ASIA Pacific Economic Papers No. 378, 2009
Japanese foreign direct investment (FDI) into China is analysed using an FDI model that accounts for different modes of FDI as well as third country effects and adds to existing literature by incorporating a new measurement of political distance. Political closeness between countries is shown to affect FDI. An improvement in political relations is associated with an increase in FDI by reducing uncertainty in the investment environment. The performance of Japanese FDI into China is shown to be high relative to its potential since the late 1980s. The signing of the bilateral investment treaty in 1988 and Chinas WTO accession in 2001 were events that helped reduce uncertainty in bilateral investment, with the latter mitigating the effects of increased uncertainty from rising bilateral political tensions after 2001.