FDI,Foreign trade

and economic
growth
An empirical study on foreign direct investment, foreign trade and economic
growth in 30 Chinese provinces from 2001 to 2020

BACHELOR THESIS WITHIN: Economics

NUMBER OF CREDITS: 15 ECTS
PROGRAMME OF STUDY: International Economics
AUTHOR: Weiyun Wang & Manru Wang
JÖNKÖPING: December 2021
Bachelor Thesis in Economics

Title: FDI, Foreign trade and economic growth in China

Authors: Weiyun Wang and Manru Wang

Tutor: Rafael Barros De Rezende

Date: 2021-12-06

Key terms: foreign direct investment, foreign trade, economic growth, China

Abstract

With the acceleration of China's reform and opening-up, and the expansion of foreign trade,
foreign direct investment (FDI) and foreign trade have become the main force driving China's
regional economic growth. This paper studies the impact of FDI and foreign trade on economic
development. By using the panel data model, the data of 30 provinces in China from 2001 to
2020 is analyzed, showing that FDI and foreign trade are positively correlated with economic
growth for China. Compared with FDI, foreign trade can promote China's economic
development. In addition, there are apparent differences in the impact of FDI and foreign trade
on economic growth between eastern and middle and western provinces, and the economic
development of China's provinces is uneven. In order to alleviate the unbalanced development,
the Chinese government should: 1. Speed up infrastructure and transportation construction; 2.
Differentiate regional trade policies; 3. Coordinate and strengthen cooperation among the
eastern, middle and western regions.

i
Table of Contents

1. Introduction .........................................................................1
1.1. Literature review ....................................................................................... 2
2. The Institutional Background .............................................4
2.1. Trade ......................................................................................................... 4
2.2. FDI ............................................................................................................. 6
2.3 Economic growth ...................................................................................... 8
3. Theoretical background & Empirical Evidence ............... 11
3.1. The Neoclassical growth model ............................................................. 11
3.2. Heckscher－Ohlin Theory ...................................................................... 12
3.3. Kiyoshi Kojima- Theory of Marginal Industry Expansion ....................... 13
4. Empirical Analysis ............................................................ 15
4.1. Variable Selection and Data Sources .................................................... 15
4.2. Panel data model .................................................................................... 17
4.2.1. Hypothesis .............................................................................................. 17
4.2.2. Stationarity test ....................................................................................... 18
4.2.3. Hausman test .......................................................................................... 19
4.2.4. Result of regression analysis ................................................................. 20
5. Conclusion ........................................................................ 26
5.1. Limitation ................................................................................................. 26
5.2. Recommendation .................................................................................... 27
Reference list ............................................................................... 29
Appendix ...................................................................................... 32
Data of Provincial GDP ........................................................................................ 32
Data of Provincial TRADE ................................................................................... 33
Data of Provincial FDI .......................................................................................... 34
Individual fixed coefficient of variation panel model ........................................... 35

ii
1. Introduction

China is not only the world's second largest consumer market, but also one of the largest
major trading countries. With the rapid development of the market economy, China's
import and export trade has been growing, which has a certain impact on the world
economy. China is one of the fastest growing economies in the world, and the
development of import and export trade generates huge gains for trade targets and creates
favorable conditions for international cross-border investment. Today, China has a pivotal
position in the international arena, so the volume of China's import and export
transactions, the exchange rate of the Chinese Yuan and other various economic patterns
have a certain impact on the world economic landscape. The trend of China's economy,
which is related to the overall development of China, is also related to the stability of the
global economy.

Since the reform and opening up, the Chinese government has vigorously introduced
foreign investment and expanded trade by taking a series of preferential measures. Trade
volume and FDI have been growing year by year. In the context of China's open economy,
economic growth is not only driven by domestic consumption, but also requires more
foreign trade and foreign investment. However, economic growth in each region of China
does not go hand in hand, but there are first and second, strong and weak. China's regional
economies largely show an uneven growth pattern, which seriously restricts its overall
development. This is closely related to the significant differences in the spatial
distribution of FDI and foreign trade. Therefore, it is necessary to make an argumentative
analysis of the data through econometric models to verify how the impact of foreign trade
and FDI on the Chinese economy really is. In this paper, we study two questions: Did
trade and FDI affect GDP developments in China? Were the effects different across
provinces?

This thesis uses FDI, Trade and GDP of 30 provinces in China from 2001 to 2020 as data.
Using Eviews, a panel data model is established based on the results of unit root test and
Hausman test. The relationship between FDI, foreign trade and economic growth in China
is empirically studied. Combining China's actual situation, economic development theory,
and empirical analysis, we provide suggestions for formulating and improving economic
policies in China's current economic situation.2 The results of the analysis show that FDI,

1
foreign trade and economic growth have a positive long-term relationship, and both FDI
and foreign trade promote economic growth, and the economic growth effect of foreign
trade is stronger. In addition, the impact of foreign trade on economic growth in the
eastern region is significantly better than that in the middle and western regions, but the
impact of FDI on economic growth is not significantly different among the three regions.

1.1. Literature review

In exploring economic development, the link between FDI, foreign trade and economic
development is a field of research that has received more attention from contemporary
scholars. There are usually two views on the relation between FDI, foreign trade and
economic development. One view is that FDI and international trade have a positive effect
on a country's economic growth. Dritsaki (2004) argues that foreign trade, FDI and
economic growth in Greece have a long-run equilibrium relationship and that the three
can reinforce each other under an open policy. Nguyen (2020) studied the impact of FDI,
exports, and imports on Vietnam's economy by using the ordinary least square method.
The test confirmed that FDI and international trade are related to Vietnam's economic
growth. FDI and exports positively affect Vietnam's economy.

Another view is that FDI and international trade have a limited impact on the economic
growth of a country. Sharma and Panagiotidis (2005) analyze the relationship between
exports and imports and economic growth in India by taking relevant data of India from
1971 to 2001 through econometric measures such as VAR model and cointegration test.
The results of the empirical analysis show that there is no stable relationship between
import and export trade and economic growth in the long run, and export trade does not
contribute to economic growth in India. Belloumi (2014) conducted a cointegration test
using the ARDL model to study a long-term relationship between economic growth, FDI,
trade openness, labor, and capital investment in Tunisia and used Granger causality to
test whether there is a dynamic causality. The results show that there is a long-run
relationship between these variables and there is no significant Granger causality between
trade and economic growth, FDI, and economic growth. From previous research results,
the relationship between GDP growth and its influencing factors has been found to be
different for different economies and market structures. Therefore ,for China, the
relationship between the three factors still needs to be studied.

