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| Can Local Financial Development Affect the Location Selection of FDI？A Quasi-natural Experiment Based on City Commercial Banks |
| LYU Chaofeng, MAO Xia
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| School of Economics, Southwestern University of Finance and Economics |
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Abstract Foreign direct investment (FDI) that involves advanced technologies plays an important role in the global diffusion of technology and can contribute to the rapid development of the host country's economy. Vigorously promoting FDI is an important strategic decision for developing countries and regions, as it can enhance their core competitiveness in technology. The financing constraints that multinational companies may face in a host country's financial market are an important factor in their investment decisions. Most studies of FDI location selection focus on a certain country or province, and discuss the differences in the infrastructures of potential host countries. Few studies have examined the impact of local financial institutions, especially the structure of the banking industry, on FDI at the city level. Since its reform and opening up policy in 1978, the Chinese government has implemented a series of financial system reforms aimed at reducing friction in financial markets and alleviating the huge financing constraints faced by enterprises. This study uses a sample of city commercial banks to study the impact of local financial development on FDI location selection. The aim is to create a reference that will improve the regional distribution of FDI and alleviate imbalances in local development in China.
The theoretical analysis shows that establishing city commercial banks can attract FDI through two channels: directly, by expanding the external financing channels of the enterprise; and indirectly, by supporting the city's overall economic development. Accordingly, we collect the data on 295 prefecture-level cities in China and 184 city commercial banks established between 1990 and 2015. We take the differences in the establishment dates of city commercial banks in different regions as a “quasi-natural experiment” and use the difference-in-differences (DID) method to study the relation between local financial development and FDI location selection. In addition, we combine these data with data on Chinese industrial enterprises from the 1998 to 2008 period to help understand the mechanism underlying this relation.
The results suggest that the establishment of city commercial banks significantly promotes FDI inflows. This conclusion remains robust after a series of robustness analyses, such as changing the statistical level, excluding outliers, placebo tests, and verification with regional and endogenous analyses using propensity score matching. Using data from Chinese industrial enterprises, we confirm that the establishment of city commercial banks eases corporate financing constraints by improving the likelihood of local enterprises obtaining loans from banks, which in turn affects the location of FDI. Therefore, local small and medium-sized financial institutions and private financial enterprises should be encouraged and supported. Local governments should pay attention to the development of urban financial institutions while also improving the regional infrastructure. Further analysis of the merger and expansion of city commercial banks shows that the expansion of city commercial banks' business scale has no noticeable effect on FDI inflows to the territories or other cities. However, the positive effect of capital scale expansion is obvious. In other words, a reasonable financial structure is more attractive to FDI than a blind expansion in the number of local financial institutions, which also proves that the position of city commercial banks in the banking structure inevitably affects the location choice of FDI.
Our contributions can be summarized as follows. First, we take urban commercial banks as the specific object of financial development and focus on the impact of local financial development on regional FDI inflows. We use the DID method to largely overcome the endogenous problem. Second, we comprehensively analyze the impact of the scale expansion behavior of city commercial banks on FDI inflows from a macro perspective, enriching the single micro-financial perspective adopted in previous studies, and provide a new theoretical basis for evaluating policies on city commercial bank operations and the adjustment of the banking industry structure. Third, we confirm that corporate financing constraints hinder foreign investment, which suggests that local governments could alleviate regional development imbalances by further leveraging the advantages of local financial institutions, and thus improving service efficiency, expanding foreign capital markets, and introducing advanced technologies.
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Received: 31 October 2018
Published: 30 March 2020
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