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Effects of Foreign Direct Investment on Firm-level Technical Efficiency: Stochastic Frontier Model Evidence from Chinese Manufacturing Firms

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Abstract

It has been recognized that multinational corporations can spill over to non-affiliated firms in host economies. Existing studies of foreign direct investment (FDI) and productivity growth often assume firms are perfectly efficient. Our paper relaxes this assumption and explores how FDI affects a firm’s technical efficiency improvement as well as its technical progress in a stochastic frontier model. The stochastic frontier model estimates a firm’s production frontier given a set of production inputs. The deviation of a firm’s actual output level from its maximum level of output is defined as technical inefficiency. Using data from more than 12,000 Chinese manufacturing firms, we find that FDI in a firm's own industry (horizontal FDI) does not necessarily improve the firm’s technical efficiency. However, firms with a larger absorptive capacity tend to benefit more from horizontal FDI than others. We also find that foreign presence in a firm’s downstream industries helps improve the firm’s technical efficiency, while foreign presence in upstream industries does not. In addition, a generalized Malmquist index decomposition shows that foreign affiliates achieve a higher productivity growth than domestic firms mainly through a faster improvement in technical efficiency rather than through technical progress.

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Notes

  1. We note that Kathuria (2001) adopts a two-stage approach and estimates production and inefficiency functions separately. The two-stage approach, compared to the one-stage approach we employ in our paper, may potentially produce biased estimated coefficients (Kumbhakar et al. 1991).

  2. It is also called the World Bank Enterprise Survey.

  3. The 2005 survey includes 30 manufacturing industries and the 2012 survey includes 20 manufacturing industries. The comparison is done based on 14 manufacturing industries that have both domestic and foreign firms and are included in both datasets.

  4. See Lovell (2003) for a detailed discussion of studies on the decomposition of Malmquist index.

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Acknowledgments

The authors would like to thank Brian Brush, Jim Granato and all participants at the Economics Seminar in September 2012 for their comments and suggestions. Wang gratefully acknowledges financial support from the Center for Global and Economic Studies and the summer Miles Research Grant at Marquette University, Milwaukee, WI.

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Authors and Affiliations

  1. Department of Economics, University of San Francisco, 2130 Fulton Street, San Francisco, CA, 94117, USA

    Miao Wang

  2. Department of Economics, University of San Francisco, 2130 Fulton Street, San Francisco, CA, 94117, USA

    M. C. Sunny Wong

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  1. Miao Wang
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  2. M. C. Sunny Wong
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Correspondence to Miao Wang.

Appendix

Appendix

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Table 7

Table 8

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Wang, M., Wong, M.C.S. Effects of Foreign Direct Investment on Firm-level Technical Efficiency: Stochastic Frontier Model Evidence from Chinese Manufacturing Firms. Atl Econ J 44, 335–361 (2016). https://doi.org/10.1007/s11293-016-9509-3

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