2
Kalirajanet.al (2009) analyzed the relationship between exports, FDI and GDP in six
emerging countries and found that the role of exports and FDI on local economic growth
varies significantly across countries. Through the Panel-Data Approach, Tiwari and
Mutascu (2011) empirically analyze the relationship between FDI and economic growth
in 23 Asian countries. The results indicate that FDI and exports promote the economic
development of these Asian countries, and the investment of labor and capital can also
promote the growth trend. These two articles have inspired us to think about the
differences between regions. However, their studies are country-based and do not
examine the differences between regions of a country. Therefore it is of theoretical and
practical importance to study the economic growth factors between regions in China.

The paper is divided into five parts: in the second part, the current situation in China is
analyzed. By introducing the current situation and structural characteristics of FDI,
foreign trade and economic growth in China, the strengths and weaknesses of China in
international trade are analyzed. The third part is the theoretical basis of the relationship
between FDI, foreign trade and economic growth. The theories related to FDI, foreign
trade and economic growth are introduced by analyzing previous studies. In the fourth
part, which is the focus of this study, an empirical analysis of the relationship between
FDI, foreign trade and economic growth for thirty regions in China is provided. Through
the panel data model, the relationship between these three variables is clearly visible in
both macro and micro dimensions. And through the individualized study of 30 provinces,
the differences among provinces are analyzed. In part five the problems in the
development of China's foreign economy are focused on and reasonable countermeasures
are proposed to promote the development and economic progress of China's foreign
economy.

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2. The Institutional Background

2.1. Trade

In December 1978, China and the United States issued the ''Joint Communiqué on the
Establishment of Diplomatic Relations'', and the door to the Western market was
officially opened to China. In the same period, the Third Plenary Session of the 11th
Central Committee was held in Beijing, officially starting the journey of China's reform
and opening up and socialist modernization. On the one hand, China actively responded
to the wave of international industrial transfer and took the initiative to integrate itself
into the world division of labor system; on the other hand, it continued to explore the
establishment of special economic zones, open coastal cities and other "enclave"
economic pilot projects, and carried out institutional reforms such as the responsibility
system of trade contracting and special customs supervision zones. The development of
foreign trade has thus entered a new chapter. In November 2001, China formally joined
the WTO, which is a milestone of China's deep participation in economic globalization
and marks a new historical stage of China's reform and opening-up. During this period,
China actively practiced the concept of free trade, carried out foreign trade policy reform
mainly around its WTO accession commitments, and participated deeply in the global
trading system. China's mega-market has opened its doors wider and wider to the outside
world, and its foreign trade partners have included more than 230 countries and regions.
In 2001, China's total foreign trade amounted to 509.77 billion dollars, increasing about
24 times over 20.6 billion dollars in 1978 (National Bureau of Statistics of China, 2021a).

According to Melitz's (2003) New New trade theory（NNTT）, the export growth of a
country can be decomposed into two paths: the intensive margin and the expansion
margin. The former points to the changes in the scale of export products, while the latter
points to the changes in the types of export products and markets. In the years following
WTO accession, a large number of low-quality firms began exporting, causing a decline
in the overall quality level of China's export products. Relying heavily on a quantity-
based development model, China’s foreign trade growth is vulnerable to changes in
external demand, trade protectionism, and rising costs. Therefore, when the U.S.
subprime crisis broke out in 2008, China's foreign trade fluctuated sharply in the face of
the severe contraction of external demand. In 2009, for the first time since the reform and

4
opening up of China, China's import and export trade experienced negative growth of
13.9%, with a year-on-year decrease of US$355.7 billion, of which export trade was most
significantly affected, with a year-on-year decline of US$299.1 billion and a growth rate
of -16%. China's export expansion vulnerability, which is highly dependent on volume
expansion, was wholly exposed during the financial crisis. In order to cope with the
negative impact of the financial crisis on foreign trade development, China quickly
adopted a series of incentive measures such as increasing the export tax rebate rate and
promoting trade facilitation, which enabled China's foreign trade to resume growth
relatively quickly.

Although the growth rate of trade still slowed down after the financial crisis (even
negative growth again in 2015 and 2016), it was still higher than the world level in the
same period. It has maintained its position as the world's top exporter and second-largest
importer for years, and in 2014 it overtook the United States to become the world's top
goods trader for the first time. While maintaining its scale advantage, China's foreign
trade development has further optimized and improved its structure, which is mainly
reflected in the following three aspects. First, the new competitive advantage of goods
with technology, brand, quality and service as the core has been rising, then gradually
replacing the processing and assembling link which only relies on the advantage of labor
resources to engage in international industrial division of labor, and promoting foreign
trade to the middle and high end of the global value chain. Second, China has actively
explored new markets and cooperation space, which is highlighted in China's import and
export volume with countries along the "Belt and Road" accounted for an increase in the
proportion of China's total imports and exports, higher than the growth rate of trade with
developed countries, which is essential to diversify market concentration risks and
achieve market diversification strategy. Third, trade in services has grown faster than the
trade in goods, with an average annual growth rate of 8%, and has maintained its position
as the world's second-largest services trader for seven consecutive years now, but the
trade deficit is still not small.

Overall, as China's economic development enters the "new normal," the focus of China's
foreign trade development has changed from the previous scale expansion to the current
stage of high-quality development. At the same time, under the promotion of
comprehensive deepening reform and opening up, China has formed a new pattern of

5
high level opening-up, creating a more extensive space for China's foreign trade
development. This has created a more expansive space for China's foreign trade
development.

