FDI In, SOE Out: Understanding the reallocation effects of FDI liberalization in China

WeiTanga,YuanWangb,∗,HaiqiWei

ABSTRACT

This paper investigates the impact of FDI liberalization on allocative efficiency in host countries.Using China's 2002 FDI deregulation as a policy experiment, we show that growth impacts ofFDI in a policy-distorted economy is primarily driven by between-firm resource reallocationrather than within-firm productivity improvements. Domestic firms with higher pre-reformmarginal revenue products of capital (MRPK) receive greater capital inflows and exhibitsubsequent declines in MRPK. We emphasize the role of FDI reform in reducing ownership-related distortions: it accelerated the exit of state capital. These results highlight that thepro-competitive effects of openness policies can act as external catalysts to mitigate domesticpolicy-induced distortions.

Keywords:

FDI liberalization  Reallocation  State-owned enterprises  China