The Impact of Foreign Direct Investment On China

The Impact of Foreign Direct Investment on Public Governance and Corruption in China
Author(s): Ming-Hsuan Lee and Mon-Chi Lio

Source: China Review, Vol. 16, No. 2 (June 2016), pp. 105-135
Published by: Chinese University Press
Stable URL: http://www.jstor.org/stable/43831389
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The China Review , Vol. 16, No. 2 (June 2016), 105-135
The Impact of Foreign Direct Investment on

Public Governance and Corruption in China *
Ming-Hsuan Lee and Mon-Chi Lio
Abstract
The impact of foreign direct investment (FDI) on the performance of

the Chinese government has recently drawn scholastic attention.
Though the literature provides insightful observations on the potential
influence that FDI has on the Chinese government, little empirical
evidence has been provided. This article constructs a dynamic panel
data set using province -level data for China from 2000 to 2009 to
estimate the impact of FDI on governance performance and the level of
corruption of provincial governments in China. The estimation strategy
includes a dynamic panel data (DPD) model and a fixed effect (FE)
model. The results suggest that foreign capital and investors improved
governance performance and reduced corruption of provincial govern-
ments. Furthermore, FDI not originating from Hong Kong, Macao, and
Taiwan had a greater impact on provincial governments, representing a
greater shock to the Chinese governments. The findings are robust
under both specifications.
Ming-Hsuan LEE is an assistant professor at the Department of Political

Economy, National Sun Yat-sen University, Taiwan. She received her Ph.D. degree
in economics from Boston University. Her research interests include develop-
ment, social and economic inequality, gender issues, and Chinese economy.
Mon-Chi LIO is professor in the Department of Political Economy, National Sun

Yat-sen University, Taiwan. He received his PhD in economics from National
Taiwan University. His research interests include development economics,
economics of crime, and political economy.
* This research was supported by the NSC (National Science Council, Taiwan),
grant 101-2410-H-l 10-021.
106 Ming-Hsuan Lee and Mon-Chi Lio
1. Introduction
Stepping out of isolation and embracing the open door policy, China has
surpassed other countries and become one of the largest recipients of
foreign direct investment after the nation's market economic reform of
1978. A large amount of research has examined the impact of foreign
direct investment on China from different perspectives. For example,
foreign direct investment has been found to contribute to China's
economic growth and technological progress,1 improve the productivity
and innovation capability of Chinese firms,2 and demonstrate better
models of corporate governance.3
In addition to the impact of foreign direct investment on industries
and firms, a few recent studies start to investigate the impact of foreign
direct investment on the Chinese government. In fact, in the interna-
tional literature, there has been extensive discussions regarding the
potential impact of foreign direct investment on the host governments. A
number of scholars hold optimistic attitudes and argue that the arriving
foreign capital will generate positive impacts on the governance of the
host government through several channels.4 For example, competition for
foreign capital encourages governments to reform their regulatory envi-
ronments, which leads to a "race to the top" in governance standards.5
Host governments often offer investor-facilitation services, such as "one-
stop shops" for investors, assisting them with expediting approvals,
obtaining sites, and brokering relationships with local firms, banks, and
government officials, which improves the efficiency and effectiveness of
governance.6 Foreign investors, most of whom are from developed coun-
tries with more complete and transparent institutions, may demonstrate a
different model of business practices and inject new values/institutions to
the host countries. These demonstration effects are anticipated to
promote the diffusion of pro-business norms and ideas that lead to the
adoption of better governance practices, protection of property rights,
and consolidation of the rule of law.7 In addition, pressure from the polit-
ical and economic power of the home countries of these multinational
corporations may force the host governments to behave more profession-
ally and transparently whenever there are legal disputes or conflicts of
interests.8
A few works focus on a more narrowly defined public governance:
the level of corruption. In the literature that examines the determinants
of corruption, it is argued that what is perceived as corrupt varies because
The Impact of Foreign Direct Investment 107
of the perceivers background and factors such as nationality,

cultural background, and so forth.9 Gerring and Thacker st
"cultural diffusion" occurs between the foreign and domestic
that internationally oriented groups may find it materially be
adopt business and political practices that are consistent w
primary foreign trade and investment partners. Their empiri
indicate that having an openness to foreign trade and in
promotes lower levels of political corruption.10 Kwok and Tad
that foreign direct investment reduces people's tolerance of c
and alters the opportunities for corruption, thereby causing
levels of corruption. In addition, the regulatory pressure from
governments and the international business community furt
corruption.11
Some scholars hold opposing positions and argue that the presence
of foreign direct investment cannot have positive influences on the host
governments and may even result in poorer governances and more
serious corruption of host governments. These scholars suggest that
instead of influencing host governments, multinational corporations
(MNCs) would conform to the local culture and the methods of business
practice of the host country because the objective of MNCs is to
maximize profits.12 They would surrender to the potential huge profits
presented in host countries and be willing to offer bribes to key officials
or decision makers. In some instances, MNCs would even cooperate and
follow requests of host governments that are sometimes against public
interests.13 As a result, the arrival of foreign capital provides opportuni-
ties for government officials to fulfill their self-interests, leading to poor
governance and corrupted behavior by the host governments.
In China, the existing literature examining the impact of foreign
direct investment on the Chinese government details mixed scenarios,
including both positive and negative influences. For example, the Chinese
government was eager for foreign capital and technology to make up for
domestic deficiency.14 As a result, the Chinese government at all levels
competed to create a business environment in which the positive effects
of technology transfer and the benefits of other intangibles such as
modern management systems could be efficiently transferred.15 However,
the Chinese government also offered to trade market access and other
privileges for technology,16 and this created opportunities for corrup-
tion.17 As another example, foreign investors were initially eager to make
use of China's cheap labor and have more recently

market.18 They injected new values, models, and
However, at the same time, they did whatever it
China to maximize profit,19 including offering brib
various requests from the Chinese government.20
Though these studies have provided insightful
potential influence from foreign capital investm
government, little empirical evidence has been p
while foreign direct investment has brought a varie
tunities to China, has it also resulted in improv
mance and a lower level of corruption? This que
empirically estimate the effect of foreign direct inv
performance and corruption of the Chinese gover
dynamic panel data set using the province-level d
2000 and 2009, which are available from the Chin
and the Procuratoria I Yearbook of China , to perfor
this period, the distribution of foreign direct inv
varied substantially across provinces, with eastern
disproportionately greater amount of the capital
varying level of exposure to foreign institutions and
inces. In this light, we believe that province-level da
appropriate samples for the purpose of this resea
employed in this article is a dynamic panel data
potential endogeneity problem stemming from re
foreign direct investment and governance/corr
system GMM (generalized method of moments) es
of this article contribute to the existing literature b
evidence on the direction of the impact of foreig
the Chinese government and improve our know
determinants of the performance of the Chinese gov
2. Public Governance and Corruption in C