2.2. FDI

The development of FDI in China is mainly divided into three stages, the first stage is the
initial stage, from 1979 to 1991. Before 1979, there was almost no FDI in China. With
the announcement of reform and opening up in 1978, China opened its door to foreign
businesspeople. The first laws and regulations on FDI were formulated in 1979 to ensure
the legalization of foreign operations in China. In 1980, the Chinese government
established four special economic zones: Shenzhen, Zhuhai, Shantou in Guangdong
Province, and Xiamen in Fujian Province. These cities have convenient coastal
transportation and excellent geographical location (Cheng, 2014). The government hopes
to attract overseas attention through these windows, especially in Singapore, Indonesia,
and other places where overseas Chinese businessmen congregated. However, due to the
cautious attitude of foreign investors, the effect of these policies was not apparent.
Foreign capital entered the domestic market on a small scale. It was not until 1991 that
FDI reached 4.366 billion.

The second stage is from 1992 to 2000. During this time, FDI overgrew. Especially since
the 1990s, after Comrade Deng Xiaoping visited the southern coastal areas in 1992, he
put forward a new concept of economic development and relaxed the system of FDI. The
government has also established some small development zones in inland areas, such as
free trade zones, export processing zones and tourism zones. These development zones
were characterized by low-cost and centralized resources, which could be deployed at any
time. These actions had a positive impact on the actual direct use of foreign investment
(Garnaut et al., 2018). It is worth mentioning that FDI in 1992 was twice that in 1991,
and the inflow of foreign investment into China doubled in 1993, reaching US US$2.75
billion. Despite the Asian financial crisis in 2000, the Chinese market was not
significantly affected, and the inflow slowed down slightly. In order to solve the widening
regional gap, the government adopted more preferential policies for inland areas. In 1999,
the Chinese government put forward the strategy of "the development of the western
region in China." The government hoped to use the remaining economic development

6
capacity of the eastern region to improve the western region's economic and social
development level. However, due to the lack of supporting facilities and investment
environment for industrial investment, this policy did not led to a significant transfer of
FDI to the middle and western regions.

The third stage is from 2001 to now. FDI has entered a phase of stable development. After
China joined the World Trade Organization in 2001, according to the relevant
requirements of the WTO, China revised three laws and regulations to classify foreign
investment. These actions defined the optional geographical distribution and target
industries of FDI in China and accelerated FDI inflow into the domestic market. Since
2004, combined with the specific environment and characteristics of the capital market,
the investment behavior of foreign investment enterprises has been liberalized, and
foreign investors have been given the right to establish investment companies (Garnaut
et al., 2018). Although the global financial crisis has weakened foreign investment, and
China's FDI fell to US$9.5 billion in 2009, it has returned to the pre-crisis state of US
US$11.47 billion in 2010. Since then, it has maintained a steady growth trend. Under the
background of the COVID-19 pandemic in 2020, the total global FDI decreased by more
than one-third, but China's FDI bucked the trend and increased by 4%, reaching the US
US$163 billion, ranking the first in the world. (UNCTAD, n.d.)

At present, FDI has become one of the vital forces to promote China's rapid economic
growth. The large-scale entry of FDI has effectively announced China's reform and
opening up, accelerated the process of marketization and internationalization, and
promoted the sustained and rapid growth of China's economy to a great extent. From the
perspective of foreign investment, foreign capital flowing into the manufacturing industry
is the largest, accounting for 21.5% of the total share. (National Bureau of Statistics of
China, 2021b). It is still mainly labor-intensive capital. The primary purpose of its entry
is to take advantage of China's large amount of cheap labor resources. This also
determines that China needs to introduce technology-intensive foreign capital to improve
China's overall technology level. Also, the distribution of FDI in China shows that the
eastern region occupies an absolute leading position, and the gap in the share of foreign
investment in the eastern and western areas is still pronounced (Tseng & Zebregs, 2002).
At present, 87.8% of foreign investment is distributed in the eastern region, 9.1% in the
middle region, and only 3.1% in the western region.

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2.3 Economic growth

GDP is one of the most important standards to measure economic output and production,
and it can describe the economic situation. GDP growth rate is also the only best indicator
of economic growth. Since the implementation of the open-door policy in 1978, China, a
developing country, has experienced excellent trade system reform. So far, China's
economy has developed rapidly and has become the second-largest economy in the world
except for the United States. GDP growing from the US$149.5 billion in 1978 to the
US$14.7 trillion in 2020 took only 43 years. (The World Bank, 2021). In recent years,
against the background of the slowdown of world economic growth, China has actively
responded to various challenges and maintained steady economic development.

It can be seen from GDP growth that foreign trade growth has made an outstanding
contribution to China's economic growth. In 1978, China's total imports and exports
amounted to US$20.6 billion, accounting for less than 1% of the total global trade. In
2001, the total value of China's imports and exports was US$509.7 billion. During this
period, the growth rate of total imports and exports was 23.7%. Meanwhile, from 1978 to
2001, GDP soared from US$0.05 trillion to US$1.73 trillion, with a corresponding GDP
growth rate of 33.6%. However, in 2020, the total import and export value of China's
goods trade was US$5.02 trillion, 244 times that of 1978. As a result, GDP also grew
steadily to US$15.85 trillion. Now, China is the world's largest commodity exporter and
the second-largest commodity importer, with a market share of 13.1% of the global import
and export share. (National Bureau of Statistics of China, 2021a).

In addition, the increase of FDI is also inseparable from China's economic growth. For
example, based on the analysis of the changes of provincial GDP data in the past 40 years,
Guangdong Province has been classified as a special economic zone since 1978. In the
next two decades, the GDP has increased rapidly from 18.585 billion yuan to 853.088
billion yuan and has be come economically the largest province in China in 1998.
(National Bureau of Statistics of China, 2021c). Similarly, the GDP of provinces
classified as special economic zones such as Jiangsu and Shanghai also soared.

Taking China as a whole, China's GDP development is good, and the quantity and quality
of economic growth are good. However, for a big country like China, it is easy to cover
up some internal problems only by analyzing the country as a whole. Therefore, we divide

8
the country into three regions: the East, the middle, and the West. Through the horizontal
comparison of the economic growth of the three regions, we can find the gaps and
deficiencies between regions. The division between regions is shown in the table below.

