Demographics and FDI: Lessons from China's One-Child Policy

Following the introduction of the one-child policy in China, the capital-labor ratio of China increased relative to that of India, while FDI/GDP inflows to China vs India simultaneously declined. These observations are explained in the context of a simple neoclassical OLG paradigm. The adjustment mechanism works as follows: the reduction in the growth rate of the (urban) labor force due to the one-child policy increases the capital per worker inherited from the previous generation. The resulting increase in China’s domestic capital-labor ratio thus “crowds out” the need for FDI in China relative to India. Our paper is a contribution to the nascent literature exploring demographic transitions and their effects on FDI flows.