Monash University
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The composition of Foreign Investment in China and the Governance Environment

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journal contribution
posted on 2017-06-05, 01:37 authored by Fausten, Dietrich K., Lake, James
The paper explores, in the specific context of China, the influence of the financial dimension of the "governance environment" on the composition of foreign investment. The hypothesis that the preferred form or mode of foreign investment is influenced by the state of financial development of the host country suggests that foreign investment in China should consist predominantly of FDI during the initial phase of China's transformation, followed by an increasing share of FPI as financial development deepens and governance arrangements become increasingly transparent and reliable. A corollary of this conjecture is that the secular evolution of the composition of foreign investment may shed some indirect, but important, light on the progress of financial development in China and on the perceived "quality" of her govemance regime. These conjectures are loosely supported by our findings. The progress of reforms in China has been effective in buttressing confidence of international investors sufficiently to maintain a substantial flow of foreign investment into China, the Asian Crisis notwithstanding. However, the continuing dominance of FDI and the absence of significant FPI growth against the backdrop of financial sector reforms suggest that international investors regard those reforms as inadequate. Financial reforms have failed to improve the governance environment sufficiently to establish investor confidence in the efficacy of domestic markets, specifically in the financial sector.


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Department of Economics.

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