Demographics and FDI: Lessons From China’s One-Child Policy

36 Pages Posted: 31 Jan 2018

See all articles by John B. Donaldson

John B. Donaldson

Columbia Business School - Finance and Economics

Christos Koulovatianos

Department of Finance, University of Luxembourg

Jian Li

Universite du Luxembourg

Rajnish Mehra

Arizona State University (ASU) - W.P Carey School of Business, Department of Economics; National Bureau of Economic Research (NBER)

Date Written: January 19, 2018

Abstract

Lucas (1990) argues that the neoclassical adjustment process fails to explain the relative paucity of FDI inflows from rich to poor countries. In this paper we consider a natural experiment: using China as the treated country and India as the control, we show that the dynamics of the relative FDI flows subsequent to the implementation of China's one-child policy, as seen in the data, are consistent with neoclassical fundamentals. In particular, following the introduction of the one-child policy in China, the capital-labor (K/L) ratio of China increased relative to that of India, and, simultaneously, relative FDI inflows into China vs. India declined. These observations are explained in the context of a simple neoclassical OLG paradigm. The adjustment mechanism works as follows: the reduction in the (urban) labor force due to the one-child policy increases the savings per capita. This increases the K/L ratio and reduces the marginal product of capital (MPK). The reduction in MPK (relative to India) reduces the relative attractiveness of investment in China and is thus associated with lower FDI/GDP ratios. Our paper contributes to the nascent literature exploring demographic transitions and their effects on FDI flows.

Keywords: Lucas Paradox, Capital-Labor Ratio, FDI-Intensity, One-Child Policy

JEL Classification: F11, F21, J11, O11, E13

Suggested Citation

Donaldson, John B. and Koulovatianos, Christos and Li, Jian and Mehra, Rajnish, Demographics and FDI: Lessons From China’s One-Child Policy (January 19, 2018). Available at SSRN: https://ssrn.com/abstract=3105722 or http://dx.doi.org/10.2139/ssrn.3105722

John B. Donaldson

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Christos Koulovatianos

Department of Finance, University of Luxembourg ( email )

4 Rue Albert Borschette
Luxembourg, L-1246
Luxembourg

Jian Li

Universite du Luxembourg ( email )

L-1511 Luxembourg
Luxembourg

Rajnish Mehra (Contact Author)

Arizona State University (ASU) - W.P Carey School of Business, Department of Economics ( email )

Tempe, AZ 85287-3806
United States
480 965 6335 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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