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The Economic Determinants of Chinese FDI to AfricaName: Tianwen HuanDepartment: Economic Development and Policies Kobe UniversitySummaryForeign direct investment (FDI) has become an increasingly popular topic in recent decades and China, as a new major emerging investor, has drawn more and more attention among world economies. As Chinese foreign direct investment has played a very important role in economic activities in Africa, this paper empirically analyzes the economic determinants of Chinese FDI to 37 African countries from to . This paper first measures exchange rate volatility using the GARCH (1,1) model. Then, all the variables presented in current US$ were adjusted by using the US GDP deflator in units of one million dollars. As the argument about the unit root test for panel data, two interpretative models are used in the final calculation to analyze the relationship between variables and Chinese FDI to Africa.The results, which illustrate how Chinese FDI to Africa is driven by characteristics of the host countries, can be summarized as follows:First, GDP can be seen as one of the most important considerations to attract Chinese FDI to Africa, which means African countries with a larger market size normally receive more Chinese FDI. In addition, Chinese investment to Africa is empirically generated as a supplementary part to Chinese exports to Africa. Interestingly, if the amount of imports from China to a single country grows too quickly, Chinese OFDI decreases to that country. Second, another determinant of Chinese OFDI to Africa can be explained by the phenomena of resource seeking. In this paper, fuel exports are used as a proxy for resource seeking. The result shows that Chinese OFDI is attracted to countries with larger energy resources. Finally, this paper finds that the relationship between macroeconomic instability and Chinese OFDI to Africa is insignificant. However, countries with a lower exchange rate attract more Chinese OFDI than countries with higher exchange rate.ContentsAbstract11. Introduction12. Literature Review32.1 Market-seeking and FDI32.2 Resource-seeking and FDI42.3 Risk Aversion and FDI52.4 Measure of Exchange Rate Volatility62.5 Summary73. Empirical Model and Data103.1 Interpretative Model103.2 Expected Results124. Methodology and Econometric Specification144.1 Econometric Methodology: Fixed Effects Panel Data154.2 Exchange Rate Volatility Estimations155. Empirical Analyses196. Conclusion216.1 Research Conclusion216.2 Research Evaluation22References24Appendix 128Appendix 231Acknowledgements33The Economic Determinants of Chinese FDI to AfricaAbstract: Foreign direct investment (FDI) has become an increasingly popular topic in recent decades and China, as a new major emerging investor, has drawn more and more attention among world economies. As Chinese foreign direct investment has played a very important role in economic activities in Africa, this paper empirically analyzes the economic determinants of Chinese FDI to 37 African countries from to . This paper first measures exchange rate volatility, stemming from the exchange rate, as one of the determinants by using the GARCH (1,1) model. The results of this study showed the fact that big market size, imports from China, abundant energy resources and low exchange rate of the host country would attract Chinese FDI. However, a too speedy growth of imports from China would decrease the FDI flowing into African economies.Keywords: Chinese FDI; Africa; Economic determinants; GARCH1. IntroductionAccording to Ruiza and Pozob (), foreign direct investment (FDI) has become an increasingly important engine to foster growth and economic development in developing countries. Because of the long-term nature, FDI is seen as being less susceptible to a crisis and has the potential to increase productivity via generating employment opportunities and transferring skills and technology. On the other hand, Nourbakhshian et al. () point out that home countries are hoping to push FDI into developing countries using guarantee funds and match marketing. In comparison to other types of capital inflows, these foreign direct investment benefits have made it an attractive economic development strategy in many developing countries.Among these developing countries, China is a rising economic power. And its economy and its relationship with other countries become more and more arresting. Sanfilippo () shows that Chinas vigorous growth over the past decades has now developed to a new stage. Official analysis in the most recent years show that, China is no longer only participated in the world economy as one of the largest recipients of foreign direct investment, but also regarded as a major source of foreign direct investment among developing countries. UNCTAD () points out that China became the worlds third largest investor in for the