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Department of Economics
Working Paper Series
An Investigation of Confucius Institute’s Effects on China’s OFDI via Cultural Difference and Institutional Quality Chensheng Xu
Feng Yao
Fan Zhang
Working Paper No. 15-45
This paper can be found at the College of Business and Economics Working Paper Series homepage:
http://be.wvu.edu/phd_economics/working-papers.htm
1
An Investigation of Confucius Institute’s Effects on China’s OFDI via Cultural Difference and
Institutional Quality
Chensheng Xu1
School of Economics and Trade
Guangdong University of Foreign Studies
Guangzhou, Guangdong 510006, P. R. China
Email: [email protected] Voice: +86 20 39328516
Feng Yao2
Economics Department School of Economics and Trade
West Virginia University Guangdong University of Foreign Studies
Morgantown, WV 26505, USA & Guangzhou, Guangdong 510006, P. R. China
Email: [email protected] Email: [email protected]
Voice: +1 304-293 7867 Voice: +86 20 3932 8858
Fan Zhang
Economics Department
West Virginia University
Morgantown, WV 26505, USA
Email:[email protected]
Voice: +1 304 216 7370
ABSTRACT: This paper uses a panel data of China's outward foreign direct investment (OFDI)
from 2004-2012 to investigate the influence of Confucius Institute on China's OFDI. We find
that Confucius Institute, as a comprehensive platform for China's foreign cultural exchange, has
a significant positive effect on China’s OFDI. Interestingly, the positive effect can be reduced
with larger cultural difference and can be increased in host countries with lower institutional
quality. Correspondingly, we find that Confucius Institute’s impact on China’s OFDI is more
obvious in host countries with smaller cultural difference or lower institutional quality.
Keywords: Confucius Institute, foreign cultural exchange, outward foreign direct investment
(OFDI), heterogeneous effect
1 Supported by Mechanism and Strategy Choice of China's Participation in Global Economic Governance
（IRT1224）.
2 Corresponding author.
2
I. Introduction
Since “Going Global” was proposed as a national strategy, China’s Outward Foreign Direct
Investment (OFDI) has amazed the world by its dramatic increase. In 2002, China’s OFDI was
only $2.7 billion, but with10 years of rapid growth, China’s OFDI reached $107.8 billion in
2013, making China the third largest OFDI investor (MOFCOM, 2014). With rapid increase in
investment scales, China’s OFDI encountered various kinds of risks that threat the properties of
investors and even the safety of employees working in the host country. Among various kinds of
risks, the risk associated with cultural difference and institutional quality presents a special
challenge to the implementation of “Going Global”, and has been one of the focuses studied (see
Li et al. 2013).
On one hand, the institutional environment in the host country, the quality of which contributes
critically to the transaction cost, is a key determinant for the safety of oversea investment. On the
other hand, with OFDI as a transnational production input, investors face potential cultural
conflicts that profoundly impact OFDI. So, to implement “Going Global” as a national strategy,
it would be especially important for the home country, China in this case, and Chinese
multinational entities to actively participate in programs that reduce transaction costs arising
from institution quality and cultural difference.
The Chinese government always emphasizes cultural exchange with other countries. To promote
the appreciation of Chinese language and the comprehension of Chinese cultural heritages,
Hanban, a subordinate branch of Chinese Ministry of Education, established Confucius Institute
(C.I.) as a non-profit public institute in 2004, which acts in a similar fashion as Germany’s
Goethe Institute, UK’s British Council and France’s Alliances Frances. With dramatic increase
in the number of C.I. and its registered students (see section II), C.I. serves as the powerbase for
3
cultural exchanges and language promotions between China and the host countries. With
“Increasing the understanding of Chinese culture and language worldwide, developing
international friendship, promoting global cultural diversity and facilitating business activities3”
as principles, we expect important impacts from C.I. on China’s OFDI.
Although many papers have discussed the determining factors of China’s OFDI, most of them
only focus on investment environments in the host countries. The home country’s activities
aiming at promoting cross-cultural administration and their potential positive impact have not
been investigated. Consequently, the effects of cultural exchanges through C.I. on OFDI are
largely ignored. In this paper, we use a panel data of China’s OFDI to fill the gap by
investigating the effects of C.I. on China’s OFDI. Particularly, its transmission mechanism
depends on the cultural difference and the institutional quality of host countries. We observe
qualitative differences on the effects of C.I. on China’s OFDI when we group host countries
according to cultural difference between home and host countries, and institutional quality of
host countries. We argue that C.I. can reduce the transaction cost arising from liabilities of
foreignness and psychic distance, by bridging the gap created due to information asymmetry.
Our conclusion provides an empirical understanding of the behavior of China’s OFDI, and a
practical reference for multinational entities who expect benefits by implementing cultural
exchange through “Going Global”.
The rest of the paper is organized as following. Section II presents a brief literature review of
OFDI’s determining factors and our hypothesis. Section III presents the benchmark model and
describes variables and data sources. Section IV describes empirical results illustrating the
4Facilitating business activities comes from an interview with the director of Hanban, Beijing, China, September 24,
2007. See Paradise (2009) for details.
4
effects of C.I. on China’s OFDI, which are subject to heterogeneities of host countries. Section V
concludes.
II. Literature Review and Test Hypothesis
II.1 Determining factors of China’s OFDI
The determining factors of OFDI have been studied by many in international business. The
Eclectic Theory by Dunning (1977, 1993) argues that ownership advantages, location advantages
and internalization advantages are essential conditions for multinational entities to invest
overseas. So, market-seeking, resource-seeking, efficiency-seeking and strategic asset-seeking
are primary investment motivations. Substantial influence of economic factors on China’s OFDI
has been demonstrated by many, see Buckley et al. (2007), Zhang and Daly (2011), Duanum
(2012), Ramasamy et al. (2012), Kolstad and Wiig (2012) and Kang and Jiang (2012).
