Productivity Gap and Inward FDI Spillovers: Theory and Evidence from China

24 Pages Posted: 9 Apr 2019 Last revised: 12 Aug 2019

See all articles by Jim Huangnan Shen

Jim Huangnan Shen

University of London, School of Oriental and African Studies (SOAS), Economics; Center for International Development, Harvard Kennedy School, Harvard University

Hao Wang

Brunel University London - Department of Economics and Finance

Steve Chu Chia Lin

National Chengchi University (NCCU) - Department of Economics

Date Written: March 16, 2019

Abstract

This paper constructs a two-stage sequential game model to investigate the spillover effect of inward FDI on improving the efficiency of domestic firms in host countries. Our model shows that, given the optimal joint-venture policy made by foreign firms, the impact of spillover effect of inward FDI is contingent upon the productivity gap between the domestic firms and foreign ones. In particular, we demonstrate that the spillover effect of FDI inward varies negatively with the productivity gap between domestic low-productivity firms and foreign firms and works conversely for high-productivity firms. This result suggests that once the productivity gap widens, the entry of foreign firms will increase the efficiency of high-productivity firms and reduce the efficiency of low-productivity firms. The implication of our theoretical predictions is that once the productivity of domestic firms (high-productivity firms) is close enough to the world productivity frontier, they will incur the positive spillover effect from the entry of foreign firms. In contrast, the domestic firms with low productivity which are more distant from the world productivity frontier will perform worse owing to the entry of foreign firms, thus leading to the negative spillover effect. Using the data from over 570,000 firms in Chinese manufacturing industry in 2011, we advance the understanding of the theoretical model through empirical analysis.

Keywords: spillover effect, inward FDI, productivity gap, efficiency improvement, high-productivity firm, low-productivity firm, Chinese manufacturing industry

JEL Classification: F43, O40

Suggested Citation

Shen, Jim Huangnan and Wang, Hao and Lin, Steve Chu Chia, Productivity Gap and Inward FDI Spillovers: Theory and Evidence from China (March 16, 2019). Available at SSRN: https://ssrn.com/abstract=3353793 or http://dx.doi.org/10.2139/ssrn.3353793

Jim Huangnan Shen (Contact Author)

University of London, School of Oriental and African Studies (SOAS), Economics ( email )

London, WC1E 7HU
United Kingdom

Center for International Development, Harvard Kennedy School, Harvard University ( email )

One Eliot Street Building
79 JFK Street
Cambridge, MA 02138
United States

Hao Wang

Brunel University London - Department of Economics and Finance ( email )

Kingston Lane
Uxbridge, Middlesex UB8 3PH
United Kingdom

Steve Chu Chia Lin

National Chengchi University (NCCU) - Department of Economics ( email )

Taipei 116
Taiwan

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