Economic Fragmentation and FDI in China

China is one of the most popular investment destinations in the world. This paper argues that FDI inflows into China are in fact driven by some fundamental inefficiencies in the Chinese economy. Specifically, one of the inefficiencies has to do with a high level of fragmentation of both goods and asset markets. This fragmentation increases demand for FDI both because market fragmentation makes indigenous Chinese firms uncompetitive and because market fragmentation creates more investment opportunities for the mobile foreign capital. This paper is a chapter from a larger book-length research project, tentatively entitled, Selling China: The Institutional Foundation of Foreign Direct Investment During the Reform Era