Foreign Direct Investment And Small And Medium Enterprises: Productivity And Access To Finance

Productivity and Access to Finance

Khee Giap Tan, Kong Yam Tan

• Publisher: WSPC
• Year: 2015
• ISBN:
  9789814678827
• Topic: Biological Sciences
• Subtopic: Science General
• Index: Biological Sciences

There is a large literature dealing with the spillover effects of foreign direct investment (FDI) flows to emerging and developing economies at the aggregate level. Beyond the aggregate impacts, a growing number of studies also examine the impact of FDI spillovers on firms of different sizes, especially small and medium enterprises (SME). This book is dedicated to exploring issues relating to the various interactions between FDI flows, productivity spillovers and SMEs in Asia and beyond. It studies globalization, FDI, and regional innovation in China, and trade and investment liberalization in India. It analyses how to promote SMEs and enhance labor productivity in Singapore. It investigates the impact of intellectual property rights processes on productivity growth. It documents the use of finance and financing patterns of informal firms. It uses empirical analysis to point out the limitations of traditional banks lending to SMEs and suggests possible policy approaches facilitating them to access growth capital. It also provides an empirical investigation of the main determinants of entrepreneurial activities.

Contents:

• Foreign Direct Investment (FDI), Productivity Spillovers and the Role of Small and Medium Enterprises (SMEs) Financing (Khee Giap Tan and Kong Yam Tan)
• Globalization, Foreign Direct Investment, and Regional Innovation in China (Yi Zhang and Hein Roelfsema)
• Trade and Investment Liberalization in India: Implications for Productivity Gains (Ram Upendra Das)
• Foreign Direct Investment, Intellectual Property Rights, and Productivity Growth (Sasatra Sudsawasd and Santi Chaisrisawatsuk)
• A New Regime of SME Finance in Emerging Asia: Enhancing Access to Growth Capital and Policy Implications (Shigehiro Shinozaki)
• Informal Firms and Financial Inclusion: Status and Determinants (Subika Farazi)
• Promoting SMEs and Enhancing Labor Productivity in Singapore: A Policy Analysis (Khee Giap Tan and Yan Yi Tan)
• Determinants of Entrepreneurs' Activities: New Evidence from Cross-Country Data (Doaa M Salman)

Readership: Academics, policy-makers, professionals, undergraduate and graduate students interested in foreign direct investment, globalization, financing of small and medium enterprises, and labor productivity.

Chapter 1

Globalization, Foreign Direct Investment, and Regional Innovation in China

Yi Zhang* and Hein Roelfsema^†

*Jinhe Center for Economic Research Xi’an Jiaotong University, P. R. China

^†Utrecht University School of Economics (USE) The Netherlands

Abstract

This chapter explores the connection between the external opening of China and differences in innovation across Chinese regions. For the period 1995–2010, we find that regions that attract inward foreign direct investment (FDI) and exports have become more innovative. Further, we show a U-shaped relation between globalization, regional income levels, and innovation, where both the lower middle-income and the most advanced regions gain from globalization in terms of increased innovation. The higher middle-income regions gain little from globalization in terms of innovation. We provide evidence that differences in ownership structures of foreign investments and outsourcing drive the results.

Keywords: Globalization; innovation; regional development; China.

1. Introduction

Over the last 20 years, China has gradually opened its market to imports and inward foreign direct investments (FDI). Since 2001, the increased outward orientation of China is cemented by its entry into the World Trade Organization (WTO), further supporting exports and outward investment flows. To date, the drivers of the strong rise of inward FDI and its effects on domestic economic and social development have received considerable academic and policy attention. Although external trade and FDI arguably have lifted hundreds of millions out of poverty, there are two major long-term concerns. First, China is still seen as the factory of the world, concentrating resources on low cost production with a strong focus on the assembly segment of the supply chain. A key concern is whether over time Chinese firms are able to upgrade their competence through innovation, enabling them to supply inputs with a higher value added, so as to capture a larger share of total revenues in consumer markets. If external opening improves the innovative capabilities of firms and workers, this is an important link between liberalization and development. Second, an oft-voiced concern in China is that external opening of the economy magnifies the income disparities across regions, as the richest regions are also benefitting most from trade and FDI. In the long run, such increased regional disparities provide pressures for unsustainable migration flows and may add to social unrest.

