Abstract
This paper studies the impact of foreign direct investment on domestic firms’ innovation in China. It provides causal evidence by exploiting China’s foreign direct investment deregulation in 2002 and employs a difference-in-difference estimation strategy. Using a matched firm-patent data set from 1998 to 2007, the results show that the quantity and quality of domestic firms’ innovation benefit from foreign direct investment. Moreover, the paper emphasizes the importance of knowledge spillover from foreign direct investment in similar technology domains. The analysis examines the role of horizontal foreign direct investment and foreign direct investment in technologically close industries—industries that share similar technology domains. The findings show that foreign direct investment in technologically close industries generates much bigger positive spillovers than horizontal foreign direct investment. The paper also shows that knowledge spillover from foreign direct investment in similar technology domains is not driven by input-out linkages. Moreover, the spillover effect is stronger in cities with higher human capital stock and firms with higher absorptive capacity.
Highlights
Innovation is an essential driver of economic growth and policy makers make huge efforts to encourage innovation, such as human capital investment and support for research and development (R&D)
Besides the traditional horizontal foreign direct investment (FDI) spillover effect, researchers have recently realized the importance of spillover within similar technology domains, because knowledge can be transferred to firms that share similar industry know-how and talent input
I, and t denote the firm, four-digit industry and year respectively. yyffffff measures the innovation output of domestic firms, which includes total patent application, design patent application, utility model patent application, invention patent application, invention patent grant, cumulative citation of invention patent after 5 years of publication. ααff is firm fixed effect; γγtt is year fixed effect; FFFFFF_ssssssssssssiiii is the horizontal FDI measure defined as output-weighted foreign equity share in each four-digit industry; FFFFFF_tttttthcccccccccciiii is the simple average of FDI presence in all industries that are technologically close to industry i in year t
Summary
Innovation is an essential driver of economic growth and policy makers make huge efforts to encourage innovation, such as human capital investment and support for research and development (R&D). We show that local human capital stock and domestic firms’ absorptive capacity can hugely magnify positive spillovers This informs policy makers about the important factors to focus on to reap the benefits from FDI. The paper found positive effect from FDI on both the level and growth rate of domestic firms’ productivity. Their paper documented benefits from foreign technology in terms of innovation and productivity that go far beyond the joint venture, to the Chinese joint venture parent firm and to entrepreneurs at firms’ upstream from and in the same industry as the joint venture. Our paper uses more detailed innovation metrics, estimates the dynamic effect of FDI exposure, and highlights a novel channel of spillovers – FDI from technologically close industries.
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