Foreign Firms and Indigenous Technology
Development in the People’s Republic of China
∗
FREDRIK SJ ¨OHOLM AND NANNAN LUNDIN

The People’s Republic of China (PRC) is currently promoting indigenous tech-
nology development through support of Chinese firms and, arguably, by restrict-
ing operations of foreign multinational firms. This policy seems to overlook
the impact of foreign firms on technology development in local firms. Para en-
postura, technology might leak out to local firms though spillovers. Además,
competition from foreign firms might force local firms to engage in technology
desarrollo. We examine the impact of foreign direct investment (FDI) en
technology development in the PRC. We start by surveying a large and grow-
ing literature on FDI and spillovers in the country. Most previous studies find
evidence of positive spillovers. We then continue to examine the effect of FDI
on competition in the Chinese manufacturing sector and the effect of competi-
tion on firms’ research and development (R&D). Our analysis is conducted on
a large dataset including all large- and medium-sized Chinese firms over the
period 1998–2004. Our results show that FDI increases competition but there
are no strong indications of competition affecting investments in R&D.

Palabras clave: People’s Republic of China, FDI, spillovers, tecnología, R&D
JEL codes: F23, L11, O31

I. Introducción

Rapid development of the People’s Republic of China (PRC) during the last
few decades is closely related to its success in attracting foreign direct investment
(FDI). The PRC is one of the world’s largest recipients of FDI which has substantially
contributed to production and export. Además, FDI to the PRC, according to some
reports, has undergone a structural change away from simple manufacturing towards
more technology-intensive activities. Por ejemplo, the PRC has become the third
most important offshore research and development (R&D) location for multinational
enterprises (MNEs) according to a survey by UNCTAD (2005).

∗Fredrik Sj¨oholm is Professor at the Department of Economics, Lund University and the Research Institute of
Industrial Economics. Nannan Lundin is Managing Director at Tekfors Ltd. The authors are grateful for comments
and suggestions made by participants at the ADB Conference on Development Issues in Asia held in November 2012
and from two anonymous referees. Xiaojing Guan, He Ping, and Jinchang Qian from the National Bureau of Statistics
of China have been helpful in providing the data. Sj¨oholm gratefully acknowledges financial support from the Ragnar
S¨oderberg Foundation.

Asian Development Review, volumen. 30, No. 2, páginas. 49–75

C(cid:3) 2013 Asian Development Bank
and Asian Development Bank Institute

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50 ASIAN DEVELOPMENT REVIEW

Despite the increase in FDI and R&D, there is a concern in the PRC that
inflows of FDI do not contribute to technology development to the same extent that
they contribute to production and export. It is noted by policymakers and academics
alike that while foreign firms account for a large share of exports and production,
their share of R&D is small. The recent emphasis on “indigenous innovation” and
“indigenous capacity building” in Chinese science and technology policy partly
reflects an uncertain and even skeptical attitude towards FDI.

Sin embargo, the discussion on FDI and R&D in the PRC neglects how indige-
nous technology development is affected by FDI. Such an effect could arise if, para
instancia, domestic firms learn from foreign-owned firms. FDI might also affect
the competitive pressure in the market which, Sucesivamente, could affect the amount of
technology development in domestically-owned firms.

The expected impact of FDI on the R&D of domestically-owned (indige-
nous) firms, sin embargo, is not clear. First and as previously mentioned, there could
be a demonstration effect or technology externalities from FDI that might affect
productivity in domestic firms. This effect is typically attributed to a spillover ef-
fect from foreign to domestic firms. A large number of studies have identified such
spillovers in various countries. The positive effect on productivity could be caused
by technological externalities but could also capture other aspects such as more
efficient use of existing technologies through a competition effect.

There could also be an effect of FDI on R&D in domestic firms. An impact
on R&D is perhaps more closely related to technology development than the above
mentioned spillover effect on productivity. The most obvious channel would be
through the impact of FDI on the market structure. The direction of this effect
is more uncertain since it depends both on how FDI affects market structure and
how market structure affects R&D. Starting with FDI and market structure, foreign
firms might increase the degree of competition in the local market but it could also
happen that successful foreign firms force local firms to exit the market with a
resulting increased industry concentration. Además, increased competition could
both increase R&D, by firms struggling to compete, or decrease R&D because of
diminishing monopoly rents.

This paper examines how FDI might affect technology development in local
Chinese firms. We will examine both general productivity effects through spillovers
from FDI and the effect of FDI on market structure and how market structure, Sucesivamente,
affects investments in R&D. Our section on spillovers surveys the large and growing
existing literature on the PRC and concludes that there is ample evidence of positive
spillovers. The exact nature of these spillovers and how they are affected by various
factors are less clear. We then continue with our second issue where we use firm-level
data containing detailed information on operational and R&D activities of large- y
medium-sized Chinese manufacturing firms for the period 1998–2004. Nuestros resultados
suggest that FDI tends to increase competition, as measured by price cost margins,
but there is no visible effect of competition on R&D intensity in Chinese firms.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 51

The paper is organized as follows. Section II discusses FDI and indigenous
technology development in the Chinese context. In Section III, we set up a conceptual
framework for our empirical analysis and briefly review previous studies in the
field of interest. We show the econometric models in Section IV, give a detailed
description of the dataset and show some descriptive statistics in Section V, y
present the results in Section VI. We then conclude the paper in Section VII.

II. The Chinese Context

The policy focus in the PRC has changed in some important respects over
the last years. One key change following the people’s party congress in 2006 tiene
been the increased focus on technology development (Chinese Ministry of Science
and Technology 2006, Sj¨oholm and Lundin 2010a). The ambition was to make the
PRC an innovation-driven economy, the background being increased uneasiness
with the dependence on manufacturing of labor-intensive goods. The perception has
been that an upgrading of production towards higher-value-added goods would be
desirable. It is argued that continued assembly of imported inputs would not enable
the country to continue its rapid development.

In light of this, Chinese officials worry that some technology indicators
other than aggregate R&D, which is increasing, seem to suggest a low level of
technology sophistication. Por ejemplo, it has been shown that most new Chinese
firms are heavily concentrated in relatively simple manufacturing activities (Sj¨oholm
and Lundin 2010a). But it is not clear that the Chinese concern is necessary. Para
instancia, Brandt, Van Biesebroeck, and Zhang (2012) show that total factor pro-
ductivity (TFP) growth has been very high in the PRC between 1998 y 2007,
which suggests that there have been considerable technology improvements taking
lugar.

This focus on technology development has been repeated by various policy-
makers at frequent occasions. Por ejemplo, in August 2009, Science and Technology
Minister Wan Gang argued that “The most effective way to withstand the impact
of the global economic meltdown is to accelerate technological innovation, el nuevo
economic growth engine.”1 More recently, President Hu Jintao argued for the impor-
tance of technology in a more broad sense, “We must focus on promoting innovation
in science and technology if we want to push forward reform and opening up policy,
the modernization of socialism, and achieve the overall target for building a moder-
ately prosperous society in an all-round way, improve the people’s living standard,
as well as achieve the great rejuvenation of the Chinese nation.”2

1“Government Pledges Strong Support for Innovation-based SMEs,” China Daily, 1 Septiembre 2009.
2“Top Leaders Urge Innovation in Science, Tecnología,” China.org.com, accedido 8 Julio 2012. Disponible en

www.china.org.cn/china/2012-07/08/content_25847720.htm

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52 ASIAN DEVELOPMENT REVIEW

The Chinese innovation strategy is also related to discussions on the middle-
income trap. This refers to the seemingly difficult task for countries that wish
to move from a middle-income position to become a high-income economy. Pocos
countries have managed such a transition in recent decades as rising wage costs tend
to erode competitiveness with slowing growth as a result (Griffith 2011). Excluding
the small city states, only three Asian economies have managed the transition from
middle-income to high-income positions: Japan in the 1960s and Taipei,China and
the Republic of Korea in the 1990s.