Specifically, market size, resource endowment, market openness, research and development, and
human resource of the host country all have a positive impact on China’s OFDI, while
geographical distance, salary level, and economic fluctuation influence China’s OFDI in a
negative fashion.
II. 2. Non-economic Risks for China’s OFDI
Risk is a key concern for oversea investments. Compared with economic risks, the non-economic
risk can cause much more damage and are more difficult to predict and control. Meldrum (2000)
shows that non-economic risk is a major concern for entities in developing countries. Though
Institutional Theory ((Busse and Hefeker, 2007; Peng et al., 2008)) believes that high
institutional quality in the host country, critical factors to attract oversea investments, can
effectively reduce the uncertainty faced by the investing entity and decrease transaction costs and
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risks, empirical results for China (Kolstad and Wiig (2012)) found that Chinese enterprises tend
to invest more in regions with lower institutional quality. Currently, there are three major
explanations for this phenomenon. First, Habib and Zurawicki (2001) show that the impact of
corruption on local investment is substantially lower than on FDI. One implication for foreign
investors is to search for some “connectivity” to address corruption. Chinese firms,
accustomed to the institutional environment in China, are more used to and apt in
handling corruption, thus are expected to have a comparative advantage in host countries
with similar low institutional quality. Second, Ramasamy et al. (2012) and Amighini et al.
(2013) suggest that state-owned enterprises dominate China’s OFDI, and they tend to pursue
non-economic objectives as they face soft budget constraint. Third, Buckley et al. (2007) and
Amighini et al. (2013) argue that resource-seeking motivation is prominent for China’s OFDI,
and host countries with abundant natural resources frequently exhibit poor political and
institutional environments.
Another thread of literatures echo what we observe above. Zaheer (1995) proposes liabilities of
foreignness as, “all additional costs a firm operating in an oversea market incurs that a local firm
would not incur”. Those costs are present through un-familiarity with the local environment and
lack of legitimacy in the host country. A key thread in this literature is that liabilities of
foreignness would increase the cost of foreign investment in a qualitatively dissimilar economy.
Ellis (2008) discussed a positive relationship between investment costs and psychic distance of
the home country and host country arising from environmental, cultural, political and economic
differences. The calculation of psychic distance involves several dimensions of economic and
social variables such as cultural differences, language, and religion, intuitional and economic
development. Contractor (2013) argues that “institutions are less-developed in emerging nations,
6
so that their firms face an environment of institutional voids.” Furthermore, institutional voids
between emerging markets and developed markets can be seen as a decided advantage for
emerging markets’ firms expanding into other emerging markets (Cuervo-Cazurra and Genc
2008). They possess enhanced ability to cope with the inefficient capital markets, poor
enforcement of local and international laws, capricious bureaucrats and erratic regulations,
typical in emerging market environments. The enhanced ability does not translate into their
ability to expand or operate in markets with high institution quality. Institutional voids increases
the transaction costs of expanding from an emerging market to a developed market due to
increased level of information asymmetries.
Though many literatures have investigated influencing factors of China’s OFDI, majority of
them focus only on investment environment in host countries, neglecting the effects of home
country’s efforts through promoting bilateral understanding. To promote the understanding of
Chinese culture and language, Hanban established C.I. in 2004. Since then, C.I. exhibits dramatic
increase in registered students and holds numerous culture appreciation events. We believe C.I.
would affect China’s OFDI through variety of channels, impacts of which should not be ignored.
II. 3. The impacts of C.I. on China’s OFDI4
Hanban establishes C.I. with four main principles, to increase the understanding of Chinese
language worldwide, to promote Chinese culture and global cultural diversity, to develop
international friendship and to facilitate business activities.
1. C.I. increases the understanding of Chinese language worldwide
5 The data and activities in the description of C.I. come from “Confucius Institute Annual Development Report
2014”.
7
In 2006, there were only 122 C.I.s and Confucius Classrooms5 established across 46 countries
with 13,000 registered students (Hanban, 2007). By the end of 2014, 475 C.I.s and 851
Confucius Classrooms have been established in 127 countries. C.I. has dispatched 33,745
Chinese teachers worldwide with more than 1,100,000 registered students (Hanban, 2015).. To
effectively disseminate Chinese language and culture, C.I. has devised various kinds of Chinese
learning materials, such as International Curriculum for Chinese Language Education and
Guidelines for Chinese Language Teaching Materials Development and has made them online
for abroad access. Confucius Institute Digital Library has also been made available to the public
with more than 200,000 volumes of resources. In 2014, More than 100 doctoral students have
enrolled into the Confucius China Studies Program to explore the genuine charm of Chinese
language.
The impacts of language have been well documented in international business. For bilateral
trading partners, we observe a significant decrease in transaction costs if they speak a common
language since a common language can effectively reduce costs associated with
misunderstanding and translation (See Helliwell 1999 and Hutchinson 2002). The results from
gravity model also indicate that immigrates would increase the trading volume between the
country they immigrate to and the country of their origin. One possible explanation is that
immigrants can effectively speak their native language and conduct accurate translation (See
Head and Ries 1998, Dunlevy and Hutchinson 1999). Melitz (2008) argues that the impact of
direct communication is larger than that of indirect communication in promoting trade and the
impact of a common language on trade can be higher than what is suggested previously. Since
C.I. provides enormous activities to promote Chinese language, we expect that increased
5 C.I.s are affiliated in universities as a department but Confucius Classrooms are incorporated into primary and
secondary schools.
8
familiarity with Chinese literacy would reduce transaction costs of international business, which
would increase China’s OFDI.