Present
Unlike most other transitional economies, China underwent major

changes in its economic ideology without significant political liberaliza-
tion.21 While China's economic reform has transformed China into prac-
tically a market economy since 1978, the Chinese political system
The Impact of Foreign Direct Investment 1 09
remains a one-party autocracy. Successful economic reform a

significant improvement in China's income level and standard
have led to numerous debates over whether democracy or aut
delivers better public governance. Some scholars argue that de
must follow established procedures to change policies whereas
can change these procedures arbitrarily.22 Others claim that autoc
deliver a more efficient outcome under two conditions: first
demand for public goods are more unified and can be easily gr
the autocrat; second, the society is deficient in social capital,
mutual trust and mutual respect, and needs to resort frequent
head of a group to resolve issues.23 In this light, the autocratic sy
China, without the long process of voting and discussion
increased the adaptability of government policies and facilita
implementation and delivery of policies. For example, scholars a
the controversial Three Gorges Dam project, which had n
profound impacts, was approved and implemented in such
fashion only because of the authoritarian system of the
government.24
However, without the supervision of the people and feedba
voters, the objective of an autocratic government can usually b
enrichment and not maximizing the people's welfare. This di
from public interests generally means that autocratic governm
to provide fewer public goods such as public schools, roads, sa
and sanitation, and pollution control.25 In addition, the Chines
ment strictly controlled the flow of information to maintain its p
power. Thus, China is notorious for its lack of transparency
bureaucracy of its administrative process. For example, the ex
internal ( ft M neibu) rules and information, which are unav
civilians and foreigners, has long been a source of contention a
tainty for investors.26 The Chinese government also tightly l
formation and activities of groups with opinions that differ from
the government; these include human right groups, religious grou
political groups. According to the World Bank's Worldwide Go
Indicators Project, the Chinese government displayed poor perf
in the dimension of "voice and accountability," which captures
tions of the extent to which a country's citizens are able to partic
selecting their government, as well as freedom of expression, free
association, and a free media.
Furthermore, the numerous opportunities for r

emerged in the process of economic transition al
corruption prevail. In the early phase of the econo
track economy of plan and market was the major
because it is not a true market but a plethora of n
cadres and bureaucrats.27 In the more recent stage
China reached the high tide of ownership restruct
enterprises and growth of hybrid and private owners
of corruption came from cadre entrepreneurship.28 T
prior distribution of national income among differ
is, the relative reduction of officials' income, drives g
and public institutions to seek extra income to sup
their staffs relative low and fixed official salaries.29
international factors (such as the "demonstration
consumption lifestyle) also contribute to the growth
Table 1 reports the governance quality of the C
drawn from IMD World Competitiveness Yearbook. Th
0 to 10, with 0 representing the poorest performance
the best performance. In line with the analysis fro
graph, the Chinese government displayed better p
implementation and adaptability; it scored poo
bureaucracy, bribing, and corruption, and its effort
regulatory environment was within the medium rang
Because China became one of the largest recipien
investment, the impact of foreign direct investme
corruption of the Chinese government deserves f
Case studies show that the Chinese government is
foreign investors to build an environment that bette
cial activities and includes more complete regulati
For example, foreign-invested enterprises made i
Chinese government to introduce laws written to
demands of investors for a flexible labor force.30
also report that some foreign investors tolerate an
of the Chinese models of business practices- offeri
on connections ( Mfâ guanxi)- because these st
promote gaining access to China through obtaining
ment projects or winning contracts.31
Table 1: Quality/Efficiency of the Chinese Government

Central bank Adaptability Government Transparency Bureaucracy Bribing and Legal
policy of govern- decisions corruption regulatory regulations
ment policy framework
1997 6.67 6.31 - 5.80 1.80 2.80 6.56 5.03
1998 6.80 5.63 5.13 5.35 1.77 2.67 6.55 5.29
1999 6.96 5.23 4.90 6.43 1.33 1.89 5.91 4.87
2000 7.04 5.03 5.28 6.31 1.60 2.22 6.20 4.92
2001 6.91 4.89 4.64 6.11 2.09 2.26 5.52 3.69
2002 6.46 5.31 4.85 4.69 2.90 2.56 5.60 4.32
2003 6.20 5.17 4.65 4.84 2.88 2.42 4.99 4.68
2004 6.50 5.30 4.50 4.15 1.57 1.17 5.54 6.69
2005 6.40 4.81 4.26 4.38 1.94 1.45 5.19 6.53
2006 6.94 5.41 5.33 5.18 2.82 2.24 6.20 6.51
2007 6.96 6.35 5.44 5.46 3.00 1.69 6.46 7.06
2008 5.56 5.08 4.93 4.64 2.88 2.08 4.91 5.30
2009 5.85 5.71 4.52 3.10 1.60 1.23 3.91 5.33
2010 6.17 6.04 4.55 3.27 2.06 1.61 4.68 5.13
Source: IMD World Competitiveness Yearbook.
Note: The scores range from 0 to 10: 0 indica

satisfactory performance. The full statem
Central bank policy: "Central bank policy h
Adaptability of government policy: "Adapt
economy is high." Government decisio
implemented." Transparency: "Transparenc
cracy: "Bureaucracy does not hinder busin
and corruption do not exist." Legal and re
framework encourages the competitiven
regulations do not hinder business activitie
As a result, the diverse and com

investment motivated us to cond
estimate the overall impact of for
performance. Table 2 presents the t
ment in China. China received ov
direct investment from its fellow
Chinese ethnic regions of Hong K
investors included mostly Wester
the United Kingdom, and others w
Table 2: Foreign Direct Investment Actually Utilized by Countries
1998 FDI 2000 FDI 2005 FDI 2009 FDI
Total 4,546,275 Total 4,071,481 Total 6,032,459 Total 9,003,267
Hong 1,850,836 Hong 1,549,998 Hong 1,794,879 Hong 4,607,547

Kong Kong Kong Kong
Virgin 403,134 United 438,389 Virgin 902,167 Virgin 1,129,858
Islands States Islands Islands
United 389,844 Virgin 383,289 Japan 652,977 Japan 410,497

States Islands
Singapore 340,397 Japan 291,585 Republic of 516,834 Singapore 360,484

Korea
Japan 340,036 Taiwan 229,658 United 306,123 Republic 270,007

States of Korea
Taiwan 291,521 Singapore 217,220 Singapore 220,432 Cayman 258,189

Islands
Republic of 180,320 Republic of 148,961 Taiwan 215,171 United 255,499

Korea Korea States
United 117,486 United 116,405 Cayman 194,754 Samoan 202,003

Kingdom Kingdom Islands
Germany 73,673 Germany 104,149 Germany 153,004 Taiwan 188,055
Netherlands 71,882 France 85,316 Samoan 135,187 Germany 121,657
France 71,489 Netherlands 78,948 Netherlands 104,358 Mauritius 110,378
Source: China Statistical Yearbook.
3. Measurement of Governance Performance and the Level of

Corruption of Provincial Governments
a. Governance
We estimate the impact of foreign direct investment on government

performance and corruption in China. Most studies measure government
performance using the weighted average of a variety of soft and hard
indicators. Hard indicators refer to economic or social indicators from
the Statistical Yearbook or various reports and measure the objective
"results" of governance; soft indicators are impression scores obtained
from executive surveys of managers who interact with the government
constantly and can thus provide subjective measures. However, given the
lack of such soft indicator data for the provincial governments of China,
we use only hard indicators to measure governance quality. We follow the
strategy of Tang and Tang and Cole, Elliott, and Zhang,32 choosing 38
indicators from the China Statistical Yearbook and the Procuratorial
Yearbook of China from 2000 to 2009 to compute the scores for
governance.33 The 38 social and economic indexes, which are