Table1 regions division

EAST MIDDLE WEST

Beijing Jilin Chongqing

Tianjin Heilongjiang Sichuan

Hebei Anhui Guizhou

Liaoning Jiangxi Yunnan

Shanghai Henan Shaanxi

Jiangsu Hubei Gansu

Zhejiang Hunan Qinghai

Fujian Shanxi Ningxia

Shandong Inner Mongolia Xinjiang

Guangdong Guangxi

Hainan

Horizontal comparison of the GDP data of various regions in China shows that the
economic development of the three regions in China is uneven and has a significant
regional gap. The eastern region is the most developed region in China's social and
economic development. The total GDP of the eastern region in 2020 was 52573.303
billion yuan, accounting for 51.75% of the national total in the same period. The western
region has a vast territory, and the land area accounts for 70.6% of the total area of the

9
country. However, in 2020, the GDP of the western region is less than 20% of the national
GDP. The middle region of China is mainly manufacturing and agricultural production.
Compared with the western region, the GDP of the middle region is better, but it accounts
for less than 30% of the national GDP in the same period. (National Bureau of Statistics
of China, 2021c). However, by vertically comparing the economic development of
various regions, it can be found that since the 21st century, the economic growth rate of
China's middle and western regions has caught up with and surpassed that of the eastern
region. The annual GDP growth rate of the western region leads the country. The regional
average GDP growth rate in 2020 reached 3.89%, while the eastern region, which
accounts for the largest proportion of China's GDP, shows a steady downward trend. This
is closely related to China's focus on supporting the economic development of the middle
and western regions at the macro level and narrowing the differences between regions.
According to The Compendium of "the eleventh Five-Year Plan of Domestic economy
and society development," the policy is to adhere to the overall regional development
strategy of promoting the western development, revitalizing the northeast and other old
industrial bases, pushing the rise of the middle region and encouraging the eastern region
to take the lead in development, improving the regional coordination and interaction
mechanism, and forming a reasonable regional development pattern. After 30 years of
reform and opening up, the eastern region has entered the post-industrialization stage,
using labor and land factors. The way that the low comparative advantage promotes
economic growth has failed. China must transfer traditional industries, upgrade economic
structure, and use the comparative advantages of technology and human capital to
promote economic growth, also in line with the neoclassical growth theory.

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3. Theoretical background & Empirical Evidence

The purpose of this chapter is to provide theoretical background and literature review for
the relationships between FDI, foreign trade, and China's economic growth.

3.1. The Neoclassical growth model

The Neoclassical growth theory describes achieving economic growth through the joint
action of labor, capital, and technology. At the same time, this theory points out that the
factors of production can replace each other, so technological progress is significant for
economic development. According to Solow (1956), this production function can be
written as Y =A* F (K, L), in which Y represents GDP, A is a determinant level of
technology, K describes the capital share, and L denotes the labor force.

In neoclassical analysis, the impact of FDI on economic growth is mainly reflected in the
increase of human capital accumulation and labor growth, the introduction of new
technology, and so on. These kinds of changes are exogenous. Therefore, FDI is an
essential channel for the host country to promote the economy through capital
accumulation. Le et al. (2021) studied the relationship between FDI and local economic
growth in Vietnam. They found that the larger the capital scale of FDI, the more
significant the impact on economic growth, and reached a certain threshold. The
neoclassical model also suggests that technological progress affects economic growth.
Borensztein et al. (1998) found that technology spillover promotes the economy's long-
term growth based on the accumulation of human capital. Still, it depends on the capital
stock and absorptive capacity of enterprises in the host country of economic growth.

Many other relevant documents show that FDI is equally important for China's economic
growth. For example, according to Berthelemy and Demurger (2000), they used panel
data to analyze 24 provinces in China, obtained that there is a dynamic relationship
between FDI and economic growth, found that the decision of FDI directly affects
economic growth, and put forward new evidence that human capital contributes to growth
through the use of foreign technology. Ran et al. (2007) studied the impact of FDI on 30
provinces and 19 industries in China using a panel data model and proved that the
inequality of FDI would expand the differences of the regional economy. The eastern
coastal provinces are the primary beneficiaries. On the contrary, the middle and western

11
provinces have had a substantial negative impact. Yu et al. (2017) also found that the
massive influx of foreign capital into China undeniably impacts the economy. The
accumulation of capital investment has a positive impact, and the employment
opportunities with the increase of foreign investment also have a positive effect. Because
of the lack of data, this paper does not include the relevant data of human capital in the
model.

3.2. Heckscher－Ohlin Theory

The Heckscher-Ohlin theory assumes that there are only two factors of production, labor
and capital. Therefore, countries with abundant capital have a comparative advantage in
capital-intensive goods while countries with abundant labor have a comparative
advantage in labor-intensive goods. Consequently, a country exports goods that use its
relatively plentiful and cheap factors of production intensively in international trade,
while imports are intensive use of its relatively scarce and expensive elements of
production. As a result, the import and export of goods between the two countries through
international trade has improved their consumption level and benefited from international
trade. Many studies have found that foreign trade plays a vital role in China's economic
growth. For example, Li et al. (2009) uses the Granger causality test to show a Granger
causality between China's foreign trade and economic development. Furthermore, the
cointegration test shows that foreign trade can promote economic growth, and there is a
long-term stable equilibrium relationship between foreign trade and economic growth.

Similarly, according to Tsen (2010), the Granger causality test is also used to prove the
two-way Granger causality between export and economic growth, domestic demand and
economic development, and export and domestic demand. By studying the relationship
between foreign trade, including total export and import, Li et al. (2010) has found that
there is a positive correlation between total export and GDP growth, and there is a causal
relationship between them. Thus, foreign trade promotes the economic development of
East China. However, the import does not directly promote the growth of GDP, so it is
impossible to prove that there is a long-term causal relationship between import and GDP.
Also, many scholars have concluded that exports affect economic growth. Some of them
used the simultaneous equations model, Salvatore (1983), to test the data of 52 developing
countries, and set dummy variables in equations, which can test how the relationship

12
between the two changes over time. Nosakhara and Milton (2014) used the vector
autoregressive model to analyze the positive relationship between Nigeria's foreign trade
and economic growth from 1981 to 2010. They found that foreign trade innovation can
expand exports and then promote rapid economic development.