2. C.I. promotes Chinese culture and global cultural diversity
C.I. has held several branded projects to increase the understanding of Chinese culture. For
example, in 2014, the Confucius Institute’s Day organized more than 3,900 varieties of activities
and performances over 1,200 C.I.s and Confucius Classrooms with more than 10 million
participants. The Confucius Institute Headquarters Open Day offered 28 activities such as
cultural seminars, academic lectures, and cultural experience activities and attracted more than
3,000 internationals and local residents in Beijing. C.I. also hosted a series of Chinese Bridge
events with more than 30,000 educational officials, university presidents, school principals,
teachers and students as participants. Besides, more than 5,531 lectures and forums has been held
in 104 countries and professional performance troupes gave 299 artistic performances to an
audience over 400,000 in total. With such intensive activities, C.I. has promoted the
comprehension and appreciation of Chinese culture and language.
Representing a nation’s image and soft power, culture is the essential combination of language,
social value, behavioral norm and logical methodology. Culture has a profound influence on
economic behaviors (Hofestete, 2003). Since overseas investment experiences cultural conflicts,
cultural difference between the home and host countries can have important influences on
foreign investment. Bhardwaj (2007) shows that the trust level and uncertainty aversion
characteristics exhibited in the culture of the host country would significantly affect foreign
investment. Additional research finds that cultural difference is a primary obstacle for foreign
direct investment. Similar language and culture can effectively avoid risks associated with
cultural difference, increase the identification of foreign investment, and reduce transaction costs,
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all of which can attract more foreign investment (Lopez and Vidal, 2010; Oh et al., 2011).
Research on China’s OFDI also reaches similar conclusion that large cultural difference
significantly impedes China’s OFDI (Kang and Jiang, 2012). Buckley et al. (2007) and Quer et
al. (2012) find that larger oversea Chinese population in the host country helps to reduce the
negative effect on China’s OFDI from cultural difference. Thus, we expect that the activities
carried out by the C.I. can improve the understanding of the true art of Chinese culture, which
will increase the volume of China’s OFDI.
3. C.I. assists the development of international friendships between China and the rest of the
world
C.I. is more than a mere institution that promotes Chinese language and encourages cultural
exchanges. It promotes international friendships by coordinating government diplomacy, public
diplomacy and folk diplomacy (Chen, 2014). Attending various activities held by C.I. becomes a
common arrangement for Chinese leaders visiting abroad. For example, Chinese President
Jinping Xi and Pakistani President Mamnoon Hussain witnessed the establishment of a C.I. in
the University of Agriculture Faisalabad in February 2014. Chinese President Jinping Xi and
Brazilian President Dilma Rousseff observed the signing of agreements for the establishment of
three C.I.s in Brazil in July 2014. Chinese Premier Keqiang Li attended the China-Africa
Economic, Trade and Culture Round Table in Addis Ababa with C.I. representatives in May
2014. Correspondingly, C.I. attracts foreign dignitaries to visit C.I. Headquarters. For example,
in February 2014, Madam Elizabeth Truss, Deputy Secretary of State at the UK department of
Education visited C.I. Headquarters and commented on the positive contributions made in
promoting Chinese culture and language in UK. Vice Premier Kamila Talieva of Kyrgyzstan
visited the C.I. Headquarters in 2013.
10
Political factors can have profound influence in international business behaviors. Dixon and
Moon (1993) note that American exporters achieve greater success in the markets of nations with
similar political philosophy and foreign policies. Dajud (2013) observe that political difference
measured by the distance between authoritarianism and libertarianism has a negative effect on
bilateral trade flows. Li and Liang (2012) find that China’s OFDI prefers host countries with
similar political beliefs, resembling international status, stable political relations and little
political friction. Zhang, Jiang and Zhou (2014) argue that bilateral senior officer visits improve
the awareness and generate positive opinions of the home country, and facilitate China’s OFDI
by creating a more friendly investing environment. By providing friendly diplomatic activities,
creating opportunities of bilateral negotiations and bridging the gap between political beliefs, C.I.
can reduce the obstacles of international business, provide additional protection to oversee
enterprises and consequently assist the growth of China’s OFDI.
4. C.I. facilitates Chinese business activities aboard
According to an interview conducted in Paradise (2009) with the director of Hanban, C.I.
successfully helped the Chongqing motorcycle industry to export motorcycle to Thailand. It also
helped Haicheng Group in Tajikistan to hire local employees with qualified Chinese knowledge.
This reduces Haicheng Group’s cost by localization. C.I. in Cambodia assisted economy and
trade negotiations between Siem Reap Province and Jiangxi Province in China. According to the
director of Hanban, “A lot of people want to do business in China. Now there are not enough
resources to help. But our people will do their best to get them the information they need.”
Anderson and Sutherland (2015) argue that the Investment Promotion Agencies established in
China by Canadian provinces can reduce the transaction cost of investment by reducing the
psychic distance and liabilities of foreignness, which increases China’s OFDI in Canada.
11
Motivated by their interesting work, we argue that as a comprehensive platform for cultural
exchange, C.I. can have important impacts on China’s OFDI. That is, if C.I.’s roles of promoting
Chinese language and culture, assisting the development of international friendships, are able to
bridge information asymmetries and lower transactions cost, it can effectively reduce the
associated liabilities of foreignness and psychic distance. Thus, we expect that China’s OFDI can
be increased by C.I..
Lien et al. (2012) examine the effects of C.I. on China’s OFDI, and they conclude that the
establishment and operation of C.I. has significant positive effects on China’s OFDI, mostly in
developing countries. They use data ranging from 1996 to 2008, so only one-third of their data
are related to the C.I. since it is launched in 2004. Lien et al. (2012) focus on the language
familiarity as the major channel through which a C.I. impacts FDI6. Built upon their important
work, our study utilizes data from 2004 to 2012, a more relevant sample, to examine the effects
of C.I.. From the discussion of the multi-functions of C.I., we believe that there are more
channels through which a C.I. impacts China’s ODFI. Specifically, we believe that cultural
difference and institutional quality are important variables for explaining China’s OFDI, and
their profound impact cannot be simply captured by the number of C.I..
