Promotion or liberalization: The effect of targeted investment policies on foreign direct investment inflows

Investment policies have been implemented by policy-makers in both developed and developing countries to open up their domestic markets to the foreign affiliates of multinational enterprises (MNEs). This study empirically examines two foreign direct investment (FDI) policies: targeted promotion and selective liberalization. It quantifies which of the two targeted measures is more effective in attracting FDI inflows and stimulating the activities of MNEs. We implement a difference-in-differences estimation that measures the effects of FDI policies by comparing affected and non-affected industries before and after the change of the FDI policies in compliance with China's accession to the World Trade Organization. Using aggregated data on foreign equity and output by MNEs' foreign affiliates in China from 1999 to 2007, the results show that selective liberalization has a positive impact on FDI inflows, especially from incumbents; however, targeted promotion does not. Our results highlight the effectiveness of selective liberalization as a policy option for stimulating industrial growth.