The middle-income trap is frequently discussed also in a Chinese context.
El Banco Mundial (2012, xvi) discusses in a report how continued high economic
growth in the PRC can be secured and highlights the need to “accelerate the pace of
innovation and create an open innovation system.” It is argued that a higher degree
of technological sophistication could balance rising labor costs and enable the PRC
to move to higher-value-added production.

An important aspect of the PRC’s technology policy is the emphasis on
indigenous technology development. En otras palabras, with general technology devel-
opment deemed insufficient, indigenous Chinese firms in particular should develop
the new products and production processes that would secure continued economic
desarrollo. This is arguably an important change of strategy in a country as de-
pendent on foreign multinationals as the PRC. The aspect of indigenous technology
development was already stressed in the 2006 5-year plan and then again in the 12th
5-year plan in 2011.

[The People’s Republic of] China should upgrade its capabilities in
indigenous research and innovation in science, technology and ad-
ministration, train more innovative talents and improve education for
workers. In a word, we will strive to speed up the construction of an
innovation country (National People’s Congress 2011, pag. 3).

Current policy promotes indigenous technology development through access
to finance and subsidies and by preferential treatment to indigenous firms in public
procurement. Another aspect of the policy has to do with increased restrictions on
foreign multinationals in the PRC. Koyama and Golub (2006) find that in a sample
de 42 countries, the PRC and India tend to have the most restrictions on FDI. El
Chinese investment regime has since become even more restrictive. Por ejemplo,
a new investment regime in 2006 has made it more difficult to acquire Chinese
companies (Sauvant 2009, pag. 12). The Chinese government has also closed some
industries to entry of foreign multinational firms. These sectors are typically the
ones considered important from a national security perspective. En años recientes, el
“economic security” criteria has additionally been used to keep foreign firms out of
the PRC.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 53

Further restrictions were introduced in 2008. Foreign acquisitions can now be
stopped by the authorities if considered a threat to local state-owned companies—an
option that was used to stop Coca Colas’ $2.3 billion purchase of Huiyuan Juice
en 2009. Other frequently used restrictions include requiring foreign firms to have
local joint-venture partners, tap local suppliers, and locate R&D in the country.

The new Chinese policies are not unproblematic. Public strategies for tech-
nology development are common in developing countries and it seems fair to say that
the results are often disappointing. Subsidies and protection of indigenous high-tech
firms have a tendency to result in a lack of international competitiveness. Además,
labor-intensive production in foreign multinational firms are presumably a suitable
development strategy for a country where a large share of the population still lives
in poverty, income inequality is large and growing, and modern sector employment
greatly needed (Karlsson et al. 2009, Sj¨oholm and Lundin 2010b).

III. FDI and R&D: Conceptual Framework and Previous Studies

As discussed above, Chinese authorities seem to be concerned by the level of
indigenous technology development. This has resulted in a more hesitant approach
towards FDI. Sin embargo, there are reasons to believe that indigenous technology
development might be affected by FDI. A suitable conceptual framework to discuss
this angle can be based on two strands of literature—the effect of FDI on the host
country’s market structure and the effect of market structure on firms’ investment in
R&D.

The presence of foreign MNEs may exert a significant influence on the
host country’s market structure. Sin embargo, different theoretical models and previous
empirical evidence show the relationship between FDI and market structure to be
highly complex.3 FDI can both increase and decrease the degree of competition
depending on the specific context.

Por un lado, FDI may increase the number of firms in an industry and
thereby decrease the concentration and increase the competition in the market,
particularly in industries with high start-up costs and high barriers to entry (p.ej.,
Barba Navaretti and Venables 2004, pag. 174). This is true for greenfield investments
but not for mergers and acquisitions, and the former type therefore has a more
competitive effect on the local economy (Haller 2005). Además, the entrance of
foreign MNEs might have a positive effect on production in existing domestic firms
through spillovers and even increase the number of firms if employees in MNEs
leave to set up their own businesses (Caves 1996). This would also tend to increase
competition.

3Ver, Por ejemplo, UNCTAD (1997) and OECD (2002) for more detailed reviews.

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54 ASIAN DEVELOPMENT REVIEW

Por otro lado, FDI may raise the level of concentration in the host-
country market (Aitken and Harrison 1999). Foreign MNEs possess competitive
firm-specific assets and might therefore be able to capture a leading market position.
The number of firms in an industry might then fall after the entry of foreign MNEs,
if only the most efficient firms can survive and less efficient (doméstico) firms are
forced to exit. Como consecuencia, the industry will become more concentrated. Es
important to note that in this case, high concentration is associated with initial high
intensity of competition. Once firms are forced out of the market, competition will
tend to decline.

With regard to the impact of market structure on innovation, this issue has
been addressed in a large body of theoretical work, which often yields conflicting
resultados (p.ej., Aghion and Howitt 1992, Aghion et al. 2005).

Innovations are, in the classic Schumpeterian view of creative destruction,
made by firms that earn no rents if they fail to innovate and that obtain monopolistic
power if they succeed. The market would be characterized by Arrow’s “replacement
efecto,” i.e., new firms replacing monopolists that fail to innovate (Flecha 1962).
Sin embargo, when competition intensifies and in turn trims down monopoly rents, el
incentive to innovate decreases. This theory therefore predicts a negative relationship
between market competition and innovation.

In contrast to the “replacement effect,” the “selection effect” of market compe-
tition predicts a positive relation between competition and innovation. Competition
may stimulate innovation when firms with innovation advantages further strengthen
their innovation capabilities in order to escape competition with “neck-to-neck”
rivals (p.ej., Vickers 1997, Boone 2000, Aghion and Schankerman 1999).

In more recent theoretical work, the relationship between competition and
innovation is described as non-monotone, which can happen when there are dif-
ferent types of innovators in terms of leaders and followers. Both the level of
the technology gap and the degree of rivalry are important aspects that are taken
into account in so-called step-by-step innovation models (p.ej., Aghion et al. 2001,
Boone 2001). The step-by-step innovation models are of particular relevance for
analyzing unlevelled industries, es decir., industries where different firms have differ-
ent levels of innovation capacity. In such industries, there are technically laggard
firms which have to catch up with the leading-edge technology before they can
compete with their more technologically advanced rivals. The ability to catch up
partly depends on the level of competition. When competition is low, the leading
firms will invest relatively little in R&D, which means that laggard firms have a
higher potential for catching up and thereby a higher incentive to innovate. En el
case of high market competition, the leading firms have a higher incentive to inno-
vate to remain in their strong position. This makes it more difficult for followers to
catch up and will, Sucesivamente, tend to decrease their incentives to innovate, y ellos
will instead try to find industrial niches with less competition from the leading
firms.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 55

As to the question of the impact competition, economic theory gives us little
guidance in making predictions on how this would affect R&D. There are reasons
to expect the effect to be positive as well as negative, and we have to address the
issue by empirical analysis to obtain information on how the relationship works in
a Chinese context.

A.

Previous Studies on FDI and Competition

There are relatively few empirical studies on the competitive effects of FDI.
One exception is Co (2001) who found both positive and negative effects of FDI
on competition in the United States depending on market conditions and the extent
of spillovers. Chung (2001) also finds mixed effects and suggests that the degree
of competitive pressure imposed by FDI depends on both the entry mode and the
various investment traits. The most interesting paper for our purposes is by Fu and
Wu (2012) who study the effect of FDI on profits in Chinese firms. They find an
inverted U-shape effect of FDI on profits, where profits tend to increase with smaller
inflows of FDI but then decrease with larger flows.