Many research have performed in-depth discussion about determining factors on China’s OFDI,
and some have acknowledged that cultural difference yield profound influence on OFDI.
However, existing studies primarily focus on cultural characteristics and differences of the host
country, ignoring the potential positive effects from cultural exchange activities carried out by
6 Lien et al. (2012, p149) pointed out that language familiarity is not the only channel through which a C.I. impacts
FDI and a C.I. often acts as an information exchange platform.
12
home country. Almost no literatures discuss empirically the effect of C.I. on China’s OFDI from
the angle of cultural difference and institutional quality. Using a panel data of China’s OFDI, we
fill this gap by including cultural difference and institutional quality explicitly as control
variables and examining the effects of C.I. on China’s OFDI. Of course, these two variables,
cultural difference and institutional quality, either do not change or change only modestly for a
country over years in the panel. By including them explicitly, we are able to ask whether there
are still impacts from C.I. on China’s OFDI by controlling different levels of cultural difference
and institutional quality across countries. If there is still positive effect from C.I. on China’s
OFDI, we argue that C.I. can indeed effectively reduce the transaction cost and information
asymmetry arising from liabilities of foreignness and psychic distance, thus C.I. can facilitate
Chinese business activities aboard. We specifically address three questions. First, as a
comprehensive platform for Chinese cultural exchanges, does C.I. have a positive effect in
promoting China’s OFDI? Second, does the effect depend on the cultural difference and
institutional quality? Third, are there any heterogeneities for the impact of C.I. on China’s OFDI?
III. Research Method
1. Model
To investigate the effects of C.I. on China’s OFDI, we use the investment gravity model and
construct the following benchmark regression model, for host country i at year t,
𝐿𝑛𝑂𝐹𝐷𝐼𝑖𝑡 = 𝛼 + 𝛽1𝐿𝑛𝐺𝐷𝑃𝑖𝑡 + 𝛽2𝐿𝑛𝐷𝐼𝑆𝑖 + 𝛽3𝐿𝑛𝑂𝑃𝐸𝑁𝑖𝑡 + 𝛽4𝑅𝐸𝑆𝑖𝑡 + 𝛽5𝐼𝑁𝑆𝑖𝑡 + 𝛽6𝐶𝐷𝑖 +
𝛽7𝐶𝐼𝑖𝑡 + 𝜀𝑖𝑡 (1) 𝑖 = 1, … , 𝑛 ; 𝑡 = 1, … , 𝑡
2. Sample
13
We use a non-financial Chinese OFDI panel data from 2004, the year C.I. was launched, to
2012 as the base sample. We exclude Hong Kong, Taiwan, Macau due to their special ties to
China. Because of missing data in certain variables, the final sample consists of observations
in an unbalanced panel dataset of 59 host countries and they are listed in Table 1.
Table 1 List of Countries
Argentina Finland Latvia Senegal
Australia France Lebanon Singapore
Austria Germany Malaysia Slovak Republic
Bangladesh Ghana Mexico South Africa
Belgium Greece Morocco Spain
Bulgaria Hungary Netherlands Sri Lanka
Brazil India New Zealand Sweden
Chile Indonesia Nigeria Switzerland
Colombia Ireland Norway Tanzania
Croatia Israel Pakistan Thailand
Czech Republic Italy Peru Turkey
Denmark Japan Philippines United Kingdom
Ecuador Jordan Poland United States
Egypt Kenya Romania Zimbabwe
Ethiopia Korea Russia
3. Explanation of variables and data sources
a. Dependent Variable
We use China’s OFDI flows to each host country (OFDIit) which comes from the
Statistical Bulletin of China's Outward Foreign Direct Investment released by MOFCOM.
Following Busse and Hefeker (2007), we use Ln(OFDI)≡ Ln[OFDI+(OFDI2+1)1/2] as
the dependent variable. We adopt this simple strategy to avoid zero or negative values.
b. Independent Variable
We use the number of C.I. (𝐶𝐼𝑖𝑡) established in host country i at year t as the independent
variable. It comes from the annual report of Hanban. C.I. promotes Chinese Language,
14
encourages cultural exchange and improves international cooperation, so we expect that
the number of C.I. has a positive effect on China’s OFDI.
c. Control Variables
Market size (LnGDPit). Market-seeking is one of the primary motivations of China's
OFDI. We expect that the host country's market size has a positive impact on China's
OFDI, ceteris paribus. We use natural logarithm of the host country's GDP as the market
size, where data comes from the World Bank database.
Geographical distance (LnDISi). Geographical distances between China and host
countries would affect foreign investment through transportation costs and transaction
costs. We measure this variable as the linear distance between two countries’ capitals and
expect the geographical distance has a negative impact on the size of China's OFDI. The
data comes from the Centre d'Études Prospectives et d'Informations Internationales
(CEPII) database.
Openness level (OPENit). Higher levels of openness imply better acceptance of the host
country toward foreign capitals and goods. We expect that the level of openness affects
China's OFDI positively. OPENit is measured by the host country’s dependence on trade,
and specifically we use the ratio of the sum of import and export over GDP. Data is
obtained from the World Bank database.
Natural Resource Endowment (RESit). Due to its scarcity in per capita resource
endowments, China strongly depends on imports of energy and mineral resources, which
makes the resource-seeking a primary motivation for “Going Global”. We use the exports
of energy, mineral and metal in percentage of total exports as a measure of natural
resource endowment in the host country. We expect a positive impact on China’s OFDI
15
from the host country’s natural resource endowment. Data for natural resource
endowments also comes from the World Bank database.
