The Effect of Financial Sector Development on FDI led Growth in China

Abstract: Over the past several decades developing countries have attracted and relied on Foreign Direct Investment (FDI) to supply their economies with the investment needed to maintain high economic growth and development. In their pursuit of FDI, many developing countries have passed policies and regulations aimed at attracting inward FDI. Because of the high growth rates and high returns on investment in many of these economies they have experience a large increase in FDI inflow over the past few decades. As these economies have grown and investment has increased, the financial services sector in the developing world has grown to service the increased demand. In 2011 the World Bank and IMF’s Financial Sector Assessment Program on China found that between 2005 and 2010 total bank assets had grown nearly 19%, while the total assets of non-bank financial institutions had grown 35.1% from 2007 to 2010 (World Bank and IMF Financial Sector Assessment Program, 2011, p.25 & 27). With this massive growth in the financial services sector it is important to understand the effects of financial sector development on FDI’s relationship to economic growth in host countries. Keeping this in mind, as policy makers continue to attract FDI it is imperative they know not only its effects on growth but what policies they can enact at a provincial level to maximize positive effects. This study uses both national and provincial level data to assess the effects of financial sector development on FDI’s relationship to economic growth. While the scholarly literature on FDI is fairly well established, literature focusing specifically on financial sector development’s effect on FDI’s and growth is less robust. Many studies such as Carkovic and Levine (2002) find that the effect of FDI interacted with financial sector development on growth to be positive, but not robust. My research utilizes variation in financial sector development between provinces in China to determine the effect financial sector development has on FDI led growth