B.

Previous Studies on FDI and Domestic Innovation

Studies on the impact of FDI on domestic innovation and R&D are also rare.
Veugelers and Vanden Houte (1990) study the Belgian manufacturing sector and
find that domestic firms tend to have lower innovation intensities the higher the share
of FDI in the industry. It is not examined if this result is caused by an effect of FDI
on the market structure.

Two studies on the PRC by Jefferson et al. (2006) and Girma, Gong, y
G¨org (2006) are related to our work. Jefferson et al. (2006) use a similar measure of
investment in R&D, the firm-level R&D-to-sales ratio, and find a negative relation-
ship between firm size and R&D intensity and a positive but fragile effect of high
industry concentration. Girma, Gong, and G¨org (2006) find state-owned enterprises
(SOEs) with foreign capital participation to have relatively high degree of innova-
tion activity. Innovations in SOEs without foreign capital participation can be both
positively and negatively affected by FDI depending on the absorptive capacity of
these firms.

C.

A Survey of Literature on FDI and Spillovers in the PRC

As discussed above, there are few studies on FDI, competition, y r&D
in indigenous firms. This stands in large contrast to the extensive literature on
spillovers from FDI. This literature examines how productivity in domestic firms can
be affected by FDI and captures a broader set of productivity-increasing mechanisms
than just the firms’ own R&D.

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56 ASIAN DEVELOPMENT REVIEW

Mesa 1. Papers on Spillovers from FDI in the PRC

Author(s)

Años

Dependent
Variable

Measure of Foreign
Presence

Result

Wei and Liu (2006)

1998–2001 Output

Liu (2008)

1995–1999 TFP

Abraham et al. (2010) 2002–2004 TFP
Du, harrison, y
Jefferson (2011)
Du, harrison, y
Jefferson (2012)

1998–2007 Output

1998–2007 Output

Shares of output,
employment,
capital

Share of output

Negative at a national level,

positive at a province level

Short-term negative effects,
long-term positive effects

Share of sales
Share of output

Positive
Positive

Share of output

Positive

Girma and Gong

1999–2002 TFP

Share of output

No effect

(2008)

Xu and Sheng (2012) 2000–2003 TFP
FDI = foreign direct investment, PRC = People’s Republic of China, TFP = total factor productivity.

Share of output

Mixed

The presence of foreign multinational firms is believed to benefit the host
country through access to advanced technologies, some of which might be absorbed
by domestic firms. Local firms might, por ejemplo, imitate foreign firms’ techniques,
either by reverse engineering or by hiring away some of their employees. Estos
types of externalities or spillovers are present within industries. There might also be
backward spillovers to suppliers and forward spillovers to customers. The former
occurs if, por ejemplo, foreign firms help suppliers to improve upon their products,
the latter if domestic firms benefit from better inputs.

The issue of spillovers from FDI has been extensively debated and examined
since the influential article by Caves (1974). The increased availability of firm-level
databases in recent years has led to new waves of studies. A few generalizations from
the large literature can be made. Primero, some of the previously large spillover effects
found in earlier papers using industry-level data were probably exaggerated. Más
recent papers on firm- and plant-level data tend to find smaller effects (G¨org and
Strobl 2001). Segundo, the results on within-industry spillovers are mixed, y ahí
are more uniform findings of positive spillovers to local suppliers and customers.
Finalmente, the extent of spillovers differs between countries and industries and depends
on the absorptive capacity, type of FDI, and degree of competition in the local
economía (Lipsey and Sj¨oholm 2005).

These generalizations seem to hold also for the PRC. Mesa 1 lists reviewed
and published studies on spillovers from FDI in the PRC using firm-level data.4 Most
studies find some sort of spillover in the PRC, more often to local firms in linkage

4There are also a large number of spillover studies on the PRC using industry-level data (p.ej., Buckley, Clegg,
and Wang 2002) and regional data (p.ej., Madariaga and Poncet 2007). Most of these studies tend to find positive
spillovers from FDI.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 57

industries rather than within industries. Por ejemplo, Du, harrison, and Jefferson
(2012) examine spillovers in a long panel of Chinese firms and find little evidence
of spillovers within the industries of investment but strong evidence for spillovers
to both supplying industries and customer industries. Similar results are found in
Liu (2008) who finds evidence of both intra-industry and interindustry spillovers
but concludes that backward linkages seems to be the strongest ones.

The paper by Xu and Sheng (2012) differs from the studies above and finds
positive spillovers from regional presence of multinational firms within the industry
but negative effects of regional presence in backward and forward industries. Él
seems plausible that geographic proximity could enhance intra-industry spillovers
but it is more difficult to understand why the presence of foreign multinational
firms should hurt local firms in the same region in neighboring industries. Accord-
ingly, Wei and Liu (2006) find evidence of positive intra-industry and interindustry
spillovers at the regional level but negative ones at a national level. Por eso, su
results suggest that local firms benefit from foreign firms in the same region but are
hurt by foreign firms in other regions, irrespective of which industries the foreign
firms are located in. The contrasting effects might be caused by a different balance
between competition effects and spillover effects from FDI within and between
regiones.

As found in studies on other countries, it seems that spillovers to local Chinese
firms are not automatic but affected by various factors. Por ejemplo, absorptive
capacity seems important. Girma and Gong (2008) examine spillovers to state-owned
Chinese enterprises. The authors find little evidence of spillovers and attribute this
to a low level of absorptive capacity.

Other studies focus on the role of geographic proximity in spillovers, an issue
already touched upon above, and on how spillovers from different types of multina-
tional firms differ. The latter issue is often analyzed in the context of spillovers from
FDI from Hong Kong, Porcelana; Taipéi,Porcelana; and Macau, Porcelana (often referred to as
South–South FDI) versus FDI from other countries (often referred to as North–North
FDI). Most studies find spillovers to be higher from North FDI than from South
FDI.

Por ejemplo, Du, harrison, and Jefferson (2012) argue that the lack of
spillovers from FDI from Hong Kong, Porcelana; Taipéi,Porcelana; and Macau, Porcelana
in their study suggests that much of the flows may really be round-tripping capital
rather than FDI. An additional finding is that FDI in firms benefiting from tax incen-
tives to investing firms “generates greater productivity spillovers than unsubsidized
firms” (Du, harrison, and Jefferson 2012, pag. 28).

Another paper on the PRC based on 4 years of census data and which uses the
distinction between FDI from Hong Kong, China and Taipei,China and FDI from
all other locations finds evidence of smaller spillovers from the South–South FDI
(Xu and Sheng 2012).

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58 ASIAN DEVELOPMENT REVIEW

Abrahán, Konings, and Slootmaekers (2010) also compare spillovers in
the PRC from North–South FDI with those from South–South FDI. They define
South–South FDI as FDI from Hong Kong, Porcelana; Macau, Porcelana; and Taipei,Porcelana
(or HMT) plus FDI from tax havens, which they include following the suggestion of
Naughton (2007, pag. 164) who states that FDI from tax havens are generally “diverted
investment from HMT or [the People’s Republic of] China itself for tax evasion.”
Spillovers from HMT and non-HMT FDI are both positive and statistically signif-
icant, but those from HMT are larger though not significantly so. Sin embargo, FDI
from HMT is negatively related to the productivity of domestic exporters and firms
located in special economic zones (SEZs).

Girma and Gong (2008) find distance to be a factor in spillovers, en esto
caso, spillovers from FDI to SOEs. One result they describe as “robust” across all
specifications is that there is “no evidence of productivity spillovers. . .outside the
region FDI takes place” (Girma and Gong 2008, pag. 735–736). SOEs also appear to
lose from the presence of “ethnic Chinese” FDI (South–South FDI) in downstream
sectors in their regions.

