Vertical Spillover Effects of Multinationals on Chinese Domestic Firms via Supplier–Customer Relationships

• Author: Faqin Lin,Chao Zhang,Lin Wang
• Published date: 01 November 2013
• DOI: http://doi.org/10.1111/j.1749-124X.2013.12045.x
• Date: 01 November 2013

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China & World Economy / 37–57, Vol. 21, No. 6, 2013

©2013 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Vertical Spillover Effects of Multinationals on Chinese

Domestic Firms via Supplier–Customer Relationships

Faqin Lin, Chao Zhang, Lin Wang*

Abstract

Foreign direct investment (FDI) can benefit domestic firms in the host country. Using firm-

level data for China, we find statistically positive vertical spillover effects of multinational

enterprises on the performance of domestic firms through backward and forward supplier–

customer relationships. The spillover effects are mainly from large multinational enterprises

and are greater for state-owned firms and in poor regions. Our results are robust for both

parametric regression and nonparametric matching techniques. Our findings have strong

policy implications: while regulations relating to building business relationships with domestic

firms when seeking foreign direct investment should be established, such policies should be

aimed at private firms, big multinationals and less developed regions.

Key words: foreign direct investment, multinational enterprises, supplier–customer

relationships, vertical spillover effects

JEL codes: F21, L14, O53

I. Introduction

It is well established that, in addition to bringing in capital, inward foreign direct investment

(FDI) by multinational enterprises (MNEs) can benefit the host country by generating

spillovers to the rest of the economy (Moran, 1998), which is the primary motivation for

developing countries to attract FDI. Theoretically, MNEs can benefit firms in the host

country via two main channels. One is the presence of FDI in the same industry, which

*Faqin Lin, Assistant Professor, School of International Trade and Economics, Central University of

Finance and Economics, Beijing, China. Email: faqinlin@gmail.com; Chao Zhang, PhD candidate, School

of International Trade and Economics, University of International Business and Economics, Beijing,

China. Email: joeyzc@126.com; Lin Wang, Postdoctoral Research Fellow, Institute of Economics,

Chinese Academy of Social Sciences, Beijing, China. Email: wlqust@126.com. Chao Zhang acknowledges

financial support from the Fulbright Scholarship and the Graduate Academic Research and Innovation

Foundation of the University of International Business and Economics (Project: A20110122).

38 Faqin Lin et al. / 37–57, Vol. 21, No. 6, 2013

©2013 Institute of World Economics and Politics, Chinese Academy of Social Sciences

leads to intra-industry or horizontal spillovers, and the other is spillovers from MNEs

operating in other industries, which leads to inter-sector or vertical spillovers. The former

includes channels such as skilled labor turnover, demonstration effects and competition

effects (Teece, 1977). The latter is primarily through the channel of supplier–customer

relationships and, therefore, may be biased towards upstream (backward spillovers) or

downstream industries (forward spillovers) (Blomstrom and Kokko, 1998).1

In the empirical literature there is greater focus and more agreement on the findings for

vertical spillovers (e.g. Driffield et al. [2002] for the UK, Javorcik [2004] for Lithuania and

Gorodnicjenko et al. [2007] for the emerging economies) than for horizontal spillovers.2

China, the largest developing and emerging economy, and, more importantly, the largest

recipient of FDI in the developing world, is of particular interest.3 The natural question is

whether there are significant spillover effects from MNEs impacting domestic firms’

performance in China.4

Earlier studies focus on regional or sectoral-level data analysis to answer this question.

Using panel data for 1993–1998 from the Shenzhen Special Economic Zone, Liu (2002)

shows that FDI generates significant technology transfer to domestic sectors. Cheung and

Lin (2004) use Chinese provincial data from 1995 to 2000 and find positive effects of FDI on

the number of domestic patent applications (innovation). A concern relating to the

aforementioned papers that apply sectoral and regional data analysis is the aggregation

bias due to a lack of specific supply–purchase contact information. For example, at the

sector level, forward linkage is assumed by subtracting exports from upstream foreign-

invested firms, so the rest of the output should go to domestic downstream firms in the

1Blomstrom and Kokko (1998, p. 248) point out that “local firms may be able to improve their

productivity as a result of forward or backward linkages with MNC affiliates.” Backward spillovers from

FDI refer to technology transfers through supply chains and forward spillovers that occur when domestic

firms gain access to new or less costly intermediate inputs. Lall (1980) also notes that technology

transfers from MNEs to local suppliers can take place in various ways.

2The first generation of empirical literature in the 1970s and 1980s to test horizontal spillovers uses

cross-section data and finds positive effects; see Blomstrom and Persson (1983) for Mexico, for example.

The second generation literature in the 1990s and 2000s uses firm-level data and finds no spillover effect

in the developing world and a positive effect in the developed world. See Javorcik (2004) for Lithuania

and Haskel et al. (2007) for the UK, for instance.

3Inward FDI in China rose to a record US$105.7bn in 2010 and reached another new record of US$116bn

in 2011(http://www.fdi.gov.cn).

4Tian (2007) looks for sources of FDI spillovers in China, and finds that spillovers occur through tangible

assets, domestically consumed and “traditional” products, and employing unskilled workers, rather than

the other way around.