FDI In China Provides Rare Productivity Boost For Local Firms

Governments of many emerging economies encourage and subsidize inbound foreign direct investment (FDI) as a way to improve the productivity of domestic firms. Academic research to date suggests that the impact is mostly less pronounced than governments would hope for from such policies. Multinationals have proved adept at taking the subsidy to move in while protecting their technology and IP from moving up or down their local supply chains or moving outwards to other industries.

China, one of the world’s largest recipients of FDI  may be an exception. A new World Bank working paper, Do Institutions Matter for FDI Spillovers? The Implications of China’s “Special Characteristics”, by Luosha Du from the University of California, Berkeley, Ann Harrison from the World Bank and Gary Jefferson from Brandeis University, suggests that there have been significant productivity improvements transmitted back up the supply chains of foreign direct investors in China.

Productivity of domestically owned firms has been boosted primarily via contacts between domestic suppliers and foreign buyers of their products.

The research also finds that these productivity spillovers have been strongest among foreign direct investments where Beijing targeted it via tax incentives. (The study covers FDI from 1998 to 2007, the year before China started phasing out differential corporate tax treatment for domestic and foreign companies, raising an intriguing question of whether, from the perspective of productivity spillovers, that was a wise policy switch.) The paper also says, less surprisingly, that FDI from Taiwan, Hong Kong and Macau, tends to have no effect on, or hurt local firms whereas that from OECD countries benefits them significantly.

The paper is a lucid, if technical read, but grist for the mill of the argument over technology transfer by foreign firms investing in China.

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