President Xi inaugurated the Silk Road Economic Belt in Kazakhstan on 7 September 2013 and the 21st Century Maritime Silk Road in Indonesia on 3 October 2013. The first initiative refers to the land corridor connecting China to Europe via Mongolia and Russia, Central and West Asia and the Indochina Peninsula. The second refers to the sea route connecting Southeast Asia, South Asia, Africa, the Middle East and Europe to China. The two initiatives are collectively known as the Belt and Road (B&R) [1
]. This long-term infrastructure development policy plan aims to improve connectivity and cooperation among countries along the B&R routes. Huang [2
] described B&R as the country’s greatest international economic ambition and provided four key points for understanding the initiative. First, the initiative’s purpose is to sustain China’s economic growth by developing new markets. Second, the intention is to exert more international influence and reshape global economic development policies away from those prescribed by the International Monetary Fund and the World Bank. Third, the initiative comprises more than infrastructure building, encompassing ‘policy dialogue, infrastructure connectivity, unimpeded trade, financial support and people-to-people exchange’. Fourth, it remains to be seen whether B&R will bring about the benefits touted. Chohan [3
] investigated B&R through the lens of the surplus recycling of China’s industrial/manufacturing output and both human and financial capital. The official publication [4
] elaborated on the B&R framework as consisting of six corridors and six means of communication across multiple countries and multiple ports. The corridors are the New Eurasian Land Bridge Economic Corridor, the China–Mongolia–Russia Economic Corridor, the China–Central Asia–West Asia Economic Corridor, the China–Indochina Peninsula Economic Corridor, the China–Pakistan Economic Corridor and the Bangladesh–China–India–Myanmar Economic Corridor. The communication modes are rail, roads, maritime transport, aviation, pipelines and aerospace integrated information networks. According to China’s official B&R web portal [1
], the initiative has the support of over 100 countries and international organisations. On 17 March 2017, the United Nations Security Council adopted Resolution 2344, which in paragraph 34, pushed for the strengthening of regional economic cooperation through regional initiatives such as B&R and regional development projects.
To the critics of B&R, it is just another extension, albeit on a transcontinental scale, of China’s debt diplomacy. Brautigam [5
] provided an insightful look at this alleged ‘debt-trap’, calling it a meme started by an Indian think tank and adopted by opponents of B&R. The author examined several ‘debt-trap’ cases regularly used to justify the meme, but found no evidence for it. In one instance, it was more a ‘lending trap for China’, as there were no tools for the country to secure repayments. Similarly, Singh [6
] found no evidence supporting the ‘debt-trap’ narrative. Another criticism of B&R is the potential export of corruption along the corridors. The World Bank [7
] highlighted this as a key risk area in infrastructure projects. This is understandable, as can be seen in the heatmap of Transparency International’s Corruption Perceptions Index (CPI) 2020, which is reproduced in Figure 1
Although China’s 2020 CPI is mid-ranking, it is below all 38 member countries [8
] of the Organisation for Economic Co-operation and Development (OECD), apart from Colombia and Mexico. Governance through effective, accountable and inclusive institutions is a key approach of the United Nations Development Programme (UNDP) to achieve the 2030 Agenda for Sustainable Development [9
]. The B&R initiative is also part of the United Nations Environment Programme’s regional initiatives for increasing environmental sustainability through the Belt and Road Initiative International Green Development Coalition launched in Beijing (25–27 April 2019) [10
]. A recent study [11
], questioned whether China’s overseas investment in B&R countries had improved institutional quality (including control of corruption). The dataset for institutional quality was the World Governance Indicators (WGI) of the World Bank, covering six governance facets: (1) Voice and Accountability, (2) Political Stability and Absence of Violence/Terrorism, (3) Government Effectiveness, (4) Regulatory Quality, (5) Rule of Law and (6) Control of Corruption. Data for China’s overseas investment were extracted from the Statistical Bulletin of China’s Outward Foreign Direct Investment reported by China’s Ministry of Commerce (MOFCOM). Except for Voice and Accountability, the authors found positive influence on the other five institutional quality dimensions. In a report to members and committees of the United States Congress on tracking China’s overseas activities, Schwarzenberg [12
