FDI Follows the Flag: State Influence Over Foreign Firms in China

Abstract

Foreign direct investment (FDI) brings not only economic benefits but also the potential for political liberalization, particularly in autocratic states. Some claim that in China the story is different. There, the Chinese Communist Party has stalled political liberalization by first pursuing economic liberalization through growing the economy with FDI. I find that foreign firms in China directly entrench state control by supporting state initiatives. The conditions that foreign firms face make them uniquely vulnerable to state influence. As the benefits FDI brings to China diminish while the Chinese domestic market grows, foreign firms give into state influence in order to gain the state support that allows them access to the domestic market. Foreign firms support the state through decreasing imports from trade partners facing bad political relations with China. Foreign firms also offer higher wages than domestic firms. A foreign firm wage premium is in the state’s interest because it increases the buying power of Chinese consumers. FDI therefore is not simple a vessel of the other liberal practices but rather can promote state control as a means to economically desirable ends.