Does fiscal decentralization promote the inflow of FDI in China?

This paper tests whether China's fiscal decentralization promotes the inflow of foreign direct investment (FDI). Using provincial panel data during 1995-2002, we find that fiscal decentralization has a positive and significant effect on inward FDI, after controlling for other factors, and fixed time and province effects in both LSDV (Least squares dummy variables) regression and system GMM (Generalized method of moments) estimations that address the endogeneity of fiscal decentralization. The results are robust to six measures of fiscal decentralization that consider budgetary amount, extra-budgetary funds and inter-governmental transfers. A simple theory is offered to explain the findings. The results during 1987-1994 are further contrasted. Policy implications are also presented.