first time ever, right after the United States and Japan.The developing countries seem to account for a large percent of the recipients of Chinese FDI. Africa, as the only region that saw foreign direct investment flows rising in , is part of the developing countries receiving large inflows from China. In reviewing Chinese FDI to Africa from to , the amount of FDI increased along a smooth trajectory except for dramatic peak value in (Figure 1). This unusual peak value may be ascribed to a Chinas African policy document published in . In the following two years after , the amount of capital flow then returned to a normal state. Though the flow of FDI grows year-by-year, not much is known about the key factors driving the decisions of Chinese capital outflows to invest abroad. As the official data for different countries provided by the Chinese government only started from , there is little research that empirically analyzes the economic pattern of Chinese FDI to Africa. This paper tries to clarify the picture, and analyzes the determinants of Chinese FDI to 37 African countries using official data supplied by the Chinese Ministry of Commerce. Figure 1: Chinese OFDI to Africa (real US$million, ).Source: Authors elaboration on China Statistical Yearbook and MOFCOM (). This paper is organized as follows. Section 2 presents a review of the literature. Section 3 introduces the data and the interpretative mode. The methodology and estimation procedures are explained in Section 4. The results of the empirical analyses are explained in Section 5 and followed by conclusions in Section 6.2. Literature ReviewMore and more research has been conducted on FDI. Looking through the economic literature on FDI, studies mainly focus on the determinants of FDI and the relationship between FDI and specific countries economic growth. The research related to this paper can be classified in four parts: the determinants of FDI to Africa, the research about Chinese outward foreign direct investment (OFDI), the literature about Chinese FDI to Africa and the relationship between exchange rate volatility and FDI (see Appendix 1 for the details). In reviewing the four different parts of literature, Sanfilippo () notes that the determinants of FDI could be attributed to three main aspects: the aim of market seeking, the purpose of resource seeking and the avoidance of risk. 2.1 Market-seeking and FDIAs mentioned above, for both Chinese OFDI and FDI to Africa, one main motivation is market searching. The market size of the receiving country is always used as an indicator to examine the relationship between market seeking and FDI, and the currency influence between the two countries can clearly measure the framework of Chinese investment in Africa.Most of the empirical studies analyzed the market size as one of the most important determinants of FDI using data on specific countries. The empirical evidence from BendeNabende () suggests that market size (GDP and GDP growth) is a long-run determinant of FDI in Sub-Saharan Africa. Asiedu () then analyzed the relationship between market size and FDI in 22 countries in Sub-Saharan Africa by using data from 1984 to , and her empirical result showed that there exists a positive and significant correlation between the market size and the amount of FDI. Later, in , Biggeri and Sanfilippo () empirically explored the determinants of Sino-African relations by using the panel data set over the period 1998-, for 43 African countries. At the end of this paper, the authors found that the relationship between market size and FDI is negative but insignificant. As the topic became more popular, two other papers about the determinants of Chinese FDI and Africa FDI were published. Both pieces of researches showed that market size have a significant positive effect on FDI. Based on data from 61 countries that accounted for 97% of Chinas total OFDI stock from 1993 to , Chou, Chen and Mai () point out that larger market size has remarkable benefits to Chinas OFDI. According to Claassen, Loots and Bezuidenhout (), market size is in fact important factor demonstrating that Chinese investment is not solely resource-driven, but also market seeking. In addition, Sanfilippo () notes that because of low costs and huge potential, China considers some African countries as a good potential market. In terms of other elements than market size, some other scholars including Chinese scholars also surveyed the relationship between imports from China and FDI. Alon, Molodtsova and Zhang () have presented evidence by using panel data on Chinese outward foreign direct investment during -. The estimates from this article suggest that a 0.15% change in Chinese OFDI would result in a 1% change in imports from China. But Chou, Chen and Mai () point out that two opposite viewpoints exist in literature, substitution and supplementary relations between OFDI and exports, with each standpoint supported by several empirical researches. Buckley et al. (), Morck et al. () and Wu et al. () have found a positive correlation between OFDI and exports, meaning that the relationship between Chinas OFDI and exports are supplementary. On the contrary, the works of Vernon (1966), Blonigen () and Swenson () show an inverse correlation between exports and Chinas OFDI, which means that the relations are substitution. 