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Does the Quality of Institutions in Host Countries

Affect the Location Choice of Chinese OFDI:
Evidence from Asia and Africa

Muhammad Abdul Kamal, Syed Hasanat Shah, Wang Jing & Hafsa Hasnat

To cite this article: Muhammad Abdul Kamal, Syed Hasanat Shah, Wang Jing & Hafsa
Hasnat (2019): Does the Quality of Institutions in Host Countries Affect the Location Choice
of Chinese OFDI: Evidence from Asia and Africa, Emerging Markets Finance and Trade, DOI:
10.1080/1540496X.2019.1610876

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Emerging Markets Finance & Trade, 1–20, 2019
Copyright © Taylor & Francis Group, LLC
ISSN: 1540-496X print/1558-0938 online
DOI: https://doi.org/10.1080/1540496X.2019.1610876

Does the Quality of Institutions in Host Countries Affect

the Location Choice of Chinese OFDI: Evidence from Asia
and Africa
Muhammad Abdul Kamal1,2, Syed Hasanat Shah 3
, Wang Jing4, and Hafsa Hasnat5
1
School of Economics, Henan University, Kaifeng, P.R. China; 2Department of Economics, Abdul
Wali Khan University, Mardan, Pakistan; 3School of Economics, Jilin University, Changchun China;
4
School of International Trade and Economics, University of International Business and Economics,
Beijing P.R. China; 5Business School, Jilin University, Changchun China

ABSTRACT: This article investigates the interactive effect of institutional quality and natural resources
(divided into fuel and nonfuel resources) on the flows of Chinese outbound foreign direct investment
(OFDI) in host countries in Asia and Africa. The findings of the article indicate that institutional quality in
host countries affect the flow of Chinese OFDI but only in nonfuel natural resource–rich countries while
institutions in fuel resource–rich countries play a insignificant role in the flow of Chinese OFDI. This
shows that quality of institutions is a significant determinant of Chinese OFDI in countries where
institutions matter while Chinese OFDI overlooks and surpasses institutions in fuel resource–rich coun-
tries. The significant interactive effect of institutions and nonfuel resources in this article suggests that
Chinese OFDI is not insensitive to quality of institutions but it depends on the sector, risk level, and
domestic imperatives.
KEY WORDS: Chinese OFDI, fuel and nonfuel resources, institutions, resource curse
JEL: E02, N5

The transformation of China from a centrally planned closed economy to an open market economy in
1978 extensively reshaped the country and the world. Reforms in China allowed foreign investment
to play a vital role in the process of economic development. Since 1978, China registered 10 percent
growth rate for over three decades and attracted huge foreign direct investment. As China developed,
Chinese ambitions and confidence to “go out global” increased which gave way to the new
phenomenon of Chinese outbound foreign direct investment (OFDI). Encouraged by the policy mix
at home and capital demand abroad, Chinese OFDI registered sharp rise from $10 billion in 2005 to
more than $100 billion by 2015 (UNCTAD, 2016). This phenomenal 10-folds increase in 10 years in
Chinese OFDI put China at par with other leading sources of OFDI. However, unlike other sources of
investment, Chinese OFDI mainly concentrates in institutionally weak countries in Asia and Africa.
This raised concern about the motive and location choices of Chinese OFDI. Therefore, institutions in
host countries and their impact on the flow of Chinese OFDI need scrutiny.
Theoretical literature and empirical findings on the location choice of OFDI suggest that high-
quality institutions allay the fear of investors and make them confident about doing business
(Bannaga et al. 2013; Lucke and Eichler 2016; Shah, Ahmad, and Ahmed 2016) while institutional
weakness, such as high political risk and lack of governance, discourages investors and their
investment (Chakrabarti 2001). But Liu and Deseatnicov (2016) consider that Chinese OFD target
institutionally weak but resource rich countries. Kolstad and Wiig (2012) and Liu, Chen, and Wu
(2018) reached to the same conclusion. These studies developed a strong link between the flow of
Chinese OFDI and natural resources in institutionally weak countries but at the cost of aggregation.

Address correspondence to Syed Hasanat Shah, School of Economics, Jilin University, China. E-mail:
haist@jlu.edu.cn
2 K. ABDUL ET AL.

They overlooked the kinds of natural resource and its impact on the path of institutional development
and the flow of Chinese OFDI. For example, institutions in fuel-rich countries are usually under the
control of a tribe or an individual who rarely let it develop against their will, while institutions in
nonfuel-rich countries more democratic, progressive, and inclusive. Therefore, in this study, we
empirically test the role of institutional capability in interaction with fuel and nonfuel natural
resources in host countries in order to better understand the location choice of Chinese OFDI in
Asian and African countries.
We contribute to the existing literature on many fronts. First, we confine our empirical
analysis to the developing countries in Asia and Africa (see the Supplementary Material, avail-
able online) as 80 percent of Chinese OFDI goes to these two regions. Second, institutions in
Asia and Africa are weak and rely on natural resources for exports; therefore, they are prone to
exploitation. Therefore, it is important to understand whether Chinese OFDI is deliberately
investing in countries with weak institutions and abundant resources or not? Third, contrary to
Kolstad and Wiig (2012), we explore the nexus between natural resources and weak institutions
in host countries in determining the flow of Chinese OFDI in a novel way i.e., by dividing
natural resources into fuel and nonfuel natural resources. Fourth, we use institutional indicators
and a composite index of them as an interactive variable with natural resources to better under-
stand the collective as well as individual effects of host countries’ institutional capacity on the
flow of Chinese OFDI. Fifth, China considers Asia and Africa important in terms of extending
political influence and assisting in their policy of “Peaceful Economic Development.” The two
regions received special attention from China in its recent Belt and Road Initiative. Therefore,
understanding the role and motives of Chinese OFDI in Asia and Africa offers them a policy tool
for proper utilization of Chinese OFDI.
The remainder of this article is organized as follows. First the paper provides descriptive overview
of FDI flow from China to Asia and then presents a theoretical foundation for our empirical analysis.
Subsequently, the paper describes the model specification, data, variables description and methodol-
ogy. The last two parts of the paper are results and conclusion.