3.3. Kiyoshi Kojima- Theory of Marginal Industry Expansion

Kojima's theory is based on Herschel Olin's theory to analyze the relationship between
FDI and foreign trade. Suppose there are two countries A and B. country A is capital-
intensive, and country B is labor-intensive. In country A, commodities X have
comparative advantages; In country B, commodities Y have comparative advantages.
According to the H-O-S theory, country A will export goods X, and country B will export
goods Y. If country A chooses to invest directly in the X industry of country B, the
imports and exports trade of country B will expand. Similarly, the imports and exports
trade of country A will also increase. This theory holds that FDI is not only the flow of
funds but also the transfer of capital, technology, and management knowledge to the host
country. In addition, Kojima (1975) pointed out that when the investing country directly
invests in the relatively inferior industries (i.e., marginal industries) of the other country,
direct investments create trade.

Therefore, Kojima mentioned that FDI and foreign trade are complementary. The most
important criteria for foreign investors should consider the existing and potential
comparative advantage model between the investing country and the host country and
make the FDI from the relatively unfavorable industries of the investing country. Starting
from marginal industries, the host country can create more quantitative and more
significant benefits for trade because of the lack of capital, technology, and management
skills. Carter and Yilmaz (1999) found that when Turkish enterprises export goods to the
host country or attract investment from the host country to enter the foreign market, the
two plans are complementary. Similarly, Marchant et al. (2002) studied the relationship
between FDI of the U.S. and export commodities of East Asian countries through the
OLS method. They concluded that there is a complementary relationship between FDI
and export.

Many scholars have also studied the relationship between FDI and trade in different
countries through different econometric methods. For example, Baliamoune-Lutz (2004)

13
used the Granger causality model to prove a causal relationship between FDI and export
volume and that FDI can positively impact export and economic growth. In the context
of trade liberalization in Latin America, Cuadros et al. (2004) examined the correlation
between FDI, trade, and economic growth in Mexico by using the VAR model and
supported the hypothesis that FDI drives economic growth.

14
4. Empirical Analysis

In order to further analyze the relationship between the influence of foreign trade and FDI
on economic growth in Chinese provinces in the empirical part of this chapter, combines
data from 30 Chinese provinces for the years 2001-2020 was combined to construct a
fixed-effects panel model, aiming to quantitatively analyze the extent to which the
economic development of each Chinese province is influenced by foreign trade and FDI,
and to comparatively study the heterogeneity of the influence of each province.

4.1. Variable Selection and Data Sources

Due to the absence of some samples, we used 30 provinces in China (except Tibet) for
the survey from 2001 to 2020. The data were obtained from the statistical yearbooks and
statistical communiqués published by the China Bureau of Statistics and each local
government. These variables are treated as follows. First, in terms of economic
development, GDP was chosen to represent; total import and export trade (TRADE) was
chosen to measure foreign trade, and foreign direct investment (FDI) in each province
was selected for metric analysis. Second, to eliminate the effect of inflation, prices were
corrected by using China's 2001 consumer price index (CPI) as the benchmark. CPI and
exchange rate data are obtained from the China Bureau of Statistics. Third, since taking
logarithms does not change the nature of the data and correlations, and makes the data
smoother, dissipating the covariance and heteroskedasticity of the model. The data in this
section are all logarithmically processed data. In addition, due to the stationarity test in
this paper, all three variables obey first-order single integer. To avoid pseudo-regression,
the model setting in this section will be based on the three first-order differenced variables
DLnGDP, DLnTRADE, and DLnFDI. The correlations were tested and analyzed using
EViews data analysis software in this paper.

Table 2 Variables and expected signs

Expected impact
index represent
on GDP

explained variable Economic development GDP

15
 import and export trade TRADE +
explanatory variable
foreign direct investment FDI +

Our hypothesis is composed of two factors: Trade and FDI. According to neoclassical
growth theory, foreign direct investment can boost capital growth and thus the economy.
Therefore, we speculate that the larger the capital size of FDI, the greater the positive
impact on GDP. And according to Heckscher- Ohlin theory, the import and export of
goods between countries through international trade have a positive impact on GDP.
Table 2 shows the expected sign of each variable.

Table 3 Descriptive statistical analysis

standard
index sample size Mean Median Max Min
deviation

GDP 600 1773.5060 1222.0290 10221.8500 36.2571 1823.0290

TRADE 600 725.3873 182.2421 8019.8570 1.9824 1320.9460

FDI 600 45.0085 22.4396 269.5692 0.0299 51.7812

LnGDP 600 6.9718 7.1083 9.2323 3.5906 1.0985

LnTRADE 600 5.2736 5.2053 8.9897 0.6843 1.7265

LnFDI 600 2.8131 3.1107 5.5968 -3.5084 1.7559

Table 3 shows descriptive statistics for different variable. Excluding the province with
missing data, the total effective sample size is 600 observations. After logarithmic
processing of all the data of the three variables, results can be concluded from the table
that the maximum values of different variables is still several times the minimum values.
This difference should also prove the content described in the background part. Due to
separate policies and geographical locations of various provinces, there is an apparent gap
between cities in the eastern region and cities in the middle and western regions.

16
4.2. Panel data model

The Panel Data model expands the sample size and increases the accuracy of estimation
compared with the time series, and can describe the data pattern of each individual in a
period.

4.2.1. Hypothesis

Based on the research objectives, the empirical part of this paper intends to construct a
complete panel regression model to study in-depth relationship and degree of influence
of economic growth by the degree of influence of foreign trade and FDI, and to derive
individual regression results for each province, and to analyze empirically in comparison
whether there is any variability in the influence relationship among provinces. The
following research hypotheses are proposed in this paper.

Hypothesis 1: Foreign trade and FDI have a positive relationship with economic growth.

Hypothesis 2: The economic growth of each province is affected differently by foreign trade and
FDI.

For hypothesis 1, a two-way fixed effects model was built to investigate the overall
results, and the model was set up as follows.

DLnGDPit = αi + λt +β1 DLnTRADEit + β2 DLnFDIit + εit

(i = 1,2,3, . . . ,28,29,30, t = 1,2,3, . . . ,18,19,20)

𝛼𝑖 is the individual effect for entity i.

𝜆𝑡 is the time fixed effect.
𝜀𝑖𝑡 is the error term.
i is the notation for province.
t is the notation for time.

For hypothesis 2, individual fixed effects model was set up to study the specific regression
coefficients for each province, and the model was set up as follows.