2.2 Resource-seeking and FDIAccording to the literature on China-Africa relations, one of the main motivations that drive Chinese investment into the continent is the need for a security in acquiring natural resources. Following market size, the second aspect of determinants of FDI is the natural resource endowments of the recipient country. The natural resource endowments used by these studies focus on the quantity of oil or fuel produced by each country.The pioneering work of Biggeri and Sanfilippo () pointed out that Chinese FDI inflow into Africa is driven by pull factors, such as the oil and agriculture endowments of the host countries. Then Sanfilippo () empirically investigated the determinants of Chinese OFDI in 41 African countries from 1998 to , and the analysis empirically support that Chinese FDI to Africa is driven in part by natural resources endowments. One year later, another paper supported the positive and significant relationship between resource seeking and Chinese FDI to Africa. Claassen, Loots and Bezuidenhout () state that oil and natural resource abundance is a very important determinant of Chinese FDI in Africa. 2.3 Risk Aversion and FDIAnother group of variables, exchange rates and economic risk are used to estimate a countrys instability. Regarding risk aversion, the normal assumption is that a high level of instability will usually lead to a decreasing investment in FDI. And the inclusion of the exchange rates is important in order to observe if a low currency value in the recipient countrys real exchange rate attracts FDI inflows into these economies.BendeNabende () first noted that besides the market growth and market size, real exchange rates is also one of the most dominant determinants of FDI in Sub-Saharan Africa. And the empirical evidence of the work of Alon, Molodtsova and Zhang () suggests that a change in the Chinese exchange rate can have an effect on outward FDI, demonstrated with the pooled data and in the interaction terms. Specifically, an appreciation of Chinese currency against the currency of other country has a positive effect on outward foreign direct investment from China. Exports coupled with the interaction term of an exchange-rate appreciation will have a negative effect on outward FDI.Besides, the exchange rate is also the variable that is used to calculate the exchange rate volatility. A lot of literatures have used exchange rate volatility to represent the economic risk, and most of them use it together with exchange rate to analyze the possibility of being the determinants of FDI. For example, Chowdhury and Wheeler () empirically checked both variables, and the result showed that innovations to exchange rate volatility explain significant portions of the forecast error variance in FDI at longer time horizons in Canada, Japan, and the United States. But the relationship between exchange rate and FDI is insignificant. One year later, Schmidt and Broll () found out that real exchange-rate risk has a statistically significant negative effect on US outward FDI flows for the majority of industries. And the significant effect affected by exchange rate is by contrast positive. After then, Lin, Chen and Rau () published a literature with the similar result that an appreciation of the exchange rate has a positive effect on foreign direct investment, based on firm-level data on the entry by Taiwanese firms into China over the period from 1987 to . But Lin, Chen and Rau () also reveal that the relationship between exchange rate volatility and FDI depends primarily on the intention of the investing firms, which means that a market-seeking FDI prefers to increase the exposure of the firms profits to exchange rate risk, while an export-substituting FDI would avoid the risk. As the analyses of exchange rate always have different results, Solomon and Ruiz () show that the exchange rate has a negative sign but is statistically insignificant. By using data on African, Asian, and Latin American economies, their work also investigated the role of exchange rate volatilitystemming from the exchange rate marketas one of the determinant of the patterns of FDI. The result of this study shows the fact that the exchange rate volatility reduces FDI. 2.4 Measure of Exchange Rate VolatilityExchange rate volatility is usually used to evaluate the fluctuations of exchange rate. Abdalla and Suliman () note that changes of exchange rate always have a normal distribution is a basic assumption for