Table 3, fall into four different categories: public services, pu
government size, and national welfare. The 19 indexes in "public s
reflect the quantity and quality of public services provided by
governments; the 7 indexes in "public goods" reflect the amount
structure or the progress of the provincial governments' cons
infrastructure; the 5 indexes in "government size" reflect t
provincial governments as a burden to the economy; the 7 i
"national welfare" reflect the living conditions of people as th
of the provincial governance. The scores of governance
through this approach include indicators of various aspects o
and social development. What they indicate is similar to the
Development Index used by the United Nations to measure t
standards of countries. Therefore, our scores of governance o
reflect the outcomes of government performance and can be i
as the transcript of the government.34
Table 3: Government Efficiency Indexes

Factors Subfactors Indexes
1 . Per Capita Government Budge

Scientific and Technology Prom
2. Rate of Products with Excellen
3. Three Types of Patent (Inventi
Designs) Applications Granted (i
4 Per Capita Transaction value i
Education, science 5. Student-Teacher Ratio of Primary Schools
and technology, 6. Student-Teacher Ratio of Secondary Schoo

culture, and public 7. Illiterate and Semi-illiterate Rate (%)
health services g share 0f Government Appropriation f
in GDP (%)
9. Institution
Government
public services 11. Beds in Health Institutions (unit/ 100,000 persons)
12. Employed Persons in Health Institutions
13. Three Accidents (Traffic Accid

Public security Accidents) (case/ 100,000 persons)
services 14. Losses in Three Accidents (yuan)
15. Number of criminal cases per 10,000 persons
. . . 16. Agro- Meteorological Services Stations (unit/ 100,000
Meteorological . . . ns)
services
18. Number of Careers Service at the end of

Social security (unit/ 100,000 persons)
services 19. Number of Urban
1 14 Ming-Hsuan Lee and Mon-Chi Lio
Factors Subfactors
Social 20. Tot

infrastructure
22. Rate of Access to Gas (%)
Government 23. Numbers Public Transportation Vehicles per 10,000

public goods persons in Cities (unit)
City infrastructure 24. Per Capita Area of Paved
25. Per Capita Green Area (sq. m)
26. Number of Public Toilets per 1

27. Ratio of Staff and Workers in Go
Total Population (person/ 10,000 persons)
28. Ratio of Staff and Workers in Government

Total Employed Persons (%)
Government 29. Ratio of Government Consumption and Final

scale Consumption (%)
30. Ratio of G
31. The Share o
Income from A
Revenue
32. Per C
(yuan)
33. Per
Households (yuan)
National 34. Engle Coefficient of Rural Households (%)
welfare 35. Engle Coefficient of Urban Households (%)
36. CPI (preceding year = 100)
37. GDP per capita (yuan)
38. Ratio of Expenditure o

Government Expenditur
Source: The data required to compute i
are available from the China Statist
index 15) are directly available from
were drawn from the Procuratorial
source of each index.)
Note: The indexes in italics are inverse cr
We compute the standard

standard deviation method fo
STDi,),t = - ^ - -
S!
STDi,j,t is the standardized value of the ;'th index of province i in year i;

Xijit is the value of the jth index of province i in year t; Ķ is the mean of
the jth index across all provinces and all years; S, is the standard
deviation of the jth index across all provinces and all years. No
standardize the indexes using the mean and the standard devia
all years and all provinces. As a result, the values of STDs are
across provinces and also over time. For inverse criterions, w
the standardized values by -1. As a result, a larger value of ST
a better performance in the jth dimension.
Table 4: Governance of Provincial Governments in China
Governance Ranking
2000 2009 Change 2000 2009 Change

Beijing 0.55 1.03 0.48 1 1 Same
Tianjin 0.14 0.64 0.50 4 5 Decline
Hebei -0.04 0.31 0.35 15 15 Same
Shanxi -0.03 0.34 0.37 14 13 Decline
Inner Mongolia -0.01 0.40 0.41 12 10 Improve

Liaoning 0.13 0.50 0.37 5 8 Decline
Jilin 0.15 0.40 0.25 3 9 Decline
Heilongjiang 0.09 0.32 0.23 7 14 Decline
Shanghai 0.35 1.02 0.67 2 2 Same
Jiangsu 0.08 0.77 0.69 9 4 Improve
Zhejiang 0.05 0.86 0.81 10 3 Improve
Anhui -0.20 0.15 0.35 23 22 Improve
Fujian -0.17 0.37 0.54 22 11 Improve
Jiangxi -0.28 0.07 0.35 26 24 Improve
Shandong -0.07 0.62 0.69 16 6 Improve
Henan -0.29 0.20 0.49 27 18 Improve
Hubei -0.08 0.19 0.27 18 19 Decline
Hunan -0.27 0.11 0.38 25 23 Improve

Guangdong -0.07 0.52 0.59 17 7 Improve
Guangxi -0.34 0.00 0.34 30 27 Improve
Hainan -0.02 0.06 0.08 13 25 Decline
Chongqing -0.29 -0.02 0.27 28 29 Decline

Sichuan -0.22 0.16 0.38 24 21 Improve
Guizhou -0.33 -0.19 0.14 29 30 Decline
Yunnan -0.09 0.04 0.13 19 26 Decline
Xizang (No data) (No data) - (No data) (No data) -

Shaanxi -0.13 0.29 0.42 21 16 Improve
Gansu -0.10 -0.01 0.09 20 28 Decline
Qinghai 0.00 0.18 0.18 11 20 Decline

Ningxia 0.09 0.35 0.26 8 12 Decline
Xinjiang 0.11 0.24 0.13 6 17 Decline
Note: A larger value indicates better governance.
The score of governance of province i in year t

using the weighted arithmetic mean method:
goveranceit =0.4 • Mean{STDi j t ' For j that belongs to the category

+0.3 • Mean{STDi)t ' For j that belongs to the category "publi
+0.2 • Mean{STDl) t | Forj that belongs to the category "govern
+0.1 - MeanfSTD^ ' Forj that belongs to the category "pnati
The weights were assigned based on the number of

category and the level of association between g
category.35 Table 4 reports the scores of governance
provides a comparison between 2000 and 2009. In both
inces, including Beijing, Tianjin, Liaoning, Shangh
Shandong, and Guangdong, displayed higher gove
2000 to 2009, all provinces displayed improvements
coastal provinces again obtaining greater enhancement
difference in the level of governance between Chines
be consistent with the disparity in regional economic
amount of inward foreign direct investment.
b. Corruption
We also use hard indicators to measure the corrupt

governments. We follow the method of Dong and Tor
the data reported in the Procuratorial Yearbook of
yearly statistics for "the number of registered cases
gation by procurator's offices per capita" for each
cases included job-related crimes such as corruption
priation of public funds, collective illegal possess
unstated source of large property, abuse of power, de
fraudulent practices. These statistics were subseq
(subtracting the mean of all statistics and then d
deviation of all statistics). We use these standardiz
measure the corruption levels of provincial govern
corruption scores for each province in each year co
provincial and interyear comparisons, and the gre
more serious the corruption.
However, using this variable as a proxy for the cor
potential problem: if provincial prosecutors in a c
not motivated or lacked the ability to handle cases, th
tion scores would be lower, but the corruption le
would not necessarily be low. Similarly, a high co
simply reflect the efforts of highly motivated prosecutors a

necessarily indicative of serious corruption. However, becau
prosecutors are subject to national exams, unified training, a
ments, we could assume that prosecutors in each province h
rable quality and motivations as well as similar probabilities to
cases.37 Therefore, this group of values provided an objective mea
the corruption level of provincial governments given the lack of
tive corruption measurements.
Table 5: Corruption of Provincial Governments in China
Corruption Ranking
2000 2009 Change 2000 2009 Change
Beijing 0.83 -1.20 -2.04 18 28 Improve
Tianjin 3.83 0.56 -3.27 2 7 Improve
Hebei 2.25 -2.12 -4.37 6 30 Improve
Shanxi 3.26 1.68 -1.58 4 1 Worsen
Inner Mongolia 0.59 -0.14 -0.73 20 15 Worsen

