Agglomeration economies or comparative advantages matter in China

Coast-interior gap in attracting foreign direct investment (FDI) in China has been seen increasing; however, the diffusion trend across provinces has become more obvious. The determinants of regional distribution of FDI among Chinese provinces have been examined using data in 28 Chinese provinces from 1985 to 2007. Alternative theories divided determinants explaining FDI location into three subgroups: agglomeration economies, comparative advantage and location tournaments. The results provide support for the agglomeration hypothesis and some determinants in comparative advantages. Among four proxies for comparative advantages, wage and GDP per head have expected effect on FDI while the effect of infrastructure is statistically insignificant. Surprisingly, human capital shows a puzzling opposite sign at high significant level. Tax rate, a proxy for location tournament, shows a significant and negative effect on FDI. Tax incentives seem to magnify the role of agglomeration economies, but the effect of GDP per capita is diminished when tax is included in the regression.