volatility, which draws a picture of the range that exchange rate changes during a given period. As an unobservable variable, the calculation of this variable is a question of serious contention. The literature has not given the answer to which method is most appropriate. However, the generalized autoregressive conditional heteroscedasticity (GARCH) model developed by Bollerslev (1986) seems increasingly adopted by many recent literatures.Before the adoption of GARCH, standard deviation of exchange rate had usually been used to measure the exchange rate volatility. To overcome the shortage of the constant one-period forecast variance, Engle (1982) proposed the autoregressive conditional heteroscedastic (ARCH) processes with no constant variances conditional on the past. To allow for a much more flexible lag structure, Bollerslev (1986) introduced a new, more general class of processes, GARCH, which since then has been widely used to calculate the volatility. Martens () uses GARCH (1,1) model to forecast daily exchange rate. Brooks and Persand () apply a GARCH model in risk management as well to make a better financial decision. In addition to these papers, Choo () pointed out that GARCH model was extended in the usage of volatility forecasting in futures market. According to the wide usage of GARCH model in studies, this paper will choose the GARCH (1,1) model to measure the exchange rate volatility. 2.5 SummaryIn conclusion, among these literature reviews, the most dominant determinants of Chinese outside FDI would be market size, imports from China, resources, exchange rate and economic risk. Drawing from the existing papers, the most probable outcome of the relationship between these variables and foreign direct investment is significantly positive except the last one, which should have a negative effect on the foreign direct investment. Usually, when the recipient country has a better GDP or a higher GDP growth, this country will have more chances and a better future for investments. So the normal assumption for market size is that a bigger economical market would attract more foreign direct investment. And most statistical results have shown that the countries that received more imports from China would have more foreign investment from China. This can be attributed to an appreciation of supplementary investment than the substituting investment. Except the market seeking variables, resource seeking is another popular variable being checked for Chinese outside foreign direct investment. According to the scholars, China would like to invest in those countries that have abundant resources, especially oil. One reason for such a motivation is to guarantee the enough energy supply. Another reason seems a little bit like a conspiracy buff, which indicates that Chinese investment in African oil countries, on account of the government policy, aims at securing access to natural resources. Identifying with the reasons above, the literatures always point out a positive relationship between the resource seeking and Chinese foreign direct investment. Another group of variables mostly used to estimate the economic stability is the exchange rate and exchange rate volatility. According to former literatures, the recipient country with lower exchange rate will of course cost less for investment. Because, the capital-exporting countries could exchange more currency in a country with low exchange rate than another country with high exchange rate with the same amount of money. As exchange rate volatility is calculated from exchange rates, most literatures would like to analyze the two variables together. But in contrast to the positive effect of exchange rate, exchange rate volatility always has been empirically indicated to have a significant negative relationship with foreign direct investment, which means the source countries prefer to invest in countries that face lower economic risk.Table 1 presents the effects of the six variables that have been widely researched in the literature. It is clear that the results are conflicting. The aim of this research is not to resolve the conflicting results. Instead, this paper will examine the extent to which the variables included in FDI for my theoretical model are significant and analyze whether these variables have a different impact on Chinese outward FDI to Africa than the previous literature.TABLE 1 Effect of selected variables on FDIDeterminants of FDIPositiveNegativeInsignificantGDPBendeNabende ()Asiedu ()Sanfilippo ()Chou, Chen and Mai ()Claassen, Loots and Bezuidenhout ()Biggeri and Sanfilippo ()GDP growthChou, Chen and Mai ()Claassen, Loots and Bezuidenhout ()Imports from China Alon, Molodtsova and Zhang ()FuelBiggeri and Sanfilippo () Sanfilippo ()Claassen, Loots and Bezuidenhout ()Exchange rateBendeNabende ()Schmidt and Broll ()Lin, Chen and Rau ()Alon, Molodtsova and Zhang ()Chowdhury and Wheeler ()Solomon an