1. China’s OFDI in Asia and Africa: An Overview

The pattern of China’s OFDI differs from the conventional pattern sources of direct investment. In
China, state-owned enterprises (SOEs) dominate OFDI mainly because the imperfect financial market
in China and Chinese government supports for SOEs discourage private firms to invest abroad. The
Chinese SOEs generate more than 70 percent of China’s total OFDI and all the major investment
projects come from SOEs. This leads some scholars to examine the motives of Chinese OFDI and its
role in investing in resource-rich but institutionally weak countries (Huang, Morck, and Yeung 2004;
Morck, Yeung, and Zhao 2008). Some call it open exploitation (Morck, Yeung, and Zhao 2008),
while others consider that Chinese firms invest in institutionally weak countries because Chinese
firms experienced adverse institutional environment at home and therefore they have an edge in
investing and surviving in countries with poor institutions (Perkins 2006).
Chinese OFDI can also be distinguished by its motives. Chinese foreign investment is not based on
the simple concept of risk and return. Rather China’s policy of “going out global” is part of an effort to
enhance the country’s global standing and address domestic needs, such as a rapid increase in demand
for natural resources, high domestic labor costs, renminbi internationalization, and the efficient use of
abundant foreign exchange reserves. The “go global” policy was also an effort to encourage domestic
investors to look outside the country in order to acquire high tech, reduce the knowledge gap, and
explore new markets for Chinese products (Cheng and Stough 2007). This has two pronged effects: it
gave a green light to local firms to go abroad and think big; and it sets a policy direction and informed
investors about domestic imperatives. Since then, Chinese OFDI has increased tremendously but its
geographical distribution remains focused on Asia and Africa. Probably it was easier for Chinese firms
to invest in Asia and Africa than to compete with established companies in the developed world. At the
 QUALITY OF INSTITUTIONS AND CHINESE OFDI 3

same time, investment in Asia and Africa was also more aligned with China’s increasing demand for
raw materials and with her political objectives. Chinese OFDI flows to Asia increased from
$40.41 billion in 2009 to $108.37 billion in 2015.1 Over the same period, Chinese OFDI to Africa
increased from $1.3 to $3 billion. Table 1 shows the increase over time in flows of Chinese OFDI to
Asia and Africa.
In addition to the regional concentration of Chinese OFDI, sectoral distribution of Chinese OFDI
in oil and mineral resources also presents interesting facts. For example, between 2004 and 2015,
25.45 percent of Chinese OFDI went to oil-rich Asian countries, while 43.43 percent went to
countries in Asia that are rich in mineral resources. The Chinese OFDI allocation to mineral- and oil-
rich countries is almost double that of FDI coming from other countries in the two sectors. In Asia,
Southeast and Central Asia are the prime targets of Chinese OFDI in the quest for natural resources.
The sectoral distribution of Chinese OFDI in Africa is not different: 26 percent goes to oil-rich
countries in Africa compared with 14 percent coming to the region from other sources, while Chinese
OFDI in mineral-rich countries in Africa is around 40 percent. This is double of the global FDI
inflows in mineral resource–rich countries in Africa, demonstrating that China is putting more money
in oil- and mineral-rich countries in Asia and Africa (Buckley et al. 2010; Cheung et al. 2012; Huang
and Wang 2011; Hurst 2011; Kolstad and Wiig 2012; Wang and Yu 2014). This attracted huge

Table 1. Pattern of China’s Outward Foreign Direct Investment in Asia and

Africa.
2006 2009 2012 2015

Value of China’s outward FDI flows (US$ billions)

Total world 17.60 56.50 87.80 145.67
Asia 7.66 40.41 64.79 108.37
Africa 0.52 1.44 2.50 2.98
Share of China’s outward FDI flows (%)a
Asia 43.52 71.50 73.79 74.40
Africa 2.96 2.55 2.85 2.06
Ratio of China’s outward FDI flowsb
Asia 2.12 2.67 2.86 2.77
Africa 1.20 0.53 0.86 0.70
Value of China’s outward FDI stock (US$ billions)
Total world 75.03 245.76 531.94 1097.86
Asia 47.98 185.48 364.41 768.90
Africa 2.56 9.33 21.73 34.69
Share of China’s outward FDI stock (%)
Asia 63.94 75.47 68.51 70.03
Africa 3.41 3.80 4.09 3.16
Ratio of China’s outward FDI stock
Asia 4.28 4.34 3.27 2.98
Africa 1.43 1.35 1.41 1.09
Distribution of Chinese FDI on the basis of oil supply (%)
Asia 33.31 27.45 24.11 21.95
Africa 52.23 45.41 41.31 36.91
Distribution of Chinese OFDI on the basis of mineral supply (%)
Asia 46.43 38.40 41.12 43.14
Africa 39.51 33.41 43.22 45.37

Sources: UNCTAD, World Bank World Development Indicators, 2012, 2015; Statistical Bulletin of
China’s Outward Foreign Direct Investment, authors’ compilation.
a
China’s OFDI flow to the region/China’s aggregate OFDI.
b
Share of China’s OFDI flow to region/share of world’s FDI inflow in the region.
4 K. ABDUL ET AL.

Table 2. Institutional Quality in the Top Host Asian and African countries, average score
(2009–15).
Voice and Political Government Regulatory Rule Control of Average of all six
Country accountability stability effectiveness quality of law corruption indicators

Top destinations for Chinese OFDI in Asia

Singapore −0.09 1.22 2.20 1.98 1.76 2.16 1.18
Indonesia 0.03 −0.64 −0.20 −0.26 −0.53 −0.65 −0.27
Kazakhstan −1.13 0.00 −0.32 −0.28 −0.58 −0.88 −0.39
UAE −0.98 0.84 1.19 0.69 0.57 1.11 0.39
Pakistan −0.83 −2.62 −0.76 −0.64 −0.83 −0.96 −0.95
Top destinations for Chinese OFDI in Africa
South 0.59 −0.07 0.38 0.37 0.11 −0.02 0.23
Africa
Congo DR −1.43 −2.17 −1.64 −1.44 −1.58 −1.33 −1.60
Algeria −0.94 −1.22 −0.53 −1.19 −0.75 −0.54 −0.86
Nigeria −0.71 −2.06 −1.08 −0.73 −1.14 −1.12 −1.14
Zambia −0.18 0.38 −0.61 −0.46 −0.38 −0.44 −0.28
Sudan −1.75 −2.41 −1.43 −1.40 −1.22 −1.38 −1.60

Source: World Bank Worldwide Governance Indicators, 2015.

attention. Table 2 shows the average institutional quality of the top Chinese OFDI recipient countries
in Asia and Africa from 2009 to 2015.

