Do Domestic Firms Benefit From Foreign Direct Investment

In the globalization processforeign direct investment (FDI) plays undoubtedly the most remarkable role. In theory, foreign direct investment is not just a kind of capital, multinationals firms carries advanced technology, management experience and human capital which will benefits recipient countries through knowledge transfer from multinations firms and helps improve the productivity of domestic firms. Thus, beginning with the 90s of last century FDI Knowledge Spillovers have become one of the hotspots of academic researchs. However, the researchs on FDI Knowledge spillovers still have been a large number of puzzles (Gorg and Greenaway,2004) and these puzzles remain in suspense!Following with internationalization and globalization trend, Chinese government begin to implement the reform and opening-up policy and encourage foreign direct investment inl978. After joining the World Trade Organization (WTO) in 2002, the government further relaxed the industry restrictions on foreign direct investment and even provided policy incentives to attract multinational firms. Eventually, China became the largest economy with stock of foreign direct investment in the world. Do Chinese domestic firms gain the advanced skills and promote their productivitis from foreign direct investmen? After three decades, China had become a "world factory", the world’s largest exports country, the world’s third largest economy. These economic performances seem to indicate that the reform and opening-up policies brought foreign direct investment and introduce the advanced technology from Multinational. However, empirical evidence of the benefits of FDI spilloversin China also had many pieces of puzzle as other countries’!First, the research on FDI horizontal spillovers found that different countries of FDI spillover are also likely to be negative and the same country’s FDI spillovers at different times may completely different. For example, the empirical research on Chinese FDI spillovers found that early FDI spillovers are mainly negative, but later it turned into positive. For these results traditional theories explain that foreign direct investment in early stage produce mainly for the competition effects, competition effects lead to domestic firms to compete with multinational corporations and loss a significant market share, which result domestic firms reducing productivity and even directly out of the market. Competitive effects can explain why in early Chinese FDI spillover is negative, but it can not explain why Chinese FDI spillover turns into positive in the later.Our research found that this is because the previous theoretical studies ignore a very important FDI spillover mechanism. Such spillover effect plays through the vertical chain between multinations and domestic firms.When multinations buy intermediate goods from upstream suppliers the advanced knowledge of multinations will spill over to suppliers and promote suppliers’productivities. When upstream suppliers also provide intermediate goods to domestic firms, the advanced knowledge from multinations will spill over to domestic firms in the same industry with multinations. This kind of FDI spillover effect totally differents from all previous spillovers effects with its unique and obvious mechanism, which we call roundabout effects. As the roundabout effect need the help of shared upstream suppliers to transfer, so it generates stronger spillover effect with increasing levels of multinations local procurement. This can be a good explanation as to why Chinese FDI spillovers is significantly negative early and turn to significantly positive in the later. Therefore, from the short term perspective, China lost the market, but in the long run we gain the technology. China has implemented the policy of "market for technology" has been effective, and to make this policy effective lies in improving multinations local procurement. So we can say FDI roundabout effect presented in this paper is not only an important complement to existing theories, as well as a new understanding of existing empirical research,which providing a wealth of policy recommendations.Secondly, the researchs on FDI vertical spillovers alse have obvious conflicts between theoretical and empirical. In theory, multinations will increase intermediate goods’ demand, thus contributing to improve the productivity of upstream suppliers. When multinations provide cheap and hight quality intermediate goods to downstream clients will also promote the productivity of domestic firms. Thus, in theory, foreign direct investment would provide positive lingkage effects. However, when using data from different countries to test vertical FDI spillovers we will get different results, some times are not significant, some times are even significantly negative. One strand of literature has tried to identify the mediating factors required for the effective transmission of knowledge spillovers. But we know the mediating factors only explain the strength of the vertical spillovers, as well as significant or not significant. It still can not explain why FDI vertical spillovers are negative.Our study points that when Rodriguez-Clare (1996) put forward lingkage effects of FDI vertical spillovers, assuming the upstream supplier of intermediate goods is completely monopolized, while the downstream manufacturers offinal goods are perfectly competitive, in which assumptions foreign direct investment into the final goods manufacturers to purchase intermediate goodsfrom local upstream suppliers bring positive externalities. But in reality, vertical market structure is very complex. When multinations monopoly in the industry chain, it is possible generate negative externalities for its upstream or downstream industries. The theory can well explain why empirical results on FDI vertical spillovers are often negative. This paper also point that position of the industry chain will affect the structure of vertically related markets and then affect FDI vertical spillovers. We propose an empirical test and find when domestic firms close the end of the industrial chain, its downstream industries is less. Then they are extremely probable face the monopsony of their downstream multinations, therefore they will subject to a smaller or even negative spillovers from multinations. The empirical results can well explain why FDI in China in the early vertical spillovers are negative, and later became positive. The reason is that the early foreign direct investment mainly in the end of industry chain, the domestic firms subject to negative spillovers.When foreign direct investment began to move to upstream industry chain, FDI vertical spillover rsturned to positive. Therefore, if host countris want to promote their industries technology, the key lies in relax the capital restrictions and attract foreign direct investment in all positions of the industry chain.Do developing countries attract foreign direct investment to get the advanced technology is feasible? Academia researchs have been a lot of controversy. Our research from theoretical and empirical perspectives studied these issues. FDI spillovers have many mechanisms, which are positive or negative. How to gain the positive externalities from FDI depends on the host government’s awareness and policy. To maximize FDI horizontal spillovers the governments need to raise the level of local procurement and to maximum FDI vertical spillovers the governments need to relax industry restrictions.