Wei and Liu (2006, pag. 553), using similar industry data and definitions of
sources of FDI in the PRC, conclude that FDI from Organisation for Economic
Co-operation and Development (OECD) countries has “played a much greater pos-
itive role in inter-industry productivity spillovers to indigenous Chinese firms” than
FDI from Hong Kong, Porcelana; Macau, Porcelana; and Taipei,Porcelana, adding that “FDI
from these two different sources has played a similar role in terms of magnitude
in intra-industry productivity spillovers within regions.” They suggest that the con-
tributions of FDI from the two sources to Chinese firms’ productivity may be of a
different nature (Wei and Liu 2006, pag. 553). Específicamente, technologies transferred
or diffused by HMT firms (South–South FDI) may be more compatible with (el
mainland’s) current resource endowments. Authors also state that “Foreign-invested
firms from OECD countries have higher technological capabilities, and their produc-
tivity spillovers may concentrate on the enhancement of technological knowledge
and competence in indigenous Chinese firms, and this is very important for (el
PRC’s) move to a higher development stage.”

A few conclusions can be made from the literature surveyed above. Primero,
most studies find evidence of some type of spillover from FDI in relation to the
PRC. Segundo, the studies differ quite substantially on exactly what type of spillovers
they find and on firm and industry characteristics that affect the degree of spillover.
There are results pointing to both interindustry and intra-industry spillovers in the
PRC, but with more evidence of the former. Además, there seems to be a clear
geographic component with FDI benefiting local firms primarily within the same
región. Absorptive capacity seems to be important and may explain why SOEs do
not appear to benefit from spillovers. Finalmente, the results from previous studies seem
to indicate less spillovers from FDI coming from Hong Kong, Porcelana; Taipéi,Porcelana;
and Macau, China than from FDI coming from other countries.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 59

IV. Econometric Models

A.

The Effect of FDI on Market Structure

We use a two-step econometric approach. Primero, we investigate the impact of
FDI on the market structure. We follow a standard approach and use the price cost
margin (PCM) as a measure of competition. This is defined as:5

PCM = Value added − payroll

Value added

(1)

A high value on PCM means a large markup and presumably a low level
of competition. Our measure of FDI penetration is calculated as the share of sales
by foreign firms in total sales in the domestic market at the 4-digit industry level.
Exports by foreign firms are excluded from the sales figures, since these do not
impose competitive pressure on the Chinese market.

The baseline econometric model is specified as:

PCM jt = α + FDIi,t−n + δFirm jt + ρ Hi,t−n + ωDOWNERw + λ1DTt

+ λ2DINDi + λ3 DRe gionr + ε jt

(2)

dónde

PCM jt is the price cost margin of firm j at time t;
FDIi,t−n indicates the presence of FDI in industry i at time t at the 4-digit

industry level, where n is the number of lags;

Firm jt represents a vector of firm-level control variables such as capital

intensidad, market share, export intensity, and relative TFP;

Hi,t−n is the Herfindahl index in industry i as a proxy for industrial concen-

tration at the 4-digit industry level; y

DOWNERw represents a vector of ownership dummy variables.
DT, DIND, and DRegion denote year dummy variables, industry dummy
variables at the 4-digit level, and region dummy variables at the 2-digit level (31
geographic units).

In the above specification, FDI and the Herfindahl index are two industry-
level variables that measure the effect of market structure on the PCM. The key
hypothesis is that high concentration raises market power and, hence, aumenta
PCM. Además, FDI may have a negative or positive effect on competition in the

5The approach makes the restrictive assumption of constant returns to scale. Konings, Van Cayseele, y
Warzynski (2005) apply an alternative methodology developed by Roeger (1995). The need to impose the constraint
that markup (alternative expression of PCM) is the same for all firms within the same industry makes this methodology
less suitable when firms are as heterogeneous as in the PRC.

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60 ASIAN DEVELOPMENT REVIEW

same industry. We do not examine if FDI affect downstream and upstream local
firms.

In examining the effect of competition on the PCM, it is also important to
control for efficiency effects. A high PCM does not necessarily only reflect low
competition in the market, but may also be associated with higher efficiency in
the firm. To control for such efficiency effects, we include a firm’s TFP relative to
average TFP in the industry.

Además, a firm’s domestic market share and export intensity might also
pick up the efficiency aspect. Market share may also capture firm-specific market
fuerza. Following previous empirical studies by Scherer and Ross (1990) and Roberts
and Tybout (1997), we specify a nonlinear relationship between domestic market
share and PCM and add a quadratic term of market share. The effect of export share
on PCM depends on the relative price elasticity of demand for the firm’s product in
the home market and abroad.

B.

The Effect of Competition and FDI on R&D Intensity

In the second step, we examine the effect of competition on R&D intensity

at the firm level and estimate the following model:

RDINT jt = α + RDINT j,t−n + PCM j,t−n + FDIi,t−n + δFirm jt + ωDOWNERw

+ λ1DTt + λ2DINDi + λ3 DRe gionr + ε jt

(3)

dónde

RDINT jt is the ratio of R&D expenditures to sales of firm j at time t; y
Firm jt denotes a vector of firm-level control variables such as the share of
science and technology personnel in total employment, export share, and firm size.
An important methodological issue when estimating this type of model is
the treatment of persistence in firms’ R&D investment behavior. We include lagged
R&D intensity to deal with this aspect, which means that we estimate a dynamic
modelo. Sin embargo, one econometric problem in estimating a dynamic model is that
OLS estimates are likely to suffer from a “dynamic panel bias.” Therefore, we fol-
low standard approaches and use system generalized method of moments (GMM)
estimates developed by Arellano and Bover (1995) and Blundell and Bond (1998)
which imply that RDINT and any other potentially endogenous variables are in-
strumented. The system first uses differenced and level versions of the estimating
equation, where lagged values in the former and lagged differences in the latter can
serve as valid instruments. The differentiated transformed instruments are assumed
to be uncorrelated with unobserved fixed effects, implying that first differentiated
variables can act as instruments for variables in levels, es decir., instrumenting levels with
diferencias.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 61

We use the Sargan/Hansen test to evaluate the instruments and the Arellano

and Bond (1991) test for autocorrelation in the idiosyncratic disturbance term eit.

V. Data and Descriptive Statistics

A.

Datos

Our data on large- and medium-sized manufacturing enterprises (LMEs) son
compiled annually by the National Bureau of Statistics of China (NBS) and cover
the period 1998–2004. All firms classified as LMEs are included making it a census
rather than a survey.6 The classification of LMEs follows the NBS’s classification
de 2000. In this classification, employment, turnover, and fixed capital are applied
as a combined indicator of firm size (see Table A2 in the appendix).7 The sample of
firms is unbalanced—there are almost 16,000 firms included in 1998 and more than
24,000 en 2004. These firms constitute roughly a third of total industrial sales and
about a fourth of total industrial employment. One source of potential bias is that
firms that shrink in size may exit our sample. En otras palabras, R&D in weak firms
(shrinking in size) might be differently affected by foreign entry. This calls for some
caution in interpreting the results.

The NBS collects information on a large number of firm characteristics such
as sales, employment, labor cost, materiales, fixed assets, export, and ownership. El
information on LMEs’ R&D activities includes R&D expenditures and the number of
employees involved in science and technology. R&D figures are sometimes claimed
to be exaggerated in the PRC, partly as a consequence of tax breaks for R&D, pero
also because of policies mandating annual R&D targets for firms. Desafortunadamente, nosotros
are not in a position to evaluate how serious this possible exaggeration could be and
if it biases our results. What we can say from other studies is that R&D seems to
be highly correlated with other R&D indicators such as sales of new products and
patents (p.ej., Sj¨oholm and Lundin 2010a), suggesting that it is a reasonable indicator
of innovative activities at the firm level.

