Nonlinear Dependence between Economic Policy Uncertainty and FDI Inflows in China

Abstract

Foreign direct investment (FDI) is the most reliable form of international capital flows, and it may be notably prone to increased uncertainty because of its high fixed costs. In this paper, we use the rolling window causality and the quantile-based Granger causality method to investigate the nonlinear dependence between economic policy uncertainty (EPU) and foreign direct investment (FDI) inflows in China for the period between 1999:M06 to 2021:M12. The empirical findings of the study show that EPU exerts a negative impact on FDI inflows during the majority of the time periods that have been studied. However, during the U.S subprime crisis in US, the effect was positive. That is, it can be inferred that the FDI inflows are not always hampered by the Chinese government's economic policy uncertainty. We enlarged our study with the quantile-based Granger causality method to assess robustness. In view of the recent dynamic economic condition and COVID-19 pandemic, the results suggest China's government should focus on more openness and improving its domestic business environment to enhance foreign investors' trust and avoid a possible drop-off in FDI inflows. © 2022, Bucharest University of Economic Studies. All rights reserved.