Dynamic Relationship between China’s IFDI and OFDI

The previous chapter examines the underlying motivations and the locational determinants of China’s outward FDI (OFDI). Like the majority of existing empirical studies on China’s OFDI, the previous chapter focuses on the effects of host country characteristics in a static framework.1 This chapter extends the discussion and analysis made in the previous chapter to examine the adjustment of China’s OFDI in a dynamic framework. In a related study, Cheng and Kwan (2000) identify the determinants of China’s inward FDI (IFDI) stock, using a partial stock adjustment model to examine the dynamic adjustment process of IFDI across the Chinese provinces. Cheng and Kwan (2000) and Campos and Kinoshita (2003) argue that the existing IFDI stock has ‘positive feedback’ on future investment, triggering the adjustment towards a long-term equilibrium stock. In other words, the partial stock adjustment model is in line with self-perpetuating growth or natural growth. It can be reflected by the lagged IFDI stock as the lagged dependent variable. Thus, the partial stock adjustment model is naturally fitted in a dynamic framework, just like any other standard partial adjustment model. The partial stock adjustment model addresses several issues that cannot be explained in a static framework. For example, this model exclusively integrates with an adjustment process, implying that IFDI stock is adjusted gradually towards its long-term equilibrium level because of cost convexity.