Dynamic relationship between China's inward and outward foreign direct investments

•FDI from developing countries continued to grow in recent years (35% of world total in 2012), particularly those from emerging markets (EE).•The sustained growth of China's OFDI motivates us to examine whether it has self-reinforcing effect.•China is an important host country of inward FDI, and an increasingly significant source country of outward FDI.•Some of the main destinations of China's OFDI are also the top sources of its IFDI.•The relationship between China's IFDI and OFDI has been ignored in previous literature and we fill this literature gap.•We investigate the dynamic adjustment process of Chinese OFDI using a partial stock adjustment model.•We examine the unobserved equilibrium OFDI stock values and to compare it with the actual stock values.•We used China's OFDI stock in 172 host countries during 2003-2009 and the system GMM estimation to examine whether the impact of lagged China's IFDI on OFDI vary by the host country's characteristics•There is strong evidence for the dynamic adjustment of China's OFDI and the agglomeration and self-reinforcing effect.•Some evidence for the positive relationship between China's lagged IFDI and its contemporaneous OFDI was found.•Two implications: (1) the existence of adjustment cost constrains the potential of China's OFDI; further liberalization of the approval regime would be helpful in reducing the adjustment cost; and (2) it is important to provide Chinese MNEs more information about the host countries-better understanding of the foreign market and faster responding in their future investment.

This paper studies the dynamic relationship of China's inward and outward foreign direct investments (FDI). It first identifies the key determinants of China's outward FDI (OFDI) in 172 host countries during 2003-2009 using a partial stock adjustment model. It finds strong evidence of dynamic adjustment in China's OFDI stock with an agglomeration effect. The dynamic adjustment and agglomeration effects are stronger in “high-tech” countries than in “low-tech” ones but indifferent in host country's resource endowments and income levels. The empirical results suggest that there exists a substantial adjustment cost in China's OFDI and that China's existing OFDI stock can gradually adjust toward its long-term equilibrium level, which is not only greater but also more volatile than the actual stock. Of particular interest is that we find a strong and positive relationship between lagged inward FDI (IFDI) and contemporaneous OFDI, implying that capital outflow from China has been partially induced by the countries which have invested in China.