Liaoning 2.05 1.34 -0.71 7 2 Worsen
Jilin 3.83 0.35 -3.48 3 8 Improve
Heilongjiang 4.05 1.17 -2.87 1 3 Improve
Shanghai 0.98 -1.18 -2.16 14 27 Improve
Jiangsu 0.87 -1.27 -2.14 17 29 Improve
Zhejiang 0.41 0.16 -0.25 22 12 Worsen
Anhui -0.42 -0.95 -0.52 29 23 Worsen
Fujian 1.78 0.60 -1.18 8 5 Worsen

Jiangxi 0.10 -0.77 -0.87 25 22 Worsen
Shandong 2.35 -0.75 -3.09 5 20 Improve
Henan 1.52 0.60 -0.92 10 4 Worsen
Hubei 0.96 0.18 -0.78 16 11 Worsen
Hunan -0.35 -0.26 0.09 28 16 Worsen
Guangdong -0.14 -1.17 -1.04 27 26 Worsen

Guangxi -0.10 -0.76 -0.66 26 21 Worsen
Hainan 0.76 -0.46 -1.22 19 17 Worsen
Chongqing 0.44 -1.11 -1.55 21 25 Improve

Sichuan 0.33 -1.10 -1.43 24 24 Same
Guizhou 0.38 -0.11 -0.49 23 14 Worsen
Yunnan 0.98 0.16 -0.82 13 13 Same
Xizang 1.75 -2.41 -4.16 9 31 Improve

Shaanxi 1.18 0.22 -0.97 12 9 Worsen
Gansu -0.49 -0.72 -0.23 31 19 Worsen
Qinghai 0.97 -0.55 -1.52 15 18 Improve

Ningxia -0.49 0.57 1.06 30 6 Worsen
Xinjiang
Note: A lar
Table 5 reports the scores of corruption acr

provides a comparison between 2000 and 2009.
corruption improved in some provinces and worsen
corruption was more serious in provinces such as T
Jilin, Heilongjiang, and Shandong; whereas in 2009
serious in provinces such as Shanxi, Liaoning,
Henan, and Ningxia. The levels of corruption in Sh
were high in both years. Other than that, we did not
geographic pattern or trend of change.
4. Empirical Strategies: The Dynamic Pane
a. Governance: All Countries
To estimate the effect of foreign direct investment on provincial gover-

nance, we specify the following dynamic panel data model, which
includes the lagged dependent variable as an explanatory variable:
governanceit =ß0+ßI ■ governanceu_l+ß2 •/ííí,(+áX¡,+0,+£í( (1)
where fdi is the amount of foreign direct investment received by province

i in year f; X is a set of control variables; di refers to the province fixed
effects; and eit is the disturbances assumed to be distributed across coun-
tries with a zero mean. The variables used for the estimates were drawn
from the China Statistical Yearbook for various years. The detailed defini-
tions and descriptive statistics of the variables are provided in Table 6.
We employ the dynamic panel data model for the following reasons.
First, the performance of a government may involve a learning process
and, as a result, the governance of a government in time t may depend
on its governance in time t-1. To account for the possible persistence of a
government's performance, we follow Lio, Liu, and Ou and work with a
dynamic, lagged dependent econometric model.38 Second, a large body of
literature has established that the quality of public governance is an
important factor for the location choice of foreign direct investment.
Failure to correct for the endogeneity problem caused by this reverse
causality may lead to inconsistent coefficients. The system GMM esti-
mator, proposed by Holtz-Eakin, Newey, and Rosen,39 and developed by
Arellano and Bover and by Blundell and Bond,40 is able to cope with the
endogeneity problem by using the dynamic properties of the data to
generate proper instrumental variables.41 More specifically, the system
GMM estimator employs the lagged value of the endogenous regr

our case governance) as an instrument to solve the endogeneit
Following the suggestions of Roodman, we used the second lag
nance as its instrument.42
Table 6: Variable Definitions and Descriptive Statistics

Variable Definition M SD Min Max
governance The score of governance 0.000 0.286 -0.830 0.957

corruption The score of corruption 0.000 0.989 -2.534 3.353
The amount of foreign direct 0 ()67 aM3 0.765

J investment as a percentage or GDP
The percentage of workers working
fdi_HMT in the units with funds from Hong 0.021 0.034 0.001 0.179
Kong, Macao, and Taiwan
fd,
J J the
~ in ~ others The the units
foreign-funded Percentage of workers working 0 028 0 036 0 001 „ 180
deficit Budget deficit as a percentage of 0 0?9 0 066 _0 419 0 303
fund
J ~ Jfixed
~ state fixed Sources
assets- of funds
state for investment
budget (%) in
popdensity Population density (persons/km2) 397.995 497.263 7.083 2997.556
gdp_pc Per-capita GDP 14462.03 11792.24 2475 73124
edu Enrollment rate in secondary

education
industrial . j . . j The size of the industrial sector _ . , _ _ _ _

industrial . jof.the
(GDP . j, industrial
of the. ,,. industrial . , . . /pnm 0.46 _ . , 0.08 0.20 _ _ _ 0.62 _
. sector/GDP) /pnm
The size of the service sector (GDP

service c . °-40 °-07 °-29 0.73
or c the service sector/GDP)
The system GMM estimator

metric problems that may ar
presence of the lagged depende
gives rise to autocorrelation.
variable is instrumented with i
correlation. Second, the panel
a large province dimension (N
for small-T large-N panels.
X is the set of control variabl
variables that might affect gov
control variables in the regr
level measured by GDP per ca
by the rate of enrollment in secondary education

Kaufmann, Kraay, and Zoido-Lobatón, governance
distributed across countries. Good governan
resources to develop, suggesting that richer coun
greater human resources are more likely to enjoy go
third control variable is the ratio of the budget def
is included to account for the potential impact of
condition on its performance. The fourth variab
percentage of total investment in fixed assets funde
We use this variable to measure the degree of fis
each provincial government in China - the higher th
funds, the lower the province's financial autono
included in the regression to address the pos
autonomy on government performance. The fifth
density, popdensity. This variable is included to e
population density helped achieve economies of s
public services or created difficulties in the provisio
To account for any potential endogeneity pro
control variables, we use the first and second lags of
as their instruments in the system GMM estimation
b. Governance: By Origins
Section 2 indicates a large amount of foreign dire

came from the Chinese ethnic regions of Hon
Taiwan. Though Hong Kong, Macao, and Taiw
Western cultural influences that may differentiate
from those of China, these areas are ethnically
share cultural values with Chinese nationals, such
tions when doing business. In addition, a large p
Macao, and Taiwan businesses are actually owned
tions that are registered as local businesses to
policies.45 Conversely, foreign investors from W
different cultural backgrounds may represent comp
tions and distinct business practices. These observ
further divide the origin of foreign direct investme
Macao, and Taiwan" (HMT hereafter) and "other f
evaluate their impacts separately. However, becau
direct investment in each province by country
employ alternative statistics: the percentage of workers wor

