In the last three decades, China has emerged from an isolated economy to the number one destination in foreign direct investment (FDI). How has FDI affected the Chinese economy? This essay summarizes the authors’ own research findings from the perspective of domestic firms in China.
The existing studies on FDI spillover effects in China have several drawbacks. First, most studies limit their research to total factor productivity (TFP) or labor productivity. Second, even for studies on TFP, different papers have produced very different results, leading to confusing conclusions. In particular, among studies that find positive FDI spillovers on TFP, many suffer from methodological flaws that lead to an upward bias in the estimates or downward-biased standard errors. Finally, there is little research studying the specific conditions under which positive spillovers actually occur. In our recently published book (with the same title, together with Galina Hale, by World Scientific), we attempt to address these issues, relying on multiple large-scale disaggregated data sets.
Using data from China’s National Bureau of Statistics Manufacturing Census (2000-2006) and the World Bank firm surveys of 2001 and 2004, we show in Chapter 2 that foreign-invested firms in China do tend to be more productive, with firms invested by regions from outside the greater China area (FRN firms) having a greater advantage. All foreign-invested firms pay higher wages to their engineers and managers, but not necessarily to their production workers. Furthermore, firms with investment from Hong Kong, Macao, and Taiwan (HMT firms) also tend to export more of their outputs. Finally, firms with foreign investment are not more likely to have introduced new products, regardless of the country origin of foreign investment.
Chapter 3 is the first chapter to explore spillover effects of FDI presence, where TFP is the performance measure of interest. We find that there is no overall significant horizontal spillover effects of FDI on TFP of domestic firms. However, significant positive horizontal spillovers are observed for private firms as a whole, and there are more significant positive horizontal spillovers of FDI from outside the greater China area than of that from within the HMT region. We also study two kinds of vertical spillovers, spillover effects of downstream FDI (or backward linkages), and those of upstream FDI (or forward linkages). For backward linkages, we find no significant overall effects for the full sample of firms. Yet positive effects are found for private firms of downstream FDI both from within and outside the greater China area. In particular, these positive effects are larger in size than the horizontal spillovers. In contrast, SOEs suffer significant negative effects of presence of FDI from outside the greater China area in downstream industries. The patterns observed for forward linkages are very similar. We view these findings as evidence that private firms are more efficient and more competitive than SOEs.
In Chapter 4 we explore the spillover effects of FDI on wages and labor quality and find that the spillover effects vary along two dimensions. First of all, FDI presence significantly drives up the wages for managers and engineers in domestic firms located nearby, but not the wages for production workers. In addition, private domestic firms raise their wages for managers and engineers at the presence of foreign invested firms, while SOEs are not significantly affected in these wages. We also find that FDI presence affects labor quality: managers hired by private domestic firms tend to have more foreign experience when FDI is presence, yet there is some evidence of quality deterioration for managers employed by SOEs. Put together, these findings suggest that foreign invested firms pose real competition with Chinese domestic firms in the labor market of skilled workers, thus driving up their wages. Furthermore, the constraints faced by Chinese SOEs may have hampered their ability to compete with foreign firms in the labor market.
The spillover effects of FDI on exports are studied in Chapter 5. While HMT investment is found to have no overall significant effects on same-industry domestic firms’ exporting behaviors, FRN investment is shown to have negative and significant effects on the ratio between exports and total sales in domestic firms in the same industry, in particular for private firms. Very similar results are obtained for vertical spillover effects, be they through backward linkages or forward linkages. We interpret these results as reflecting the combined effects of the following mechanisms through which FDI impacts domestic firms: (1) the technological and managerial spillovers that increases the competitiveness of domestic firms’ output on the international market; (2) the competition between foreign invested firms and domestic firms on the export market that pushes domestic firms’ output away from exports; and, (3) the supplier and client relationships established between foreign and domestic firms that pull domestic firms’ output toward domestic market. The evidence suggests that FDI from regions outside the greater China area are more likely to engage domestic firms in their supply chains within China.
Chapter 6 studies the spillover effects of FDI on the innovation behaviors of domestic firms, arguably the most important long term impact of FDI on the Chinese economy. The patterns observed, however, suggest a rather grim view of FDI’s influence on the innovation activities of Chinese indigenous firms. Findings based on the NBS census show that FDI presence significantly lowers the probability of having new product sales in domestic firms, whether the FDI is made in the same industry, in downstream industries, or in upstream industries. In addition, the negative effects hold regardless of where the foreign capital comes from. Results from the World Bank data analysis give a somewhat positive picture, where some domestic private firms increase their likelihood of new product introduction. However, these results also indicate that the new products that are introduced tend to be imitations rather than authentic innovations.
With continued growth in FDI inflow projected for the foreseeable future, China needs to recalibrate its policies and the above research findings may inform policy making.
Cheryl Long
Associate Professor, Director of the Asian Studies Program, Colgate University and Xiamen University
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