Spillover effects of foreign direct investment: how do region-specific institutions matter?
| Verfasser | Yi, Jingtao |
| Posten | RESEARCH ARTICLE - Report |
Abstract This study examines the role of region-specific institutions in explaining foreign direct investment (FDI) spillovers. The findings reveal that domestic firms in different regions of China do not equally benefit from inward FDI. Firms that operate in regions with higher levels of intellectual property right protection, market development and international openness are better able to absorb spillovers and improve their productivity. By demonstrating how subnational location-bound institutions influence the spillover effects of FDI, the paper extends prior literature that largely focuses on either firm- and industry-specific determinants or on country-level institutional idiosyncrasies.
Keywords Foreign direct investment * Spillovers * Productivity * Regions * Chinese firms
1 Introduction
Foreign direct investment (FDI) generates spillovers that often benefit local firms in the host country. As both foreign and local firms have to accommodate institutional conditions that vary not only between countries, but also within the host economy (Wright et al. 2005), institutions shape the choices, behaviour, interaction and performance of firms and, consequently, influence the spillovers that advantage local firms. In this study, we examine how region-specific institutions affect FDI spillovers. Despite the view that FDI generates spillovers that benefit local firms in the host country, research on this topic has yielded a mixed set of results (Gorg and Greenaway 2004), including positive effects (Buckley et al. 2002; Liu et al. 2009; Wang et al. 2012), negative effects (e.g., Feinberg and Majumdar 2001; Jordaan 2008), marginal effects (e.g., Haskel et al. 2007) and a nonlinear relationship between foreign presence and local firms' performance (Girma 2005; Girma et al. 2008: Buckley et al. 2007a).
As one of the largest FDI destinations, China has attracted considerable scholarly attention. Some studies examine whether the presence of FDI affects the productivity of domestic firms and report positive spillovers (e.g., Buckley et al. 2002, 2007a; Liu et al. 2009; Wei and Liu 2006). Others look into the conditions under which spillovers occur, such as how the diversity of country of origin (Buckley et al. 2007a; Zhang et al. 2010) and process of entry (speed and irregularity) influence FDI spillovers (Wang et al. 2012), or the types of domestic firms and industries that benefit from spillovers (e.g., Buckley et al. 2007b). These studies typically find that the occurrence and magnitude of FDI spillovers depend upon a number of contingencies, implying that not all firms can benefit from FDI. Nevertheless, despite a large volume of studies, more research on FDI spillovers is required to identify the conditions under which such effects are large, small or nonexistent.
Extant research on China and other countries has two important limitations. First, although institutions, defined as the rules of the game (North 1990), shape firm behavior, choices and performance, the link between institutions and FDI spillovers has been overlooked. Second, many studies focus on multiple countries or sectors, but we still know little about whether the observed firm-specific spillover effects of FDI are contingent on, or independent of, the context of subnational regions. The characteristics of a region are critical for understanding FDI spillovers because differences in factor endowments influence not only the levels of inward FDI in a region, but also the potential for spillovers from FDI. To address these gaps, this paper examines how FDI spillovers are affected by region-specific institutions, including intellectual property right (IPR) protection, market development, and international openness, within a given country. These three constructs capture different dimensions of region-specific economic institutions and collectively influence not only the transfer and development of technology in foreign firms (and thus the spillover potential) but also the absorptive capacity of domestic firms and therefore the effects of FDI spillovers.
The paper extends the prior literature in three directions. First, the extant international business literature suggests that institutions, such as regulatory and political institutions, may influence how much FDI a country can attract (Meyer and Nguyen 2005; Zhou et al. 2002). However, the question of how geographically localized characteristics influence the extent to which local firms benefit from the presence of technologically advanced MNEs remains under-theorized. This is a surprising lacuna since the institutional idiosyncrasies that attract FDI in a specific region may also influence the effects of such FDI. For instance, firms in regions that possess high quality institutions might also be those best placed to gain from the foreign presence. Accounting for the role of institutions is important when studying FDI spillovers in emerging economies, where institutions are overly complex and rapidly changing. We extend the literature on FDI location choices by examining how region-specific institutions facilitate or constrain the extent to which domestic firms benefit from FDI. Modeling spillovers in this manner enables us to explain how the effects of FDI vary across subnational locations, and establish a conceptual link between two distinct research strands--namely, the antecedents and outcomes of FDI.