"foreign-funded units" and "units with funds from Hong Ko
and Taiwan." To examine whether the origin of foreign direct inv
generates different influences on host governments, we est
following equation:
governance it = ß0+ß1 • governanceit_1+ß2 fdi_HMTit+ß3 • fdi_O

SXit+di+Cit (2)
where fdi_HMT denotes the percentage of workers working in HMT-

funded units and fdi_Others represents the percentage of workers
working in other foreign-funded units.
c. Corruption: All Countries
To examine the impact of foreign direct investment on corruption, we

adopt the same specification as in equation (1):
corruption it =ß0+ßi * corruption^* ß2 fdi^SZ^+d^ejt (3)
The lagged dependent variable is also included in the equation to control

for the possible persistence of corruption. The system GMM estimator is
employed to address the possible endogeneity problem stemming from
reverse causality between foreign direct investment and corruption.
In the equation, Z is the set of control variables. Following previous
literature, we include four control variables. The first two variables are
GDP per capita (gdp _j)c) and the secondary education enrollment rate
(edu). Previous studies suggest that in areas with higher incomes or
educational levels, the public is usually less tolerant of corruption.46 The
other two control variables are the ratio of GDP of the industrial sector
to the overall GDP ( industrial ) and the ratio of GDP of the service sector
to the overall GDP {service). The incidence of corruption is usually
related to the prevalence of rent-seeking opportunities.47 The process of
industrialization often creates a large number of rent-seeking opportuni-
ties; for example, changes in zoning policies in response to the increasing
demand for industrial and commercial land, tenders for national
construction projects, and competition for import or export quotas have
all created opportunities for improper rent-seeking for government offi-
cials. Therefore, we include two variables that measure the progress of
industrialization, industrial and service , to captu

also use the first and second lags of the control v
ments in the system GMM estimation.
d. Corruption: By Origins
To examine the possible variations in the impact

foreign direct investment of various origins, we
equation:
corruptionit =ß0+ßi * corruptionit_1+ß2 fdi_HMTit+ß3 fdi_Othersit

+8Zit+6i+£it (4)
We use the second lag of corruption as its instrument; for other

control variables, we use their first and second lags as instruments. The
proprietary Stata program, called xtabond2 and written by Roodman,48 is
employed to estimate equations (1) to (4).
5. Estimation Results
a. FDI and Governance
Table 7 reports the estimation results for the impact of foreign direct
investment on governance in equations (1) and (2). In addition to the
results from the dynamic panel data (DPD) model, we also list the results
from the fixed effect (FE) models in columns (1) and (4) for comparison.
In addition, the results of the DPD regressions incorporating year fixed
effects are also reported in columns (3) and (6).
The results of all specifications are consistent and show that foreign
direct investment had a positive impact on provincial governance in
China. The coefficient of f di in the DPD model in column (2) is 0.232
and is statistically significant. The coefficient of fdi in the DPD model
with year fixed effects in column (3) is 0.240 and is also statistically
significant. Both coefficients are smaller than the coefficient obtained
from the FE specification in column (1), which may be indicative of the
upward bias of the FE estimate due to the feedback effect from the
possible reverse causality between foreign direct investment and gover-
nance. Because the DPD coefficients remain positive and significant, the
positive impact of fdi on governance is robust to different estimation
models. This finding indicates that based on our estimation,

mixed scenarios (positive and negative consequences of foreig
investment) were observed in China, the positive influenc
arriving foreign capital and investors may have outweighed th
influences. As a result, the overall impact of foreign direct invest
the performance of provincial governments was positive.
Table 7: Estimation Results for the Dependent variable Governance
Dependent variable: governance

(1)FE (2)DPD (3)DPD (4)FE (5)DPD (6)DPD
0.545*** 0.545*** 0.545*** 0.569***
governances-! {Q 055) (Q Q55) (Q 055)
0.145*** 0.232*** 0.240***
J (0.024) (0.038) (0.043)
T 0.550 0.449* 0.438
(1.722) (0.272) (0.299)
#L 1.846*** 0.684*** 0.699***

fdi_others #L (063ļ) (0222) (02ļ9)
In in
In in 'gap_po
Mp 'gap_po DO (0026)
Mp DO 0A52*** °'297***
(0043) (0061) °'433*** 0 u.zyi
(0027) u.zyi 291***
0 291*** 0
0 u.
, 0.013*** 0.003 0.004* 0.013*** 0.004* 0.005*
(0.004) (0.002) (0.002) (0.014) (0.002) (0.002)
, - -0.025* -0.023 -0.031 -0.009 -0.021 -0.021
eJl (0.011) (0.023) (0.033) (0.037) (0.016) (0.016)
, , -0.021 0.001 0.064*** 0.008** 0.003 0.002
juna_state (aQļ6) (Q()03) (()()()3) (()()03) (()()()3) (()()()3)
w . . -0.020 -0.019** -0.018* -0.040 -0.010 -0.017*
w inypopaensity) (Q ()()6) (() QQ9) (Q 25ļ) (()()()9)
Province fixed ^ ^ ^ ^ ^ ^
effects
Year fixed No No No No No No
effects
R2 .75 .82
Hansen Hans
Hansen Hansen test test
p .991 .899 .900 .991

AR(2) test (z) 1.28 1.48 1.07 1.28
p .199 .140 .286 .199

DifF-in-Hansen ^(54) = /^(58) = ^(61) = /^(66) =
test 5.39 15.88 23.2 22.18
p .168 .185 .842 .728

N 300 270 270 300 270 270
Note: Numbers in parentheses a
When we divide foreign direct investment by o

their respective impacts on governance, we find th
fdi_others are consistently positive and statistically s
the coefficients of fdi_HMT are smaller than the coe
and are even statistically insignificant in models (4
tion results are consistent with our conjecture tha
different ethnicities and from different cultural bac
in completely different institutions and distinct mod
tices, thereby generating a greater "shock" to prov
China than would investors from Hong Kong, Maca
Regarding the results of the control variables, the
cance of the coefficients of the control variables varies in different
models, but the directions are consistent. Provinces with higher income
levels or higher education levels display better governance performance
after controlling for other factors, suggesting that more resources and
better human resources contribute to better government performance.
This finding is consistent with the finding of Kaufmann, Kraay, and
Zoido-Lobatón. The coefficients of deficit are negative, indicating that
provincial governments with greater financial deficits delivered lower-
quality governance. The coefficients of fund_state are positive, suggesting
that greater financial autonomy was associated with better governance
performance. This finding is consistent with the argument of De Borger
and Kerstens.49 Population density has a negative coefficient, implying
that the growing population has become a source of pressure and has
increased the difficulties of public governance. These difficulties, as
currently faced by major cities in China, may have placed great pressure
on the local provision of public goods, such as environmental protection,
low-income housing, health care, and education, and have caused local
governments to hesitate in cancelling the household registration system.
After each estimation, we adopt three tests: the Hansen test to
examine whether the estimation encounters an overidentification
problem; the AR (2) test to examine the problem of autocorrelation in
the estimation; and the difference-in-Hansen test to examine whether the
instruments used for the equations in levels are exogenous. The chi-
square value of the Hansen test, the z-statistics of the AR (2) test, and the
chi-square value of the difference-in-Hansen test are also reported in
Table 7 for each specification. Because all of the statistics were insignifi-
cant, we accept the null hypotheses that there is no indication of an over-
identification problem or autocorrelation and the instruments used for
the equations in levels are exogenous.
b. FDI and Corruption
Table 8 reports the estimation results for equations (3)

addition to the results from the DPD model, we also list the r
the FE models in columns (7) and (10) and the results of the D
sions incorporating year fixed effects in columns (9) and (12).
Table 8: Estimation Results: Corruption
Dependent variable: governance

