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Routledge

Applied Economics, 2005, 37, 51-55 Taylor 6. Francii Croup

On the link between Japanese ODA


and FDI in China: a microeconomic
evaluation using conditional
logit analysis
Severine Blaise
CEF/-CNRS, Facitlte des Sciences Econotniques, Universite de la
Mediterranee, CEREFI, Facttlte d'Economie Appliquee, Universitt;
cl'Aix-Matseille III, 15-19 Allee Claude Forhin 13627
Aix-en-Provence, France
E-tnail: severine_hlaise@hotmail.com

This study investigates the effectiveness of Japan's official development


assistance in promoting foreign direct investments inflows in the case of
the People's Republic of China. Conditional logit analysis using province
level statistics from 1980 to 1999, shows that Japanese aid Oows did have a
significant positive impact on private investors location choice even though
other profit-maximizing factors such as the level of economic activity had
a leading spillover effect. In a context of growing scarcity of aid, the study
concludes by asserting the importance of a complementary process in
which foreign aid is aimed at enhancing the development of infrastruc-
tures, acting as a pre-requisite for future direct investments. Finally, Japan
providing an interesting case study, we stress the need for a better
cooperation between public and private sectors in development assistance
programmes.

I. Introduction tion of aid programmes by evaluating its effectiveness


in promoting foreign direct investments (FDI). In
Ever since Japan emerged as the largest donor of the case of the People's Republic of China (China
official development assistance (ODA) in volume, its hereafter) the link between the Japanese public and
motives and practice for giving aid got more and private sector in development cooperation is investi-
more attention. Heavily criticized from both inside gated. Indeed, the underlying idea is that ODA
and outside Japan, Japanese aid policy has long projects act as a prerequisite for future private
been depicted as 'mercantilist' and routinely accused investment, notably through the development of
of 'unfair aid practices'. The concentration of aid infrastructures in recipient countries.
fiows on Asian countries, the emphasis on capital China is one of the Asian countries that had the
projects for economic infrastructures, the strong most intense relationship with Japan for cultural,
involvement of Japan's private sector in development historical and strategic reasons. Even though Japan
co-operation are the key features of the Japanese aid has always been distrustful of China, after the
programme that have been under harsh scrutiny Second World War the 1972 Sino-Japanese rappro-
(Ensign, 1992). chement and the 1978 Sino-Japanese Peace and
The purpose of this study is to verify whether Friendship Treaty laid foundations for the
Japanese aid leans on a better economic rationaliza- rapid development of bilateral relations. China
Applied Economics ISSN 0003-6846 print/ISSN 1466-4283 online © 2005 Taylor & Francis Group Ltd 51
htlp://www.tandf.co.uk/journals
DOI: 10.1080/0003684042000281534
52 S. Blaise

began its economic reform and open-door policy and tion lies in their restriction to tnacroeconomic
for the first titne showed a willingness to accept for- framework. As pointed out by Mosley (1986), while
eign aid. As a consequence, the Japanese aid pro- at the microeconomic level evaluation of aid effec-
gramme to China began much later than in other tiveness brings generally satisfactory results, macro-
Asian countries (see Story, 1987 for a survey). Even economic analysis remain quite atnbiguous (the
though, from 1979 Japanese aid grew substantially: so-called 'Macro-Micro paradox'). Moreover, in the
from 1982 to 1986 China was the largest recipient of case of large countries such as China, because there is
Japanese aid and ever since it has been the second a great disparity in the geographical distribution of
largest recipient next to Indonesia.' In the meantime, those financial fiows, it does not seem very relevant to
China has been economically very important to consider the country as a whole. Consequently, one
Japan: the enormous potential of its market has led would rather perform a tnicroeconomic evaluation of
tnany Japanese companies to invest in China, and the the relationship between Japanese ODA and FDI,
two countries rapidly became major trade partners. using province level statistics of the Chinese economy
The next section presents an econometric analysis as well as detailed data on Japanese affiliates'
aitned at verifying the role of ODA projects in the activity. This evaluation is carried out on the period
location decision of Japanese private investors using 1980-1999. Statistics for ODA are issued frotn the
conditional logit analysis. The literature on the eco- Japan Bank for International Cooperation (JBIC)
nomic itnpact of FDI is vast and this issue will not be online database for loan aid, and ODA Annual
discussed here. However, following Ichikawa (1991), Report of the Ministry of Foreign Affairs for grant
one could assert that FDI, unlike portfolio invest- aid. ODA is referred to as the sutn of loan and grant
ment, promotes the dissemination of valuable knowl- aid, setting aside technical cooperation. Those
edge and entrepreneurship in the form of research statistics have been classified by provitice (calculation
and development, production technology, marketing from the author). As far as FDI are concerned, Toyo
skills, managerial expertise, and so on. That is, direct Keizai Overseas Japanese Companies Data are used
investment is a vehicle for the dissemination of these from the 1990 and 1999 editions which also allow
inputs and services, not simply a provider of finance. one to have a classification by Chinese province
Thus, direct investtiient - particularly in manufactur- of Japanese affiliates activities. Statistics for each
ing - is more likely than portfolio investment to pro- Chinese province are cotnpiled from China
mote econotnic growth. Therefore, one could expect Statistical Yearbook published by China Statistical
ODA to contribute substantially to the economic Publishing House, various volumes. This process
growth of a recipient country not only through its will allow one to have a tnore precise perception of
direct impact, but also indirectly by promoting the the 'spillover effect' of foreign aid.
inflows of FDI.

