FDI location choice: Agglomeration vs institutions

Abstract

Using an extensive data set on foreign invested enterprises in China from US, EU, Japan and Korea, we explore the role of agglomeration economies (network externalities) and government institutions as well as other more traditional factors in determining the (regional) locational choice of foreign direct investment (FDI). Employing firm-level discrete choice model, we find that provinces with stronger public institutions and higher horizontal and vertical agglomerations tend to attract more foreign investments. Furthermore, we explore the interplay of institutions and agglomeration economies. We detect that foreign horizontal agglomeration can partially overcome the negative impact of weak institutions on FDI entry. However, we obtain mixed evidence regarding the interplay between institutions and domestic horizontal agglomeration or vertical agglomeration. Copyright © 2007 John Wiley & Sons, Ltd.