Abstract

We investigate theoretically and empirically the impact of foreign direct investment (FDI) on the product innovation activity of Chinese firms. We extend the existing literature by examining a new type of spillover benefit, as well as new mechanisms by which knowledge spillovers occur. Theoretically, we extend the existing FDI spillover literature that mainly focuses on industry-level spillover effects on productivity by examining FDI spillovers at both firm and location levels, and their impact on product innovations. Using the knowledge-based view of firms we argue that knowledge spillover is likely to occur when foreign firms form joint ventures with local firms and/or when local firms are located in cities with concentrated foreign activities. Empirically, we utilize product innovation information for nearly 40,000 Chinese
firms in high technology industries over the period 2000-2005. We find conditional support for our theory. Specifically, we find that in locations with strong clustering of innovative foreign invested firms, local firms benefit from knowledge spillovers and are themselves more likely to introduce product innovations. However, in locations where foreign concentration is measured not by innovations, but by employment or capital local firms do not benefit from foreign knowledge spillovers. These contrasting results suggest that only when foreign invested firms conduct innovative activities can they generate positive locational spillovers. We also find conditional support for knowledge spillover through joint ventures. This spillover benefit becomes weaker if we control for the locational spillover of foreign innovations. These results suggest that relative to location, joint ventures may represent a weaker knowledge spillover mechanism. We discuss the implications of these results for firm strategy and government policy.