Host-Location Financial Development and Foreign Direct Investment : City-Level Evidence from China

This paper examines the effect of host-location financial development (HFD) on foreign direct investment (FDI) in 166 Chinese cities between 2003 and 2009. Using pooled panel and generalized two-stage least square estimators, we find a complementary HFD-FDI nexus, and that this is particularly prominent in interior and smaller cities. Our results remain robust to different ways to measure HFD and FDI and suggest an external-finance effect, whereby strong HFD enables risk-sharing between foreign subsidiaries and local partners. Based on our findings, we suggest that local officials seeking to increase FDI should prioritize the development of soft determinants and that improving the efficiency of the financial system is a worthwhile initial step to take in pursuit of this objective