Does Foreign Direct Investment Hamper Indigenous Technological Creation? Theory and Evidence from China

What impact does foreign direct investment (FDI) have on indigenous technological creation? Despite the answer to this question is both academically interesting and practically important, systematic empirical studies are lacking. This study attempts to help fill this gap by conducting an empirical investigation of the effects of FDI on indigenous technological creation using a firm-level survey data in China. Our empirical analysis yields two findings. First, a firm’s expenditure on research and development (R&D) decreases with the amount of FDI it receives. Second, sector-level FDI has a greater positive impact on the R&D effort for the firms with more foreign presence. Combining these two effects together, we find that the net effect of FDI on indigenous R&D effort is negative. Further, we provide a theoretical explanation for our empirical findings through examining the complementary effect and substitution effect of FDI on domestic R&D. Finally, our study has interesting policy implications for China and other developing countries in the utilization of FDI for economic development. JEL classifications: F21, F23, O32, O33 * Department of Economics, Lingnan University, Tuen Mun, Hong Kong. E-mail: [email protected]. ** Hong Kong Institute of Economics and Business Strategy, School of Business and Economics, University of Hong Kong, Pokfulam Road, Hong Kong. E-mail: [email protected].