We take up both these issues in this chapter and study the interaction between external liberalization, longrun development through innovation, and regional income disparities. By using a panel of Chinese regions, for the period 1995–2010, we investigate the (causal) connection between external opening and innovation at the regional level. Controlling for geographical fixed effects and focussing on patterns within regions, we show that regions that engage in trade and attract more FDI indeed become more innovative. We also show that the effects differ among geographical lines and across regional income levels. We show that the effect of globalization on innovation is stronger in the eastern coastal regions and is less pronounced in other regions. Connected to this finding, we show that the effects of external opening are strong for both the richest regions and the poorest regions, while higher middle-income regions are the relative losers from globalization. Overall, our analysis shows that external liberalization in China has had a positive effect on economic development though over time it may magnify income disparities within China through scattered effects on innovation and technological upgrading across regions.

The main contribution of this chapter is that it provides a systematic analysis of the connection between globalization, innovation, and disparities in China at the regional level. Several recent papers, to be discussed in more detail in Sec. 2, also analyze innovation across regions, pointing out the importance of research and development (R&D) spending, public stimulus, and the role of universities. But most of these papers do not address the role played by globalization. In contrast, papers that discuss the role of exports and FDI on technology diffusion in general do not address the issue of the widening regional disparities as a consequence of globalization. We also complement several firm-level studies using survey data that often do not have a time component. In addition, due to the overall improvement and availability of regional data over time, we are able to use broader measures for globalization and innovation, which provides more robust results.¹

A second contribution of the chapter is that it incorporates many novel multidisciplinary theoretical insights from business studies and economics to empirically analyze the effects of globalization on innovation in China. Although still an important channel, the older literature focuses rather exclusively on the role of regional absorptive capacity as a moderator for inward FDI and high-tech imports to result in technology spillovers (Blomstrom et al., 2001).² Recently, several scholars have argued that entry modes matter for the transfer of technology (Antràs, 2003; Grossman and Helpman, 2005; Grossman et al., 2005; Hennart and Brouthers, 2007). As we show in Sec. 3, the dominant entry mode by foreign firms differs markedly across regions, which in turn has a substantial within-region effect of globalization on innovation. We show that joint ventures are correlated with higher levels of local innovation, and that innovation is lower in regions where full foreign ownership dominates. Further, we take account of the recent theoretical arguments that differences across regions in external orientation of firms (exports and outward FDI) account for a substantial share in the variation in innovation (Cheung, 2010).

A third contribution is that the analysis caters to the shift in public policy attention towards long-term economic growth through national innovation policies and systems (see for example, Sun and Liu, 2010; Zhou and Wei, 2011; Wei and Liefner, 2012). When over time factor accumulation growth slows down, economic development will rely on increases in total factor productivity. It is well recognized that large differences in FDI driven capital accumulation initially have contributed to a widening income gap between the coastal and the interior regions. However, since 1992, the Chinese government has aggressively pursued a policy that aims to divert FDI towards the interior regions. Yu et al. (2008) show that such policies on average have been a success in channelling FDI to backward regions, so it is of interest to investigate whether this policy change has contributed to innovation and thus to lowering regional income inequality in the long run.

The chapter is set up as follows. In Sec.2, we discuss related literature that address the effects of FDI on technological development, to those that connect regional development to innovation and technology adoption, ending with closely related papers that also analyze the link between globalization and innovation in a regional context. Section 3 introduces the data and provides a descriptive analysis of the variables that are of the most concern to this chapter: globalization, innovation, and economic development across regions. Section 3 also discusses the econometric methods used in the study. Section 4 presents the empirical results, where we zoom in on differences across income groups, modes of globalization, and changes in the effects of globalization over time. Section 5 concludes this chapter.

2. Related Literature

The effects of trade liberalization and globalization on economic structure and innovation are widely studied in the literature, especially in the context of the early endogenous growth models (Grossman and Helpman, 1990, 1991; Grossman et al., 1993). In general, international technology transfer is widely seen as an important contributor to economic development. The early papers have a strong focus on the technology diffusion in the networks of multinational corporations that engage in FDI towards developing countries and emerging markets. Key mechanisms are the demonstration effect and the mandatory sharing of technology in mergers, acquisitions and joint ventures, which allow domestic firms to upgrade quality and launch new products. Further, the increase in competition in the domestic market because of entry of foreign multinationals provides stronger incentives for local firms to innovate.

