Does Foreign Direct Investment Lead to Industrial Agglomeration?

52 Pages Posted: 29 Mar 2019

See all articles by Wen-Tai Hsu

Wen-Tai Hsu

Singapore Management University

Yi Lu

National University of Singapore (NUS) - Department of Economics

Xuan Luo

INSEAD

Lianming Zhu

Kyoto University

Date Written: March 28, 2019

Abstract

This paper studies the effect of foreign direct investment (FDI) on industrial agglomeration.Using the differential effects of FDI deregulation in 2002 in China on different industries, we find that FDI actually affects industrial agglomeration negatively. This result is somewhat counter-intuitive, as the conventional wisdom tends to suggest that FDI attracts domestic firms to cluster for various agglomeration benefits, in particular technology spillovers. To reconcile our empirical findings and the conventional wisdom, we develop a theory of FDI and agglomeration based on two counter-veiling forces. Technology diffusion from FDI attracts domestic firms to cluster, but fiercer competition drives firms away. Which force dominates depends on the scale of the economy. When the economy is sufficiently large, FDI discourages agglomeration. We find various evidence on this competition mechanism.

Keywords: Industrial Agglomeration, Ellison-Glaeser Index, Competition, Foreign Direct Investment, Special Economic Zones, WTO, China

Suggested Citation

Hsu, Wen-Tai and Lu, Yi and Luo, Xuan and Zhu, Lianming, Does Foreign Direct Investment Lead to Industrial Agglomeration? (March 28, 2019). INSEAD Working Paper No. 2019/11/EPS. Available at SSRN: https://ssrn.com/abstract=3361487 or http://dx.doi.org/10.2139/ssrn.3361487

Wen-Tai Hsu

Singapore Management University ( email )

Yi Lu

National University of Singapore (NUS) - Department of Economics ( email )

1 Arts Link, AS2 #06-02
Singapore 117570, Singapore 119077
Singapore
65-65166834 (Phone)

HOME PAGE: http://ylu6.weebly.com

Xuan Luo (Contact Author)

INSEAD ( email )

Boulevard de Constance
77305 Fontainebleau Cedex
France

Lianming Zhu

Kyoto University ( email )

Yoshida-Honmachi
Sakyo-ku
Kyoto, 606-8501
Japan

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