The industry classification is similar to the classification ISIC, Rev. 3. El
included sectors at the 2-digit industry level can be found in Table 3. In our econo-
metric analysis, we construct industry-level variables such as industry concentration
and FDI penetration at the 4-digit industry level in order to have industrial control
variables that are as disaggregated as possible.

Finalmente, the effect of FDI on competition and R&D might differ for firms
with different kinds of ownership. Por lo tanto, we divide our dataset into domestic

6See Jefferson et al. (2003) for a detailed description of the same data.
7To compare market structure over time, we have reclassified the firms in 1998–1999 according to the new
classification. This explains why the number of firms can differ from the officially published sources where the
classification of firm size is not the same for the period prior to and after 2000.

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62 ASIAN DEVELOPMENT REVIEW

Mesa 2. Number of Foreign Firms and Foreign Share of Chinese Manufacturing,
1998–2004 (share of total manufacturing)

Año

Número de
Foreign Firms

Firms

Value-added

R&D
Expenditure

Export

Employment

3,489
3,764
4,221
4,585
5,327
6,512
8,745

1998
1999
2000
2001
2002
2003
2004
R&D = research and development.
Fuente: Authors’ calculations on Chinese firm data.

0.22
0.23
0.25
0.27
0.29
0.31
0.36

0.26
0.28
0.30
0.31
0.33
0.36
0.40

0.21
0.23
0.20
0.23
0.23
0.25
0.29

0.58
0.61
0.63
0.66
0.68
0.71
0.76

0.14
0.16
0.18
0.20
0.23
0.27
0.34

and foreign subsamples according to the classification given by Table A3 in the
appendix.

B.

Estadísticas descriptivas

The share of foreign firms in our data on Chinese manufacturing between
1998 y 2004 is seen in Table 2.8 Foreign firms include wholly foreign-owned
firms and joint ventures between foreign and domestic firms.9 Foreign ownership
has increased substantially in relative as well as absolute terms. Por ejemplo, el
number of foreign-owned firms increased by 150% over the period—from 3,489
en 1998 a 8,745 en 2004. This increase was higher than in domestically owned
firms, with the foreign share of LMEs rising from about 22% a 36%. El otro
variables show a similar pattern of rapid increases. Foreign-owned firms account for
about one-third of employment, 40% of value-added, and a staggering 76% of total
exports.

Turning our attention to the focus of this paper, R&D, it is interesting to note
that foreign share is relatively small. Foreign share of R&D expenditures was 21%
en 1998, which was larger than the foreign share of employment and about the same
as the foreign share of LMEs. Sin embargo, this increased to only about 29% en 2004,
or lower than the foreign share of any other economic indicator in Table 2. Uno
conclusion that can be drawn from the figures is that even if the PRC has become
increasingly attractive as a location of foreign firms’ R&D, as suggested for instance
by UNCTAD (2005), this trend has grown more slowly than the increase in foreign
firms’ production, employment, and export.

8The share of foreign firms in total Chinese manufacturing is likely to be lower since domestic firms dominate

among the non-included small firms.

9Por eso, firms with any foreign ownership share are classified as foreign. Changing the threshold of foreign
ownership that is required for a firm to be classified as foreign does not have any major impact on the econometric
resultados.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 63

Mesa 3. Foreign Firms, Price Cost Margins, y r&D Intensities across 2-digit Level
Industries, 2004

Número de
Firms

Share of Foreign
Firms (%)

PCM (%)

R&D
Intensity (%)

FDI Domestic VA

R&D

FDI Domestic FDI Domestic

13 Processing food from
agricultura

252

14 Production, Procesando

214

654

361

351
1673
353
158
123

80

432
185
80

340

1443
593

191
776
483
376
79

184

180
110
257

27

221
158

58

165

173
454
322

114
98
331
383
215

437
795

1445

221

186

187
268
1482

813
460
475
1265
742

1231
965

488

169

154

of food
15 Beverage
17 Textiles
18 Wearing apparels
19 Leather, footwear
20 Wood, timber, bamboo

products
21 Manufacture of
furniture

22 Pulp and paper
23 Publishing, print
24 Musical instruments,
sport goods
25 Refined petroleum
products
26 Basic chemicals
27 Pharmaceuticals,

medicinal chemistry

28 Manufacture of
chemical fiber
29 Rubber products
30 Plastics products
31 Non-metallic mineral

products

32 Ferrous metals
33 Non-ferrous metals
34 Metal product
35 Machinery, general
36 Machinery, special
purpose

37 Transport equipment
39 Electrical machinery
and apparatus

40 Computadora,

comunicación
41 Office machinery,

measuring instrument

42 Manufacture n. mi. C.

Fuente: Authors’ calculations.

38

43

39
28
45
67
33

82

43
46
69

9

21
23

31

46
55
23

11
16
50
34
24

46
43

86

82

45

8

29

43
32
15
50
11

82

38
37
54

7

15
22

18

23
28
26

4
25
21
24
13

32
23

49

42

07

11.3

15.4

0.09

0.22

15.6

13.2

0.15

0.40

19.9
10.6
9.6
9.4
9.0

17.0
8.1
11.0
11.4
14.5

0.25
0.32
0.09
0.11
0.21

0.37
0.36
0.17
0.23
0.37

11.1

10.5

0.15

0.28

12.3
17.7
9.0

11.5
16.2
8.0

0.23
0.21
0.19

0.26
0.21
0.66

16.4

15.9

0.08

0.16

12.0
14.8

12.3
10.9

0.67
1.44

0.77
1.34

8.1

8.5

0.21

0.63

10.0
11.6
14.3

15.7
11.4
15.4
14.1
15.6

13.1
11.0

11.9
14.5
13.1

12.4
11.3
12.1
8.2
7.3

8.0
10.8

0.20
0.27
0.50

0.41
0.82
0.15
0.67
0.60

0.70
0.47

0.69
0.59
0.35

0.24
0.56
0.54
1.29
1.43

1.30
1.17

11.9

13.5

0.60

2.93

12.1

10.3

0.84

2.85

11.6

4.6

0.09

1.47

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We continue by looking at the foreign share of different sectors. Mesa 3
shows that the number of foreign firms is highest in electronic products (sectors
39–41) and textiles, clothes, and shoes (17–19). In relative terms, FDI is of great
importance in many industries and of particularly high importance in footwear,

64 ASIAN DEVELOPMENT REVIEW

furniture, sporting goods, computers, and office machines, where more than two-
thirds of the value added come from foreign-owned firms. Once more, the foreign
share of R&D expenditures tends to be lower than the shares of other economic
indicators. Por ejemplo, the foreign share of R&D expenditures is 50% or above in
only three sectors (leather and footwear, furniture, musical instruments and sporting
goods) and the foreign share of R&D is lower than the foreign share of value added
in all but four industries (beverage, textiles, non-metallic mineral products, y
non-ferrous metals).

The PCM is higher in foreign firms than in domestic firms in about two-
thirds of the industries. There seem to be important sector-specific effects in PCMs
as foreign and domestic firms show a similar pattern across sectors. Por ejemplo,
PCMs are particularly high in food, beverage, petroleum, metals, and machinery
and low in clothing, footwear, wood products, and some chemical industries. Para
domestic firms, the PCM is also relatively high in publishing and plastics and low in
various machinery sectors. More importantly, there is no obvious relation between
the share of foreign firms in a sector and the PCMs in domestic firms—PCMs are
relatively high in some sectors with low foreign presence such as ferrous metals and
petroleum products, but also high in some sectors with high foreign presence such
as plastics and computers.

