Dialect Diversity and Foreign Direct Investment in China

• Published date: 01 March 2021
• Author: Wei Feng,Yanrui Wu,Yue Fu
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/cwe.12370

©2021 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 49–72, Vol. 29, No. 2, 2021 49

Dialect Diversity and Foreign Direct Investment

in China

Wei Feng, Yanrui Wu, Yue Fu*

Abstract

This paper examines the relationship between dialect diversity and foreign direct

investment (FDI) using a dataset of 230 Chinese cities for the period 2000–2014. We

fi nd that dialect diversity and FDI absorption are negatively correlated. However, this

negative relationship disappears gradually over time. Several underlying mechanisms

are identified. In particular, it is found that dialect diversity impedes human capital

development and hence obstructs FDI absorption. Our results also show that there

are threshold and spatial spillover effects. This research increases knowledge of FDI

location choice and has implications for foreign investment policymaking.

Key words: dialect diversity, economic growth, FDI absorption, human capital

JEL codes: F21, F41, G18

I. Introduction

According to the World Bank (2019), net infl ows of foreign direct investment (FDI)

in China1 were US$168.2 billion in 2017, which accounted for 8.6 percent of global

FDI. A unique feature of China’s inward FDI is that China absorbed a large volume

of FDI from East Asia. In 2017, the top sources of FDI were Chinese Hong Kong

(US$98.9 billion), Singapore (US$4.8 billion), Chinese Taiwan (US$4.7 billion),

South Korea (US$3.7 billion), and Japan (US$3.3 billion).2 These countries and

regions are geographically adjacent to and have strong linguistic links with the Chinese

mainland. For example, two Chinese dialects, Min and Hakka (or Kejia), are spoken

*Wei Feng (joint corresponding author), Associate Professor, School of Economics and Management,

Southeast University, China. Email: weifeng717719@126.com; Yanrui Wu (corresponding author), Professor,

Business School, University of Western Australia, Australia. Email: yanrui.wu@uwa.edu.au; Yue Fu, Teaching

Assistant, School of Economics and Management, Shanghai University of Political Science and Law, China.

Email: rochellefu@163.com. This research was supported fi nancially by the Social Science Foundation of

Jiangsu Province (No. 20EYA003) and the Fundamental Research Funds for the Central Universities (No.

2242020S20055).

1Unless stated otherwise, “China” refers to the Chinese mainland in this paper.

2These statistics were drawn from the China Ministry of Commerce Business Data Center.

Wei Feng et al. / 49–72, Vol. 29, No. 2, 2021

©2021 Institute of World Economics and Politics, Chinese Academy of Social Sciences

50

primarily on the south Chinese mainland but also in Taiwan. So is Yue (or Cantonese),

which is spoken in Guangdong and Hong Kong. A linguistic link may be benefi cial to

communication and cooperation (Falck et al., 2010; Ma, 2017), and hence may play an

important role in the location selection of FDI. However, this factor is often overlooked

in the literature on FDI location choice, especially when FDI faces different kinds

of dialects in host countries such as China. Instead, the existing studies on FDI have

focused on factors such as country effects (Baltagi et al., 2007; Garretsen and Peeters,

2009), human capital (Noorbakhsh et al., 2001; Thangavelu and Narjoko, 2014),

infrastructure (Shapiro, 2003; Varella et al., 2006), industrial agglomeration (Du et al.,

2008; Majocchi and Presutti, 2009), market size (Asiedu, 2006; Goh and Wong, 2010),

and institutional quality (Du et al., 2012).3

On the one hand, the use of different languages may generate additional transaction

costs or cognitive hurdles, which inhibit investment, financing, and trade. Oh et al.

(2011) empirically test the impact of transaction costs caused by linguistic differences on

international trade and FDI across countries. They fi nd that speaking the same language

increases trade and FDI flows between countries and the effect of having a common

language on FDI is greater than that on trade. Lazear (1999) and Selmier and Oh (2013)

also put forth the same view that a common language can promote trade and investment

between countries or areas. Lu and Zhu (1995) point out that dialect advantages can

promote investment fl ow from Singapore to China. Falck et al. (2010) construct a dialect

similarity matrix and find that cultural identities formed in the past can still influence

today’s economic exchange. Ma (2017) identifi es the link between investment from Hong

Kong, Macau, and Taiwan (HMT) and dialect areas in Chinese mainland.

On the other hand, some scholars believe that diverse languages can provide

more tools for both individuals and groups to facilitate communication. Melitz (2008)

believes that linguistic diversity is conducive to promoting a country’s foreign trade,

mainly because linguistic diversity can cope with any communication barriers and

diffi culties related to reading and writing in foreign trade. Ashraf and Galor (2011) also

support the opinion that linguistic diversity has played a positive role in the process of

industrialization.

The above literature review demonstrates that there is hardly any study that

identifies dialect diversity as an important factor in attracting FDI, especially in the

context of China. This paper fi lls the void in the literature by exploring the relationship

between dialect diversity and FDI absorption and using prefecture-level data in China.

First, three hypotheses regarding the relationship between local dialect diversity and

FDI absorption are proposed. Second, following the existing literature, the degree of

3Sahiti et al. (2018) and Tocar (2018) provide excellent reviews of the literature regarding determinants of FDI.