Political Relations and Chinese Outbound Direct Investment: Evidence from Firm- and Dyadic-Level Tests

Chinese outbound direct investment (ODI) has been a controversial phenomenon and an increasingly important research topic. We argue that ignoring the role of international relations in Chinese outbound investment is an important oversight in the literature on the determinants of Chinese ODI. Building on the literature on international politics and FDI in general, we identify the mechanisms and reasons for why China's political relations with potential hosts significantly influence firm investment decisions and ODI flow patterns. A novel empirical contribution of the paper is to test the effects of interstate political relations on Chinese ODI using two interrelated and complementary empirical tests: one at the firm level based on survey responses of 346 Chinese investors and the other at the dyadic level based on Chinese ODI flows to some 95 countries from 2003 to 2005. We find that the more importance a Chinese firm attributes to interstate relations, the more likely its investment decisions will be affected and that Chinese ODI is more likely to flow to countries with which the Chinese government has better political relations. Our analysis also addresses the puzzle of why Chinese ODI tends to go to countries of high political risks. Chinese investors go to those environments, not because of their risk acceptant preferences, but rather because of the risk-reduction effect of good political relations. Scholars of Chinese ODI as well as FDI in general should note that international politics does matter to the distribution of international production capital.