Do local industrial agglomeration and foreign direct investment to China enhance the productivity of Taiwanese firms?

Abstract

This article examines the impacts of industrial agglomeration and outward foreign direct investment (OFDI) on the total factor productivity (TFP) of Taiwanese firms. A vertical FDI-based model of heterogeneous firms is proposed to analyze how agglomeration economies and technology incompatibilities between parent firms and their affiliates can affect firm productivity. This model suggests that firms located in areas with more concentrated industrial agglomerations are more productive, while those engaging in OFDI may not perform better in terms of TFP. Using plant-level data, this article constructs an indicator of industrial agglomeration to appraise agglomeration economies on firm productivity. Based on the data for 578 manufacturing firms and the agglomeration indicator, we estimate a cross-sectional econometric model to empirically assess the productivity effects of industrial agglomeration and OFDI. The empirical results show that local industrial agglomerations exert a positive contribution to firm productivity, but that FDI in China has no significant effects on Taiwanese firms' TFP.