FDI and Firm Productivity in Host Countries: The Role of Financial Constraints

50 Pages Posted: 19 Mar 2021

See all articles by Wontae Han

Wontae Han

The Chinese University of Hong Kong, Shenzhen

Jian Wang

The Chinese University of Hong Kong, Shenzhen; Shenzhen Finance Institute

Xiao Wang

University of Science and Technology of China

Date Written: January 31, 2021

Abstract

This paper studies the effect of FDI firms' financial advantages on firm productivity in host countries and examines the related policy implications. If FDI firms face lower financing costs but have higher fixed production costs than local firms, a simple Melitz-type model predicts that because of their financial advantages, FDI firms could have even lower cutoff productivity than local firms, especially in financially vulnerable sectors. The same mechanism will also lower the average productivity of FDI firms especially in financially vulnerable sectors, although FDI firms on average are still more productive than local firms. These predictions are supported by the Chinese firm-level data. Then, we study policy implications in a two-country model that resembles these empirical patterns. The counterfactual policy analysis shows that offering tax benefits to FDI firms could be counterproductive because it attracts FDI firms that are even less productive than local firms. The policy in the host country to improve its financial market efficiency could also hurt the country's welfare because of the interaction between financial market reforms and the distortionary taxes imposed on local firms to finance FDI subsidies.

Keywords: Foreign direct investment; financial constraints; firm productivity; China

JEL Classification: F15; F21; F23; F36; F60

Suggested Citation

Han, Wontae and Wang, Jian and Wang, Xiao, FDI and Firm Productivity in Host Countries: The Role of Financial Constraints (January 31, 2021). Available at SSRN: https://ssrn.com/abstract=3776807 or http://dx.doi.org/10.2139/ssrn.3776807

Wontae Han

The Chinese University of Hong Kong, Shenzhen ( email )

CUHK-SZ, 2001 Longxiang Avenue
Shenzhen, Guangdong 518172
China

HOME PAGE: http://https://sites.google.com/site/econhanwt/

Jian Wang (Contact Author)

The Chinese University of Hong Kong, Shenzhen ( email )

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

Shenzhen Finance Institute ( email )

Xiao Wang

University of Science and Technology of China ( email )

China

HOME PAGE: http://https://sites.google.com/site/xiaowangeconomics/

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