FDI Spillovers at the National and Subnational Level: The Impact on Product Innovation by Chinese Firms

We investigate the degree to which the presence of inward foreign direct investments (FDI) influences product innovation by emerging market firms. We begin with FDI spillover effects at the national level, the common approach in the literature. We further examine spillover effects at the subnational level because knowledge spillovers have been found to be localized. We study both intra-industry and inter-industry FDI spillovers in a subnational location, based on the distinction in the cluster literature between Marshall–Arrow–Romer specialization externalities and Jacobian diversification externalities. Using information from more than 346,000 Chinese manufacturing firms from 2000 to 2006, we find that Chinese firms improve product innovation when they are located in cities with concentrated foreign innovative activities in the same industry. These intra-industry spillover benefits decrease quickly, however, as foreign presence increases and, at high levels of foreign concentration, are dominated by the crowding-out effect. We also find evidence of inter-industry spillover benefits in a city; diversity of industries with a foreign presence contributes to product innovation by Chinese firms.