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China has been running a large trade surplus with the rest of the world, particularly with the USA and EU. This has caused considerable diplomatic tensions and tremendous pressure on the Chinese currency. Existing analytical studies, however, mostly focus on real exchange rate and income as determinants of China's trade imbalances. Little attention has been given to the role of inflow and outflow of Foreign Direct Investment (FDI). The purpose of this paper is to fill in this gap in the literature by adding FDI to China's trade balance model.
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