The Relationship Between Exchange Rate And Foreign Direct Investment Of China

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Investigation of Gravity Model
Relationship between Exchange rate and Foreign Direct Investment of China
Junshan Chen
The report bases on the theories of relative cost of production and the relative wealth effect analyzes the potential impact caused by exchange rate upon foreign direct investment. The target country selected is China; while the research period is identified as 1980 to 2012. In order to undertake the empirical study, the gravity model is referred to when establish the regression model, relying upon the regression results released by Stata. The increase of real exchange rate, i.e. the appreciation of RMB will restrict the inflow of foreign direct investment. Furthermore, the GDP will positively affect the level of foreign direct investment; while the average domestical wage will negatively impact the level of foreign direct investment. In addition, the policy change will generate a dramatic influence upon the level of foreign direct investment and thus has to be taken into deep consideration when the regression analysis is undertook.
Literature review In terms of the relationship between exchange rate and the foreign direct investment, there are mainly two theories which are respectively ‘relative production cost effect’ and ‘effect of relative wealth’. Specifically, on the one hand the relative production cost is put forward by Cushman in 1985. In his perspective, the devaluation of domestic currencies will reduce the relative cost of
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