There are several papers that study the effect of inward FDI on the innovation performance of Chinese firms. Buckley et al. (2002) analyze the effects of FDI across sectors and firms. They find that the investment of foreign firms has a positive effect on productivity.³ A large number of studies confirm this finding (see for example, Cheung, 2010 and the references therein). However, there is considerable dispute about the relative importance of FDI when compared to other drivers of innovation, such as public investment in R&D and science and technology policies. On the one hand, for example Tang and Hussler (2011) argue that FDI is more important for innovation than the national innovation system. By contrast, in a study of the information and communication technology (ICT) sector, Wei et al. (2012) argue that locational and firm-level capabilities are more important drivers for innovation than FDI. Even stronger, controlling for endogeneity by focussing on a specific sector and specific locations, they show that innovation is negatively associated with the external orientation of firms in the ICT sector.

There have been other important qualifications that concentrate on the interaction of underlying firm and region specific factors to stress the nonlinear effect of FDI on local innovation. When taking account of endogeneity by looking at subsamples of industries and firm size, Hu and Jefferson (2002) show that absorptive capacity and complementarities in capabilities are important moderators for FDI to result in technology spillovers to local firms. In this line, an upcoming issue is whether the mode of cooperation between foreign and domestic firms affects technology transfer between partners. For the ICT sector, Sun and Du (2011) investigate the effects of the nature of the relationship between domestic and foreign owned firms on technology spillovers. They show that when firms only have production linkages, there is no significant effect on technology upgrading. By contrast, their analysis reveals that in general substantial spillovers occur when firms have technology cooperation agreements. Hence, perhaps trivial, when local domestic firms predominantly have arms-length production relations such as outsourced production contracts, the effects of inward FDI on local innovation are much less when compared to joint ventures in which partners cooperate and technology is shared. All in all, there is ample evidence that local conditions such as absorptive capacity, complementarities in production structure, public support, and the nature of the contractual relationships between foreign and domestic firms all matter for the effects of FDI on local innovation.

As Chinese domestic firms over time have become major exporters, it can be expected that experience in foreign markets also results in higher levels of innovation. The role of foreign market entry on innovation has recently received considerable attention. In the seminal Melitz (2003) model, productivity differences across firms drive internationalization, where the most productive firms (i.e., the most innovative firms) within an industry are internationally active. This setup mirrors the empirical findings of Bernard and Jensen (1999) who show that productivity drives internationalization for developed economies — and not the other way around. However, De Loecker (2007) shows that for middle-income countries exporting can have a substantial effect on firm productivity and innovation. For China, Cheung (2010) argues that FDI has positive effects on innovation through increased exporting capabilities of domestic firms. Guan and Ma (2003) show that exporting has a positive impact on innovative capabilities of Chinese firms. So far, there is little analysis beyond case studies that outward FDI by Chinese firms contributes to domestic innovation.⁴

There are large regional differences in innovation, which are seen as a major reason for regional income inequality (see Chan et al., 2008 and Hu and Jefferson, 2008 for surveys on spatial determinants of innovation in China). Sun (...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• About the Editors
• Introduction Foreign Direct Investment (FDI), Productivity Spillovers and the Role of Small and Medium Enterprises (SMEs) Financing
• Chapter 1 Globalization, Foreign Direct Investment, and Regional Innovation in China
• Chapter 2 Trade and Investment Liberalization in India: Implications for Productivity Gains
• Chapter 3 Foreign Direct Investment, Intellectual Property Rights, and Productivity Growth
• Chapter 4 A New Regime of SME Finance in Emerging Asia: Enhancing Access to Growth Capital and Policy Implications
• Chapter 5 Informal Firms and Financial Inclusion: Status and Determinants
• Chapter 6 Promoting SMEs and Enhancing Labor Productivity in Singapore: A Policy Analysis
• Chapter 7 Determinants of Entrepreneurs’ Activities: New Evidence from Cross-Country Data
• Index