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In spite of being the second largest recipient of FDI in the world, China shows limited evidence of considerable FDI benefits on growth (Fan and Hu 2007; Luo 2007; Ran et al. 2007). Motivated by Alfaro et al.s (2003) model, this study tests whether poor financial market development might be responsible for the relatively low benefits of FDI on growth in China. We apply BlundellBond system GMM estimators to a panel of Chinese provinces. Our results indicate that poor financial intermediation does indeed limit the transmission of FDI benefits within the Chinese economy. Moreover, the study reveals preliminary evidence that banks credits to unproductive State Owned Enterprises (SOEs) constitute poor financial intermediation with negative growth implications. In contrast, credits to small private enterprises are associated with a positive impact of FDI on growth.

How Does Financial System Efficiency Affect the Growth Impact of FDI in China?