FOREIGN DIRECT INVESTMENT AND INNOVATION: EVIDENCE FROM CHINESE FIRMS’ PATENT FILINGS

One main motivation of attracting inward foreign direct investment (FDI) for emerging economies is to obtain knowledge spillovers from developed countries and promote domestic innovation. The effects of FDI on innovation include both the direct effects from FDI on targeted domestic firms and indirect effects from foreign ownership on other foreign and domestic firms’ innovation. Applying a design with a two-stage randomization procedure that allows for both direct and indirect effects of FDI on innovation and allows these two effects to vary with the share of foreign firms in a well-specified cluster, we empirically investigate the effects of inward FDI on Chinese firms’ innovation using patent filings as a proxy for innovation. Our findings indicate that the potential innovation of firm varies with the share of foreign firms in the cluster. The approach used in this paper can help researchers and policymakers to better understand the benefits of inward FDI promotion programs, agglomeration and regional policy.