Foreign Direct Investment (FDI) has in the past approximately twenty years become increasingly important for every nation globally. Today, an increasing number of these countries experiencing success in the attraction of a substantial and increasing amount of FDI (Lenka & Sharma, 2013–2014). Moreover, today, the innovative performance of any country is a vital determinant of global competitiveness and national progress (economic development of the country) (OECD, 2007). Consequently, innovation has become another central element for the growth and development of the economy of any country.
A country’s potential and capacity for innovation and incorporation of its innovation has undoubtedly become an important factor in determining the global competition of a country. It is also predicted that it will play a more important part in future competitiveness (OECD, 2007). From such an outlook, it is evident that FDI and innovation have become a vital component of economic development for countries.

China’s economy for over thirty years has grown at an annual rate of 10%. By 2010, the country had gone above Japan and became the second largest economy worldwide (Xing & Pradhananga, 2013). For China, internationalization of its economic activities and abilities to innovate has been primarily promoted by FDIs. This has transformed China into a technological powerhouse and a key source of knowledge and technological transfer through the FDIs within the nation’s economy (Lenka & Sharma, 2013–2014). Endogenous models and theories in economics have expressed and explained the importance of the two factors in the growth and development of China’s economy.

The available empirical studies done highlight a positive impact of the two factors on the economy either alone or when combined. Their roles depend on the country in take into consideration. Therefore, they may have outcomes that are non-significant, positive, or negative. However, the importance of the two factors on the economy of a country depend the conditions within the economy, institutions, and technological levels of a particular country. This paper, therefore, aims at studying FDI and innovation on economic development. The paper focuses on China and how the growth and development of its economy has been determined by these factors.

1.1 Background of the Study

China, in 1979 started its economic reforms which called for the foreign capital involvement in its economy. Since then, the country has received a significant part of the international flows of direct investment that turned away China from special regimes towards the implementation of  nation-wide open policies for FDI (Fu, 2008). From the time of introduction of these policies the economy of China, the economy of China has been growing at a faster rate compared to that of the pre-reform period and for the major part avoided the major economic disruptions that have been existing in the global market (Morrison, 2015). From 1979 when the reforms were made to 2014, the annual real GDP for China averaged about 10% implying that the country has been doubling its economic size in real terms after every eight years (Morrison, 2015). The global recession slackened China’s economic growth where its growth in real GDP went down from 14.2% in 2007 to 9.6% in 2008 and further to 9.2% in 2009(Morrison, 2015). These are as illustrated figure 1 below.

Source: (, 2014)

As a response, the government of China in a similar manner to 1979 took measures to cushion these effects through the implementation of a stimulus package and expansion of its monetary policy. These measures did not only boost consumption but also FDI that prevented a sharp economic slowdown for the country (Morrison, 2015).  Presently, China lies second only after the USA as the greatest FDI receiver and is the leader among developing nations (Azarhoushang, 2013). This is as illustrated in the figure below. Low costs of labor, cheap land, incentives from the government and a huge domestic market make the country attractive for foreign companies to invest. From the existing research studies and data, the Chinese administration has over the years has economically benefited from FDI through the design and implementation of policies that promote FDI (Fu, 2008). However, the current reduction of the country’s growth and development since 2014 where the nation has been registering negative real GDP growth is an indicator of a possible negative impact of FDI. This, as a result, brings to attention the significance of FDI on China’s economic development.

Figure 2: China’s FDI inflows ranking

Source: (Long, 2014).

In addition, technological capabilities are also a vital component of competitiveness at the national, regional, and/or firm levels. Since the economic reforms that took place between 1978 and 1979 in China, the country’s economy has experienced significant growth as mentioned above (Wu , 2010). However, exports and manufacturing activities that are dependent have been promoting the country’s growth in the past (Wu, 2010). The dependency on exports and activities as aforementioned in manufacturing, made china increasingly susceptible to global economic shocks (Wu, 2010). For instance, the 2008 credit crisis experienced in the US resulting in the financial meltdown that had a deleterious impact on the economy of China (Wu, 2010). To protect the economy of China and ensure consistency in growth and development, new policies were introduced, in addition to the already existing ones on FDI. These were targeted at increasing the role of innovation in the country’s economic development (Wu, 2010). The aim was to transform the economy to become a knowledge-intensive economy and reduce its dependence on exports and external markets (Schaaper, 2009). This is as envisioned in the country’s “Medium-to-Long-Term Plan of National Science and Technology Development (2006-2020)” that was announced in 2006.

Due to this, the country is robustly engaging in the promotions of innovation. This is as reflected in indicators such as the development of China’s expenditure on Research and Development (R&D) (Schaaper, 2009). Moreover, there is increased employment of scientists and engineers within the R&D sector to promote innovation. Finally, there is also an increased expansion of R&D inputs that have consequently increased innovation in the country’s economy (Schaaper, 2009).  The development of innovative capabilities for a nation has been crucial in the economic improvement and growth of countries. Studies have been undertaken in the past ten years on the systems of innovation used by different countries and how they have impacted the development (economic) of these countries (Wu, 2010). It is postulated that a distinctive and systematic element concerning innovation a local phenomenon that cannot be forecast by the more accustomed international innovation frameworks.

Previous scholarly research and popular commentary have attributed China’s economic development to its large market and low manufacturing costs. However, more recent accounts have noted that the significant development of China’s economy can be attributed to more than the large market and low production cost. Other factors such as FDI and innovation have been found to play a vital role. This study highlights the part FDI and innovation have played in China’s economic development.

1.2 Statement of the Problem

The past twenty years have been characterized by increased internationalization that has produced an unexpected significant rise in the flows of FDIs globally including in China. This has had a huge impact on the development of the state. Moreover, there has been growing interest among economists in establishing innovations’ role in growth and development among nations. China is considered the most recent story of economic success in the world experiencing a consistent annual economic growth a phenomenon that can be attributed to the country’s shift from to a growth model that is dependent on knowledge and technology (innovation).

This study’s purpose is, therefore, to conduct a research through a review of literature and statistical analysis of the role of the two factors in China’s economic development of China. It also aims at finding out the effects of the two aspects on the economic development of China. The existing data and statistical evidence indicate that FDI and innovation have more positive effects compared to the negative on China’s performance economically. China is among the best examples countries that have become successful economically by absorbing FDIs absorption and incorporation innovation to ensure sustainability that have transformed the nation and made them the foundation economic development for China. This paper will analyze the origins of FDI and innovation including their relationship and how they link up to promote economic development.

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