UNIVERSITY OF CALIFORNIA, SAN DIEGO Credibility and Flexibility: Political Institutions and Foreign Direct Investment A dissertation submitted in partial satisfaction of the requirements for the degree Doctor of Philosophy in Political Science and International Studies by Yu Zheng Committee in charge: Professor Susan Shirk, Co-Chair Professor Peter Cowhey, Co-Chair Professor Lawrence Broz Professor Roger Gordon Professor Stephan Haggard Professor Barry Naughton 2007 The dissertation of Yu Zheng is approved, and it is acceptable in quality and form for publication on microfilm: ______________________________________________ ______________________________________________ ______________________________________________ ______________________________________________ ______________________________________________ Co-Chair ______________________________________________ Co-Chair University of California, San Diego 2007 iii DEDICATION To Xiaowei and Nanxi, with all my love. iv TABLE OF CONTENTS SIGNATURE PAGE --------------------------------------------------------------------------------------------iii DEDICATION ---------------------------------------------------------------------------------------------------iv TABLE OF CONTENTS ----------------------------------------------------------------------------------------v LIST OF TABLES---------------------------------------------------------------------------------------------- vii LIST OF FIGURES ------------------------------------------------------------------------------------------- viii LIST OF APPENDICES----------------------------------------------------------------------------------------ix VITA ------------------------------------------------------------------------------------------------------------- xii ABSTRACT OF THE DISSERTATION ------------------------------------------------------------------- xiii CHAPTER 1: INTRODUCTION -------------------------------------------------------------------------------1 I. Existing Literature on Institutions and Investment --------------------------------------------------------2 II. Theoretical Foundations--------------------------------------------------------------------------------------6 Nonlinear Relationship between Political Institutions and FDI-----------------------------------------7 Political Institutions and Foreign Firms -------------------------------------------------------------------8 III. Why Study China? ----------------------------------------------------------------------------------------- 11 Why Study Local Institutions? ----------------------------------------------------------------------------- 16 IV. Contributions------------------------------------------------------------------------------------------------ 18 V. Outline of the Dissertation --------------------------------------------------------------------------------- 19 CHAPTER 2: CREDIBILITY AND FLEXIBILITY: COMPARATIVE INSTITUTIONAL ADVANTAGE AND FOREIGN DIRECT INVESTMENT ---------------------------------------------- 21 I. Introduction --------------------------------------------------------------------------------------------------- 21 II. A Debate on the Relationship between Political Institutions and Investment ----------------------- 24 Dispersed Authority ----------------------------------------------------------------------------------------- 24 Concentrated Authority ------------------------------------------------------------------------------------- 27 III. Theory and Hypotheses------------------------------------------------------------------------------------ 31 IV. Empirical Analysis: Political Institutions and FDI ----------------------------------------------------- 37 Dependent Variable ----------------------------------------------------------------------------------------- 38 Independent Variable---------------------------------------------------------------------------------------- 39 Control Variables -------------------------------------------------------------------------------------------- 40 Findings------------------------------------------------------------------------------------------------------- 43 V. Empirical Analysis: Tests of Causal Mechanism -------------------------------------------------------- 48 Political Institutions and Policy certainty ---------------------------------------------------------------- 48 Political Institutions and Investment Incentives --------------------------------------------------------- 51 Findings------------------------------------------------------------------------------------------------------- 52 VI. Conclusion -------------------------------------------------------------------------------------------------- 56 CHAPTER 3: POLITICAL INSTITUTIONS AND THE COMPOSITION OF FDI--------------- 62 I. Introduction --------------------------------------------------------------------------------------------------- 62 II. Bargaining Relationship between MNCs and Host Governments ------------------------------------ 64 Obsolescing Bargain Model (OBM)----------------------------------------------------------------------- 64 Critics of OBM and Political Bargaining Model (PBM) ----------------------------------------------- 66 III. Theory and Hypotheses------------------------------------------------------------------------------------ 70 1. Production Strategy -------------------------------------------------------------------------------------- 73 2. Asset Specificity------------------------------------------------------------------------------------------- 75 IV. Data and Models-------------------------------------------------------------------------------------------- 81 Dependent variables ---------------------------------------------------------------------------------------- 83 Independent variables--------------------------------------------------------------------------------------- 83 Interaction Terms -------------------------------------------------------------------------------------------- 85 Control Variables -------------------------------------------------------------------------------------------- 86 V. Findings------------------------------------------------------------------------------------------------------- 89 VI. Conclusion -------------------------------------------------------------------------------------------------- 95 CHAPTER 4: FDI AND SPECIAL ZONE POLICY IN CHINA --------------------------------------- 97 v I. Introduction --------------------------------------------------------------------------------------------------- 97 II. Flexible Arrangements in Special Zones ----------------------------------------------------------------100 III. The Political Logic of the Special Zone Policy--------------------------------------------------------110 The Central Government ---------------------------------------------------------------------------------- 112 Local Governments-----------------------------------------------------------------------------------------127 IV. The Composition of Foreign Investment in China ----------------------------------------------------133 Evolution of the Composition of FDI --------------------------------------------------------------------133 Rival Theories-----------------------------------------------------------------------------------------------139 V. Conclusion --------------------------------------------------------------------------------------------------141 CHAPTER 5: NOT A MAGIC BULLET: HOW DO LOCAL INSTITUTIONS AFFECT FDI IN CHINA? -----------------------------------------------------------------------------------------------------------144 I. Introduction --------------------------------------------------------------------------------------------------144 II. Research Design--------------------------------------------------------------------------------------------148 III. Central-Local Relations ----------------------------------------------------------------------------------150 IV. Governance Structure -------------------------------------------------------------------------------------156 V. Legal Environment -----------------------------------------------------------------------------------------162 VI. Statistical Evidence ---------------------------------------------------------------------------------------167 Dependent Variables and Explanatory Variables-------------------------------------------------------169 Control Variables -------------------------------------------------------------------------------------------172 Findings------------------------------------------------------------------------------------------------------173 VII. Conclusion ------------------------------------------------------------------------------------------------179 CHAPTER 6: CONCLUSION--------------------------------------------------------------------------------188 I. Questions and Answers-------------------------------------------------------------------------------------189 Question 1: Why Do Multinational Firms Invest in Autocracies as well as Democracies?-------189 Question 2: What Explains the Variation in the Composition of FDI among Countries?---------190 Question 3: What Explains the Change in FDI Composition in China? ----------------------------192 Question 4: What Explains the Inequality of FDI Distribution within China? ---------------------195 II. Implications and Future Research Plans ----------------------------------------------------------------196 Fiscal Federalism and Local Governments’ Accountability ------------------------------------------196