The effects of foreign direct investment on human capital accumulation—Evidence from China

Abstract This paper examines the effect of foreign direct investment (FDI) on human capital accumulation in China. The identification strategy exploits variations in FDI inflows across manufacturing sub‐sectors caused by China's FDI liberalisation and initial sectoral composition patterns across cities. Using a panel of city‐level data from 1990 to 2005, the paper shows that FDI liberalisation accelerated human capital accumulation. Cities with higher exposure to FDI liberalisation experienced higher growth in high school and college enrollment. FDI incentivizes individuals' investment in their human capital by paying a higher wage premium for skilled workers, pushing up the skill premium in the local labor market, and raising household income. Compared to export‐oriented FDI and FDI in less‐skilled industries, market‐seeking FDI and skill‐intensive FDI have a much larger effect on college enrollment.