A stochastic frontier analysis of FDI and spillovers: Evidence from firms in China

It has long been recognized that technological spillovers of multinational corporations, horizontally and/or vertically, to non-affiliated firms create a beneficial productivity impact in the host economy. This paper studies the effects of both horizontal and vertical FDI – both upstream and downstream FDI – on a firm’s level of technical efficiency. Comprehensive survey data on approximately 12,000 domestic and foreign firms in 30 two-digit manufacturing industries in China over 2002-2004 are used in a stochastic frontier framework. We identify the contribution of technical efficiency and technical progress to productivity growth. We find that horizontal FDI (FDI in a firm’s own industry) is negatively associated with a firm’s technical efficiency. But there exists a complementarity between horizontal FDI and a firm’s R&D. In other words, firms with R&D investments benefit more from foreign presence in the same industry than firms that do not have R&D investments. The result suggests that not all firms can benefit from FDI spillovers. Yet, positive spillovers are closely related to a firm’s capacity to absorb new technology and knowledge

In terms of vertical spillovers, we find positive FDI spillovers occur from foreign end users to domestic suppliers. MNCs can help their suppliers in the host country to build production facilities and provide technical support to raise the quality of suppliers’ products. On the other hand, our results indicate that foreign presence in upstream industries could have an adverse effect on the level of technical efficiency of firms as end users. The scope of sourcing from foreign firms in upstream industries may not be as large as expected.

Generalized Malmquist decomposition shows that foreign affiliates achieve higher productivity growth than domestic firms. The average annual TFP growth across different manufacturing industries was 9.8% over 2002-2004. Foreign firms, on average, exhibit a faster TFP growth rate (10.4%) than domestic firms (9.7%). This difference is mainly due to different rates of technical efficiency change. Both foreign and domestic manufacturing firms in China have similar rate of technical progress at 6.4%. But foreign firms on average experience a faster improvement in technical efficiency than domestic firms (4.1% vs. 3.5%).