] highlighted several issues with data from MOFCOM including only recording officially approved projects. Furthermore, the definition of construction activities versus investment projects has changed over the years making trend analyses difficult. In addition, the pervasive use of offshore financial centres for overseas investment by Chinese entities makes data collection/tracking challenging. There are nongovernmental organisations tracking China’s economic activities such as the China Global Investment Tracker (CGIT) published by the American Enterprise Institute (AEI) and the Heritage Foundation [13
]. CGIT has its own issues, as only projects at USD 100 million or above are included and the recording occurs when a project is announced and not updated for changes, for example, cancellation, postponement, scale changes, etc. Still, as the author noted, data from databases such as CGIT is often used and quoted in global policy discourse. In the 2020 Global Go To Think Tank Index Report [14
] of The Heritage Foundation is ranked sixth whilst AEI is ranked seventeenth. A ranking by the website AcademicInfluence.com (accessed on 11 November 2021) [15
] has both the Heritage Foundation (second) and AEI (sixth) in its 2021 top ten most influential think tanks. Hence, the purpose of this paper is to investigate whether the conclusion of [11
] holds true when data from CGIT (with different collection criteria) are used instead of data compiled by MOFCOM. In addition, as far as the authors are aware, studies in this area using the GMM linear dynamic panel model estimation method have yet to use a sequential model selection approach as shown in [16
]. The quality of inference in GMM estimation is highly sensitive to the selections made by researchers from the numerous choices available [17
]. Cheng and Bang [18
] showed that studies need to be more explicit regarding the specifications and rationales for GMM model selection. A systematic selection approach adapted from [16
] is used here.
2. Literature Review
The literature on foreign direct investment (FDI) and quality of institutions (QI) is part of the international business research on location-choice for FDI and the broader study on the determinants of FDI [20
]. FDI is broadly defined as direct equity investments including greenfield, joint ventures and mergers and acquisitions overseas by firms, namely multinational enterprises (MNEs) [23
]. For institutions in a country/location, North [24
] defined these as ‘humanly devised constraints that structure political, economic and social interactions’, both formal and informal. Better institutions increase the potential return of such interactions either from increases in benefits/profits or reductions in transaction costs. Hence, the nature of host countries’ institutions will have an impact on FDI.
The eclectic or OLI (ownership, location and internalisation) paradigm is extensively used as the analytical framework for determinants of FDI and the foreign activities of MNEs [25
]. A firm’s overseas activities (investment or trade) are ascertained by the interface of the three sets of interacting OLI variables that, alone, are the components of three subparadigms. The first subparadigm, the ownership (O) of specific advantages versus other foreign or domestic firms in a host country, would increase the likelihood of an FDI. The second subparadigm, the location (L) attractions of alternative countries/locations that allow an MNE to increase or use its O competitive advantage, would impact whether the firm undertakes an activity at home or overseas. The third subparadigm, the internalisation (I) benefits, allows a firm to assess how it would engage in an overseas activity given its O advantage in a selected L. The greater the I benefit, the higher the likelihood of a firm engaging in an FDI versus other nonequity arrangements such as trade, licensing or outsourcing. From this eclectic paradigm, countries/locations where institutions do enable firms to maximise their OLI advantages would be attractive destinations.