DLnGDPit = λt + β1i DLnTRADEit + β2i DLnFDIit + εit

(i = 1,2,3, . . . ,28,29,30, t = 1,2,3, . . . ,18,19,20)

17
𝜆𝑡 is the time fixed effect.
𝜀𝑖𝑡 is the error term.
i is the notation for province.
t is the notation for time.

4.2.2. Stationarity test

In order to avoid pseudo-regression and ensure the validity of the estimation results, the
stationarity of each panel series must be tested. And the most common way to test the
data stationarity is the unit root test. In the asymptotic process of non-stationary panel
data, Levin and Lin (1993) found that the limiting distribution of these estimators is a
Gaussian distribution, and these results can also be applied to panel data with
heteroskedasticity, and an early version of testing for panel unit roots was established.
Later, the LLC method for testing panel unit roots was proposed after the improvement
by Levin et al.(2002). Maddala and Wu (1999) also proposed the ADF-Fisher and PP-
Fisher panel unit root test methods. In this paper, we choose the LLC test, ADF-Fisher
and PP-Fisher tests to detect the smoothness.

Table 4 The results of the stationarity test

Levin,Lin & Chu ADF-Fisher PP-Fisher

Indices Result
Statistic Prob Statistic Prob Statistic Prob

non-
LnGDP 4.2299 1.0000 13.6907 1.0000 0.2348 1.0000
stationary

non-
LnTRADE 0.6845 0.7532 22.9624 1.0000 40.9634 0.9715
stationary

non-
LnFDI -8.3742 0.0000 68.6551 0.2075 62.7492 0.3791
stationary

D(LnGDP) -11.1946 0.0000 103.8130 0.0004 107.8490 0.0001 stationary

D(LnTRADE) -16.0153 0.0000 229.5360 0.0000 361.7110 0.0000 stationary

18
 D(LnFDI) -20.6069 0.0000 271.2370 0.0000 333.5400 0.0000 stationary

From the results in Table 4, the original series of the explained variable LnGDP and the
explanatory variables LnTRADE and LnFDI cannot reject the original hypothesis test,
while the first-order differences of all variables reject the original hypothesis test at the
5% level, which means that the variables LnGDP, LnTRADE and LnFDI are all I(1)
variables, while DLnGDP, DLnTRADE, DLnFDI are all I(0) variables. To avoid pseudo-
regression and increase the accuracy of the regression results, we build a panel regression
model using the variables after first-order differencing. Since the variables we use are I(0)
variables, we can judge that they have a long-run equilibrium stable relationship. The
purpose of the cointegration test is to detect whether a linear combination of a set of non-
stationary series has a stable equilibrium relationship. Therefore, in this paper, we do not
conduct cointegration test but to directly use Hausman test.

4.2.3. Hausman test

The choice of panel data models usually takes two forms. One is the fixed effects model
(FEM). If the intercept of the model is different for different cross sections or different
time series, the regression parameters can be estimated by adding dummy variables to the
model. The other type is the random effects model (REM). If the intercept term in the
fixed-effects model includes the average effect of the cross-sectional random error term
and the temporal random error term, and both random error terms obey a normal
distribution, the fixed-effects model becomes a random-effects model. To consider
whether the optimal model for the sample data is a fixed effect or a random effect,
Hausman test is made on the differenced sample data.

Table 5 The results of Hausman Test

Test Summary Chi-Sq.Stat d.f. Prob

Cross-section random 11.1379 2.0000 0.0038

Cross-section random effects test comparisons:

Variable Fixed Random Var(Diff.) Prob.

19
 D(LnTRADE) 0.1049 0.0951 0.0000 0.0013

D(LnFDI) 0.0434 0.0477 0.0000 0.0039

The p-value is equal to 0.0038, implying that the null hypothesis of no systematic
difference is rejected at the 1% level for both, and therefore fixed effects should be
selected for estimation in the modeling.

4.2.4. Result of regression analysis

Table 6 Regressions of the effects of foreign trade and FDI on GDP

Variable Coef. Std.Error t-Stat Prob

DLnTRADE 0.1242*** 0.0139 8.9580 0.0000

DLnFDI 0.0533*** 0.0079 6.7807 0.0000

_Cons 0.1132*** 0.0030 37.7196 0.0000

R-squared 0.2401 F-Stat 5.4830

Adjusted R-squared 0.1963 F-Prob 0.0000

Note: ***, **, * are significant at 1%, 5%, 10% level respectively

Since the coefficients after first-order differencing can be seen as the growth rate of the
original variables. The above results imply that overall, every 1 percent growth in TRADE
causes 0.1242 percent growth in GDP; every 1 percent growth in FDI causes 0.0533
percent growth in GDP.The difference between provinces is reflected in the fixed effect
term, collated as shown in the table below: the eastern provinces are basically less than
0, while the middle and western provinces are opposite. It indicates that the economy of
the middle and western provinces has been growing faster in recent years. This is
consistent with the theoretical data in the previous section.

Table 7 𝛼𝑖 parameter estimation in two-way fixed-effects model

20
 EAST MIDDLE WEST

Beijing -0.0050 Jilin -0.0207 Chongqing 0.0234

Tianjin -0.0102 Heilongjiang -0.0363 Sichuan 0.0182

Hebei -0.0176 Anhui 0.0062 Guizhou 0.0247

Liaoning -0.0343 Jiangxi 0.0145 Yunnan 0.0114

Shanghai -0.0145 Henan 0.0037 Shaanxi 0.0185

Jiangsu 0.0091 Hubei 0.0107 Gansu 0.0074

Zhejiang 0.0006 Hunan 0.0087 Qinghai -0.0025

Fujian 0.0097 Shanxi 0.0049 Ningxia 0.0001

Shandong -0.0080 Inner Mongolia -0.0021 Xinjiang -0.0023

Guangdong -0.0028 Guangxi 0.0112

Hainan -0.0021

In addition, the relationship between foreign trade and FDI on economic development for
30 Chinese provinces using individual regression model is organized as follows. Due to
the large amount of data, only those provinces that pass the significance test are shown in
the paper. From the results of the regression estimation of individual fixed effects variable
coefficient model, the analysis is carried out mainly from the following aspects:

1. The impact of 30 regions on the economy in terms of structure from the value of β1i.

Table 8 𝛽1𝑖 parameter estimation in individual fixed coefficient of variation panel model