2. Theoretical and Empirical Background

Different theories explain the flow of OFDI in different perspectives. Some emphasizes policy and
non-policy factors as the main determinants of OFDI (Fedderke and Romm 2006), while others
consider push and pull factors as main driving forces behind the flow of OFDI. Policy factors suggest
that a country invests in another country because of trade restrictions or change in market rules and
regulations, whereas non-policy factors enhance the flow of OFDI because of geographic proximity,
cultural affinity, market size, factor endowments, institutional environment, or economic stability in
host country (Mateev 2009). The second group uses push and pull factors to clarify the flow of OFDI
(Calvo, Leiderman, and Reinhart 1996; Fernandez-Arias 1996; Fernández-Arias and Montiel 1996;
Gottschalk 2001). Cyclical and structural conditions are push factors, and the socioeconomic and
political environment is a pull factor.
Dunning’s eclectic paradigm is another perspective that sheds light on a theoretical framework
for explaining firm behavior and its interest in outward direct investment. This approach posits
that outward investment is a way to take advantage of ownership (O), location (L), and inter-
nalization (I). The advantages of ownership and internalization are linked to firm-specific advan-
tages in manufacturing, distribution, cost minimization, and the provision of subsidies, whereas
location choice depends on the peculiar characteristics and country-specific advantage of the host
countries. Locational advantage plays an important role in firm decisions about their investments
abroad. Dunning further divided location advantages and its role in attracting OFDI into four
categories (market seeking, efficiency seeking, resource seeking, and strategic asset seeking).
These categories are used to understand the flow of China’s OFDI (Amighini, Rabellotti, and
Sanfilippo 2013; Buckley et al. 2010; Cheung and Qian 2009; Kolstad and Wiig 2012; Zhang and
Daly 2011).
In this study, we focus on the role of the resource-seeking motivation in Dunning’s paradigm and give
secondary importance to the market- and efficiency-seeking motives of Chinese OFDI. We do not
 QUALITY OF INSTITUTIONS AND CHINESE OFDI 5

consider the strategic asset–seeking motivation mainly because this strategy requires a different discus-
sion and is beyond the scope of this article. Thus, we apply Dunning’s approach in investigating the
relationship between international trade and investment to address the following main questions:

(1) What are the motivations behind China’s OFDI in Asia and Africa?
(2) What role host countries institutional factors play in Chinese firms’ decisions to invest in Asia
and Africa?
(3) Does the nexus of weak institutions and natural resources affect the investment decision of
Chinese firms in Asia and Africa?
(4) Is Chinese OFDI more attracted to host countries with weak institutions and rich fuel
resources?

Many studies on Chinese OFDI are descriptive (Deng 2003, 2004; Taylor 2002; Wong and Chan
2003; Wu and Chen 2001), and a few empirical studies focus only on case studies of high-profile
companies (Liu and Li 2002; Warner, Sek Hong, and Xiaojun 2004; Zhang and Filippov 2009). Other
studies discuss different aspects of Chinese OFDI such as firms’ absorptive capacity (Deng 2010),
historical background (Buckley et al. 2008), political risk (Liu, Chen, and Wu 2018), business
variations (Cheung and Qian 2009), exchange rate (Li and Rengifo 2018), institutional environments,
entrepreneurial status and orientation (Y. Liu, Li, and Xue 2011), and the use of advantages
associated with their home markets (Huang and Wang 2011). Only a few empirical studies, such as
Kaufmann, Kraay, and Mastruzzi (2011), have examined the relationship between the location choice
of China’s OFDI and the host countries’ institutional factors (including voice and accountability
[VA], political stability [PS], government effectiveness [GE], regulatory quality [RQ], rule of law
[RL], and control of corruption [CP]). Focusing on the influence of the institutions in host countries
on China’s OFDI has produced complicated and varied results because of different sample sizes and
observation periods.
Buckley et al. (2010) indicated that China’s FDI is positively influenced by high political risk in
host countries. Chang (2014) shows that Chinese firms invest in countries that are rich in resources
and have poor institutions, while Cheung and Qian (2009) report the insignificant impact of institu-
tions in host countries on attracting Chinese OFDI; moreover, they consider that natural resources
play a role in the flow of China’s OFDI. Kolstad and Wiig (2012) consider that the interaction effect
of institutions and natural resources in countries that are not members of the Organization for
Economic Cooperation and Development is positive and significant, and for that reason, host
countries with abundance of natural resources and poor institutions might be attractive targets for
OFDI. Quer, Claver, and Rienda (2012) find that political risk in host economies is not associated
with China’s OFDI location choice because China’s foreign investment is not concerned about risk
(as most of OFDI come from SOEs), but it does not mean that all Chinese firms are indifferent to risk
(Duanmu 2012; Huang and Wang 2011). Similar findings are also reported in studies on Germany
(Schüler-Zhou and Schüller 2009), Italy (Pietrobelli, Rabellotti, and Sanfilippo 2011), and the United
Kingdom (Cross and Voss 2008).
North (1990) considers “institutions are the rules of the game in a society, […] the humanly
devised constraints that shape human interaction. […] They structure incentives in human exchange,
whether political, social or economic.” Institutions in a country put a check on economic actors and
determine economic activities (Tim 2013). Institution on one hand shapes the context and on other is
a product of it where “the situation of today shapes the institutions of tomorrow through a selective,
coercive process, by acting upon men’s habitual view of things” (Veblen 1899). The nature of
resource and its availability directly affect the “men’s habitual view” and therefore depend on the
context institutions varies. For example, institutions in “resource curse” fuel–abundant countries
usually revolve around a few individuals, while institutions take a different path in nonfuel resource
countries where they are based on democratic norms (Erega and Peter 2016).
6 K. ABDUL ET AL.