Finalmente, R&D intensities are relatively high in pharmaceuticals, machinery,
transport equipment, electronics, computers, and office machinery, but there is a
large difference between foreign and domestic firms. R&D intensity is higher in
foreign firms than in domestic ones in only three sectors: non-metallic mineral
products, ferrous metals, and non-ferrous metals. It is difficult to detect a direct
relationship between PCM and R&D intensity. Domestic firms conduct relatively
large shares of R&D in some sectors with high PCMs such as computers and in
some sectors with low PCMs such as machinery. Respectivamente, there is no obvious
relation seen in Table 2 between FDI share and R&D intensity in domestic firms.

VI. Resultados

A.

The Effect of FDI on Price Cost Margins

We start by estimating the effect of FDI on the PCM using the complete
sample of firms with results shown in Table 4. A number of different estimators
are used: OLS with and without industry and regional dummies and a fixed-effect
estimator. It should be noted that the relatively short time period together with lagged
dependent variables makes the fixed-effect estimations relatively weak but including
them gives us a sense of the robustness of the results.10 Moreover, there are obvious

10We also tried to estimate random effect models but they did not pass the Hausman specification test and

were therefore not included.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 65

Mesa 4. Determinants of Price Cost Margins at the Firm Level, 1998–2004 (full sample,
doméstico, and foreign firms)

OLS (1)
−0,002
(0.016)
−0.027∗
(0.015)
4.365∗∗∗
(1.562)
–

FE (3)
OLS (2)
0.002
−0,001
(0.009)
(0.008)
−0.031∗∗∗ −0.023∗∗
(0.009)
(0.009)
2.239∗
2.585∗
(1.352)
(1.486)
–
–

FE (6)
0.001
(0.010)

OLS (5)
OLS (4)
−0,002
−0,000
(0.022)
(0.011)
−0.037∗∗ −0.038∗∗∗ −0.032∗∗∗
(0.010)
(0.018)
1.727
3.068
(2.035)
(3.099)
0.009
0.003
(0.037)
(0.070)

(0.010)
1.622
(1.782)
0.009
(0.032)

–

–

–

0.055
(0.041)

0.035
(0.022)

0.048∗
(0.027)

−0.192∗∗ −0.275∗∗∗ −0.111∗∗∗
(0.038)
(0.047)
(0.067)
0.001∗∗
0.003∗∗∗
0.002∗∗
(0.0005)
(0.0008)
(0.0008)
3.187∗∗∗
3.244∗∗∗
2.946∗∗∗
(0.195)
(0.234)
(0.544)
0.220∗∗∗
0.208∗∗∗
0.196∗∗∗
(0.013)
(0.004)
(0.015)
−0.022∗∗∗ −0.017∗∗∗ −0.002
(0.007)
(0.005)
(0.005)
−1.050∗∗
–
–
(0.359)
−0.880∗∗
(0.331)
−1.691∗∗∗
(0.418)

–

–

–

–

−0.192∗∗ −0.276∗∗∗ −0.110∗∗
(0.038)
(0.050)
(0.064)
0.001∗∗∗
0.003∗∗∗
0.002∗∗
(0.0005)
(0.0008)
(0.0008)
3.189∗∗∗
3.243∗∗∗
2.947∗∗∗
(0.195)
(0.234)
(0.539)
0.220∗∗∗
0.208∗∗∗
0.197∗∗∗
(0.013)
(0.004)
(0.011)
−0.022∗∗∗ −0.017∗∗∗ −0.002
(0.007)
(0.005)
(0.005)
–1.051∗∗
–
–
(0.359)
–0.880∗∗
(0.330)
–1.689∗∗∗
(0.418)

–
–

–

–

Variables

FDI penetration
(con 1 lag)
FDI penetration
(con 2 lags)
Herfindahl index
(con 1 lag)
FDI penetration ×
Herfindahl index
(con 1 lag)

FDI penetration ×
Herfindahl index
(con 2 lags)

Market share

Market share ×
market share
Capital–labor ratio

Relative TFP

Export intensity

Ownership dummy

(Private)

Ownership dummy

(JV–HTM)

Ownership dummy
(JV foreign and
Foreign)
Year dummies
Industry dummies
Regional dummies

R2

Sí
No
No
0.20

Sí
Sí
Sí
0.33

Sí
No
No
0.20

Sí
Sí
Sí
0.33

Sí
–
–

Within: 0.23
Between: 0.19
En general 0.20
23,123

Sí
–
–

Within: 0.23
Between: 0.19
En general 0.20
23,123

Observaciones
∗∗∗= significant at 1% nivel, ∗∗= significant at 5% nivel, ∗= significant at 10% nivel, HTM = Hong Kong, Porcelana;

23,123

23,123

23,123

23,123

Taipéi,Porcelana; Macau, Porcelana, JV = joint venture.

Nota: Standard errors in parentheses are adjusted both for heteroskedasticity and potential dependency among firms

in the same industry at the 4-digit level.

Fuente: Authors’ computations.

instances of omitted variables and simultaneity biases. We try to control for these
aspects but the results should be interpreted with caution and be seen as correlations
rather than causations.

Our first estimation shows that FDI has a negative impact on the PCM, pero
there is a time lag before the competition from FDI exhibits an effect (Mesa 4). Lag 1

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66 ASIAN DEVELOPMENT REVIEW

of FDI is statistically insignificant but lag 2 is significant. Excluding lag 1 of FDI
did not change the results for lag 2, while including lag 2 of the Herfindahl index
rather than lag 1 did not change its significance (not shown). Además, the PCM is
high in concentrated markets. The results seem stable across different estimations
(columnas 2 y 3).

Turning to the other variables, results show that capital-intensive firms with
high levels of TFP have high PCMs and that, surprisingly, firms with large market
shares and export intensities have low PCMs.11 Significant and negative coefficients
of ownership dummy variables in columns (2) y (4) comprise another interesting
outcome. This suggests that, compared to the reference group of SOEs and collective
firms, both domestic private firms and foreign-owned firms have low PCMs. Este
can be due to both market-related and institutional effects. Como ejemplo, SOEs
often obtain subsidies in terms of, por ejemplo, access to capital at below market
interest rates, which might explain the relatively high PCMs.

The above estimations on the effect of FDI on PCMs are rather conservative
considering that we control for market shares and industry concentration. Estos
variables are likely to be endogenous to FDI and we therefore run the risk of
underestimating the impact of FDI on competition. Excluding the market share
and Herfindahl index increased the coefficient on FDI marginally (not shown).
Respectivamente, experimenting with different subsets of control variables had no major
impact on the results.

To further examine the robustness of the results, and whether the effect of FDI
on the PCM depends on the degree of market concentration, we insert an interaction
term of FDI and the Herfindahl index. As shown in columns 4–6, the negative effect
of FDI on PCMs remains robust and a significant interaction effect can only be
observed in the fixed-effect estimation where the competitive effect imposed by FDI
seems to be weaker in industries with high concentration.

Our main interest is to examine how FDI affects the competition for do-
mestically owned firms. Por lo tanto, we repeat the estimations above but exclude
foreign-owned firms and joint ventures. Los resultados se muestran en la tabla. 5.12 El
estimations yield fairly similar results, but with two differences if compared to
the full sample estimations in Table 4. Primero, the negative effect of export intensi-
ties on the PCM disappears. Segundo, domestic firms in concentrated industries do
not have comparably high PCMs. The results are again robust to the inclusion of
interaction variables as seen in columns 4–6 and to changes in the lag structure (no
mostrado).

11We also used labor productivity as an alternative productivity measure. Firms with high labor productivity

were found to have high PCM, while the results for the other included variables remained unchanged (not shown).

