FDI, Urbanization, and Economic Growth Linkages in India and China

Introduction

Foreign direct investment is a direct investment into production or business in a country by an individual or company of another country, either by buying a company in the target country. It has strong linkages with economic growth and urbanization of a country. Urbanization plays a huge role in stimulating growth of a country. China has developed tremendously after the country launched its reforms and adopted its open door policy in 1978. For three decades, China has gained a two-digit annual growth rate on average when it gradually deviated away from the traditional doctrines of a central-planned economy and put into practice the market oriented economy. With the rapid economic development, cities, as centers for economic activities, have been expanding at an unprecedented speed. Urbanization in China has taken on new dimensions as a result of increasing globalization since introduction of economic reforms. The urban growth and other economic activities during new round of globalization can be measured largely by the inflows and outflows of Foreign Direct Investment (FDI) which has become one of the driving forces binding countries into closer economic interdependence, and it continues to expand. The rapid increase in FDI flows has generated considerable impact on industrialization and urbanization in China. The role of foreign direct investments in the growth and urbanization of China and India has captured the attention of many researchers and analysts. China has historically attracted more FDI than India as a share of GDP, particularly in the early stage of its economic transformation. China achieved a significant growth rate of over 9 percent per year during 1990 to 2010 which was highest in the world during that period. This achievement was mainly due to adoption of radical changes and huge inflow of FDI to Chinese cities. China used to be one of the most closed economies in terms of policy toward foreign investment and external debt. Starting from virtually no foreign-owned firms on Chinese soil before 1979, China has now become one of the largest developing host countries for foreign investment. The coastal region enjoys more growth than inland region and most of the FDI (84 per cent) in China is invested in coastal region due to higher urbanization (Heid & Ries, 1996). China’s need for FDI was related to its export oriented industrial structure – for example, it created special economic zones to attract foreign investment by exempting investors from regulations applicable elsewhere in China. There exist significant positive correlation between urbanization and flow of FDI to a particular region both in china and India. In this context, the objective of the present study is to analyze the causality and linkage between urbanization and FDI inflow with evidences from China and India.