Quid Pro Quo, Knowledge Spillovers, and Industrial Quality Upgrading: Evidence from the Chinese Auto Industry

This paper studies the impact of FDI via quid pro quo (technology for market access) in facilitating knowledge spillovers and quality upgrading. Our context is the Chinese automobile industry, where foreign automakers are required to set up joint ventures (JVs) with domestic automakers to facilitate technology transfers in return for market access. Our identification strategy exploits a unique dataset of detailed vehicle quality measures and relies on within-product variation across quality dimensions. We show that affiliated domestic automakers tend to adopt the quality strengths of their JV partners, consistent with knowledge spillovers. We rule out alternative explanations, such as endogenous JV formation, geographic proximity, overlapping customer bases, brand image association, and patent transfers. Additional analysis suggests that worker flows and supplier networks mediate knowledge spillovers. Overall, knowledge spillovers due to ownership affiliation under quid pro quo contributed 8.3% of the quality improvement experienced by affiliated domestic models between 2001 and 2014, relative to nonaffiliated domestic models.