How can China invest in Countries where others are Expropriated?∗

Poor rule of law is usually a binding constraint for foreign investment and lending. But recently Chinese firms disproportionally invest overseas in countries with weak institutions. How do they manage this exposure? Our model appeals to China’s buying power as importer and also to its within-country coordination to act like a single agent. These two factors allow China to credibly commit to sizable trade sanctions in case the host country expropriates. Thus, purchasing power is used to sustain other investments, analogous to trade-credit between a small firm and its main buyer. This additional “stick” becomes more important for FDI in non-traded goods, which face weaker enforcement of compensations post expropriation or devaluations. Using data on outward Chinese FDI (2003-2007) we find support for our model. First, China shows revealed comparative advantage as investor in countries with both poor institutions and a large share of exports going to China. In contrast, simply having poor institutions is not a robust predictor of the Chinese share of FDI, suggesting that the interaction with oligopsonistic power plays a role. Second, we find that the effect is concentrated in non-traded goods; giving also less traction to explanations in which multinationals prefer to own the assets producing the exported good (e.g. Antrás, 2003). Third is the intensive margin, with Chinese projects being 50% bigger in size than those of other countries in the same destination. Overall, our results suggest an additional channel in which Chinese growth would expand capital flows to developing nations. JEL classification: F21, F23, F34, F51, G32 , G33.