Rank parameter β1i

21
 Coef. t-Stat

1 Guangdong 0.3778*** (4.5769)

2 Shandong 0.3276*** (3.1712)

3 Zhejiang 0.2908*** (3.3197)

4 Shanghai 0.2584*** (3.7444)

5 Jiangsu 0.2477*** (3.4558)

6 Fujian 0.2309* (1.8746)

7 Guangxi 0.2282* (1.7276)

8 Liaoning 0.2148* (1.8969)

9 Jilin 0.2104** (2.3013)

10 Jiangxi 0.1945** (2.2850)

11 Beijing 0.1838*** (2.9125)

12 Hebei 0.1615** (2.1805)

13 Sichuan 0.1570*** (3.2977)

14 Xinjiang 0.1325* (1.8210)

15 Gansu 0.1315** (2.3800)

Note: ***, **, * are significant at 1%, 5%, 10% level respectively

22
The value of β1i is the coefficient value of foreign trade of each province in the formula,
which indicates the degree of economic impact of foreign trade of 30 provinces. Different
value of β1i leads to different impacts of foreign trade of 30 provinces. After sorting β1i
for all provinces in Table 8, it can be seen that the coefficients of Guangdong, Shandong
are greater than 0.3. It means that each 1 percent increase in TRADE, GDP will grow by
more than 0.3 percent. This is a significant advantage in promoting GDP growth. Besides,
all provinces that passed the test have test coefficients of 0.13 or more. Foreign trade also
has a positive impact on the development of the local economy.

It is worth noting that of the 15 provinces that have passed the test, 9 belong to the eastern
region, and there are 3 provinces in the middle and the western region, respectively. This
is because the eastern region is a coastal area with convenient shipping and transportation,
which lowers the production cost. It helps the eastern region to have comparative trade
advantages, also makes the economic foundation of the eastern region better with the
supporting facilities more perfect, thus promotes a virtuous circle of trade development.
It also shows that China's development is uneven. Therefore, if we want to reduce the
differences between regions, the middle and western regions should flexibly use various
methods to promote trade.

2. The impact of 30 regions on the economy in terms of structure from β2i.

Table 9 𝛽2𝑖 parameter estimation in individual fixed coefficient of variation panel model

β2i
Rank parameter
Coef. t-Stat

1 Shaanxi 0.6792*** (2.6895)

2 Hubei 0.3623** (2.1083)

3 Henan 0.3442*** (5.4190)

4 Hebei 0.2063* (1.9016)

23
 5 Sichuan 0.1290*** (5.7958)

6 Anhui 0.1276* (1.8113)

7 Chongqing 0.1116*** (3.8001)

8 Tianjin 0.0956* (1.7815)

9 Yunnan 0.0823*** (2.8362)

10 Shanxi 0.0733* (1.8969)

11 Liaoning 0.0564* (1.9692)

Note: ***, **, * are significant at 1%, 5%, 10% level respectively

The value of β2i in the formula indicates the coefficient value of FDI in each region, and
therefore indicates the degree of impact of FDI on the economy of each region. The
ranking of β2i for all provinces in Table 9 shows that FDI in Shaanxi has the largest
positive impact on economic growth, with each 1 percent increase in FDI causing a
0.6792 percent increase in GDP, respectively. The role of FDI in promoting economic
growth is very important. The coefficients of Hubei, Henan, and Hebei are all greater than
0.2, which also means FDI has a significant contribution to the growth of the local
economy.

In terms of foreign direct investment, there is little difference among the three regions.
The eastern, middle and western regions have 3, 4, and 4 provinces, respectively. This
may be related to the catalog of advantageous industries for foreign investment in middle
and western regions formulated and promulgated by China in 2000, and the projects in
the catalog enjoy preferential policies. In addition, China has also formulated several
preferential foreign policies to attract foreign investment in the middle and western
regions. In addition, the cost of labor and land in the east has gradually increased, which
also makes the inflow of foreign capital gradually offset to the middle and western
regions.

24
3. Sichuan, Hebei and Liaoning may become the bright spot of China's future
development.

Although the development of the country needs to be fully perfected, the strategy of
getting rich first is also necessary. For example, from the country's perspective, it is
necessary to take advantage of the coastal provinces' convenience to promote the
continent's economic development once the economic base is available. On the other
hand, when integrated development encounters difficulties, it is necessary to highlight the
provinces and cities that are easy to develop. Only in this way can more efficient growth
be achieved. Combining the two tables above, it is more obvious to analyze that Sichuan,
Hebei, and Liaoning have better economic development than other provinces in terms of
foreign trade and FDI. The pulling effect of FDI and foreign trade on the economy are
both more obvious.

The rapid economic development of various provinces in eastern China is attributed to

establishing four special economic zones along the coast. These four special economic
zones take the Export-oriented Economy as the development goal and encourage foreign
investment through tariff reduction and exemption, the introduction of advanced
technology and other measures. Referring to the strategy of the eastern region, the middle
and western regions can also drive the development of the surrounding regional economy
by developing the economy of representative cities. As the provincial capital of Sichuan,
Chengdu is committed to building an international gateway hub and an inland open
economic highland. In 2020, the foreign direct investment reached 2.55 billion US
dollars, ranking first in the middle and western regions. Taking Chengdu as the central
point of the development of the west of region, it can drive the surrounding cities to attract
foreign investment and economic development through the diffusion effect.

Hebei and Liaoning are important parts of the Bohai Rim Economic Zone. The belt and
road initiative is the golden opportunity for the development of the Bohai economic circle.
Giving full play to the advantages of ports, industries, science and technology in the
region, accelerating the development and building of the region’s economic belt, realizing
the transformation of old and new kinetic energy and the transformation of economic
development mode is of great significance to improve the quality of economic growth in
the north.

25
5. Conclusion

In the 70 years since the establishment of China's reform and opening up, the development
of foreign trade has made large achievements in terms of scale growth, structural
upgrading and market expansion. Once having a total import and export trade of only
US$1.13 billion in 1950, China has become the world's largest exporter and the second
largest importer. China's foreign trade policy has also evolved from a protective trade
policy under the initial state-planned economic system, through a gradual process of trade
liberalization, to the current high-level, all-round opening policy oriented to high-quality
development. China's growth history is an object of reference for developing countries.

