Political Risk and Firm Exit: Evidence from the US-China Trade War
46 Pages Posted: 13 Sep 2021
Date Written: September 2, 2021
Does international conflict induce foreign firms to “follow the flag” and exit from a profitable market? We show that the US-China trade war broadly elevated political risks for multinational corporations (MNCs) operating in China, increasing firm exit overall. However, investment treaties can mitigate political risks at the country level while firm entrenchment determines resilience to risk at the firm level. Using a new dataset on all foreign-invested firms registered in China between 2014 and 2019, we implement difference-in-difference and triple-difference models to isolate the impact of increased political risks on MNC exit in the context of the US-China trade war. Our findings show that US and allied firms were not more likely to exit China, suggesting that foreign direct investment outflows do not "follow the flag." Instead, firm exit is determined by the balance of heightened political risks against the availability of firm-level and institutional resources to mitigate these risks.
Keywords: international political economy, trade, foreign direct investment, fdi
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