3. Methodology and Model Specification

This study empirically investigates the impact of institutions in 84 host countries in Asia and Africa
(see the Supplementary Material, available online, S 3) on the location choice of Chinese OFDI from
2009 to 2015.2 The large number of cross sections (N) and short time periods (T) of panel data and
the problem of potential endogeneity in our models 1 and 2 suggest that the best technique to use in
empirical testing is panel GMM (generalized method of moments). The panel GMM is reported under
two headings: difference GMM and system GMM. In this study, we opt for the latter, mainly because
it has some desirable characteristics. Bond, Hoeffler, and Temple (2001) consider that system GMM
better addresses the issue of unobserved country heterogeneity, omitted variable bias, measurement
error, and potential endogeneity. Endogeneity requires the selection of an effective instrument.
Therefore, in this study, we use the lag in the gross domestic product (GDP) and trade openness as
instruments.3 To check the validity of the instruments, we relied on the Sargan/Hansen specification
test, while the investigation of serial correlation in the error terms is conducted with AR1/AR2.
Based on this discussion, we propose the following main model for empirical specification.

OFDIit ¼ Constatn þ β0 OFDIit1 þ β1 Controlsit þ β2 NaturalResourceEndowmentit

þ β3 Institutionsit þ β4 Institutions  NaturalResourcesEndowmentit þ εit (1)

We present our model on natural fuel resources in algebraic form as

LNFDIit ¼ αit þ β0 LNFDIit1 þ β1 LNZit þ β2 LNFuelit þ β3 LNCompit þ β4 LNFuel

 LNCompit þ εit (2)

The model for nonfuel natural resources (metal, ore, etc.) is given as

LNFDIit ¼ αit þ β0 LNFDIit1 þ β1 LNZit þ β2 LNMetalit þ β3 LNCompit þ β4 LNFuel

 LNCompit þ εit (3)

LNFDI in Equations 2 and 3 is the stock of China’s OFDI in Asian and African countries. Our data
cover the period 2009–15, which can be justified by the speed of China’s global initiative after the
2007–8 financial crises. We collected data on Chinese OFDI from UNCTAD’s Statistical Bulletin on
China’s Outward Foreign Direct Investment.
Cai (1999) assumes that China is experiencing rapid economic growth and creating firms that will
require large supplies of primary resources in the coming years. Similarly Buckley et al. (2008) and
Cai (1999) believe that the availability of energy and natural resources in China is inadequate for
domestic requirements. Therefore, to support rapid economic growth, Chinese firms are using OFDI
to obtain natural resources such as energy, petroleum, and minerals (Hobdari et al. 2010; Wu and Sia
2002). Therefore, we use natural resource endowment—the share of fuel (LNFuel) and nonfuel
(LNMetal) in total exports of host countries from Asia and Africa—as determining factors of
Chinese OFDI.
Moreover, our variable for institutions consists of six indicators reported in the World Bank’s
World Governance Indicator: VA, PS and absence of violence/terrorism, GE, RQ, RL, and CP. These
dimensions of governance are reported in scores from 0 to 100. Higher scores represent a better
institutional environment, while lower scores reflect weak institutions.4 The same rule applies to the
composite index (LNComp) made up of six indicators. We use these indicators and composite index
in the model alternatively. In models 1 and 2, we use a composite index and individual indicators,
respectively.
The size of the market in host countries, which attracts Chinese OFDI, is measured by GDP. The
size of the market offers investing firms opportunities for increased sales and enhanced profitability.
 QUALITY OF INSTITUTIONS AND CHINESE OFDI 7

Furthermore, a large market has greater demand for goods and services (Bevan and Estrin 2004;
Buckley et al. 2010). Bilateral trade is also an effective determinant of paving the way for foreign
investment. Therefore, we rely on GDP and bilateral trade as control variables in models 2 and 3.
Table 3 presents the description, theoretical justifications, and sources of the variables used in models
2 and 3 (covariance matrix and summary statistics of the variables are given in the Supplementary
Material, available online, S1 and S2, respectively).

4. Results and Discussion

The results of system GMM regression models are reported in Tables 4–6. Table 4 reports system GMM
results for fuel resources interaction with institutions in determining Chinese OFDI, and Table 5 reports
results for nonfuel resources. Table 6 reports results for oil-exporting countries. We separated oil-
exporting countries from Asian and African regions mainly because institution in oil-exporting countries
revolves around personalities or tribes. We simply can call it resource curse where to secure vested
interest, the elites snub the natural and balanced growth of institutions. Table 4 presents 14 models with 6
indicators of quality institution and 1 composite index both in isolation (models 1–7) and in interaction
with fuel resources (models 1a–7a). The results show that the lagged values of OFDI, the absolute market
size, and bilateral trade in host countries significantly attract Chinese OFDI. Fuel resource in some cases
in Table 4 reports significant values in attracting Chinese OFDI, while in other cases, fuel resource does
not attract Chinese OFDI. Among our variables of interest, composite index adversely affects the flow of
Chinese OFDI both in isolation as well as in interaction with fuel (Tables 1 and 4). This show as overall
quality of institutions improves in fuel-rich host countries, the flow of Chinese OFDI decreases and vice
versa. This result is something which provides basis for criticism of Chinese OFDI. However, the need is
to look deep down at indicators level whether institutional quality at indicators level behaves in tandem
with composite index or not?

Table 3. Description of Variables.

