hand column of graphs and per capita (in US dollars deflated to 2000 and converted at purchasing power parity exchange rates) in the right-hand column of graphs.
Panel A. Chinese Foreign Direct Investment Inflow

Panel B. US Foreign Direct Investment Inflow

Panel C. World Average Foreign Direct Investment Inflow

]

Figure 2. Entertainment and Travel Costs versus Prosperity

Each observation represents a Chinese province. Prosperity is gauged by per capita GDP in yuan is averaged over 1998 through 2003. Entertainment expenses are the proportion of 2003 company expenses classified as “entertainment and traveling costs” expressed as a fraction of 2003 sales, averaged by head office city. Provincial figures are averages across cities located in that province.

Figure 3. Private Property Rights Protection and Prosperity

Each observation represents a Chinese province. Prosperity is gauged by per capita GDP in yuan is averaged over 1998 through 2003. Private property rights protection is the fraction of the time surveyed business executives report that private property rights are protected in disputes with the State.

Figure 4. Entertainment and Travel Costs versus Growth

Each observation represents a Chinese province. GDP growth is averaged over 1998 through 2003. Entertainment expenses are the proportion of 2003 company expenses classified as “entertainment and traveling costs” expressed as a fraction of 2003 sales, averaged by head office city. Provincial figures are averages across cities located in that province. The slope black line is an OLS estimated trend line.

Figure 5. Private Property Rights Protection and Growth

Each observation represents a Chinese province. GDP growth is averaged over 1998 through 2003. Private property rights protection is the fraction of the time surveyed business executives report that private property rights are protected in disputes with the State.

Figure 6. Private Property Rights and Foreign Direct Investment

Foreign direct investment in each Chinese province, on the horizontal axis, is measured as a fraction of gross domestic product. Private property rights protection in that province, on the vertical axis, is the fraction of the time surveyed business executives report that private property rights are protected in disputes with the State. Values graphed are after partialing out the effect of per capita GDP.

Private

property

rights

FDI as fraction of GDP

Figure 7. Entertainment and Travel Costs versus Foreign Direct Investment

Foreign direct investment in each Chinese province, on the horizontal axis, is measured as a fraction of gross domestic product. Entertainment expenses are the proportion of 2003 company expenses classified as “entertainment and traveling costs” expressed as a fraction of 2003 sales, averaged by head office city. Provincial figures are averages across cities located in that province. Values graphed are after partialing out the effect of per capita GDP.

Entertainment and travel costs

FDI as fraction of GDP

Figure 8. Errors using responsible government to predict FDI inflow

Residuals from using regression 3.2, which gauges the quality of government with the responsible government score, to predict FDI inflow into China (out-of-sample prediction) and into various other weak-institution countries (in-sample predictions).

Figure 9. Errors using rule of law to predict FDI inflow

Residuals from using regression 3.2, which gauges the quality of government with the rule of law survey score, to predict FDI inflow into China (out-of-sample prediction) and into various other weak-institution countries (in-sample predictions).

1 For example, we might control for size by scaling inward FDI by GDP. We might use GDP per capita or average wage levels to control for general development and also wage level. We might use the length of roads scaled by a province’s geographic size to proxy for infrastructure development.

2 There are a few cases of negative FDI inflow, which we do not consider in our analysis.

3 ICRG data has the advantage of covering the majority of countries from 1982 on. For details, see Knack and Rahman (2004) or www.prsgroup.com.

4 In the case of executive constraints, Brazil is in, but Hungary is out.

5 The calculation is as follows: Δln(1 + per capita FDI) = 9 x Δpredicted growth; so ln(1+FDIpc_China') - ln(1+FDIpc_{weak institution controls}) = 9 x 7.1% and therefore FDIpc_China/FDIpc_{weak institution controls}= 0..8945/FDIPC + 1.8945, which evaluated at FDIPC = 21.61, the sample mean for our low institution sample, turns out to be 1.94.

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