Does foreign direct investment really enhance China's regional productivity?

Abstract

While foreign direct investment (FDI) is widely recognized as one of major driving forces on promoting the regional economic growth in China, its impact on regional productivity is unclear and less systematically investigated. This article investigates the effect of FDI on regional productivity in China. Specifically, we adopt a newly developed measure of total factor productivity (TFP) to deal with the endogenous inputs choice accompanied with various measures of FDI, enabling to provide robust estimates on the TFP effect of FDI. Moreover, we examine the role of absorptive ability on the FDI-TFP nexus and explore the existence of FDI spillover effect on productivity across regions. The potential difference in productivity effect of FDI between coastal and non-coastal regions is also examined. Based on the province-level panel dataset over the period 1997–2006, the various estimates show that the overall productivity effect of FDI is significantly positive, while this effect depends heavily on the host region's absorptive ability. Technological gap is found to associate with a significantly negative coefficient along with the finding that FDI tends to exhibit a higher impact on productivity in coastal regions than their non-coastal counterparts, highlighting a widening income inequality between coastal and non-coastal regions in China.

Keywords:

• Foreign direct investment
• productivity
• spillover effect

JEL Classifications:

• F21
• O19

Acknowledgements

We are grateful to conference participants for discussions and suggestions at the Chinese Economists Society (CES) Annual Conference, held at Nanning, China, June 2009. We like to express our appreciation to two anonymous referees for providing invaluable comments and suggestions. Financial support of National Central University is also gratefully acknowledged. As usual, all errors of omission and commission are ours.

Notes

 1. Actually, the open door policy was first proposed by Ziyang Zhao when he was a high-ranking government official and served as the leading reformer who implemented market reforms in the late 1970s.

 2. There is an abundant of studies showing that there is growing regional imbalance in China – for example, Chen and Fleisher (1996), Yao and Zhang (2001), and Kanbur and Zhang (2005).

 3. The definitions and distinctions concerning explicit and tacit knowledge, please see Zoltan and Perner (1999).

 4. Tian (2007) is the unique study that accounts for the three sources of FDI technology spillover in China.

 5. For example, Globerman (1979) for Canada, Blomström (1986) for Mexico, Sjöholm (1999a) for Indonesia, Javorick (2004) for Lithuania, and Haskel, Pereira, and Slaughter (2007) for UK.

 6. There are some papers investigating the interactive effect between absorptive ability and FDI on promoting economic growth, for example Lai, Peng, and Bao (2006) and Kuo and Yang (2008).

 7. The condition, f_ml f_{l ω} > f_ll f_{m ω}, is sufficient to ensure that the input demand function m_it  = f (k_it , ω _it ) is strictly increasing in ω.

 8. The detailed derivation on the semi-parametric estimates of TFP, please see Levinsohn and Petrin (2003). In addition, the STATA codes for the semi-parametric estimate of TFP are available in Petrin, Poi, and Levinsohn (2004).

 9. The causality relation between productivity and exporting are referred to the self-selection effect and learning-by-exporting in literature, e.g. Clerides, Lach, and Tybout (1998).

10. When this variable is calculated by using the stock measure of FDI (FDIPROD), it does not take logarithm.

11. The detailed process on calculating this variable, please see Funke and Niebuhr (2005).

12. The matrix of correlation coefficients is shown in the Appendix.

13. See Islam, Dai, and Sakamoto (2006) for a comprehensive review on China's productivity growth.

14. Levin, Lin, and Chu (2002) suggest that their panel unit root test is relevant for moderate size with N between 10 and 250 and T between 25 and 250, and then our panel data consists of 31 provinces of China for the periods 1997 to 2006, which is not suitable size for the assumption of LLC test.

15. The LLC and IPS tests were developed by Levine et al. (2002) and Im, Pesaran, and Shin (2003), respectively.

16. Pedroni (1999) derives asymptotic distributions and critical values for several residual based tests of the null of no cointegration in panels where there are multiple regressors.