An Empirical Study of the Influence of Foreign Direct Investment on U.S.-China Trade Deficit

Abstract

With a recent trend of possible trade war between the United States and China, international trade has become a hot topic and played a more important role in political world as well as for academic research. This study uses a fixed effect model with panel data from 2008 to 2016 and analyzes what affects the trade imbalance between the United States and China. The study especially focuses on the influence of Foreign Direct Investment (FDI) on the trade deficit between the two countries. A state-level analysis is added in the construction of empirical model to increase the number of total observation and determine the effects of key variables. The state-fixed effects will control for other state-invariant factors. The study concludes that FDI has a significant influence on the reduction of trade deficits. It could achieve this function through the increase of total imports and therefore reduce trade deficits. In addition, GDP also has a non-negligible influence on trade imbalance status that we should take into consideration for potential policy recommendations. The study gives policy recommendations for both sides: China should continue to seek long-term and efficient communication with the United States, while the U.S. ought to treat China equally in the market and also maintain a stable financial and economic environment.