(7)FE (8)DPD (9)DPD (10)FE (ll)DPD (12)DPD
, , 0.254* 0.221* 0.234 0.255**

corruptionj-l , , {Q H5) (Q m {Q m) (() m)
-0.147*** -0.151* -0.201
* (0.060) (0.090) (0.157)
M- MMT i -0.492** -0.122* -0.131
i (02ļ6) (056ļ) (0.633)
,L -1.267*** -0.233*** -0.414
fdi_others ,L (0 278) ((U)67) (Q m)
w , v -0.371** -1.253*** -0.628 -1.025*** -0.198*** -0.225
liHgap_pcj w (0.195) (0.421) (0.881) (0.190) (0.045) (0.952)
, -0.062*** -0.149*** -0.126*** -0.079*** -0.206*** -0.153***
(0.014) (0.039) (0.042) (0.015) (0.051) (0.052)
. . , 5.460*** 5.563 3.620 4.338*** 1.256** 0.604
industrial (ļ 2gg) (4 49()) (5 Mļ) (ļ ^ (() 669) (()7()g)
1.794 1.306 -1.300 0.200 0.811 -0.248
S6rVlCe (1.449) (5.153) (6.224) (1.435) (0.628) (0.934)
Province fixed
- Yes Yes Yes Yes Yes Yes
effects -
Vp^r IC* fiypfl 1ACU

IC* 1ACU No No Yes No No Yes
effects
R2 .24 .32
Hansen
Hansen Han
Hansen test test 9 3ļ ļ9 ļ2 ļ6 22 ļ6 AQ
p .977 .899 .989 .998
AR(2) test (z) -0.37 1.48 -0.18 0.22
p .890 .140 .863 .867
Diff-in-Hansen ^(56) = ^(58) = ^(65) = ^(70) =

tesť 5.94 15.88 7.63 3.24
p .994 .185 .543 .544

N 300 270 270 300 270 270
Note: Numbers in parentheses are s
The findings show a negative overall impact of f

ment on corruption. The coefficient of fdi in th
column (7) is -0.147 and is statistically significant
column (8), the coefficient of fdi is -0.151 and is a
cant. This finding indicates that, given that we
negative influences of the arriving foreign invest
behavior of government officials regarding corr
benefits may have outweighed the drawbacks. Thu
foreign direct investment in our estimation help
corruption among provincial governments in Chin
When we divide foreign direct investment by
their respective impact on corruption, we obtain s
regression of governance. The coefficients of fdi_
the coefficients of fdi_HMT are smaller. Specifica
fdi_others and fdi_HMT in the FE model in colu
-0.492, respectively. In the DPD model in column (
fdijothers and fdi_HMT are -0.233 and -0.122, re
cients are statistically significant. The estimatio
foreign investors from origins other than Hong K
had a greater influence in reducing corruption am
ment officials in China. The greater differences in v
models of business practices between China and t
may be able to explain our findings.
The results of the control variables are consistent
previous literature. The coefficients of gdp _pc an
mostly significant, suggesting that there was less cor
higher incomes or educational levels. The coeffic
size of the industrial sector, are positive and are stat
models (7), (10), and (11). This result is consistent
that the incidence of corruption was usually assoc
lence of opportunities for rent-seeking. The large am
opportunities that emerged in the process of indus
led to a rising incidence of corruption. However,
service are statistically insignificant. A possible inter
the economies of scale displayed in the service
smaller than those of the industrial sector. Thus,
seeking opportunities is smaller, and this leads to
on corruption.
The results of the Hansen and AR (2) tests indicated no ove

cation or auto-correlation occurred because the chi-square val
Hansen test and z-statistics for the AR (2) test were both ins
The difference-in-Hansen test results indicated that the instruments used
for the equations in levels were exogenous.
6. Conclusion
The impact of foreign direct investment on host countries has been

examined widely in the economic and business literature. While the
majority of the literature focuses on the impacts experienced by indi-
vidual firms, a much smaller body of literature studies the potential effect
experienced by the host government. Stepping out of isolation and
embracing the open door policy, China has surpassed other countries
and become one of the largest recipients of foreign direct investment in
the past three decades. Some scholars argue that foreign investors
generate positive impacts on the Chinese government through the
demonstration effect and the regulatory pressure from the international
business community. However, other scholars argue that these profit-
maximizing foreign investors would eventually conform to the Chinese
way of business practices and start offering bribes and relying on connec-
tions. The debate over the direction of the impact of foreign direct invest-
ment on the Chinese government motivates us to examine this question
empirically. We construct a dynamic panel data set using the province-
level data in China from 2000 to 2009 and estimate the overall impact of
foreign direct investment on governance and the level of corruption
among provincial governments in China.
The results show that, despite the observation of mixed scenarios
(positive and negative consequences of foreign direct investment) in
China, the overall impact of foreign direct investment on the perfor-
mance of provincial governments was positive. Furthermore, when we
divide foreign direct investments by origin and estimate their respective
impacts on governance, we find that foreign direct investment from
places other than Hong Kong, Macao, and Taiwan had a greater influence
on provincial governance performance.
The findings regarding corruption are similar. Although we observed
both positive and negative influences of the arriving foreign capital and
investors on the behavior of Chinese government officials regarding
corruption, the overall impact of foreign direct

our estimation was that it helped reduce the corr
cial governments in China. In addition, foreign
other than Hong Kong, Macao, and Taiwan had a
reducing corruption. We interpret and attribute thi
differences in values, institutions, and model
between China and these other countries, which
greater "shock" to provincial governments in Ch
portion of HMT businesses are actually owned b
register their firms in Hong Kong and Macao to
policies offered to HMT businesses. This trend m
capital from Hong Kong, Macao, and Taiwan had l
nance and corruption in Chinese governments.
The empirical results of this article provide an
over the direction of the impact of foreign direc
nance and corruption in China. Our findings also
direct investment has brought economic growth,
ment, employment opportunities, and more diversit
lifestyle to China, it has also resulted in better prov
terms of better governance performances and lower
This study has some limitations. First, the govern
scores used in this study were calculated usin
because of the lack of soft indicator data at the pro
measure public opinion. If provincial soft indicat
available, they would substantially facilitate future
issue of governance and corruption. Second, con
suitable alternative measurements, we use the per
in HMT and other foreign enterprises to represent
from HMT and other countries. However, this m
the HMT investments because HMT businesses tend to be more labor-
intensive. More detailed data pertaining to foreign direct investment in a
province by country becoming publicly available would also greatly facili-
tate future research.
Appendix: Data Source for the Government Efficiency