Theoretical
Variable Proxy justification Data source

China’s OFDI China’s FDI stock in Asian countries – Statistical Bulletin of China’s
Outward Foreign Direct
Investment, UNCTAD
Market size Host country GDP Market World Bank Development
seeking Indicators
Bilateral trade Annual volume of bilateral trade Market China Statistical Yearbooks,
(exports + imports) seeking UNCTAD
Natural resource Natural resources: ore, metal, and minerals Resource World Bank Development
endowment (fuel export as percentage of all merchandise seeking Indicators
and nonfuel) exports in the host country
Fuel: fuel export as percentage of all
merchandise exports in the host country
Host country’s VA Institutional World Bank Development
institutional PS and absence of violence/terrorism Factors Indicators
indicators GE
RQ
RL
CR
Comp

VA: Voice and accountability; PS: political stability; GE: government effectiveness; RQ: regulatory quality; RL: rule of
law; CR: control of corruption; Comp: composite index.
 8
Table 4. System-GMM Regression Results for Chinese OFDI (interaction institutions and fuel natural resources).
Model 1 Model 1a Model 2 Model 2a Model 3 Model 3a Model 4 Model 4a Model 5 Model 5a Model 6 Model 6a Model 7 Model 7a

0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453 0.8453
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
LNGDP 0.2034 0.2005 0.2489 0.1512 0.0553 0.05 (0.012) 0.2213 0.2433 0.1601 0.0160 0.0211 0.0873 0.2622 0.1922
(0.000) (0.022) (0.052) (0.042) (0.022) (0.055) (0.082) (0.040) (0.001) (0.031) (0.035) (0.021) (0.021)
K. ABDUL ET AL.

LNBTrade 0.0152 −0.0105 0.5592 0.9222 −0.0023 0.0239 −0.5091 −0.6092 0.0599 0.1385 0.1831 0.8129 0.1781 0.2781
(0.021) (0.030) (0.013) (0.032) (0.084) (0.034) (0.032) (0.010) (0.080) (0.090) (0.061) (0.024) (0.012) (0.012)
LNFuel −0.3528 −0.3130 0.1122 0.1545 −0.0986 −0.3130 0.0121 0.0301 0.2001 0.1877 0.0075 −0.6633 −.03122 −0.2223
(0.010) (0.002) (0.110) (0.102) (0.210) (0.002) (0.112) (0.082) (0.200) (0.056) (0.221) (0.765) (0.112) (0.224)
LNComp −0.1931 −0.1802
(0.032) (0.050)
LnComp −0.0921
× LNFuel (0.030)
LNPS 0.0511 0.1188
(0.022) (0.050)
LNPS −0.0288
× LNFuel (0.179)
LNCR 0.0611 −0.0211
(0.001) (0.069)
LNCR −0.0899
× LNFuel (0.006)
LNVA −0.0739 −0.4086
(0.485) (0.840)
LNVA 0.2005
× LNFuel (0.190)
LNGE −0.0321 −0.4433
(0.922) (0.120)
LNGE 0.2507
× LNFuel (0.260)
LNRQ −0.6591 −0.1112
(0.533) (0.317)
LNRQ 0.0527
× LNFuel (0.307)
LNRL −0.3095 −0.0441
(0.901) (0.861)
LNRL −0.2106
× LNFuel (0.061)
AR(1) 0.012 0.001 0.000 0.000 0.000 0.001 0.032 0.002 0.000 0.000 0.000 0.050 0.000 0.009
Prob >
Z=
AR(2) 0.383 0.117 0.282 0.199 0.323 0.387 0.683 0.189 0.276 0.151 0.191 0.421 0.213 0.223
Prob >
Z=
Sargan 0.621 0.617 0.656 0.776 0.887 0.798 0.621 0.534 0.455 0.523 0.717 0.656 0.666 0.754
Pr > Chi2
Hansen 0.795 0.699 0.596 0.611 0.769 0.711 0.691 0.673 0.598 0.689 0.741 0.723 0.632 0.622
Pr > Chi2
No. of 84 84 84 84 84 84 84 84 84 84 84 84 84 84
countries
No. of 588 588 588 588 588 588 588 588 588 588 588 588 588 588
obs.

p < 0.01, p < 0.05, and p < 0.10 in parentheses show significance at the 1, 5, and 10 percent levels, respectively.
QUALITY OF INSTITUTIONS AND CHINESE OFDI
9
 10
Table 5. System-GMM Regression Results for Chinese OFDI (interaction of institutions and nonfuel natural resources).
Model 1 Model 1a Model 2 Model 2a Model 3 Model 3a Model 4 Model 4a Model 5 Model 5a Model 6 Model 6a Model 7 Model 7a

LNFDIt1 0.7521 0.6453 0.7151 0.8002 0.7886 0.7429 0.8748 0.8993 0.8564 0.8606 0.8661 0.8221 0.8753 0.7953
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
LNGDP 0.4334 0.3905 0.3724 0.2952 0.2293 0.2135 0.2913 0.2488 0.3221 0.3110 0.3281 0.3653 0.2622 0.3921
(0.008) (0.002) (0.051) (0.032) (0.001) (0.001) (0.050) (0.099) (0.030) (0.091) (0.031) (0.005) (0.041) (0.021)
K. ABDUL ET AL.

LNBTrade 0.0158 0.0107 0.0542 0.0229 0.0123 0.0282 0.1093 0.1092 0.0999 0.1883 0.1931 −0.8129 0.1497 0.1661
(0.021) (0.020) (0.313) (0.323) (0.084) (0.034) (0.032) (0.030) (0.080) (0.090) (0.161) (0.124) (0.012) (0.012)
LNMetal 0.3128 0.3100 0.0125 0.0146 0.0986 0.3150 0.0828 0.0901 0.0651 0.07877 0.0175 −0.0633 0.3122 0.1223
(0.034) (0.022) (0.010) (0.092) (0.210) (0.102) (0.019) (0.083) (0.000) (0.006) (0.291) (0.788) (0.000) (0.002)
LNComp 0.4421 0.3980
(0.012) (0.015)
LnComp 0.5968
× LNMetal (0.000)
LNPS 0.0881 0.0878
(0.000) (0.000)
LNPS 0.1282
× LNMetal (0.009)
LNCR −0.0339 −0.0211
(0.018) (0.019)
LNCR −0.0891
× LNMetal (0.060)
LNVA 0.0119 0.0086
(0.081) (0.041)
LNVA 0.0405
× Metal (0.094)
LNGE 0.0322 0.0338
(0.000) (0.020)
LNGE 0.1507
× LNMetal (0.061)
LNRQ 0.1598 0.125 (0.01)
(0.031)
LNRQ 0.0287
× LNMetal (0.071)
LNRL 0.3075 0.4044
(0.101) (0.111)
LNRL 0.341
× LNMetal (0.019)