ill. Model
II. Methodology
The location decision of a Japanese investor in China
A nutnber of works was carried out on the relation- is analysed by means of a conditional logistic regres-
ship between ODA and FDI in the case of Japan. sion in which ODA is introduced along with other
Nevertheless, the causal relation that has been eval- profit-maximizing factors.
uated is rather the opposite. That is, to assert the Conditional logit tnodel has been widely used in
impact of FDI as a detenninant of ODA fiows.^ As previous empirical studies of location choice. For
far as we know, few studies (with contrasted results) example Head et al. (1995) examined the agglomera-
have considered the possibility that ODA act as a tion benefit and location choice of Japanese tnanufac-
prerequisite for future Japanese FDI.^ These studies turing in the USA. Fukao and Yue (1997) analysed
suffer a nutnber of shortcotnings ranging from the determinants of FDI by Japanese electronic firms.
tnisspecification for some, to invalid estimation Belberdos and Carree (2002) also examined the loca-
tnethodology for others. Yet, their cotnrnon limita- tion of Japanese Investment in China, focusing on

' ODA Annual Report, Ministry of Foreign Affairs, various years.


^See for exatnple Teranishi (1983); Okamota and Yokota (1992).
"^The International Development Center of Japan (1997); Yosioka et at. (1998); Inui (2000) and tnore recently Nakatnura et al.
(2001).
Link between Japanese ODA and FDI in China 53
agglomeration effects, Keiretsu and firm heterogene- likelihood method, which maximizes the likelihood
ity. Urata and Kawai (1999) studied the determinants function (Equation 3).
of the location of FDI by Japanese small and In other respects, as pointed out in previous studies
medium-sized enterprises.'' The conditional logit the location choice criteria may vary across different
model was first developed in economic analysis by sectors. Therefore, the estimation is carried out in
McFadden (1973). both manufacturing and noti-tnanufacturing sectors.
The purpose of this study is to verify if, in a given The following variables enter into consideration as
province, the amount of Japanese aid has an iiTipact independent varia-bles:
on the location choice of Japanese private investors,
for instance through the development of infrastruc- - Agglomeration effect: economic activities of
ture. To model the location of Japanese FDI in existing Japanese firms in one province that
China, it is assumed that Japanese firms undertake generate positive externalities for nearby firm
FDI in a ptovince where they can iTiaximize their engaged in similar activity. This is tneasured by
profit after evaluating relevant characteristics of the number of e.xisting Japanese affiliates before
alternative locations. By assuming that the firm has the venture began operation {JAtnc and ./Antnc,
a production function of Cobb-Douglas form, let us respectively for lTtanufacturing and non-
describe the profit (JT) of firm / obtained from under- manufacturing sector). Note that this number
taking FDI in province y as Equation 1. is used plus one in order to be able to use the
log of the variable.
TTjj — ^QA ]J . . . afiiAifij .C (1) - Level of economic activity: economic size of
the provinces is controlled for by including the
where a^,..., «„, are unknown parameters, X^ per capita GDP (GDPc). Indeed, the larger the
(s=\,... ,m) are variables describing the characteris- economic size of a region, the tnote likely that
tics of the province j (f=\,...,ti), and /x,y is a it will receive foreign investments.
random disturbance term capturing province- and - Production cost: labour cost is recognized as one
investment-specific heterogeneity in total factor of the most important factors. It is given by the
productivity. average wage level of workers (Wage), which is
Given profit Equation 1, if and only if jXij is dis- expected to discourage investtnent especially in
tributed as Type I extreme value (independent ran- the case of manufacturing location.
dom variable) according to the Weibull distribution, - Infrastructure: a well developed transportation
then the probability that provincey will yield investor infrastructure reduces the costs of itnporting
/the highest profit among all the provinces is given by
inputs and exporting or distributing output as
the logit expression (Equation 2) (McFadden, 1973).
well as a good communication infrastructure
facilitates and reduces the cost of cotnmunica-
exp tion of affiliates. Consequently, the infrastruc-
(2) ture indicator is expected to have a positive
impact on the location decision of private
7=1 investors.
One expresses the number of FDI selections made by The dtitntny Coast (C) is also introduced,
Japanese firm /' in the province j as Wjj ( / = 1 , . . . , //). which takes the value 1 if the region is located
This dependent variable takes the value 1 if the prov- on the coast side and 0 otherwise, as well as
ince is selected by the investor and 0 otherwise. the distance from Japan (DIST).
Finally, one obtains the probability of observing A measure of the quality of telecotnmunica-
such FDI pattern as Equation 3. tion infrastructure is also included: the nutnber
of long-distance telephone lines (Telecotn).
Finally, the eutnulative atnount of Japanese aid
(3) (ODAc) is also introduced, which is also sup-
posed to reinforce the developtnent of infrastruc-
The parameter (c/o,..., c/,,,), which indicate the ture, especially in the transportation sector.
characteristics of potential host provinces to - Human capital: the level of education is expected
Japanese FDI, are estimated by the maximum to have a positive impact on the location deci-