Institutional Quality (INSit). The institutional environment in the host country is a key
determinant for the safety of oversea investment. Better institutional environment
potentially entails lower transaction costs and less transaction risk. So in general we
expect institutional quality contributes positively towards a country's OFDI. Due to the
peculiar preference of China’s OFDI in low institutional quality host country mentioned
in the last section, the sign of INSit can be negative. We use the index of economic
freedom published by the Heritage Foundation. This index covers a total of 10 variables,
including Business Freedom, Trade Freedom, Monetary Freedom, Government
Size/Spending, Fiscal Freedom, Property Rights, Investment Freedom, Financial
Freedom, Freedom from Corruption and Labor Freedom. According to the index’s 2008
definition, “The highest form of economic freedom provides an absolute right of property
ownership, fully realized freedoms of movement for labor, capital, and goods, and an
absolute absence of coercion or constraint of economic liberty beyond the extent
necessary for citizens to protect and maintain liberty itself.”7 Since the economic fluidity
and institutional adaptation a society can possess is highly correlated with economic
freedom, we use this index as an approximate measure of institutional quality, and higher
index value indicates better institutional quality. In our dataset, Singapore has highest
institutional quality with a value of 88.9 while Zimbabwe exhibits lowest institutional
quality with a value of 21.4. China has an institutional quality level of 52.7, ranked 51st in
our sample.
7 This definition comes from the "Frequently Asked Questions". Index of Economic Freedom. 15 January 2008.
16
Cultural difference (CDi). Cultural difference influences the communication, efficiency
within an entity and the identification of the host country toward the oversea investment
of home country. We consider cultural difference a primary risk source for oversea
investment and expect that cultural difference has a negative impact on China’s OFDI.
We calculate cultural difference based on Kogut and Singh (1988),
, (2)
where, Iki represents the kth dimension cultural variable for country i, Ikc stands for the kth
dimension cultural value for China and Vk represents the variance of the kth dimension
cultural values across all countries. The data comes from the website (http://geert-
hofstede.com). The four cultural variables include Power Distance, Individualism versus
Collectivism, Masculinity versus Femininity and Uncertainty Avoidance. Larger values
in CDi indicate largest cultural difference. For example, in our sample, the largest cultural
difference is observed in Demark with a CDi level of 5.23 while the smallest cultural
difference is exhibited in Philippines with a CDi of 0.29.
4. Methodology
Since we use geographical distance between the host country and China, a variable constant
across time, as a control variable, we can’t use the Fixed-Effects model. We estimate the
Random-Effects model (RE) and the Pooled Ordinary Least Squares (POLS) model, and
evaluate their performances using LM-test. To handle the potential heteroskedasticity, we
used Huber-White robust standard error (White, 1980).
When we explore the impacts of C.I. on OFDI, causality would be a major concern. One can
argue that the increase of China’s OFDI in host countries will cause Chinese government to
4
2
1
/ /4
k i k c ki
k
C D I I V
17
establish C.I.s. Lien et al. (2012) mentioned that it takes a long time for Hanban to establish a
new C.I. in the host country. The establishment of a C.I. follows a formal procedure, with a
foreign organization (a university) initiating the process by submitting an application
proposal. It must demonstrate a strong demand for Chinese language instruction in the local
community and university as well as the willingness and ability of the applicant to contribute
to the establishment and growth of a C.I.. The proposal will then be reviewed and potentially
approved by Hanban after more than a year, then agreement will be reached by the host and
Hanban afterwards. This long gestation period, on average around 18 months, enhances
C.I.’s reputation and creditability, and mitigates concerns for endogeneity, especially when
lagged C.I. number is used in the model.
We examined the correlation between the residual of our benchmark model and C.I. and
didn’t find any high or significant level of correlation. Results from Granger-Causality test
also suggest that endogeneity wouldn’t been a major concern in our case. We fail to reject
the null hypothesis that China’s OFDI does not Granger-cause the establishment of C.I., but
the null hypothesis that the establishment of C.I. does not Granger Cause China’s OFDI is
rejected. This indicates a unidirectional relationship between C.I. and China’s OFDI, that is,
the presence of the establishment of C.I. proceeds the investment decision of China’s OFDI.
We employ the benchmark model to investigate the overall effects of C.I. on China’s OFDI.
However, the benchmark model doesn’t explore the feature of transmission mechanism as
well as the potential heterogeneity of the impact of C.I.. To this end, based on the principles
of the C.I., we further examine the effect of cultural difference between the host country and
China and the effect of the institutional quality of the host countries on the transmission of
the impact of C.I.. To examine these two potential transmission channels, we introduce the
18
interaction term between C.I. and cultural difference as well as the interaction term between
C.I. and the institutional quality of the host country based on the benchmark model. We
further examine the effects of C.I. due to heterogeneity in cultural difference and in
institutional quality. To do this, we divided the sample into different subgroups according to
the median of cultural difference and that of institutional quality. Then, we perform
estimation using benchmark model and discuss the heterogeneous effects of C.I. on China’s
OFDI in different types of host countries.
IV. Results and Discussions
1. Correlation Analysis and Descriptive Statistics
Table 2 Correlations and Descriptive Statistics
LnOFDI LnGDP LnDIS RES OPEN INS CD CI
LnOFDI 1
LnGDP 0.3769 1
LnDIS -0.0512 -0.1616 1
RES 0.1169 -0.0364 0.3491 1
OPEN -0.0329 -0.1864 -0.2264 -0.1961 1
INS 0.0814 0.4215 -0.0507 -0.1687 0.3665 1
CD -0.0325 0.4173 0.0472 -0.1093 -0.0508 0.5075 1
CI 0.272 0.4903 -0.0807 -0.0264 -0.1413 0.1977 0.1367 1
Average 6.5036 16.8335 8.9189 20.19778 84.7718 63.7606 2.3245 2.7833
Standard
Deviation 4.6129 1.7019 0.5267 20.8295 56.0907 10.4936 1.4206 6.9423
Table 2 provides the correlation coefficients among variables and the corresponding descriptive
statistics. The results indicate relatively low correlations among the variables, with the maximum
correlation being 0.5075 between institutional quality and cultural difference. Thus multi-
collinearity would not be a major concern. To be more rigorous, we performed the variance
inflation factor (VIF) test and found the VIF value is much smaller than 10, which further
confirms that multi-collinearity does not present a major challenge. The correlation between C.I.