AR(1) 0.021 0.111 0.001 0.065 0.236 0.001 0.000 0.000 0.020 0.060 0.001 0.009 0.00 0.000
Prob >
Z=

AR(2) 0.181 0.484 0.383 0.376 0.385 0.453 0.468 0.400 0.396 0.277 0.182 0.255 0.234 0.433
Prob >
Z=

Sargan 0.891 0.459 0.341 0.506 0.751 0.822 0.821 0.845 0.760 0.433 0.567 0.656 0.921 0.711
Pr > Chi2

Hansen 0.697 0.545 0.591 0.675 0.610 0.699 0.796 0.513 0.654 0.773 0.699 0.643 0.596 0.798
Pr > Chi2

No. of 84 84 84 84 84 84 84 84 84 84 84 84 84 84
countries

No. of 588 588 588 588 588 588 588 588 588 588 588 588 588 588
obs.

p < 0.01, p < 0.05, and p < 0.10 in parentheses show significant at the 1, 5, and 10 percent levels, respectively.
QUALITY OF INSTITUTIONS AND CHINESE OFDI
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 12
Table 6. System-GMM Regression Results for Chinese OFDI (top 23 oil-exporting countries from Asia and Africa).
Model 1 Model 1a Model 2 Model 2a Model 3 Model 3a Model 4 Model 4a Model 5 Model 5a Model 6 Model 6a Model 7 Model 7a

LNFDIt1 0.4222 0.5387 0.5384 0.4903 0.5310 0.5554 0.4108 0.4997 0.5100 0.4876 0.5314 0.4843 0.4762 0.4822
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
LNGDP 0.1433 0.2072 0.2000 0.1555 0.5113 0.0025 0.2113 0.348 0.0677 0.0116 0.1211 0.0886 0.2029 0.1778
(0.450) (0.421) (0.792) (0.428) (0.424) (0.629) (0.255) (0.172) (0.143) (0.401) (0.444) (0.133) (0.295) (0.343)
K. ABDUL ET AL.

LNBTrade 0.0107 −0.0106 −0.0556 −0.0213 −0.0123 −0.0312 −0.0992 −0.0699 0.1591 0.1385 −0.1831 −0.1829 −0.2781 −0.0611
(0.661) (0.333) (0.139) (0.193) (0.114) (0.233) (0.334) (0.137) (0.385) (0.390) (0.261) (0.340) (0.323) (0.121)
LNFuel −0.1681 −0.2361 0.5632 0.4545 −0.1622 −0.3220 0.1103 0.0322 0.1781 0.2243 0.3050 −0.1277 −.02667 −.03431
(0.151) (0.201) (0.134) (0.102) (0.150) (0.112) (0.313) (0.192) (0.017) (0.003) (0.131) (0.225) (0.102) (0.094)
LNComp 0.0031 0.0021
(0.231) (0.051)
LnComp × LNFuel −0.2441
(0.139)
LNPS −0.1671 −0.0188
(0.121) (0.501)
LNPS × LNFuel −0.1588
(0.123)
LNCR 0.1123 0.0118
(0.202) (0.229)
LNCR × LNFuel 0.2393
(0.106)
LNVA −0.5129 −0.4336
(0.165) (0.740)
LNVA × LNFuel −0.2705
(0.700)
LNGE −0.1001 −0.2137
(0.225) (0.201)
LNGE × LNFuel 0.4329
(0.650)
LNRQ −0.1594 −0.3772
(0.483) (0.216)
LNRQ × LNFuel 0.0224
(0.127)
LNRL −0.0905 −0.0487
(0.731) (0.611)
LNRL × NFuel −0.0087
(0.110)
AR(1) Prob > Z = 0.032 0.011 0.013 0.021 0.198 0.000 0.000 0.001 0.000 0.019 0.328 0.210 0.032 0.000
AR(2) Prob > Z = 0.595 0.587 0.597 0.335 0.753 0.682 0.584 0.688 0.485 0.585 0.530 0.732 0.831 0.182
Sargan Pr > Chi2 0.724 0.461 0.715 0.785 0.864 0.653 0.345 0.751 0.334 0.554 0.724 0.444 0.456 0.834
Hansen Pr > Chi2 0.615 0.656 0.657 0766 0.566 0.395 0.555 0.644 0. 0.323 0.543 0.709 0.845 0.885
No. of countries 23 23 23 23 23 23 23 23 23 23 23 23 23 23
No. of obs. 161 161 161 161 161 161 161 161 161 161 161 161 161 161

p < 0.01, p < 0.05, and p < 0.10 in parentheses show significant at the 1, 5, and 10 percent levels, respectively.
QUALITY OF INSTITUTIONS AND CHINESE OFDI
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14 K. ABDUL ET AL.

