Quid Pro Quo, Knowledge Spillover, 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 spillover and quality upgrades. Our context is the Chinese automobile industry, where foreign automakers are required to set up joint ventures (the quid) with domestic automakers in return for market access (the quo). 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 joint venture partners, consistent with learning and knowledge spillover. We rule out alternative explanations, such as endogenous joint venture formation, geographic proximity, overlapping customer bases, brand image association, and patent transfers. Additional analysis shows that worker flows and supplier networks mediate knowledge spillover. Finally, using an equilibrium model for the auto industry, we show that knowledge spillover due to ownership affiliation, in additional to any industry-wide knowledge spillover, improved the quality of affiliated domestic models by 3.8-12.7% and raised their profits by 1.0-3.5% between 2007 and 2014.