From firm decision-making literature, Francis et al. [23
] expanded on the institutional isomorphism (firms becoming similar) theory from [28
] to form a multilevel theoretical framework on FDI. DiMaggio and Powell [28
] described three institutional environment pressures—coercive, mimetic and normative. Coercive pressure emanates from institutions as defined by [24
]. Mimetic pressure comes from uncertainty which promotes imitation. Normative pressure stems from professional consensus. Francis et al. [23
] explained the changing isomorphic pressure firms face at different levels (country, industry and firm) depending on the stages of FDI. At the initial entry stage, coercive pressure at the country level and mimetic pressure at the industry level have the most influence. Host country legal and regulatory factors such as profit repatriation and intellectual property protection would affect investment decisions. Meanwhile, firms tend to follow FDI decisions already made by industry peers, as they provide ‘evidence’ of the suitability of a particular country. For countries, the policy implication is clear. Having institutions closer to global expectation (reducing coercive) would be attractive to foreign firms, especially if the country is not yet a popular FDI destination (mitigating mimetic). For subsequent FDI entries, a firm already has the practical experience and, hence, its internal professional consensus becomes more important (reliance on normative).
There is extensive empirical scholarship on quality of institutions (QI) being a key determinant of FDI. In a study of 164 countries from 1996 to 2006 (both developed and developing), Buchanan et al. [29
] found a 1 to 1.69 standard deviation ratio relationship between QI and FDI. This accords with an earlier study by [30
] that found institutions to be a significant determinant, separately from GDP per capita. Daude and Stein [31
] and Ali et al. [32
] showed the importance of QI on FDI, with results consistent for different model specifications and techniques. With China being a significant FDI recipient, Fan et al. [33
] investigated whether China’s large FDI inflows, given its weaker QI, invalidate the positive relationship between QI and FDI. The authors concluded that, controlling for factors such as economic growth track record and demography, China’s level of FDI per capita is at comparable levels with other host countries with the familiar QI-FDI relationship.
In line with development in the global institutional framework [34
], more recent and, for this paper, more relevant literature is investigating whether FDI leads to an improvement in QI. This is especially relevant given the widespread FDI outflows from China to developing and less developed countries, even before B&R. Fukumi and Nishijima [36
] investigated 19 countries across Latin America and the Caribbean using data from the International Country Risk Guide (ICRG) [37
], Freedom in the World [38
] and the World Bank’s Database of Political Institutions 2000 [39
]. The authors used simultaneous equations to avoid endogeneity biases and regression results point towards a bidirectional relationship between QI and FDI and indicate a virtuous cycle of FDI improving QI, which in turn attracts further investment. Similarly, the results of [40
] investigating property rights also suggest the positive influence of FDI on QI. Foreign investment brings better manufacturing and production technology together with better social and institutional norms. The authors utilised a panel of 70 developing countries from 1981 to 2005 and argued that not only are lower tax rates important for foreign investors, but also better QI. This incentivises governments to provide better institutions as they compete for foreign investments. Economic data were sourced from UNCTAD and the World Bank whilst QI data were from ICRG. For a robustness check, the paper tested both FDI flows and FDI stock as an explanatory variable. The results were consistent across the two variables. The authors indicate that current FDI stock affects the quality of property rights protection, whereas FDI flows could be more a reaction to improving property rights protection. Instead of cross-country panel data, Dang [41
] used within-country data from 60 provinces in Vietnam with the QI measured using a survey of private businesses’ qualitative assessment of provincial economic governance (Vietnam Provincial Competitiveness Index). Foreign investment was instrumented using the distance of a provincial capital to the main economic centres of Hanoi, Da Nang or Ho Chi Minh City. The results using two-step GMM confirm that FDI leads to improvement in QI and a size effect (larger disbursements of FDI deliver higher QI). Using similar methodology, Long et al. [42
] also found a similar relationship of ‘FDI-induced institutional improvement’ for host regions in China. The authors examined two aspects of QI for Chinese domestic firms, namely tax/fee burdens and quality of legal protection. The paper utilised data from a 2005 survey conducted by the World Bank and the National Bureau of Statistics of China (NBSC) of 12,400 firms in 120 cities across all Chinese provinces except Tibet, the Chinese Private Enterprise Survey in 2006 and 2008 and NBSC’s industrial survey in 2000. Two instrumental variables selected for FDI were provincial highway density in 1937 (reflective of current infrastructure but not current local QI) and the number of World Heritage Sites in each province (correlation with foreign visitors/potential investors, but not local QI). Positive correlation is reported between higher levels of FDI (four years’ lag) and reduced tax/fee and higher quality rule of law.