"* Other examples can be found in Fukao (1996), Fukao and Tei (1996).
54 S. Blaise
sion especially in non-manufacturing sectors confirms that aid has a spillover effect on the location
as it enhatices the quality of human capital. decision of Japanese investors. This positive effect
The education level is measured by the number is shown to be slightly more important for non-
of .stuiletits enrolled in senior middle schools as a manufacturing activities. Indeed, ODA projects
percentage of population (EDU), The log of all have been concentrated mainly on economic infra-
variables is used, except for the dummy C as well structures, considered as high priority by the
as the Distance variable. Chinese government itself, in order to resolve serious
bottlenecks in the econotny (Soderberg, 1996), This
is also proved by the impact of infrastructure indi-
cator such as telecommunication facilities. This had
IV. Results an important 'spillover effect' on promoting Japanese
investors' activities. As far as the loan component of
Results of the conditional logistic regression are given ODA is concerned (which constitutes the bulk of
in Table 1, The agglomeration effect and the level of Japanese aid to China), this finding confirms the
econornic activity appear to have the largest impact idea that the incentive for future private investment
on location choice by Japanese investors in manufac- and technology transfer not only allowed a high rate
turing as well as non-manufacturing sectors. For both of reimbursement of loan aid, but that the duty to
sectors the two variables are strongly significant, reirnburse constitutes an indicator of solvability
holding the highest positive coefficient (especially well perceived by private investors (Teboul and
for non-tnanufacturing activities). Bassino, 1997),
As expected, high wage level strongly discourages Furthermore, it is found that manufacturing
Japanese investors in the manufacturing sector. This activities tend to locate in coastal areas, which offer
shows that Japanese affiliate activities in labour inten- considerable transport facilities for itnporting
sive sector took advantage of China's cheap labour. inputs and exporting production output. However,
This finding is corroborated by the significant nega- this factor is not significant in the location decision
tive itnpact of education level in the same sector. In of non-manufacturing activities. Finally, the distance
non-tnanufacturing activities, wage level also holds a frotn Japan is proved to have a negative itnpact
negative coefficient, but the variable is less significant. on FDI location in both sectors, still favouring
Education level is positive but not significant. It can
north and coastal provinces.
be suggested that in the later sector, investors give
more importance to qualified labour force.
The amount of Japanese ODA attributed to each
province is strongly significant in the two sectors and
V. Conclusion

Table I. Conditional (fixed-etfeets) logistie regression This econometric analysis allowed one to support
the view that Japan's ODA has been quite effective
Variable Manufacture Non-manufacture in promoting Japanese FDI in China, Even though
C 0,297*** -0,045 other profit-maximizing factors such as the level of
(3,245) (-0.275) economic activity or the agglotneration effect of
LJAc 0,623*** 0.605*** Japanese firtns had a leading role in location decision
(9,552) (6.872)
of Japanese investors, the allocation of aid projects
LODAc 0,129*** 0.189***
(3,880) (2.715) did have a significant positive impact, Japanese ODA
LGDPc 0,638*** 1.220*** programmes in China have been mainly allocated to
(4,514) (4.829) infrastructure projects (especially in transportations),
LWAGE -0,679*** -0,651** paving the way for future private investment. In
(-3,617) (-1,923)
LEDU -0,635** 0,39
Japan, this complementary process is generated by
(2.218) (0,745) both institutional and infonnal links between the
DIST -0,174*** -0,299** public and private sectors and appears to be substan-
(-2,599) (-2,160) tially beneficial to the recipient country. In a context
LTELECOM 0,285*** 0,399*** of growing scarcity of aid, a detailed analysis of this
(3,823) (3,737)
Log likelihood -4147,6929 -1290,6864 effective framework of development cooperation
could be an enriching and useful exercise.
*, **, *** tnark the results which are respectively 10%, 5%,
1% significant.
Link between Japanese ODA and FDI in China 55
Acknowledgements McFadden, D. (1973) Conditional logit analysis of qualita-
tive choice behavior, in Frontiers in Econometrics (Ed.)
I would like to express all my gratitude to professor P. Zaremka, Acadetnic Ptess, New York.
Kyoji Fukao for his precious advice and comments Mosley, P. (1986) Aid effectiveness: the Micro-Macro
regarding this study and to professor Ding Jianping Parodox, Institute of Development Studies Bulletin,
for generous provision of Chinese statistics. 17(2), 22-7.
Nakamura, O., Shishido, S., Minato, N., Kutokawa, M.
and Kawakami, A. (2001) Chugoku to Indonesia ni
taisuru wagakuni no ODA no hikaku kenkyu: ODA-
FDI wo fukwnu tahumongata tnodelu hunseki [A cotn-
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