FDI Knowledge Spillovers and Innovativeness of Chinese Firms

We investigate theoretically and empirically the impact of foreign direct investment (FDI) on the product innovation activity of Chinese firms. We extend the existing literature by examining a new type of spillover benefit, as well as new mechanisms by which knowledge spillovers occur. Theoretically, we extend the existing FDI spillover literature that mainly focuses on industry-level spillover effects on productivity by examining FDI spillovers at both firm and location levels, and their impact on product innovations. Using the knowledge-based view of firms we argue that knowledge spillover is likely to occur when foreign firms form joint ventures with local firms and/or when local firms are located in cities with concentrated foreign activities. Empirically, we utilize product innovation information for nearly 380,000 Chinese manufacturing firms over the period 2000-2006. After controlling for the endogeneity of joint venture formation, we find strong support for knowledge spillovers through joint ventures. We find conditional support for locational level spillovers: In locations with strong clustering of innovative foreign firms, local firms benefit from foreign knowledge spillovers; However, in locations where foreign concentration is measured not by innovations, but by sales or capital, local firms do not benefit from foreign knowledge spillovers. Finally, we find that firms with strong absorptive capacity benefit more from FDI knowledge spillovers at the firm and location levels. We discuss the implications of these results for firm strategy and government policy.