A dissenting paper is [43
]; using bilateral FDI data for 134 countries (developed and developing) from 1990–2009, the author found no significant positive effect (reduction in QI gap) of both developed and developing bilateral FDI into developing countries. On an aggregate level, developing countries’ FDI into a developing host country had a negative effect (increase in QI gap between aggregate QI and host country QI). The use of the QI gap could be problematic, as an increase in gap could be due to the host country’s QI improvement occurring at a slower rate versus the aggregate QI rate of investing countries. For 19 developing Asian countries from 2002–2015 (data from The Freedom House, The Heritage Foundation, ILO, UNESCO, World Development Indicators [WDI], World Economic Forum and WGI), Huynh et al. [44
] investigated the three-way linkages between FDI, the shadow economy and QI. The authors found a bidirectional positive relationship between FDI and QI. The bidirectional relationship between QI and the shadow economy and between the shadow economy and FDI were both negative. Zhang et al. [45
] investigated the spillover effects of China’s B&R investments into 36 developing countries from 2003 to 2017 using panel vector autoregressive modelling (with impulse response function, variance decomposition analysis and Granger causality test). The dataset used was a QI index of the six WGI measures created using the entropy-weighted method and data from the Human Development Index (UNDP). Spillovers were positive with the most impact on QI occurring in the fourth year after a Chinese investment. Pan et al. [11
] looked specifically at China’s B&R investments (data from MOFCOM) impact on QI in host countries and found significant positive impact for most but not all measures of QI from WGI using the two-step GMM.
This paper conceptually replicates the study of [11
] on whether China’s investment in B&R countries improves host country institutional quality. The novel approach is the use of datasets compiled by non-China sources and the application of a sequential model approach adopted from [16
]. The model specification chosen for all six QI measures passes the AB first/second order autocorrelation test and are all within the SH overidentification test p
-value range suggested by [16
]. The empirical results broadly support the conclusion of [11
] that China’s B&R investment has a positive impact on some of the WGI’s measures of QI. For this paper, the consistent impact of China’s investment stock and flow intensities (as measured by this study) on host countries’ QI, across Model (1) in Section 4.1
and Model (2) in Section 4.2
, together with the latter’s robustness check, is on the single measure of zCC (Control of Corruption). This may be surprising at first, but can be understood given that anticorruption is a recurring top policy of President Xi since 2012. As state owned/controlled institutions are the main drivers of the B&R initiative, it would be astonishing if these institutions did not ‘toe the line’ in their overseas activities. Additionally, China has been consistently promoting itself as a responsible international player focussing on economic development through the B&R initiative. Hence, there would be across-the-board pressure to ensure that overseas activities adopt international best practices. The lack of impact on other QI measures can be interpreted as due to China’s long-held policy of noninterference in other countries’ internal affairs.
Another contribution of this paper is the support it lends to the hypothesis that a country’s GDP per capita is a key determinant of QI. The results from the two models and the robustness check, for some measures of QI (Regulatory Quality and Rule of Law), agree with [67
] (using different measures of QI from ICRG) for GDP per capita of a country to be an important determinant (positive) of QI. Economic growth leads to better institutions, as the availability of resources allows for the building and strengthening of institutions.
This study adds to the body of literature on the impact of China’s B&R initiative across the globe. As noted by a number of authors, data from the initiative are still limited. As shown in the CGIT database, some B&R countries have had only limited investment, whilst others have more regular investments and new countries continue to join the initiative. This will remain a rich area for academic studies, and with the launch of the US-led G7’s Build Back Better World [68
] and the EU’s Global Gateway [69
], both in 2021, would provide opportunities for comparative studies between the former and B&R in the future.