Friday, July 6, 2012

For China, Trade is not Simply About FDI

An empirical study undertaken at the University of Hong Kong examining the phenomenon of trade and foreign direct investment in mainland China has demonstrated a key policy point of China's FDI policy. Namely, its not about how much FDI China can attract, but about maximizing productivity spillovers. Its about how much wealth actually remains in the domestic hands and how much productivity growth the domestically-owned Chinese economy experiences as a result of foreign investment.

Typically, when we talk of trade with developing countries and emerging economies, we think of a number of key concepts, all of which have their roots in western academia. Talk of trade-based economic growth and development turns to focus on Foreign Direct Investment, whose sheer volume is simply supposed to be broadly good for growth. Good policy would therefore focus on simply a maximization of FDI-lead growth. Or so we in the global north - two centuries removed from our own actual history of economic development during the industrial revolution - are told.

Necessary but not Sufficient
For China however, FDI is not universally considered as unambiguously positive. While economic growth is certainly considered to be a positive aspect of FDI, this is "necessary but not sufficient" in determining whether or not foreign investment is actually positive for the country. After all, The question then, is what precisely would be sufficient?

For China, perhaps the real question is not one of how much wealth can be generated in China with foreign investment, but rather, how much wealth actually remains in the domestic hands as a result of foreign investment. The key ingredient seems to be spillovers. That is, improving the productivity of the locally-owned economy. Presumably, this involves modernization in technological level, managerial practice, and employee know-how in the domestically-owned share of the economy.   

The Study and its Meaning
This study is an empirical examination of the productivity spillovers at the firm level. The central question it asks its quite straightforward: Are domestic Chinese firms affected by the presence of international firms in China? The study finds evidence that the technology gap leads to large productivity spillovers. In fact, the larger the technological gap, the larger the potential spillover. What this all means of course, is that FDI policy is not really a question of quantity. Sound FDI policy should revolve around bringing the most sophisticated possible firms to China, then maximizing spillover effects on domestically-owned firms by maximizing capture of technology, know-how, and managerial practices.

Foreign direct investment (FDI) is believed to bring positive spillovers to domestic firms in the host country. Empirical studies, however, have found conflicting evidence on the effects of FDI. In this study, we use a firm-level industrial census to estimate the relationship between the intensity of foreign presence and performance of domestic firms in China. More specifically, we attempt to answer the following questions. First, are Chinese domestic enterprises affected by the presence of foreign invested firms operating in the same industry which they do business in? Second, are Chinese domestic enterprises affected by the presence of foreign invested firms operating within related industries at the same locality where they conducted their businesses? It is a fact that a substantial portion of FDI in China are originated from neighboring economies, especially from the three most Chinese populated economies Hong Kong, Macao and Taiwan, that are technologically much less advanced than industrial countries. Finally, we examine whether foreign investment firms from these economies affect the Chinese domestic firms differently compared to those from other investing countries. The estimation results offer some support for the existence of positive spillovers. There seems to be stronger evidence that domestic industries benefit from foreign presence in the related industries within the province. Employment shares of foreign affiliates, especially those with investors from advanced countries, are associated with higher productivity. The impact of foreign presence within the industry is rather mixed. Employment shares of firms with investment from greater China area are negatively associated with domestic productivity while those with other foreign investment are positively associated with domestic productivity. It supports the argument that larger technology gap provides large potentials for technology spillover. For investment from greater China area, smaller technology gap present less potential gain. More over, they may be in direct competition with domestic firms and result in shrinking market share for domestic firms.

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