A causality analysis of the FDI‐wages‐productivity nexus in China
| Date | 09 February 2010 |
| Published date | 09 February 2010 |
| Pages | 5-23 |
| DOI | https://doi.org/10.1108/17544401011016654 |
| Author | Bala Ramasamy,Matthew Yeung |
| Subject Matter | Economics |
Analysis of the
FDI-wages-
productivity nexus
5
Journal of Chinese Economic and
Foreign Trade Studies
Vol. 3 No. 1, 2010
pp. 5-23
#Emerald Group Publishing Limited
1754-4408
DOI 10.1108/17544401011016654
A causality analysis of the
FDI-wages-productivity
nexus in China
Bala Ramasamy
China Europe International Business School,
Shanghai, People’s Republic of China, and
Matthew Yeung
Lee Shau Kee School of Business and Administration, The Open University of
Hong Kong, Hong Kong SAR, People’s Republic of China
Abstract
Purpose – The purpose of this paper is to examine the relationships between foreign direct
investment (FDI), wages and productivity in China. The direction of causality among these variables
is also to be emphasized.
Design/methodology/approach – The authors develop a system of equations and test the
relationships based on a vector autoregressive regression (VAR) model and two-step generalized
method of moments (GMM)-type estimation approach. They use a panel data set of China’s provinces
for a 20-year time period, 1988-2007, and also distinguish between the coastal and inland provinces.
Findings – The resultconfirms the cheap labor argument for China,although this particularly true for
inland provinces. In the coastalprovinces, FDI inflow influencesthe wage rates upwards. FDIalso has a
positive effect on productivity, particularly in the coastal provinces, but does not act as a significant
determinant of FDI.
Research limitations/implications– Factors other than wage rates and labor productivity are also
important determinants of FDI. This paper focuses on the interplay of these three variables, while
assuming other factors constant.
Practical implications – Cheap labor asan attraction of FDI is a short term policy. Improvementsin
productivity should be the focus both in the coastal and the inland provinces. A conducive business
environment, a suitable education policy and incentives for greater R&D contribute toward improving
labor productivity, which in turn attracts greater FDI inflow.
Originality/value – The paper providesempirical evidence on the directionof causality between FDI
inflow, wages rates and labor productivity in one system of equations.
Keywords China, International investments, Productivity rate, Pay structures
Paper type Research paper
1. Introduction
Between 2005 and 2007, about 28 percent of global foreign direct investment (FDI)
inflows went to the developing world. In 2006, China received USD 69 billion or 5.3
percent of global FDI inflow (UNCTAD, 2007). China’s position as the largest recipient
among developing countries has continued since the early 1990s, and thus it is not
surprising that literature that deals with FDI in China has inked most economic and
business journals worldwide.
In this paper, we consider the role of wages and productivity as determinants of
FDI, and further evaluate the impact of FDI inflows on these two variables. Like many
other developing countries, China’s comparative advantage in the international market
is anchored in its cheap labor force (Beijing Review, 2006), allowing it to attract large
amounts of efficiency seeking FDI and earning the title, ‘‘the world’s factory floor’’
(Baglole, 2004). Recent reports however show this advantage being lost to countries
like Vietnam and India. Nike, for instance, expanded four production lines in Viet nam,
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rather than in its Guangdong based affiliate (China Daily, 2005). The Economist (2005)
reported a tight labor market for both manual and skilled workers in China. D oes the
cheap labor argument still hold for China? Alternatively, has increasing FDI pushed
wages up and become detrimental to attracting further foreign investment?
Although government policies favoring FDI is intended to create jobs, the more
important long term objective is the spillover argument. Particularly for developing
countries, FDI brings with it a package comprising not only capital, but also
management know-how, new technology and the foundations for research and
development (R&D). Through the interaction between foreign and domestic firms,
technology is transferred (Wang and Blomstrom, 1992), thus allowing local firms to
build their own competencies. An important result of the transfer and lear ningof suc h
competencies is an increase in productivity. In the case of China particularly, to what
extent has the inflow of FDI improved levels of productivity? On the other hand,
having received foreign know-how since the early 1980s, can growth in productivity be
an important FDI determinant for China?
In this paper, we address these questions by considering the nexus between FDI,
wages and productivity.We depart from previous work in this area by:
.considering all three variables in a system of equations; and
.not assuming the direction of causality between these variables.
In particular, we use a dynamic panel data comprising of variables at China’s
provincial level between 1988 and 2007; and employ Granger causality tests to
determine directions of causality.
2. FDI, wages and productivity in China: spatial differences
China offers an interesting case for the study of the relationship between FDI inflow,
wage rates and labor productivity, not only due to its massive annual FDI inflows, but
also due to the spatial variance that exist across the country (Coughlin and Segev, 2000;
Bao et al., 2002). Figure 1 shows the distribution of FDI stock from 1985 to 2007 across
China’s provinces. The map clearly shows the uneven spread of FDI. Seven top
provinces – Guangdong, Jiangsu, Fujian, Shanghai, Shandong, Liaoning and Beijing
account for about 75 percent of FDI stock while seven bottom provinces – Ningxia,
Xinjiang, Guizhou, Gansu, Inner Mongolia, Yunnan and Shanxi account for a little
more than 1 percent. A clear distinction between these provinces is geog raphy – the
former provinces are coastal and cities opened to foreign investment since the
beginning of economic reforms; the latter are inland provinces.
Figure 2 shows the variation in nominal wage rates (averaged for the years 2000-
2007) across China’s provinces. Note the obvious similarities and differences between
Figures 1 and 2. Coastal provinces that are able to attract large amounts of FDI tend to
have higher average wages. Interestingly, the western-most provinces, which are at the
first quartile in terms of FDI stock, tend to have relatively high wage rates. Could these
high relative wages be a deterrent to greater FDI inflow? We address this issue later in
the paper.
As for labor productivity,Figu re 3 shows that productivity per laboris higher along
the coast and eastern provinces compared to provinces in the middle and western
areas. Visual observation shows a stronger relationship between FDI and productivity,
rather than FDI and wage rates. These relationships are the focus of our analysis.
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