Quantifying Foreign Direct Investment Productivity Spillovers in China: A Computable General Equilibrium Model

• Date: 01 December 2013
• DOI: http://doi.org/10.1111/asej.12019
• Published date: 01 December 2013
• Author: Ziliang Deng,Rod Falvey,Adam Blake

Quantifying Foreign Direct Investment

Productivity Spillovers in China:

A Computable General Equilibrium Model*

Ziliang Deng, Rod Falvey and Adam Blake

Received 27 June 2011; accepted 6 March 2013

For the purposes of this study, we will construct a static monopolistically-

competitive computable general equilibrium model to quantify the endogenous

productivity spillovers from foreign and domestic firms, using the Chinese

economy as a case study. Our simulation results indicate: (i) that the net spillover

effects are positive in terms of national total output, GDP and welfare; (ii) that both

state-owned and privately-owned firms benefit, but that private firms benefit more;

(iii) that industries with large volumes of foreign direct investment (FDI) do not

necessarily observe the largest spillover effects; and (iv) that the spillover effects

become more prominent when the initial market structure is more concentrated.

Keywords: productivity spillovers, foreign direct investment, computable general

equilibrium model.

JEL classification codes: O33, F21, C68.

doi: 10.1111/asej.12019

I. Introduction

Foreign direct investment (FDI) plays an increasingly significant role in the

global economic system, especially for the emerging economies. From the host

country’s perspective, productivity spillovers to domestic firms are arguably one

of the most important benefits of FDI, and many developing countries have

adopted preferential FDI policies, characterized as ‘swapping domestic market

access for advanced foreign technology and productivity’, in pursuit of such

spillovers (Long, 2005; Deng et al., 2011).

*Deng (corresponding author): School of Business, Renmin University of China, Haidian District,

Beijing 100872, China. Email: ziliang.deng@ruc.edu.cn. Falvey: Faculty of Business, Bond Univer-

sity, QLD 4229, Australia. Blake: School of Tourism, Bournemouth University, BH12 5BB, UK.

This research was sponsored by the Foundation of Humanities and Social Sciences, Ministry of

Education, China (10YJC790044) and the Scientific Research Foundation for the Returned Overseas

Chinese Scholars, Ministry of Education, China. The authors are grateful for the constructive com-

ments and helpful suggestions from an anonymous referee, Jun Du, Xiaolan Fu, Sourafel Girma,

Yundan Gong, Honglin Guo, Aoife Hanley, Beata Javorcik, Richard Kneller, Guilan Kong, Shantong

Li, Chris Milner, Jeffery Round, Thomas Rutherford, David Tarr, Chengqi Wang, Shujie Yao and Fan

Zhai. Earlier versions of the model were presented at the 19th Chinese Economic Association (UK)

Annual Conference (Cambridge, April 2008), the 7th GEP International Postgraduate Conference

(Nottingham, April 2008), the 11th Annual Conference on Global Economic Analysis (Helsinki,

June 2008), the University of Oxford–China Centre for Economic Research Conference (Oxford,

September 2008) and seminars at Keele University (December 2008 and March 2009).

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Asian Economic Journal 2013, Vol. 27 No. 4, 369–389 369

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Asian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd

Since the 1990s, there has been much emerging literature, both theoretical and

empirical, examining FDI productivity spillovers and their effects (e.g. Khalifah

and Adam, 2009). The results have been mixed, with the estimated spillover

impact ranging from positive and high to insignificant or even negative (Görg

and Strobl, 2001; Crespo and Fontoura, 2007; Meyer and Sinani, 2009;

Havranek and Irsova, 2011). The contrasting evidence indicates that there is no

universal relationship between inward FDI and the productivity of host-country

firms. The estimated effects of FDI spillovers depend on the countries, years and

industries covered, the estimation methodology employed and many other con-

tingent factors (Görg and Strobl, 2001; Crespo and Fontoura, 2007; Meyer and

Sinani, 2009; Havranek and Irsova, 2011). In light of this, the recent literature

has gradually shifted focus to such factors. For example, empirical studies on

FDI spillovers in China have identified significant impacts of several factors,

such as the absorptive capacity of domestic firms (Fan and Hu, 2007; Girma and

Gong, 2008), inter-region linkages (Madariaga and Poncet, 2007), the technol-

ogy intensity of foreign enterprises (Buckley et al., 2007; Lin et al., 2009),

short-term learning costs (Liu, 2008), the ownership of domestic enterprises

(Girma and Gong, 2008) and the speed and rhythm of FDI entry (Wang et al.,

2012).

Measuring the effects of FDI productivity spillovers as economy-wide and

cross-sector (as opposed to sector-specific) phenomena requires a general equi-

librium framework, for which computable general equilibrium (CGE) modeling is

an obvious candidate. To date, there have been only a handful of studies dedicated

to modeling FDI productivity spillovers using CGE. Gillespie et al. (2002) treat

FDI spillovers as an exogenous externality, while Lejour et al. (2008) allow the

magnitude of the spillovers to vary with the size of the FDI. However, typically

the values of key parameters are taken from the general literature and are not

specifically related to the economies in question. The present study aims to

overcome this weakness by combining econometric techniques to quantify FDI

productivity spillovers with CGE modeling to simulate their effects.

We chose the Chinese economy for two main reasons. First, China has become

an attractive FDI destination over the past three decades of ‘reform and opening-

up’ (Deng et al., 2007). Since 1993, China has been the largest FDI host among

the developing countries, and its FDI inflow has resulted in significant spillover

impacts on the region. Second, as part of an economy in transition, firms in China

fall into three ownership types: state-owned enterprises (SOEs), domestic

privately-owned enterprises (POEs) and foreign-invested enterprises (FIEs).1

This naturally raises the question of whether FDI-induced productivity spillovers

benefit both domestic ownership types equally. Our simulation results show that

1 SOEs include enterprises with their largest share of registered capital invested by state agencies.

FIEs include enterprises registered as joint-venture, cooperative, sole (exclusive) investment enter-

prises or limited liability corporations with 25 percent or more funds from outside mainland China.

POEs include all types of enterprises other than SOEs and FIEs.

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© 2013 The Authors

Asian Economic Journal © 2013 East Asian Economic Association and Wiley Publishing Asia Pty Ltd