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Does Foreign Direct Investment Lead to Industrial Agglomeration

Author

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  • Hsu, Wen-Tai

    (School of Economics, Singapore Management University)

  • Lu, Yi

    (Tsinghua University)

  • Luo, Xuan

    (INSEAD)

  • Zhu, Lianming

    (Osaka University)

Abstract

This paper studies the effect of foreign direct investment (FDI) on industrial agglomeration. Using the differential effects of FDI deregulation in 2002 in China on different industries, we find that FDI actually affects industrial agglomeration negatively. This result is somewhat counter-intuitive, as the conventional wisdom tends to suggest that FDI attracts domestic firms to cluster for various agglomeration benefits, in particular technology spillovers. To reconcile our empirical findings and the conventional wisdom, we develop a theory of FDI and agglomeration based on two counter-veiling forces. Technology diffusion from FDI attracts domestic firms to cluster, but fiercer competition drives firms away. Which force dominates depends on the scale of the economy. When the economy is sufficiently large, FDI discourages agglomeration. We find various evidence on this competition mechanism.

Suggested Citation

  • Hsu, Wen-Tai & Lu, Yi & Luo, Xuan & Zhu, Lianming, 2018. "Does Foreign Direct Investment Lead to Industrial Agglomeration," Economics and Statistics Working Papers 16-2018, Singapore Management University, School of Economics.
    • Handle: RePEc:ris:smuesw:2018_016
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    Cited by:

    1. INADA Mitsuo, 2019. "Promotion or Liberalization: The Effect of Targeted Investment Policies on FDI Inflows," Discussion papers 19071, Research Institute of Economy, Trade and Industry (RIETI).
    2. Mitsuo Inada, 2022. "Promotion or liberalization: The effect of targeted investment policies on foreign direct investment inflows," Pacific Economic Review, Wiley Blackwell, vol. 27(5), pages 489-505, December.

    More about this item

    Keywords

    Industrial agglomeration; Ellison-Glaeser index; Competition; Foreign direct investment; Special economic zones; WTO; China;
    All these keywords.

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