8 Averages and standard deviations for RES and OPEN are in percentage.
19
and China’s OFDI is 0.2720, preliminarily illustrating the positive effects of C.I. on China’s
OFDI. We observed that the average number of C.I. is 2.78 but with a large standard deviation of
6.94.
2. The Effects of C.I. on China’s OFDI
Utilizing the entire sample, we perform regression estimation with the control variables, with and
without C.I. variable, to investigate the effects of C.I. on China’s OFDI. Estimation results are
summarized in Table 3. The LM test rejects the null hypothesis of the “non-existence of random
effects” which implies Random Effects (RE) model is reasonable. We report the results from
both RE model and POLS model and we do not observe significant difference between them.
Without C.I., we find that market size of the host country (LnGDPit) has significant positive
effects on China’s OFDI, confirming that market-seeking is an important motivation for China’s
OFDI. The estimate of geographic distance (LnDISi) fails to pass the significance test, indicating
that geographical distance may not be an important determinant of China’s OFDI. Natural
resource endowment (RESit) has a significant positive effect, demonstrating the resource-seeking
objective for China’s OFDI. The parameter estimate for openness (OPENit) is positive which
suggests the openness of the host country has a positive impact in attracting China’s OFDI.
Institutional quality (INSit) failed to pass the significance test but the coefficient is negative
which suggests the unique preference of China’s OFDI in investing in the host countries with
relatively lower institutional quality. Cultural difference (CDi) has a significant negative effect
on China’s OFDI, suggesting cultural difference can significantly hinder China’s OFDI. The
results are mostly consistent with existing literatures.
20
After introducing C.I. (CIit), the estimators for other control variables do not change significantly.
Thus, we focus on the coefficient estimate for C.I.. Both RE model and POLS model indicate the
coefficient is positive and statistically significant at 1% significance level. This suggests that by
promoting Chinese language, encouraging cultural exchange, and improving international
friendship and cooperation, C.I. can positively stimulate the growth of China’s OFDI, a result
consistent with Lien et al. (2012).
As stated before, cultural difference presents important impediments for the growth of China’s
OFDI. Promoting Chinese language and encouraging cultural communication are the
fundamental tasks for C.I., and these tasks enable other countries to understand China better. The
more people studies Chinese, the better the communication and the more efficient the economic
and technological cooperation is between the host country and China. Furthermore, with
“harmony” as the principle, C.I. actively introduces China to the world and shows the unique
charm of Chinese culture as well as exhibits China’s harmonious, civilized, friendly and
responsible image, improving international influence and enhancing mutual understanding and
international recognition. By eliminating misunderstanding and conflicts, it would also be
possible to reduce the effects of “China threat theory” and “Chinese neo-colonialism”. From this
perspective, one possible channel for C.I. to affect China’s OFDI is through the reducing the
negative impact of the cultural difference between the host country and China.
Today, C.I. is more than a mere institution that promotes Chinese language and encourages
cultural exchanges. It also promotes economic development and improves diplomatic relations.
As a non-profit educational organization established by Chinese government in host countries,
C.I. provides a platform for diplomatic activities. Therefore, C.I. can promote relationship
between China and the rest of the world. Based on the institutional theory, formal and informal
21
institutional arrangements are the basic factors determining external uncertainties. Thus a good
institutional environment helps to reduce external risks for OFDI. The establishment of friendly
and cooperative relationships between the host country and China delivers protection in addition
to what has been provided by the host country’s institutional environment. Thus, by promoting
international relationships and encourage multinational cooperation, C.I. provides potential
substitution protection for China’s OFDI in addition to host country’s institutional environment.
Table 3 C.I.’s Effects on China’s OFDI
Variables
Overall Sample Overall Sample
RE Model POLS
Model RE Model
POLS
Model
（1） （2） （3） （4）
Intercept -21.223*** -18.753*** -17.678*** -15.922***
(4.946) (2.866) (5.143) (3.399)
LnGDP 1.650*** 1.529*** 1.433*** 1.334***
(0.204) (0.121) (0.193) (0.129)
LnDIS 0.157 0.150 0.144 0.163
(0.654) (0.389) (0.677) (0.429)
RES 0.034*** 0.028*** 0.031*** 0.027***
(0.011) (0.007) (0.011) (0.008)
OPEN 0.008 0.008** 0.008 0.009**
(0.006) (0.004) (0.006) (0.004)
INS -0.015 -0.022 -0.016 -0.022
(0.041) (0.026) (0.043) (0.028)
CD -0.865*** -0.781*** -0.718*** -0.652***
(0.239) (0.147) (0.205) (0.136)
CI - - 0.062*** 0.070***
(0.022) (0.022)
R2 0.136 0.224 0.133 0.211
F-Statistics 13.392*** 24.640*** 9.882*** 17.348***
Sample Size 518 518 461 461
Notes: ***, **, and * represents 1%, 5% and 10% significance level. And values
in parenthesis represent corresponding standard deviations.
3. The Unique Features of Transmission Mechanism of C.I.’s impact on China’s OFDI
We first examine the transmission mechanism of C.I.’s impact on China’s OFDI, through
cultural difference. We expect that C.I. can reduce the negative effects of cultural difference.
