Summary:
In the past 30 years, especially since joining the WTO, China has attracted substantial international direct investment from foreign-funded enterprises. According to the World Investment Prospects Survey Report 2010–2012 issued by the United Nations Trade and Development Organization, China topped the list of the world's 15 most attractive investment destinations. By 2015, China had accumulated 1.6 trillion U.S. dollars in actual foreign investment, accounting for about 8% of the global total for the same period, the second largest inflow of foreign investment to a single country after the U.S. How has this foreign entry affected the performance of indigenous firms？ Independent innovation is the engine and source of economic growth along with the adjustment and optimization of economic structures. This paper analyzes the impact of foreign entry on innovation by indigenous firms and also the underlying mechanisms, which are of great importance in systematically assessing China's use of FDI in recent years and the future adjustment of its foreign investment policy. The data used in this study are from the Annual Survey of Industrial Enterprises (ASIE) from 1998 to 2007 obtained from the National Bureau of Statistics. The survey covers all state-owned industrial enterprises and non-state-owned enterprises with “above-scale” income (i.e., main business income exceeding 5 million yuan). Based on the quasi-natural experiment of FDI liberalization arising from the revision of the “Industrial Guide for Foreign Investment” in 2002, this paper adopts the difference-in-differences (DID) method to investigate the impact of foreign entry on indigenous firm innovation and its underlying mechanisms. The results show that foreign entry not only helps to promote indigenous firm innovation but also increases the duration of innovation. In addition, we find that good intellectual property insurance tends to strengthen the positive impact of foreign entry on indigenous firm innovation, and this result is robust to alternative measures of both innovation and foreign entry. Last but not least, we explore the mechanisms via which foreign entry affects indigenous firm innovation, and find that “R&D ability improvement” and “financial constraint reduction” are the two important channels through which foreign entry promotes indigenous firm innovation. The results contain significant policy implications. According to the findings, foreign entry significantly promotes indigenous firm innovation, thus China ought to further formulate and improve relevant policies to attract FDI more vigorously. For instance, it is feasible to continuously improve the facilitation of foreign entry through innovative use of the foreign investment system and by conducting national treatment plus negative list management. Another important finding is that regional intellectual property protection not only promotes indigenous firm innovation directly, but also tends to strengthen the positive impact of foreign entry on indigenous firm innovation, thus China should further enhance and improve its regional intellectual property insurance. This paper makes the following contributions. First, most studies on the relation between foreign entry and indigenous firm innovation are based on aggregate data at the macro level, using traditional econometric methods for empirical research. However, this paper is based on micro data and adopts the difference-in-differences method which effectively overcomes endogeneity problems and provides a more accurate evaluation of the impact of foreign entry on indigenous firm innovation than previous studies. Second, this paper not only investigates the impact of foreign entry on indigenous firm innovation, but also analyzes the relation between the two from the perspective of the duration of innovation. Third, considering the significant regional differences in the degree of intellectual property protection in China, this paper integrates intellectual property protection into a unified analytical framework, and finds that good intellectual property insurance tends to strengthen the positive impact of foreign entry on indigenous firm innovation. This finding is important for future policymaking to more effectively utilize foreign capital to promote indigenous firm innovation. Last but not least, based on abundant samples from ASIE, this paper uses a mediation model to test in depth how foreign entry affects indigenous firm innovation.
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