Index Source
1. Per Capita Governm

Expenditures for Scientif
Promotion (yuan)
2. Rate of Products with

3. Three Types of Patent
Models and Designs) Ap
(item/ 100,000 persons)
4. Per Capita Transaction
Market (yuan) Region
5. Student-Teacher Ratio of Primary Schools 20-32 Basic S
by Region
6. Student-Teacher Ratio of Secondary Schools 20-30 Basic Statistics on Regular Junior
Secondary Schools by Region
20-29 Basic Statistics on Regular Senior
Secondary Schools by Region
7. Illiterate and Semi -illiterate Rate (%) 3-13 Illiterate Population Aged 15 and over by
Sex and Region
8. The Share of Government Appropriation for 7-8 Government Expenditure by Region
Education in GDP (%)
9. Institutions for Culture and Art (unit/

persons) by Region
1 0. Number of Magazines and Newspapers 21-2
Published (kind) by Region
11. Beds in Health Institutions (unit/ 100,000 21-36 Beds in Health Car
persons)
12. Employed Persons in Health Institutions 21-33 Medical Technical Personnel in Health
(person/ 100,000 persons) Care Institutions per 1,000 Persons
13. Three Accidents (Traffic Accidents, Fires 22-15 Basic Statistics on Traffic Accidents by
and Pollution Accidents) (case/ 100,000 Region
persons) 22-16 Basic Statistics on Fires by Region
11-44 Environment Pollution and Destruction
Accidents
14. Losses in Three Accidents (yuan) 22-15 Basic Statistics on Traffic Accidents by
Region
22-16 Basic Statistics on Fires by Region
11-44 Environment Pollution and Destruction
15. Nu
16. Ag
(unit/ 100,000 persons)
17. Earthquake Monitoring Stations 20-72 Situation of

(unit/ 100,000 persons)
18. Number of Careers Service at the end of 4-28 Situations

year (unit/ 100,000 persons)
19. Number of Urban Community Welfare 22-38 Co

Facilities (unit/ 100,000 persons) Areas by
20. Total Investment in Fixed Assets (100 5-3 Total
million yuan) Country by Status of Registration and Region
Index Source
2 1 . Ratio of Area of Nat

Provincial Area (%) Region
22. Rate of Access to Gas (%) 10-14 Level of Public Facilities in
23. Numbers Public Transportation Vehicles 10-14 Level of Public Facilities

per 10,000 persons in Cities (unit)
24. Per Capita Area of Paved Roads (sq. m) 10-14 Level of Public Facilities i
25. Per Capita Green Area (sq. m) 10-14 Level of Public Facilities in
26. Number of Public Toilets per 10,000 persons 10-14 Level of Public Facilities
(unit)
27. Ratio of Staff and Workers in Government 4-10 Number of Staff and Workers at Year-End by
Agencies and Total Population Sector and Region
(person/ 10,000 persons)
28. Ratio of Staff and Workers in Government 4-10 Number of Staff and Workers at Year-End by
Agencies and Total Employed Persons (%) Sector and Region
29. Ratio of Government Consumption and 2-23 Final Consumption Expenditure and Its
Final Consumption (%) Composition by Region
30. Ratio of Government Expenditures and 7-8 Government Expenditure by Region
GDP (%)
3 1 . The Share of Penalty and Confiscatory 7-7 Government Revenue by Region

Income and Income from Administrative
Fees in Total Government Revenue
32. Per Capita Annual Net Income of Rural 9-2 1 Per Capita Net Income of Rural Households
Households (yuan) by Region
33. Per Capita Annual Disposable Income of 9-15 Per Capita Annual Incom
Urban Households (yuan) Households by Sources and Region
34. Engle Coefficient of Rural Households (%) 9-26 Per Capita Consumption Expenditure of
Rural Households by Region
35. Engle Coefficient of Urban Households (%) 9-16 Per Capita Annual Consumption
Expenditure of Urban Households by Region
36. CPI (Preceding Year = 100) 8-5 Consumer Price Indices and Retail Price
Indices by Region
37. GDP Per Capita (yuan) 2-15 Gross Regional Product by Three Strata of
Industry
38. Ratio of Expenditure on Policy- related 7-8 Government Expenditure by Region

Subsidies and Government Expenditure (%)
Note: The data required to compute indexes 1, 5, 6, 7, 8, 13, 14, 15, 27, 28, 30, 31, 34, 35, and 38
are available from the China Statistical Yearbook. The data for the other indexes (except
index 15) are directly available from the China Statistical Yearbook. Because the numbers of
tables vary in the China Statistical Yearbook for different years, we used the 2009 yearbook
as an example and listed the numbers and names of the tables from which the indexes are
drawn. The data for index 15 were drawn from the Procuratorial Yearbook of China.
Notes
1 Kevin Honglin Zhang, "How Does Foreign Direct Investment Affect

Economic Growth in China?," Economics of Transition, Vol. 9, No. 3 (2001),
pp. 679-693; Xiaohui Liu, Peter Burridge, and Paul J. N. Sinclair, "Relation-
ships between Economic Growth, Foreign Direct Investment and Trade:
Evidence from China," Applied Economics , Vol. 34, No. 11 (2002), pp.
1433-1440.
2 Peter J. Buckley, Jeremy Clegg, and Chengqi Wang, "The Impact of Inward
FDI on the Performance of Chinese Manufacturing Firms," Journal of Inter-
national Business Studies , Vol. 33, No. 4 (2002), pp. 637-655; Dongsheng
Zhou, Shaomin Li, and David K. Tse, "The Impact of FDI on the Produc-
tivity of Domestic Firms: The Case of China," International Business Review ,
Vol. 11, No. 4 (2002), pp. 465-484; Yingqi Wei and Xiaming Liu, "Productivity
Spillovers from R&D, Exports and FDI in China's Manufacturing Sector,"
Journal of International Business Studies , Vol. 37, No. 4 (2006), pp. 544-557.
3 Sourafel Girma and Yundan Gong, "FDI, Linkages and the Efficiency of
State-Owned Enterprises in China," Journal of Development Studies , Vol. 44,
No. 5 (2008), pp. 728-749.
4 In the literature, the governance of government is often evaluated based on
several dimensions including the quality and quantity of public goods
provision, the size of the government, national welfare, political freedom,
and the level of government intervention (as a negative factor). Rafael La
Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, "The
Quality of Government," Journal of Law ; Economics , and Organization , Vol.
15, No. 1 (1999), pp. 222-279; Renwu Tang and Tianwei Tang, "Particularity
of Government Efficiency and Its Indexes for Measure," Journal of Beijing
Normal University (Social Science Edition ), No. 2 (2004), pp. 100-106;
Ren-wu Tang and Tian-wen Tang, "The Measurement of Provincial Govern-
ments' Efficiency of China in 2002," Chinese Public Administration , No. 6
(2004), pp. 64-68; Balaguer-Coll, Maria Teresa, Diego Prior, and Emili
Tortosa- Ausina, "On the Determinants of Local Government Performance:
A Two-Stage Nonparametric Approach," European Economic Review , Vol.
51, No. 2 (2007), pp. 425-451.
5 Wayne Sandholtz and Mark M. Gray, "International Integration and
National Corruption," International Organization , Vol. 57, No. 4 (2003), pp.
761-800; Edmund J. Malesky, "Provincial Governance and Foreign Direct
Investment in Vietnam," in Twenty Years of Foreign Investment in Vietnam ,
edited by Pham Tuyet Nga and Nguyen Binh Thuy. Hanoi, Vietnam: Knowl-
edge Publishing House (2010), pp. 147-162; Pablo M. Pinto and Boliang
Zhu, "Fortune or Evil? The Effect of Inward Foreign Direct Investment on
Corruption" (Working paper, Columbia University, 2013).
6 Hubert Brossard, "Importance of Organizations for