12The estimations include SOEs, collective firms, and private firms. Shareholding firms and “other firms” are
not clearly defined (es decir., can include foreign ownership) and have therefore been excluded. As an additional robustness
check, they were included in the domestic subsample but this had little impact on the results (not shown).

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 67

Mesa 5. Determinants of Price Cost Margins at the Firm Level, 1998–2004
(domestic firms)

Variables

FDI penetration
(con 1 lag)
FDI penetration
(con 2 lags)
Herfindahl index
(con 1 lag)
FDI penetration ×
Herfindahl index
(con 1 lag)
FDI penetration ×
Herfindahl index
(con 2 lags)

Market share

Market share ×
Market share
Capital–labor ratio

Relative TFP

Export intensity

Ownership dummy

(Private)
Year dummies
Industry dummies
Regional dummies
R2

OLS
(1)
−0,010
(0.030)
−0.037
(0.024)
6.386∗∗
(2.760)
–

OLS
(2)
−0,017
(0.010)
−0.033∗∗
(0.014)
1.138
(2.846)
–

FE (3)
−0.019
(0.015)
−0,013
(0.016)
3.288
(2.487)
–

–

–

–

OLS
OLS
(5)
(4)
−0.019
−0,004
(0.020)
(0.042)
−0.073∗∗ −0.042∗∗
(0.022)
(0.036)
0.248
2.752
(3.431)
(4.431)
0.021
0.023
(0.086)
(0.167)

0.309
(0.200)

0.078
(0.139)

FE (6)
−0.024
(0.020)
−0.038∗
(0.021)
2.481
(2.693)
0.020
(0.080)

0.176∗
(0.094)

−0.202∗∗ −0.248∗∗∗ −0.157∗∗
(0.055)
(0.058)
(0.091)
0.002∗∗
0.003∗∗∗
0.002∗∗
(0.0007)
(0.0008)
(0.0010)
3.281∗∗∗
3.189∗∗∗
3.805∗∗∗
(0.287)
(0.439)
(1.186)
0.196∗∗∗
0.182∗∗∗
0.179∗∗∗
(0.005)
(0.014)
(0.021)
−0.014∗
0.015
0.000
(0.015)
(0.011)
(0.010)
−0.421
–
–
(0.372)
Sí
Sí
Sí
0.35

Sí
No
No
0.16

Sí
–
–
Within: 0.17
Between: 0.14
En general 0.15
12,891

−0.220∗∗ −0.250∗∗∗ −0.158∗∗
(0.055)
(0.059)
(0.099)
0.002∗∗
0.003∗∗
0.003∗∗
(0.0007)
(0.0008)
(0.001)
3.274∗∗∗
3.190∗∗∗
3.803∗∗∗
(0.288)
(0.439)
(1.170)
0.196∗∗∗
0.182∗∗∗
0.179∗∗∗
(0.005)
(0.014)
(0.021)
0.015
0.000
−0.014
(0.015)
(0.010)
(0.010)
−0.425
–
(0.373)
Sí
Sí
Sí
0.35

Sí
No
No
0.16

Sí
–
–
Within: 0.17
Between: 0.14
En general 0.16
12,891

Observaciones
12,891
∗∗∗= significant at 1% nivel, ∗∗= significant at 5% nivel, ∗= significant at 10% nivel.
Nota: Standard errors in parentheses are adjusted both for heteroskedasticity and potential dependency among firms

12,891

12,891

12,891

in the same industry at the 4-digit level.

Fuente: Authors’ computations.

The proper definition of a market in a large country like the PRC can be
discussed. Our definition assumes the competitive effect of FDI to be the same
throughout the country. This might be questionable hence we also constructed
FDI penetration variables as the foreign share of a region–industry (region being
defined as east, west, or central). The overall results remained unchanged, pero el
FDI coefficient was slightly larger suggesting the competitive effect of FDI to be
strongest within the same region.

We also experimented with alternative estimation methods. Por ejemplo, nosotros
tried to specify a dynamic model with lagged PCMs as the independent variable.

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68 ASIAN DEVELOPMENT REVIEW

Mesa 6. Determinants of R&D Intensity at the Firm Level, 1998–2004
(GMM estimations)

Variables

R&D intensity
(con 1 lag)

PCM

(con 1 lag)
PCM × PCM
(con 1 lag)
FDI penetration
(con 1 lag)

Skill share

Export intensity

Firm size

Ownership dummy

(Private)

Ownership dummy

(JV-HTM)

Ownership dummy
(JV foreign &
Foreign)
Year dummies
Industry dummies
Regional dummies

Domestic
Firms
0.289∗∗∗
(0.039)
0.003
(0.005)
0.000
(0.000)
−0,003
(0.003)
0.069∗∗∗
(0.013)
0.002
(0.002)

All Firms
0.273∗∗∗
(0.034)
0.003
(0.004)
0.0000
(0.0001)
0.001
(0.001)
0.069∗∗∗
(0.011)
0.0000
(0.001)
−0.156∗∗∗ −0.177∗∗∗
(0.054)
−0.149∗∗∗
(0.038)
−0.103∗
(0.061)
−0.053
(0.062)

(0.067)
−0.124∗∗
(0.051)
–

–

Sí
No
No

Sí
No
No

FDI Firms
0.204∗∗∗
(0.038)
0.003
(0.004)
0.000
(0.000)
0.001
(0.001)
0.070∗∗∗
(0.008)
−0,001
(0.001)
−0.118∗∗
(0.061)
–

–

0.057∗∗
(0.029)

Sí
No
No

High-tech
Firms
0.387∗∗∗
(0.064)
0.027∗∗
(0.012)
−0.0004∗∗
(0.0002)
−0,001
(0.004)
0.090∗∗∗
(0.019)
−0,002
(0.003)
−0.174
(0.135)
−0.358∗
(0.215)
−0.121
(0.263)
0.023
(0.277)

Sí
No
No

Non high-tech
Firms
0.225∗∗∗
(0.033)
−0,004
(0.003)
0.000
(0.000)
0.002
(0.001)
0.062∗∗∗
(0.012)
0.001
(0.001)
−0.114∗∗
(0.054)
−0.124∗∗∗
(0.033)
−0.152∗∗∗
(0.058)
−0.125∗∗∗
(0.057)

Sí
No
No

R2
AR (2)
Hansen test
Observaciones
Nota: ∗∗∗= significant at 1% nivel, ∗∗= significant at 5% nivel, ∗= significant at 10% nivel, HTM = Hong Kong,

–
0.212
0.475
39,687

–
0.971
0.428
22,942

–
0.282
0.668
34,701

–
0.144
0.835
16,745

–
0.261
0.719
4,986

Porcelana; Taipéi,Porcelana; Macau, Porcelana, JV = joint venture.

Fuente: Authors’ computations.

Sin embargo, although the estimations confirmed previous results on PCMs and R&D,
the models failed to pass the Sargan/Hansen specification tests and are therefore not
mostrado.

To sum up the results so far, it has been shown that FDI imposes significant
competitive pressure on Chinese firms. The result is robust to different estimators
and various industry- and firm-level controls as well as to different subsamples. Nosotros
now continue to examine if this increased competition has an effect on investments
in R&D.

B.

The Effect of Price Cost Margins on R&D Intensities

Results from the GMM estimations are shown in Table 6. Most results are

stable across different models and samples.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 69

The results show no strong signs of an effect of competition on R&D. El
PCM coefficient is statistically insignificant in the different samples: all firms, solo
domestic firms, only foreign firms, and non-high-tech firms. The one possible ex-
ception to a non-significant effect of competition can be seen in high-tech industries
where high competition (low PCM) has a negative effect on R&D.13 We also in-
cluded an FDI variable, which is expected to capture the effect of FDI on R&D after
controlling for the indirect effect on competition. Such an effect could be through
demonstration effects or technology spillovers. The results consistently show that
no such effect seems to exist in Chinese manufacturing.