Among the six variables, PS and corruption (CR) are used consistently in the previous literature to
examine the relationship between Chinese OFDI and governance in host countries. In our study, PS in
host countries significantly affects Chinese FDI inflows with positive signs. This shows that Chinese
OFDI is sensitive to PS, a result quite contrary to the findings of composite index in Table 4 as well
as to previous studies on PS. The coefficient of CR in model 3 in Table 4 is positive and significant,
however, in model 3a of Table 4, it turns into negative. This shows that Chinese investment increases
as corruption increases, particularly in interaction with fuel resources. The finding of corruption in
host countries and Chinese OFDI is line with previous studies like Buckley et al. (2010) and Kolstad
and Wiig (2012) but the positive relation of reduction in corruption and Chinese OFDI in model 3 in
Table 4 gives a new dimension to the discussion on corruption and Chinese OFDI nexus. It is not
Chinese OFDI and corruption rather it is corruption in a particular inelastic sector that creates
a vacuum for risk-loving and rent-seeking FDI. Other indicators except RL report insignificant
results showing that the behavior of Chinese firms in terms of institutional indicators is either
changing or shows no sign of fuel exploitation. RL interactive variable with fuel in model 14a in
Table 4 shows negative effect on Chinese OFDI, meaning when RL weaken in host countries,
Chinese OFDI to these countries increases. One such example is Chinese investment in Sudan.
However, the main reason behind such investment is Chinese SOEs. They are the main investors and
they are backing to take a risk and invest in energy in politically unstable countries. The insignificant
values of diagnostic test AR2 and Hansen test in Table 4 confirm the validity of instruments and of
the model.
The positive and significant role of host countries’ market size, lagged values of Chinese OFDI,
and bilateral trade in Table 5 are some of the major determinants in attracting Chinese OFDI in Asian
and African countries. Similarly, nonfuel natural resources are another important variable in attracting
Chinese OFDI. This shows that a range of variables plays a role in metal- and ore-exporting countries
in attracting Chinese OFDI. A composite index of institutions and different indicators of institutions
in Table 5 shows that Chinese OFDI location choice is significantly affected by the quality of
institutions in metal- and ore-exporting countries. The interaction terms are significant and positive
for all institution factors and report higher values and show that Chinese firms gave due consideration
to the institutional framework in ore- and metal-rich countries. Because of increasing demand at
home, ores and metals are the prime targets of China’s OFDI. Thus, host countries with abundant ore
and metal resources and better institutions attract significant Chinese OFDI, which confirms the
findings of He, Xie, and Zhu (2015), who suggest that the pattern of Chinese OFDI changes over time
and today Chinese OFDI is directed to countries with better institutional environments.
China’s focus on ores and metals and lack of interest in fuel resources has other plausible
explanations. First, manufacturing demand for ore and metal in China is growing. Second, China
has abundant fuel reserves and is investing substantially in alternate sources, such as renewable
energy, to satisfy domestic requirements. Third, to maintain a stable supply of fuel, China is now
investing globally to reduce reliance on producers in the Middle East because of its volatility. Fourth,
China has a comparative disadvantage in sophisticated technology and equipment used in extracting
natural resources in traditional locations such as the Middle East and thus has been crowded out by
investment from the United States and the European Union.
Because of the resource curse and regional disputes, institutions in oil-exporting countries roam
around the vested interest of personalities and tribes and often follow a different path. Therefore,
a similar exercise was repeated for the 23 oil-exporting countries in Asia and Africa (see the
Supplementary Material, available online, S 4). The results for oil-exporting countries are reported
in Table 6. The general perception given by Table 6 is that institutions in oil-exporting countries play
an insignificant role in determining Chinese OFDI. These findings can be justified by the theoretical
constructs known as the Dutch disease or the resource curse. Countries with substantial oil reserves,
such as those in the Middle East, are the least interested in attracting FDI, first, because these
countries have sufficient funding from oil sales revenue to finance domestic projects, including
 QUALITY OF INSTITUTIONS AND CHINESE OFDI 15

exploration for and extraction of natural resources (Rogmans and Ebbers 2013), and, second, because
most Middle Eastern countries are largely dependent on oil exports, FDI is discouraged by the
complicated ownership requirements stipulated in the resource sectors. This theoretical explanation is
supported by the level of observed FDI restrictions, as reported by the World Economic Forum
(Lopez-Carlos and Schwab 2005; Rogmans and Ebbers 2013). This suggests that fuel resources in
host countries are no longer attractive for Chinese OFDI, which has entered a mature phase in which
high-quality resources and institutions matter (Buckley et al. 2010; Kang and Jiang 2012).
To investigate whether the effects of natural resources on China’s OFDI depend on the institutional
quality of the host country, we estimate models studying the interaction of natural resources and
institutional variables. One possible concern that might arise because of these interacted variables is
the high serial correlation and the endogeneity problem. The probability values of specification tests,
such as Sargan and Hansen and AR1 and AR2 in Tables 4–6, confirm the validity of the selected
instruments and show no serial correlation.

5. Concluding Remarks
This article studies the effect of institutional quality and natural resources on the location choice of
Chinese OFDI in Asian and African countries from 2003 to 2015. The two regions combined receive
80 percent of Chinese OFDI, while the share of Chinese OFDI out of total incoming OFDI in Asia
and Africa is higher than it is in other regions. The performance of Asia and Africa is weak in terms
of institutional quality and, therefore, the huge inflow of Chinese OFDI in the two regions sparked
discussion on the motives of Chinese OFDI. In this article, we tried to explore the nexus between
Chinese OFDI and quality of institutions along with resource availability in the host countries in Asia
and Africa. Our findings suggest that China’s OFDI is attracted to fuel-rich countries with poor
institutional environments. But when we test the same argument for nonfuel resources, the result
varies. We found that the interaction effect of institutional factors and nonfuel natural resources has
positive and significant coefficients, which suggests that the availability of nonfuel natural resources
increases the positive impact of institutional factors on China’s OFDI. In other words, our results
indicate that the quality of institutions matters in locating Chinese OFDI in host countries with
abundant nonfuel natural resources, whereas it is insignificant or negative in fuel resource–rich
countries. The surprising result of the study is that the interaction impact of institutional factors
and oil resources on China’s OFDI is insignificant. This finding on one hand negates the much hyped
discussion on the Chinese OFDI resource exploitation in host countries and on the other demands
a separate analysis of Chinese OFDI in fuel-rich countries.
Among the other important variables of interest, the impact of market size on Chinese OFDI is
insignificant in fuel-rich countries; however, it is positive in nonfuel resource–rich countries.
Moreover, bilateral trade has a significantly positive effect on the flow of Chinese OFDI and
substantially influences the investment decisions of Chinese firms in nonfuel resource–rich
countries.
This study has some policy implications for Asian and African economies. The positive significant
impact of institutions in nonfuel natural resource–rich countries suggests that Chinese OFDI started
giving due consideration to the quality of institutions. Therefore, enhanced quality of institutions can
better attract Chinese OFDI.