Second, regions within a given nation may differ significantly in institutional setups. Prior research (on FDI determinants), however, focuses on country-level institutions, assuming that institutions are homogenous across subnational regions in a country. This neglect of consideration of subnational effects might not be that critical for host countries with relatively homogeneous subnational institutions. However, these effects are likely to be much more important for host countries with heterogeneous institutions across subnational regions, such as China. Yet extant literature offers limited knowledge of how such cross-regional institutional variations influence the effects of FDI on local firms. We argue that variations in region-specific institutions constitute different sets of opportunities and constraints among host country regions, shaping differential regional effects of FDI spillovers. This helps us explain how differences in region-specific institutions can account for a significant portion of the variations in FDI spillovers in different regions, thus adding to the understanding of FDI spillovers in a cross-region context.
Third, a few studies have shown that FDI spillovers have a regional dimension. For example, some studies find that FDI spillovers are confined within regions (Girma et al. 2001; Wei and Liu 2006), while others show that such benefits may spread across other regions (Ke and Lai 2011; Mullen and Williams 2007). Prior research has also examined FDI spillovers at the regional level (Cheung and Lin 2004; Qi et al. 2009; Huang et al. 2012). Although these studies help us distinguish between local and inter-regional FDI effects, little is known about how regional institutional characteristics shape the way in which FDI affects local firms within the same region. As such, prior research only provides a partial account of the phenomena of regional FDI spillovers. By examining how region-specific institutions influence the effects of foreign presence on the productivity of local firms, this study shifts the debate from whether spillovers occur along regional lines to the question of under which institutional conditions FDI impacts domestic firms in the same region. Our approach is consistent with a growing stream of research that explicitly recognizes the strategic roles of geographic space (e.g., Girma et al. 2001; Nachum 2000).
China is a particularly suitable context for this study not only because the country has received a large amount of FDI but also because it has undergone major political and economic reforms that have led to provincial institutions varying greatly (Hong et al. 2014). Our framework--which is tested against a recently constructed large panel dataset comprising 357,958 firms--challenges current thinking about FDI spillovers and demonstrates how the presence of foreign firms interacts with location-bound institutions to jointly shape the spillover effects of FDI.
2 Institutional Change and FDI in China
Emerging economies are often characterized by underdeveloped markets, extensive state intervention, inefficient intermediaries and weak contract enforcement (Khanna and Palepu 1997). These in turn increase transaction costs and create uncertainty, influencing firm behavior in a manner that differs from that in developed economies (Khanna and Yafeh 2007; Khanna and Rivkin 2001). Many emerging economies have therefore implemented institutional transitions. The marketization reform in China since 1978 has involved a process of decentralization (Boisot and Meyer 2008). The central government of China delegated responsibility for economic performance and the control of some state-owned enterprises and other organizations to provincial governments (Boisot and Meyer 2008). These reforms devolved regulatory authority from the central to local governments and incentivized provincial governments to promote economic development. Decentralization has created a "Chinese Style Federalism" that is characterized by local protectionism and a greater degree of regional authority over policy-making, legal development and enforcement (Chan et al. 2010).
As a result, unlike Western countries in which institutions are largely homogenous across subnational regions, political and economic reforms in China have created an environment that significantly differs across regions. China's transition is characterized by path dependency, political fragmentation and uneven reform of institutions (e.g., Grabher and Stark 1997), leading to a multi-layered institutional system...
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