The coefficients of lagged R&D intensity are positive and highly significant,
indicating persistence in R&D and justifying inclusion of the lag.14 We also ob-
serve a significant and positive effect of skills share but a significant and negative
effect of firm size on R&D intensity.15 These results are robust across the different
especificaciones. Finalmente, private domestic and foreign firms seem to have lower R&D
intensities than SOEs after controlling for various firm characteristics.

We tried to estimate specifications with the same control variables as in
the PCM estimations. Excluding skills share and replacing firm size with market
share had no impact on the results (not shown). Además, estimations including
TFP unfortunately did not pass the specifications tests. As an alternative robustness
check, we estimated a fixed-effect model but the results did not change (not shown).
Además, a relatively large proportion of the firms do not engage in R&D at all. Él
might be that such firms are located in small segments of industries where they are
not significantly affected by foreign firms or the industry level of competition. Nosotros
examined this issue by including only those firms that have positive R&D spending
in at least one year of their existence. Once more, the results remained unchanged
(not shown). Por eso, we conclude by noting that the effect of firms’ PCMs on R&D
intensities seems to be insignificant with the result appearing robust across samples
and estimation methods.

VII. Concluding Remarks

FDI can be an important channel for developing countries to gain access to
new technology. The impact of FDI on the technology development of domestically
owned firms is less examined, but it is frequently argued that technology externalities
or a demonstration effect could have a positive impact. Another little examined effect

13We follow OECD (2006) and define high-tech as including pharmaceuticals; aircraft and spacecraft; radio,
television, and communication equipment; office, accounting, and computing machinery; and medical, precisión, y
optical instruments.

14We also estimated the model by including a 2-year lag of R&D intensity. The coefficients on the second lag

turned out to be insignificant, and those on the first lag remained significant (not shown).
15Jefferson et al. (2006) find a similar effect of firm size on R&D intensity.

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70 ASIAN DEVELOPMENT REVIEW

of FDI on technology development in domestically owned firms works through the
impact on competition. FDI might affect the degree of competition in the market
which in turn may affect efforts to upgrade technology in domestic firms.

We have surveyed the literature on FDI and spillovers in the PRC. It seems
that the spillovers are relatively large for suppliers and customers, for firms within
the same region as the foreign firms, and from FDI coming from OECD countries.
The studies on spillovers focus on the effect on productivity (labor or TFP) in local
firms. It can be argued that this is only an indirect measure on technology and not
the primary concern of the Chinese government. We therefore center our analysis
on the impact of FDI on R&D in Chinese firms.

Our hypothesis was that FDI could positively or negatively affect R&D
through an impact on the degree of competition. We find a strong and robust negative
effect of FDI on PCMs of firms which suggests that FDI does increase the level
of competition in Chinese manufacturing. This result stands in some contrast to
studies on countries other than the PRC, which typically find mixed effects of FDI
on competition (p.ej., Co 2001, Chung 2001, Fu and Wu 2012).

We continue the analysis by examining determinants of R&D with a special
focus on the role of competition. The general conclusion is that we find a high degree
of persistence in R&D and little evidence of any effect of competition, negative or
positivo, on the level of R&D. The result is slightly different from Jefferson et al.
(2006) who find a positive (albeit fragile) effect of industry concentration on R&D.
Además, there is no indication of a direct effect of FDI on R&D in domestic firms,
which contrasts with the finding on FDI in Belgium by Veugelers and Vanden Houte
(1990) who estimate a negative effect. Finalmente, firms with high R&D intensities tend
to have a relatively skilled labor force and to be relatively small in size. Además,
SOEs tend to be more R&D intensive than domestic and foreign private firms.

It is clear from our analysis that many issues need more research. Por ejemplo,
the available data does not permit us to examine how small Chinese firms are
affected by FDI, or how firms in upstream and downstream industries are affected.
Respectivamente, the effect of FDI on alternative measures of technology development
such as patents or changes in the product mix awaits further research. It is also
possible that FDI might have an effect on the impact of R&D in local firms even if
the amount of R&D is not affected.16

Bearing these caveats in mind, we believe our results contribute to the ongoing
policy debate in the PRC. Más importante, there is substantial evidence of a positive
effect of FDI on productivity in local firms. Some of these productivity gains might
be caused by technology spillovers but there could also be other explanations. Hacemos
not find any positive impact of FDI on R&D in domestically owned firms. Por eso, él
seems that although FDI has contributed to productivity, it has not been an important
force for promoting R&D investment in domestic firms.

16We are grateful to an anonymous referee who highlighted these areas as suitable for future research.

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 71

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74 ASIAN DEVELOPMENT REVIEW

Apéndice

I.

Total Factor Productivity Calculation:

ln TFP ji = ln Y ji − αK i ln K ji − αl ln L jt − αMi ln M ji

where Y is real gross output, K is real capital, L represents number of employees,
and M real material use. αl is the share of wages in output and αMi is the share
of material inputs in output. αK i is calculated as one minus the shares for labor
and material inputs. We deflate output, capital, and materials by the appropriate
4-digit industry price deflator. Following Foster, Haltiwanger, and Krizan (2001),
we calculate the factor shares at the 4-digit industry level to minimize the effects of
measurement errors. We use annual weights in our calculations.

Variable

PCM
Market share
Capital intensity
Relative TFP
Export intensity
R&D intensity
Skill share
Firm size

Table A1. Variable List and Definitions

Definición

Firm-level Variables

(Value added − payroll)/Value added
Sales by firm i/Total domestic sales of industry j at the 4-digit industry level
Log(Capital stock/Total number of employees)
TFP for firm i /Average TFP in industry j at the 4-digit industry level
Export/Total sales
R&D expenditure/Total sales
Number of S&T personnel/Total number of employees
Log (Real total sales)

FDI penetration
Herfindahl index

Sales by foreign firms/Total domestic sales at the 4-digit industry level
Sum of squared firm-level (doméstico) market shares at the 4-digit industry level

Industry-level Variables

(h)

Table A2. Classification of Large, Medium, and Small Enterprises

Employment (persona)
Turnover (yuan, millón)
Fixed assets (yuan, millón)

Fuente: National Bureau of Statistics of China.

Large (1)
2000+
300+
400+

Medium (2)

300–2000
30–300
40–400

Pequeño (3)
300−
30−
40−

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FOREIGN FIRMS AND INDIGENOUS TECHNOLOGY DEVELOPMENT 75

Table A3. Ownership Classifications

Code

Ownership

110
141
151

120
130
142

171
172
173
174

Domestic Ownership: SOE

State-owned enterprises
Stated-owned, jointly operated enterprises
Wholly stated-owned enterprises

Domestic Ownership: Collective

Collective-owned enterprises
Shareholding cooperatives
Collective-owned, jointly operated enterprises

Domestic Ownership: Private

Private wholly owned enterprises
Private-cooperative enterprises
Private limited liability enterprises
Private shareholding enterprises

Foreign Ownership: Hong Kong, Porcelana; Taipéi,Porcelana; y
Macau, China Invested

210
220
230
240

310
320
340

Overseas joint ventures
Overseas cooperatives
Overseas wholly owned enterprises
Overseas shareholding limited companies

Foreign Ownership: Foreign-invested Joint Ventures

Foreign joint ventures
Foreign cooperatives
Foreign shareholding limited companies

Foreign Ownership: Foreign Invested

330

Foreign wholly owned enterprises

Fuente: National Bureau of Statistics of China.

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