22
Naturally, C.I.’s impact on China’s OFDI can also depend on the level of cultural difference. We
introduced the interaction term between the cultural difference and the C.I. in the model and
presented the estimation results on the left panel in Table 4. We find that, in both RE and POLS
models, the estimate for the interaction term (CI*CD) is significantly negative. This suggests that
substitution effect exists between cultural difference and C.I. in the sense that the partial impact
of C.I. on China’s OFDI depends on the level of cultural difference in the host country. When
the cultural difference is small, C.I. has a significant positive impact on China’s OFDI but this
effect will decrease when we increase the level of cultural difference. Specifically, when the
cultural difference between China and host countries exceeds 4.15 in POLS model, the impact of
C.I. on China’s OFDI will turn from positive into negative, adversely affecting China’s OFDI. In
our sample of 59 host countries, only eight of them exceeded the threshold, (for example,
Hungary exhibits a cultural difference level of 4.18) implying that the establishment of C.I. will
promote China’s OFDI in most host countries. Smaller cultural difference assists C.I. to promote
China’s OFDI.
We expect that C.I. can provide substitution protection in place of the host country’s institutional
environment. To investigate the transmission channels of C.I. on OFDI through institutional
environments, we introduced the interaction term between the institutional quality and the C.I.
(CI*INS) in the model. Estimation results are presented on the right panel of Table 4. In both RE
model and POLS model, the estimate for the interaction term is negative and significant at 1%
level. This suggests substitution effect exists between institutional quality and C.I. in the sense
that the partial impact of C.I. on China’s OFDI also depends on the level of institutional quality
in the host country. Specifically, when the institutional quality in host country is low, C.I. has
significant positive impact on China’s OFDI but this effect will decrease when we increase the
23
level of institutional quality. When the institutional quality in the host country exceeds 85.17 in
POLS model, the impact of C.I. on China’s OFDI will turn from positive into negative, reducing
China’s OFDI. In our sample of 59 host countries, only Singapore exceeded the threshold. So the
establishment of C.I. will promote China’s OFDI in most host countries. Lower levels of the
institutional quality will facilitate C.I. to promote China’s OFDI.
Table 4 The Transmission Mechanisms of C.I. on China’s OFDI
Variables
Overall Sample Overall Sample
RE Model POLS
Model RE Model
POLS
Model
（5） （6） （7） （8）
Intercept -14.632** -13.667*** -18.381*** -16.869***
(5.748) (3.482) (4.978) (3.330)
LnGDP 1.284*** 1.189*** 1.372*** 1.259***
(0.223) (0.144) (0.127) (0.089)
LnDIS 0.120 0.219 0.236 0.273
(0.673) (0.393) (0.641) (0.406)
RES 0.034*** 0.029*** 0.029*** 0.024***
(0.012) (0.008) (0.011) (0.008)
OPEN 0.010* 0.011*** 0.007* 0.007***
(0.006) (0.003) (0.004) (0.002)
INS -0.053 -0.056***
- - (0.034) (0.022)
CD - - -0.742*** -0.694***
(0.118) (0.076)
CI 0.327* 0.394*** 0.438*** 0.511***
(0.170) (0.152) (0.086) (0.099)
CI*CD -0.079* -0.095**
- - (0.047) (0.041)
CI*INS - - -0.005*** -0.006***
(0.001) (0.001)
R2 0.115 0.192 0.135 0.214
F-Statistics 8.401*** 15.366*** 10.110*** 17.611***
Sample Size 461 461 461 461
Notes: ***, **, and * represents 1%, 5% and 10% significance level. And values
in parenthesis represent corresponding standard deviations.
In both circumstances, with or without interaction terms, we observed significant positive
coefficient for C.I.. This suggests C.I. could affect China’s OFDI positively after controlling for
cultural difference and institutional quality across different countries. Cultural difference and
institutional quality are accumulations of historical heritages and they either do not change (in
24
the case of cultural difference between China and other host countries) or change modestly in our
sample (in the case of institutional quality). But perceptions of host countries on cultural
difference and institutional quality toward China could be influenced. With intensive activities
held by C.I.s, locals in host counties can understand Chinese language more efficiently and
appreciate Chinese culture. This can reduce hostility towards Chinese multinational entities and
creates a more friendly business environment. Thus, we expect that C.I. indeed reduces the
transaction cost and information asymmetry arising from liabilities of foreignness and psychic
distance. For example, after the establishment of C.I., variety kinds of Chinese language classes
and training programs have been administered in the host countries. This provides a thorough
education of Chinese language in the host country, and consequently trains qualified employees
with substantial Chinese fluency. This enables multinational entities to hire local employees who
can communicate in Chinese effectively.
4. The Heterogeneous Effects of C.I. on China’s OFDI
To examine the effects of C.I. on China’s OFDI due to heterogeneities in host countries, we
divide our sample into subgroups using the medians of cultural difference and institutional
quality, and estimate the benchmark model within the subgroups. The estimation results for
subgroups based on cultural difference are presented in Table 5. Our results suggest that the
effect of C.I. on China’s OFDI does exhibit heterogeneity via cultural difference. In the
subgroup with smaller cultural difference, C.I. has a significant positive effect on China’s OFDI.
Within larger cultural difference subgroup, the positive coefficient for C.I. is not statistically
significant. The estimation results in both RE model and POLS model are similar.
This suggests that through promoting Chinese language and encouraging cultural exchanges, C.I.
can effectively reduce the impediments for China’s OFDI due to cultural difference, but this
25
effect primarily exists in the host countries with smaller cultural difference. One possible reason
is that language promotions and cultural exchanges cannot be done overnight. In countries with
similar cultures, both sides have understood each other’s tradition to some extent, and people in
host countries can easily adopt Chinese language and culture, which facilitates C.I. to promote
OFDI. In host countries with larger cultural difference, it is relatively more difficult. Thus, the
effect of C.I. on China’s OFDI is restricted by cultural difference, suggesting more time and
cultural exchange activities are needed for C.I. to achieve better performance in the host country
with larger cultural difference.