During an Investment Decision Process: An Explo
Management International Review , Vol. 38, No. 3 (1
Riddle, Jennifer M. Brinkerhoif, and Tjai M. Nielsen,
Them Home: Public-Sector Innovation for Diaspora
Promotion," Public Administration and Development
pp. 54-66.
7 Christine Oliver, "Sustainable Competitive Advantage: Combining Institu-
tional and Resource-Based Views," Strategic Management Journal , Vol. 18,
No. 9 (1997), pp. 697-713; United Nations Conference on Trade and Devel-
opment (UNCTAD), World Investment Report 1999 (Geneva: UNCTAD,
1999); Chuck C. Y. Kwok and Solomon Tadesse, "The MNC as an Agent of
Change for Host-Country Institutions: FDI and Corruption," Journal of
International Business Studies , Vol. 37, No. 6 (2006), pp. 767-785.
8 For example, the US Foreign Corrupt Practices Act (1977) prohibits US
firms from giving anything of value (such as a payment, gifts, or bribes) to
induce a foreign government to enter into a contract or business advantage
or relationship. Many US MNCs, including Las Vegas Sands, Pfizer,
Walmart, and IBM, have been or are currently under investigation for
possible violations of the Foreign Corrupt Practices Act and may face huge
penalties. Similar legislation, the Convention on Combating Bribery of
Foreign Public Officials in International Business Transactions, was enacted
in 1997 in the global business community. Philip F. Sutherland, "The World
Bank Convention on the Settlement of Investment Disputes," International
and Comparative Law Quarterly , Vol. 28, No. 3 (1979), pp. 367-400; Ingmar
Björkman and Gregory E. Osland, "Multinational Corporations in China:
Responding to Government Pressures," Long Range Planning , Vol. 31, No. 3
(1998), pp. 436-445; Todd Allee and Clint Peinhardt, "Delegating Differ-
ences: Bilateral Investment Treaties and Bargaining over Dispute Resolution
Provisions," International Studies Quarterly , Vol. 54, No. 1 (2010), pp. 1-26.
9 Mari-Liis Sööt and Kadri Rootalu, "Institutional Trust and Opinions of
Corruption," Public Administration and Development , Vol. 32, No. 1 (2012),
pp. 82-95.
10 John Gerring and Strom C. Thacker, "Do Neoliberal Policies Deter Political
Corruption?," International Organization , Vol. 59, No. 1 (2005), pp.
233-254.
1 1 Kwok and Tadesse, "MNC as an Agent of Change."

12 See Note 5.
13 Ethan Gutmann, Losing the New China: A Story of American Commerce,

Desire , and Betrayal (New York: Encounter Books, 2005).
14 Barry Naughton, The Chinese Economy: Transitions and Growth (Cambridge,
MA: MIT Press, 2006).
15 John Henley, Colin Kirkpatrick, and Georgina Wilde, "For

Investment in China: Recent Trends and Current Policy Issu
Economy , Vol. 22, No. 2 (1999), pp. 223-243.
16 Björkman and Osland, "Multinational Corporations in China"; N
Chinese Economy.
17 In some cases, the Chinese government rewarded MNCs that w
to follow the special requests such as condemning the campaigns
ties of human right groups and religious groups, supporting the
Policy, and transferring techniques and related technologies to
Chinese government to monitor its people. Gutmann, Losin
China .
18 Naughton, Chinese Economy.

19 A new form of bribery is that some MNCs, using their political and
economic influences in home countries, offer foreign citizenship to Chinese
government officials, arrange and financially support foreign education for
children of Chinese government officials, or arrange free luxurious tours
(domestic and abroad) disguised as business or conference trips for Chinese
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34 Due to the lack of soft indicator data, the subjectiv
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48 Roodman, "How to Do xtabond2."
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The Impact of Foreign Direct Investment On China

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The Impact of Foreign Direct Investment On China

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The Impact of Foreign Direct Investment on Public Governance and Corruption in China

Author(s): Ming-Hsuan Lee and Mon-Chi Lio

The Impact of Foreign Direct Investment on

Ming-Hsuan Lee and Mon-Chi Lio

The impact of foreign direct investment (FDI) on the performance of

Ming-Hsuan LEE is an assistant professor at the Department of Political

Mon-Chi LIO is professor in the Department of Political Economy, National Sun

of the perceivers background and factors such as nationality,

use of China's cheap labor and have more recently

2. Public Governance and Corruption in C

Unlike most other transitional economies, China underwent major

remains a one-party autocracy. Successful economic reform a

Furthermore, the numerous opportunities for r

Table 1: Quality/Efficiency of the Chinese Government

1998 6.80 5.63 5.13 5.35 1.77 2.67 6.55 5.29

1999 6.96 5.23 4.90 6.43 1.33 1.89 5.91 4.87

2000 7.04 5.03 5.28 6.31 1.60 2.22 6.20 4.92

2001 6.91 4.89 4.64 6.11 2.09 2.26 5.52 3.69

2002 6.46 5.31 4.85 4.69 2.90 2.56 5.60 4.32

2003 6.20 5.17 4.65 4.84 2.88 2.42 4.99 4.68

2004 6.50 5.30 4.50 4.15 1.57 1.17 5.54 6.69

2005 6.40 4.81 4.26 4.38 1.94 1.45 5.19 6.53

2006 6.94 5.41 5.33 5.18 2.82 2.24 6.20 6.51

2007 6.96 6.35 5.44 5.46 3.00 1.69 6.46 7.06

2008 5.56 5.08 4.93 4.64 2.88 2.08 4.91 5.30

2009 5.85 5.71 4.52 3.10 1.60 1.23 3.91 5.33

2010 6.17 6.04 4.55 3.27 2.06 1.61 4.68 5.13

Source: IMD World Competitiveness Yearbook.

Note: The scores range from 0 to 10: 0 indica

As a result, the diverse and com

Table 2: Foreign Direct Investment Actually Utilized by Countries

1998 FDI 2000 FDI 2005 FDI 2009 FDI

Total 4,546,275 Total 4,071,481 Total 6,032,459 Total 9,003,267

Hong 1,850,836 Hong 1,549,998 Hong 1,794,879 Hong 4,607,547

United 389,844 Virgin 383,289 Japan 652,977 Japan 410,497

Singapore 340,397 Japan 291,585 Republic of 516,834 Singapore 360,484

Japan 340,036 Taiwan 229,658 United 306,123 Republic 270,007

Taiwan 291,521 Singapore 217,220 Singapore 220,432 Cayman 258,189

Republic of 180,320 Republic of 148,961 Taiwan 215,171 United 255,499

United 117,486 United 116,405 Cayman 194,754 Samoan 202,003

3. Measurement of Governance Performance and the Level of

We estimate the impact of foreign direct investment on government

governance.33 The 38 social and economic indexes, which are

Table 3: Government Efficiency Indexes

1 . Per Capita Government Budge

and technology, 6. Student-Teacher Ratio of Secondary Schoo

13. Three Accidents (Traffic Accid

18. Number of Careers Service at the end of

services 19. Number of Urban

Social 20. Tot

Government 23. Numbers Public Transportation Vehicles per 10,000

City infrastructure 24. Per Capita Area of Paved

25. Per Capita Green Area (sq. m)

26. Number of Public Toilets per 1

28. Ratio of Staff and Workers in Government

Government 29. Ratio of Government Consumption and Final

National 34. Engle Coefficient of Rural Households (%)

welfare 35. Engle Coefficient of Urban Households (%)

36. CPI (preceding year = 100)

37. GDP per capita (yuan)

38. Ratio of Expenditure o

Note: The indexes in italics are inverse cr

We compute the standard

#L 1.846* 0.684* 0.699***