Acknowledgments
We are thankful to the editor, Journal of Emerging Markets Finance and Trade, and to the reviewers
for their critical comments.
16 K. ABDUL ET AL.

Funding
This study is supported by a project “一带一路”战略实施中推进人民币国际化问题研究”
(2015ZDA017) and by Jilin University Project No. 450060522164x2015.

Notes
1. To avoid round tripping, we excluded Chinese OFDI in Hong Kong.
2. The selection of the countries is based on the availability of data from 2009 to 2015.
3. Excluding host countries’ bilateral trade with China.
4. Data on political stability come from the WGI and the scale of the index has been changed from −2.5–2.5
to 0–10.

ORCID
Syed Hasanat Shah http://orcid.org/0000-0001-6509-8297

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& Maastricht University) Working Papers Series, 41. Available at: http://www.merit.unu.edu/ publications/wppdf/2009/
wp2009-041.pdf.

Appendix Table 1. Correlation Matrix

Variables LNFDI LNGDP LNBTrade LNMetal LNFuel LNPS LNCR LNVA LNGE LNRQ LNRL LNComp

LNFDI 1.00
LNGDP 0.37 1.00
LNBTrade 0.70 0.61 1.00
LNMetal 0.36 0.27 0.16 1.00
LNFuel 0.41 0.20 0.20 −0.08 1.00
LNPS 0.63 0.22 0.19 0.21 0.17 1.00
LNCR −0.21 0.31 0.30 0.15 0.11 0.62 1.00
LNVA −0.29 0.26 0.25 0.34 −0.26 0.23 0.34 1.00
LNGE 0.19 0.39 0.43 0.25 0.19 0.53 0.23 0.52 1.00
LNRQ 0.16 0.16 0.24 0.20 −0.11 0.50 0.53 0.54 0.67 1.00
LNRL −0.25 0.32 0.32 0.27 0.15 0.67 0.44 0.49 0.34 0.56 1.00
LNComp 0.22 0.35 0.19 0.42 0.17 0.65 0.77 0.74 0.81 0.79 0.81 1.00
 QUALITY OF INSTITUTIONS AND CHINESE OFDI 19

Appendix Table 2. Summary Statistics

Variable Mean Std. dev. Min. Max. Obs.

LNFDI Overall 5.352557 2.0476 −0.13926 10.37302 n = 581

Between 1.930689 0.185713 9.399889 N = 83
T=7
Within 0.709696 2.204556 7.385179
LNFuel Overall 0.909437 3.282709 −14.6229 4.604872 n = 581
Between 3.14601 −7.51293 4.601471 N = 83
T=7
Within 1.26466 −7.02846 10.30427
LNMetal Overall 0.601413 2.204551 −9.31961 4.459215 n = 581
Between 2.068755 −8.14782 4.355938 N = 83
T=7
Within 0.790299 −5.11797 5.449766
LNGDP Overall 10.46214 1.882823 6.725333 15.64058 n = 581
Between 1.883889 6.801837 15.49186 N = 83
T=7
Within 0.180836 9.600519 10.9122
LNBTrade Overall 7.99472 1.993726 2.70805 12.745 n = 581
Between 1.962313 3.804465 12.60511 N = 83
T=7
Within 0.405099 6.170045 9.511057
LNCP Overall 1.352977 0.360372 0.282908 2.251843 n = 581
Between 0.353853 0.559641 2.231384 N = 83
T=7
Within 0.077147 0.955028 1.680535
LNGE Overall 1.370766 0.384516 0.423559 2.257588 n = 581
Between 0.381028 0.543153 2.239658 N = 83
T=7
Within 0.064589 1.027296 1.668018
LNPOL Overall 1.473339 0.423217 −0.39411 2.079786 n = 581
Between 0.408305 −0.01727 2.047587 N = 83
T=7
Within 0.118845 0.757424 2.313857
LNRQ Overall 1.355919 0.460315 −0.73701 2.253509 n = 581
Between 0.448579 −0.55242 2.190789 N = 83
T=7
Within 0.112909 0.35333 2.153047
LNRL Overall 1.359345 0.363994 0.274854 2.157507 n = 581
Between 0.359747 0.528281 2.135664 N = 83
T=7
Within 0.066427 0.94672 1.664767
LNVA Overall 1.228755 0.466146 −0.44188 2.022871 n = 581
Between 0.455651 −0.30153 1.959784 N = 83
T=7
Within 0.108731 0.480582 2.276878
LNComp Overall 1.35685 0.342657 0.322142 2.085419 n = 581
Between 0.339124 0.562641 2.069235 N = 83
T=7
Within 0.059988 0.950547 1.690248

N: Cross section; T: time period; n: number of total observations.

20 K. ABDUL ET AL.

Appendix Table 3. Countries from Asia and Africa Analyzed

Algeria Egypt Kenya Morocco South Africa

Angola Equatorial Guinea Kuwait Mozambique South Korea

Bahrain Eritrea Kyrgyz Republic Myanmar Sri Lanka
Bangladesh Ethiopia Lao Namibia Sudan
Benin Gabon Lebanon Nepal Tajikistan
Botswana Gambia Lesotho Niger Tanzania
Brunei Ghana Liberia Nigeria Thailand
Burundi Guinea Libya Oman Togo
Cambodia India Macao Pakistan Tunisia
Cameroon Indonesia Madagascar Philippines Turkey
Cape Verde Iran Malawi Qatar UAE
Chad Iraq Malaysia Rwanda Uganda
Congo Israel Maldives Saudi Arabia Uzbekistan
Congo DR Japan Mali Senegal Vietnam
Cote D’Ivoire Jordan Mauritania Seychelles Yemen
Cyprus Kazakhstan Mauritius Sierra Leone Zambia
Djibouti Mongolia Singapore Zimbabwe