This paper uses the panel data model to analyze the foreign trade, FDI, and economic
development of 30 provinces in China from 2001 to 2020. All in all, it is concluded that
there is a positive correlation between foreign trade, FDI, and economic development,
and China's economic growth rate remains at a high level. According to the established
regression equation, it is found that the foreign trade coefficient of 0.1242 is greater than
the FDI coefficient of 0.0533, which shows that for China, the pulling effect of foreign
trade on economic growth is more remarkable than FDI.

However, due to China's vast territory, the economic development mode and development
level between different provinces and cities are very different. In different regions, the
relationship between FDI, foreign trade and economic growth has their own
characteristics. From the data results of regression analysis of various provinces, there are
significant differences in foreign trade, FDI, and economic development. As far as the
eastern provinces are concerned, the economy is mainly positively affected by foreign
trade. For some middle and western provinces, FDI can positively affect their economic
growth, which both verify the argument in the theoretical background. It is worth noting
that the impact of foreign trade and FDI on the economic development of many provinces
is not significant, which may lead to the instability of China's overall foreign economic
growth, which should be paid attention to by relevant government departments.

5.1. Limitation

This thesis has some limitations in the study of China, and there are many factors that
affect economic development. For example, besides FDI, import, and export considered

26
in the thesis, they include labor force, technological progress, domestic capital, national
policies and other political and economic factors. Therefore, this thesis only selects
relevant elements about the external economy. Thus it affects the accuracy of the
conclusion to some extent. In addition, due to the difficulty of collecting data from 30
provinces and cities, we do not analyze the "crowding-in" or "crowding-out" effect of
FDI on domestic investment in each region of China. These are also essential aspects of
the impact of FDI and foreign trade on economic growth, which need to be studied in-
depth to reveal the relationship between FDI, foreign trade and economic development in
each region of China more comprehensively.

5.2. Recommendation

According to the empirical results, some suggestions for the future development of each
province are put forward:

(1) Actively take various measures to attract foreign investment in the middle and western
regions, mainly to improve the investment environment in the west and middle regions to
reduce the regional economic differences. The government should strengthen the
cooperation among the eastern, middle, and western regions. The middle and western
regions can also drive the development of the surrounding regional economy by
developing the economy of representative cities. Also, the west and middle regions are
rich in resources, such as mineral resources, land resources, energy resources, etc. Local
governments can develop these high-quality resources to alleviate the unbalanced
development of foreign direct investment and foreign trade in China.

(2) Strengthen the infrastructure construction in the middle and western regions . Create
conditions for undertaking good industrial transfer from the east. Due to the geographical
environment and government policies, the infrastructure in the middle and western
regions is lagging behind, which restricts the development of local economy. The middle
and western regions should seize the development opportunities brought by the "Belt and
Road" strategy to accelerate infrastructure construction. At the same time, the middle and
western regions need to seize the opportunity of industrial transfer to realize the
adjustment and upgrading of industrial structure, and give full play to local comparative
advantages to truly transform resource advantages into economic advantages and promote
significant economic growth.

27
(3) The government should formulate differentiated trade policies according to local
conditions and fully use the complementary and mutually promoting relationship between
FDI and foreign trade. At the same time, the local government should also improve
efficiency, reduce the cost of foreign exchange and provide a convenient process for
handling various business procedures.

28
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31
Appendix

Data of Provincial GDP

32
Data of Provincial TRADE

33
Data of Provincial FDI

34
Individual fixed coefficient of variation panel model

parameter λt β1i β2i

Beijing 0.0055 0.1838*** (2.9125) 0.0482 (0.8269)

Tianjin -0.0045 0.1367 (1.2408) 0.0956* (1.7815)

Hebei -0.0271 0.1615** (2.1805) 0.2063* (1.9016)

Liaoning -0.0232 0.2148* (1.8969) 0.0564* (1.9692)

Shanghai -0.0025 0.2584*** (3.7444) 0.1478 (1.0084)

Jiangsu 0.0280 0.2477*** (3.4558) 0.0579 (0.8341)

Zhejiang 0.0241 0.2908*** (3.3197) 0.0762 (1.1381)

Fujian 0.0244 0.2309* (1.8746) -0.0141 (-0.2398)

Shandong 0.0236 0.3276*** (3.1712) -0.0323 (-0.4252)

Guangdong 0.0204 0.3778*** (4.5769) 0.0374 (0.5617)

Hainan 0.0004 0.0263 (0.3338) -0.0153 (-0.3446)

Jilin -0.0092 0.2104** (2.3013) 0.0476 (1.1328)

Heilongjiang -0.0339 0.0900 (1.4990) 0.0387 (1.3357)

Anhui -0.0070 0.0877 (0.8976) 0.1276* (1.8113)

Jiangxi 0.0385 0.1945** (2.2850) 0.0136 (0.2042)

Henan -0.0567 0.0542 (1.0267) 0.3442*** (5.4190)

35
 Hubei -0.0095 0.1374 (1.2394) 0.3623** (2.1083)

Hunan 0.0036 0.0877 (0.8237) 0.0902 (0.5605)

Shanxi 0.0005 0.1374 (1.4884) 0.0733* (1.8969)

Inner
0.0079 0.1664 (1.5237) 0.0464 (1.4554)
Mongolia

Guangxi 0.0356 0.2282* (1.7276) 0.0238 (0.6023)

Chongqing 0.0035 0.0128 (0.2903) 0.1116*** (3.8001)

Sichuan 0.0253 0.1570*** (3.2977) 0.1290*** (5.7958)

Guizhou 0.0227 0.0141 (0.2745) 0.0174 (0.3992)

Yunnan 0.0066 0.0690 (1.0224) 0.0823*** (2.8362)

(-
Shaanxi -0.1084 -0.1638 0.6792*** (2.6895)
1.0714)

Gansu -0.0018 0.1315** (2.3800) 0.0074 (0.2384)

Qinghai -0.0010 0.0246 (0.5173) -0.0095 (-0.5013)

Ningxia 0.0063 0.0302 (0.5048) 0.0184 (0.3558)

Xinjiang 0.0082 0.1325* (1.8210) 0.0140 (0.2626)

Note: ***, **, * are significant at 1%, 5%, 10% level respectively

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