Table 5 Effects of C.I. on China’s OFDI Subject to
Cultural Heterogeneity
Variables
Subgroup with large
Cultural difference
Subgroup with small
Cultural difference
RE Model POLS
Model RE Model
POLS
Model
（9） （10） （11） （12）
Intercept -31.234*** -29.988*** -13.386*** -12.895***
(10.900) (7.644) (6.019) (3.667)
LnGDP 1.897*** 1.827*** 1.061*** 1.028***
(0.329) (0.229) (0.236) (0.147)
LnDIS
0.378 0.340 0.433 0.609
(1.144) (0.769) (0.863) (0.535)
RES 0.041* 0.038** 0.027* 0.018*
(0.022) (0.015) (0.016) (0.010)
OPEN 0.015 0.011* 0.006 0.010*
(0.009) (0.006) (0.007) (0.005)
INS -0.006 -0.016 -0.020 -0.052
(0.050) (0.032) (0.043) (0.034)
26
CD -0.394 -0.382 -1.292*** -1.050***
(0.482) (0.319) (0.440) (0.301)
CI 0.028 0.021 0.404*** 0.355***
(0.021) (0.019) (0.150) (0.114)
R2 0.224 0.342 0.097 0.140
F-Statistics 9.503*** 17.085*** 3.297*** 4.999***
Sample Size 238.000 238.000 223.000 223.000
Notes: ***, **, and * represents 1%, 5% and 10% significance level. And values
in parenthesis represent corresponding standard deviations.
Table 6 Effects of C.I. on China’s OFDI Subject to
Institutional Heterogeneity
Variables
Subgroup with High
Institutional Quality
Subgroup with Low
Institutional Quality
RE Model POLS Model RE Model POLS
Model
（13） （14） （15） （16）
Intercept -27.772*** -27.683*** -11.069*** -5.470***
(9.758) (7.911) (7.955) (5.514)
LnGDP 1.719*** 1.727*** 1.146*** 0.872***
(0.222) (0.184) (0.251) (0.229)
LnDIS -0.187 -0.175 0.463 0.449
(1.004) (0.806) (0.749) (0.475)
RES 0.042** 0.043*** 0.022** 0.011
(0.019) (0.015) (0.010) (0.007)
OPEN 0.013** 0.013*** -0.009 -0.017
(0.006) (0.004) (0.021) (0.015)
INS 0.070 0.065* -0.069 -0.077*
(0.046) (0.199) (0.052) (0.045)
CD -0.351 -0.348* -1.157*** -1.065***
(0.257) (0.199) (0.245) (0.163)
CI 0.035 0.032 0.268*** 0.369***
(0.022) (0.021) (0.044) (0.058)
R2 0.223 0.292 0.145 0.225
F-Statistics 9.407*** 13.469*** 5.247*** 8.933***
Sample Size 237 237 224 224
Notes: ***, **, and * represents 1%, 5% and 10% significance level. And values
in parenthesis represent corresponding standard deviations.
The estimation results for the subgroups based on institutional quality are presented in Table 6. Similarly,
we only focus on the coefficient estimate for C.I.. Results suggest that in the host countries with high
27
institutional quality, the coefficient is positive but not statistically significant. Conversely, in the host
countries with lower institutional quality, the coefficient is positive and statistically significant. Both RE
model and POLS model support this result. Recall that C.I. promotes international friendship and
cooperation, provides protection and assists the growth of China’s OFDI. C.I. can effectively substitute
the protection from the host country and reduce potential institutional risk, making it another channel for
C.I. to advocate China’s OFDI. In host countries with poor institutional quality, C.I. will provide
prominent protection to China’s OFDI. In host countries with more sounding institutional quality, formal
legal arrangements might have provided sufficient protection for China’s OFDI, decreasing the
effectiveness of substitution protection from home country.
V. Conclusion
In this paper, we use a panel data of China’s OFDI from 2004 to 2012 and investigate the effects
of C.I. on China’s OFDI. For the first time, we examined the features of transmission
mechanisms and the heterogeneous effects of C.I. on China’s OFDI. We show that C.I. can
stimulate the growth of China’s OFDI after controlling for different levels of cultural difference
and institutional quality across different countries. We expect that the effects of C.I. on China’s
OFDI are transmitted through two important channels. First, through developing international
cultural exchange and promoting Chinese language, C.I. could effectively reduce negative effects
on China’s OFDI due to cultural difference. Second, C.I. improves international friendship and
cooperation, which can compensate the insufficient government protection from the host country
with poor institutional quality and provides extra protection from the home country. We argue
that C.I. indeed reduces the transaction cost and information asymmetry arising from liabilities
of foreignness and psychic distance. Interestingly, we find that the effects of C.I. on China’s
OFDI exhibit heterogeneities. In host countries with smaller cultural difference or with lower
institutional quality, C.I. exhibits more prominent effects to promote China’s OFDI.
28
From the perspective of home country, we investigate the critical influences from international
cultural exchange activities, provide a new scope in understanding the behaviors of OFDI and
supplement the theoretical framework of OFDI for the transitional and developing countries. In
the event of globalization, all countries across the world should communicate to address
challenges. Culture and language can serve as bridges among countries. Our results have the
following suggestions for home countries. First, to facilitate domestic entities in “Going Global”,
home countries should actively participate in culture exchange activities. Second, to encourage
economic growth, future establishments of cultural institutions should focus on countries that
have large markets and plentiful natural resources. This will assist OFDI to fully utilize
international markets and resources. Third, to enhance the contribution of cultural institutions,
special attentions need to be paid to the heterogeneities in host countries since C.I., in our case,
has more significant effects in host countries with smaller culture differences or with lower
institutional quality.
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