When does FDI matter? The roles of local institutions and ethnic origins of FDI

Abstract

How foreign direct investment (FDI) affects a host environment is a much discussed yet less understood topic of salience for international business managers, policy makers and researchers. Using panel data from 287 Chinese cities over the period 1999-2005, our study assesses (1) the multiple impacts of FDI in both positive and negative domains, (2) the role of local institutional development in moderating these impacts, and (3) whether the moderating effects of institutions differ depending upon the origins of the incoming investment (ethnic- versus non-ethnic-linked). Our analysis shows that indeed, FDI is a double-edged sword: it enhances the host city's economic growth, labor productivity and innovation but it also causes employment reduction and pollution in host cities. Moreover, the host city's institutional development is found to enhance the positive impacts of FDI and reduce its negative ones. Interestingly, the moderating effect is smaller for ethnic-linked FDI than for non-ethnic-linked FDI. As the first comprehensive attempt to unravel the role of institutional development in moderating the ambiguous impacts of FDI in multiple domains, this study confirms that a host's ability to absorb the benefits of FDI while curtailing its associated costs is both plausible and pivotal. As our world becomes flatter and FDI more entrenched in a host's economic and social development, this study provides important implications. © 2012 Elsevier Ltd. All rights reserved.