What determines technological spillovers of FDI: Evidence from China

1. What determines technological spillovers of FDI: Evidence from China Galina HALE & Cheryl LONG

2. Introduction • China has been actively encouraging the inflow of foreign direct investment. Such a policy is justified if there are positive spillovers on domestic firms. • We study the spillover effects of FDI in the case of China and the mechanisms through which such spillovers occur.

3. Introduction Contributions to the literature: • Provide a detailed study on the effects of FDI in China. • Debate over how technology gap impacts FDI spillovers. Blomström, Globerman and Kokko (1999). • Analysis of specific mechanisms through which FDI spillovers occur (demonstration channel, the competition channel, the forward and backward linkages and the labor mobility channel).

4. Introduction Results: • Domestic firms with higher absorptive capacity experience positive spillovers, while those with low initial productivity witness negative spillovers. • Labor mobility channel and the network effect channel: Firms that are able to hire managers and engineers from the foreign firms have higher productivity. Firms that hire younger and more skilled labor force tend to have higher productivity when there is more presence of FDI in their city and industry. (Interaction among employees is a mechanism for spillovers).

5. Empirical approach • Effects of Foreign presence on the TFP of domestically owned firms in the same city-industry: Yjic = αi + αc + β1Ljic + β2Kjic + β3 FDI ic+ηZjic+εjic αi: industry FE αc : city FE Yjic: log of Value added of the firm j in industry i in city c. FDIic : measure of foreign firm presence in the city-industry cell where the domestic firm belongs. Zjic: set of variables capturing other firm characteristics.

6. Data • World bank in 2001 conducted the data. Data from the study of Competitiveness, Technology and firm linkages. • 2 questionnaires : - Senior Manager of the main production facility. - Accountant or personnel manager of the firm. A stratified random sample of 300 establishments is drawn in each pf the following cities: Beijing, Chengdu, Guangzhou, Shanghai, and Tianjin, giving a total sample size of 1 500.

7. Productivity of domestic and foreign firms • Foreign firms have higher productivity than domestic firms in China ; FDI embodies more advanced technology and management practices. • Predict the total factor productivity of each firm as the residual term: Yj = β0+β1 Lj+β2 Kj+εj(1) (1) : εj= TFP 1 (1) + firm age and firm scale = TFP 2 (1) + firm age + firm scale + average education+ average age + average age squared = TFP 3

8. Productivity of domestic and foreign firms We conduct t-tests comparing the TFP of domestic firms with that of firms with foreign ownership in year 2000. Some results : • Foreign firms are younger and enjoy greater economy of scale and have more educated employees (more skilled). • Foreign firms value the quality of skilled labor and hire managers with foreign firm work experience.

9. FDI Spillovers in China • Absorptive Capacity : There is a significant difference in the distribution of absorptive capacity across cities: It is significantly higher in Guangzhou, Shanghai and Beijing than in Chengdu and Tianjin. • Sample: Only domestic firms in order to avoid endogeneity problems.

10. FDI Spillovers in China

11. Interpretation • Domestic firms with absorptive capacity over 0.56 enjoy positive spillovers from FDI, while those with capacity below 0.56 suffer negative spillover effects.

12. FDI Spillovers in China

13. Interpretation • When we take into account the labor mobility channel and the network externality channel, the effect of firm absorptive capacity on FDI spillovers disappears. • Network externality for domestic firm is possible through high skilled workers (they attend to conferences, product shows) and through young motivated workers for whom it’s easier to develop new knowledge and learn new skills.

14. Robustness tests We find the same results when: • Estimate all the regressions with labor productivity instead of value added as the dependent variable and capital intensity instead of capital input among the explanatory variables. • Redefine absorptive capacity using alternative definition of TFP (TFP2 and TFP3, as described above). • Instead of using the share of largest foreign partner we use total foreign share because part of the total foreign share may be portfolio. The two measures are highly correlated even if it’s not appropriate. • In order to make sure that our results are not driven by just one city, we re-estimate all the regressions dropping one city at a time.

15. Conclusion • FDI has positive spillover effects on domestic firms when employee age and education are taken into account, but such positive spillovers disappear once industry and regional FE are controlled for. • Domestic firms with high initial productivity enjoy positive spillovers while those with low initial productive witness negative spillovers. • Movement of managers and engineers from foreign to domestic firms enhances the productivity of domestic firms, and younger and more skilled workers increases the FDI spillover effects. • Dormestic firms with high initial productivity tend to hire younger and more skilled workers, which helps faciliatet technological transfer and FDI spillovers.

16. Contribution • Since 2006, Hale and Long tried to detect positive spillovers of FDI presence but nothing was found : HALE, G. and LONG, C. (2011), ARE THERE PRODUCTIVITY SPILLOVERS FROM FOREIGN DIRECT INVESTMENT IN CHINA?. Pacific Economic Review, 16: 135–153 • R&D impact on my TFP with firm level data.

17. R&D spillovers • Horizontal spillovers: Impact of my neighbors’ R&D (locality, sector) on my TFP. • Vertical spillovers: Hale & Long and Javorcik talk about upstream and downstream linkages. Dependent Variable: TFP or VA/Employment Explanatory Variables: FEi, FEy,ΣR&D/Sales, Foreign, Agei, Skilli, Sizei