FDI technology spillovers within and across industries: evidence from China.

AuthorTian, Xiaowen

INTRODUCTION

In recent decades, more and more multinational companies (MNCs) invested directly in other countries, particularly emerging markets, and some of the host countries successfully made use of the foreign direct investment (FDI) to generate rapid economic growth. The rise of the four Asian small dragons (Hong Kong, Taiwan, Singapore and Korea) in the 1960s-1970s and rapid growth of China and India in recent years all benefits from the vast inflows of FDI. (1) In particular, China adopts many preferential policies, such as tax holidays, tax reduction and tax rebate, to attract FDI, and has now become the largest FDI recipient in developing countries and the fastest-growing economy in the world. The apparent correlation between FDI inflows and economic growth triggered off a fascinating discussion on how FDI affects the host countries. While there was little dispute on the positive effect of FDI inflows on the national economy of host countries as a whole, however, there are profound disagreements over the impact of FDI on the productivity of domestic firms in the host countries. A central issue in the debate is whether and how FDI produces technology spillovers to the domestic firms.

While some believe that FDI generates positive technology spillovers to the domestic firms by competition, demonstration and training of employees, others point to the negative effect of market stealing and skill stealing of FDI on the domestic firms [Gorg and Strobl, 2001; Aitken and Harrison, 1997, 1999; Girma, Greeaway and Wakelin, 2001]. In line with the theoretical ambiguity, empirical research has produced mixed results. Some studies, particularly the pioneering works by Caves (1974), Globerman (1979), Blomstrom and Persson (1983), Blomstrom (1986), Blomstrom and Wolff (1994), and Kokko (1994, 1996), show evidence of positive technology spillovers from FDI to domestic firms. Other studies, particularly the most recent ones by Aitken and Harrison (1999), Djankov and Hoekman (2000), and Kathuria (2000), find that FDI negatively affects the productivity of domestically owned firms. The same mixed results are also found in empirical studies on FDI spillovers in China. Li, Liu and Parker (2001), Liu, Parker, Vaidya and Wei (2001), Buckley, Clegg and Wang (2002) and Liu (2002) find evidence of positive FDI technology spillovers to Chinese domestic firms, while Hu and Jefferson (2002) find a negative impact of FDI on productivity of Chinese domestic firms.

Except for a few exceptions, most of these studies examine only FDI technology spillovers within industries, i.e., the so-called intra-industry spillovers, with little attention being paid to possible FDI technology spillovers across industries. recently, Kugler (2000; 2006) argues that technology embodied in FDI may pass on to domestic firms outside the industries where FDI is located, and the so-called inter-industry spillovers could be even stronger than the intra-industry spillovers. (2) Empirical work began to emerge and show some evidence of FDI technology spillovers across industries (see, for instance, Sjoholm 1999a, Blalock 2001 and Smarzynska 2004).

Kugler does not, however, pay any attention to possible negative FDI inter-industry technology spillovers. As a matter of fact, Kugler (2000, p.1, 41) even goes as far as to claim that only positive "interindustry FDI spillovers materialize" and can "explain evidence of contemporaneous correlation among FDI flows and TFP growth". In theory, as will be shown below, FDI could affect the productivity of domestic firms either positively or negatively both within and across industries; FDI technology spillovers could well be in favor of domestic firms within the industry where FDI is located, rather than domestic firms in other industries; and what are materialized in inter-industry FDI technology spillovers are very likely to be negative, rather than positive.

This paper sets out to discuss the issue of both intra-industry and inter-industry FDI technology spillovers, and test some hypotheses about the direction of the technology spillovers using firm-level data from China. In what follows, we begin with a general discussion about possible positive and negative effects of FDI on domestic firms both within and across industries, and propose some testable hypotheses in section 2. In section 3, we describe the empirical model, variables and data used in the empirical examination of the Chinese case. Section 4 presents the regression results, and section 5 concludes the paper.

DEBATE ON FDI TECHNOLOGY SPILLOVERS

It has been argued for a long time that FDI may positively affect the productivity of domestic firms in a number of ways. The first is a competition effect. Competition from FDI may force domestic firms to reform management styles and update production technology in order to increase their competitive capacity. The second is a demonstration effect. When domestic firms are exposed to the products, production technology and management know-how of MNC affiliates, they may learn by observing the knowledge embodied in them. The third is an employment effect. MNC affiliates train their employees who may later move to domestic firms with learnt skills (Aitken and Harrison, 1999; Blomstrom, Kokko and Zejan, 2000; Gorg and Strobl 2001).

These positive technology spillovers have been largely illustrated in the context of an intra-industry setting in prior studies. recently, Kugler (2000) argued that positive FDI technology spillovers should occur mainly across different industries, not within an industry. This is because MNCs choose location and organizational strategies in a way that minimizes the risk of technology leakage to potential competitors, especially those in the same industry. The so-called generic technology, that is, the technology that can be deployed in production across several industrial sectors, is thus more likely to spill over to domestic firms than industry-specific technology, and it requires less absorptive capacity than industry-specific technology. As a result, "the host country firms within the MNC subsidiary's sector will tend to experience limited technological gains ensuing FDI, whereas producers in other sectors may benefit", and "spillovers from FDI should be primarily inter-industry and not intra-industry" (Kugler, 2000, p.1).

Although the argument makes some sense, Kugler overlooks the fact that the developments of information technology make it very difficult for MNCs to protect their technology from leaking to potential competitors in the same industry, particularly when joint ventures are taken as the entry mode of the MNCs; that domestic firms in the industry where FDI is located have a much wider range of technologies to choose to absorb, industry-specific and generic alike, than domestic firms in other industries who can only choose among generic technologies; and that due to the close business linkage between domestic firms with MNC affiliates in the same industry, the aforementioned positive effects of competition, demonstration and employment may reach the domestic firms in the same industry first and may then gradually spread to domestic firms in more distant industries. Therefore, it is very likely that FDI technology spillovers are actually in favor of domestic firms in the industry where FDI is located, rather than domestic firms in other industries. In addition, Kugler fails to realize that inter-industry FDI technology spillovers could even turn negative, as is in the case of intra-industry FDI technology spillovers.

An increasing number of scholars have recently argued that FDI may generate negative intra-industry technology spillovers, that is, it may adversely affect the productivity of domestic firms within the industrial sector where FDI is located. Aitken and Harrison (1997, 1999) pointed to, for instance, a market stealing effect: MNC affiliates draw away demand from domestic firms and force them to cut down production so that domestic firms suffer from productivity decline as they have to spread the fixed cost over a smaller amount of products. Furthermore, Girma, Greeaway and Wakelin (2001) pointed to a skill stealing effect: MNC affiliates attract away the best workers from domestic firms, leaving them with less skilled employees, which cause a decline in productivity in domestic firms. The market stealing and the skill stealing indicate that the adverse effects of FDI come primarily from competition. That is, the aforementioned competition effect could turn negative when MNC affiliates compete with domestic firms within the same industry for customers, human resources and other resources to the effect that it adversely affects productivity of...

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